In April, I wrote about a bill, SB 726 (Hueso), that would have added a new section to the Corporate Securities Law banning false statements to government officials for the purpose of manipulating the price of a company's security by triggering an investigation. See "Bill Aims To Put The Kibosh On Alleged Hedge Fund Stock Price Manipulation". Recently, Senator Hueso amended the bill to punt the issue to the Commissioner of Business Oversight. As amended, the bill now simply provides: "The commissioner shall adopt regulations to prohibit fraudulent and manipulative practices by persons undertaking short sales in the securities market."
The Securities and Exchange Commission describes a "short sale" as "a sale of a security that the seller does not own or a sale that is consummated by the delivery of a security borrowed by, or for the account of, the seller. 17 CFR 242.200(a). Investors sell a security short because they expect the price to decline. If this expectation is met, they profit by selling high and buying low. Although some may condemn short selling as a form of speculation, the practice supports efficiency in pricing and liquidity. Nonetheless, it cannot be gainsaid that a short seller has an economic incentive to take actions to drive the price down.
The analysis of SB 726 prepared by the Assembly Committee on Banking and Finance, raises three good questions about the latest iteration of SB 726:
- It is unclear what "short sales" means as it is not defined in the bill or existing law.
- It is unclear what "securities market" means as it is not defined in the bill or existing law.
- It is unclear what problem exists in California that the bill is trying to address. Is this a statewide issue or an issue that should be addressed nationally?
Perhaps the California legislature will hold more sway over the Commissioner than Congress does over the SEC. Section 929X of the Dodd Frank Wall Street Reform and Consumer Protection Act added Section 9(b) to the Securities Exchange Act. Section 9(d) declares manipulative short sales to be unlawful. It also directs that the SEC adopt rules "as are necessary or appropriate to ensure that the appropriate enforcement options and remedies are available for violations" of this prohibition. Although Congress imposed no deadline on the SEC, it has been six years and the SEC yet to propose a rule.