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Understanding Short Sale Activity

Large investors who accumulate long positions are required to publicly disclose their holdings. Why then aren’t there disclosure obligations for large short sellers?

President and CEO of OTC Markets Group Inc.

President and CEO of OTC Markets Group Inc.
President and CEO of OTC Markets Group Inc.

Quality data is essential to well-functioning markets. Improving the availability, relevance and usefulness of data aligns with OTC Market Group’s OTCM mission to create better informed, more efficient financial markets. In our experience, short selling remains one of the most highly-debated topics among academics, companies, investors, market makers and broker-dealers. As a market operator and company CEO, I believe it’s critical to address the misconceptions that still exist around short sale data and the correlation to a stock’s fundamental value.

Short selling, the sale of a security that the seller does not own, has long been a controversial practice in public markets. Advocates for short selling believe it builds price efficiency, enhances liquidity and helps improve the public markets, while critics are concerned that it can facilitate illegal market manipulation and is detrimental to investors and public companies. Given the diverse range of opinions and opposing views, we believe the first step is to take a deeper dive into the data and help separate out the noise.

“The Reliable” – FINRA Equity Short Interest Data

The most accurate measure of short selling is the data reported by all broker-dealers to FINRA on a bi-weekly basis. These numbers reflect the total number of shares in the security sold short, i.e. the sum of all firm and customer accounts that have short positions.

This information is available on on the company quote pages. As an example, OTC Markets Group has a few hundred shares sold short on average, which represents a fraction of our daily trading volume and shares outstanding.

FINRA Rule 4560[1] requires FINRA member firms to report their total short positions in all over-the-counter (“OTC”) equity securities that are reflected as short as of the settlement date. In 2012, FINRA clarified that firms must report short positions in each individual firm or customer account on a gross basis[2] under FINRA Rule 4560. Therefore, firms that maintain positions in master/sub-accounts or parent/child accounts must calculate and report short interest based on the short position in each sub- or child account.

Since this data is part of a clearing firm’s books and records, it is of high quality and FINRA regularly inspects broker-dealer compliance with the rule. Of course, it would be great if this data was collected and published daily (with an appropriate delay).

“The Misleading” – Daily Short Volume

In contrast, the most frequently misinterpreted data is the Daily Short Volume, sometimes referred to as Naked Short Interest. This data shows the percentage of published trade reports[3] (called media transactions in FINRA Rules) that were marked short. As an example, the recent data for OTC Markets Group shows that up to 90% of the trading volume comes from short selling on some days. If we did not carefully track our bi-weekly Short Interest, we could easily be led to believe that short selling is rampant in our stock.

Seeing the above data can be alarming for public companies and their investors, until they understand the inner workings of how dealer markets function and broker trades are reported—which render the data virtually meaningless.

Since this data also comes from FINRA, what gives? The daily short selling volume is misleading because market makers and principal trading firms report a large number of trades as short sales in positions that they quickly cover. For market makers with a customer order to sell, they will temporarily sell short (which gets published to the tape as a media transaction for public dissemination) and then immediately buy from their customer in a non-media transaction that is not publicly disseminated to avoid double counting share volumes. SEC guidance also mandates that almost all principal trading firms that provide liquidity at multiple price levels, or arbitrage international securities, must mark orders they enter as short, even though those firms might also have strategies that tend to flatten by end of day. Since the trade reporting process for market makers and principal trades makes the Daily Short Volume easily misleading, we do not display it on

Making daily short reporting data easily-digestible and relevant is not hard. On the contrary, it should be easy to aggregate all of the short selling that is reported as agency trades, as well as all of the net sum of buying and selling by each market maker and principal trading firm. This would paint a clear picture for investors of overall daily short selling activity. Fixing the misleading daily short selling data would bring greater transparency and trust to the market.

“The Missing Piece”– Short Position Reporting by Large Investors

There is ample evidence that short selling contributes to efficient price formation, enhances liquidity and facilitates risk management. Experience shows that short sellers provide benefits to the overall market and investors in other important ways, which include identifying and ferreting out instances of fraud and other misconduct taking place at public companies. That said, we agree with the New York Stock Exchange and National Investor Relations Institute that there is a serious gap in the regulation of short sellers related to their disclosure obligations[4]. We understand that well-functioning markets rely on powerful players who cannot be allowed to hide in the shadows. Since we require large investors, who accumulate long positions, to publicly disclose their holdings, why aren’t there disclosure obligations for large short sellers? This asymmetry deprives companies of insights into their trading activity and limits their ability to engage with investors. It also harms market functions and blocks investors from making meaningful investment decisions.

One point is clear, we all need to continue to work collaboratively with regulators to improve transparency, modernize regulations and provide investors with straightforward, understandable information about short selling activity. We want good public data sources that bring greater transparency to legal short selling activity as well as shine a light on manipulative activities. All while not restricting bona fide market makers from providing short-term trading liquidity that reduces volatility.

[1] 4560. Short-Interest Reporting

(a) Each member shall maintain a record of total “short” positions in all customer and proprietary firm accounts in all equity securities (other than Restricted Equity Securities as defined in Rule 6420) and shall regularly report such information to FINRA in such a manner as may be prescribed by FINRA. Reports shall be received by FINRA no later than the second business day after the reporting settlement date designated by FINRA.

(b) Members shall record and report all gross short positions existing in each individual firm or customer account, including the account of a broker-dealer, that resulted from (1) a “short sale,” as that term is defined in Rule 200(a) of SEC Regulation SHO, or (2) where the transaction(s) that caused the short position was marked “long,” consistent with SEC Regulation SHO, due to the firm’s or the customer’s net long position at the time of the transaction. Members shall report only those short positions resulting from short sales that have settled or reached settlement date by the close of the reporting settlement date designated by FINRA.


[3] “certain matching principal trades involving a Market Maker are now explicitly included within the riskless definition, and reported to the public tape only once.” Notice of change to the NASD’s trade reporting rules designed to reduce fees charged under Section 31 of the Securities Exchange Act and to limit the double-counting of volume for trades executed in the over-the-counter market.

[4] NYSE Group. Inc., along with the National Investor Relations Institute (“NIRI”), hereby respectfully submits this petition for rulemaking to the U.S. Securities and Exchange Commission (the “Commission”) pursuant to Rule 192(a) of the Commission’s Rules of Practice, requesting that the Commission promulgate rulemaking pursuant to Sections 10 and 13(f) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which were amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), in order to require the periodic public disclosure of short-sale activities by institutional investment managers.

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