The American Bankers Association (ABA) has accused short-sellers of causing market distortion through “manipulation and abuse” following the recent volatility in the US banking market – urging the financial regulator to investigate trading behaviour.
Short selling has long been a controversial practice, especially during times of high market volatility. Case in point, the meme stock crisis of January 2021: in which a short squeeze on penny stocks like mom-and-pop shop Gamestop caused a retail backlash (and subsequent trading freeze) that changed the face of the markets – and lost short sellers themselves an estimated US$13 billion. A key driver of the sweeping capital markets reforms announced by SEC chairman Gary Gensler last year, the Gamestop saga brought the practice – and its practitioners – sharply into the spotlight.
But short-sellers themselves argue that they play a critical role in the efficient functioning of the market – stabilising prices and reducing volatility during times of stress. And with the US banking sector careening ever closer to a full-blown credit crunch following the high-profile collapse of institutions including Silicon Valley Bank and First Republic, short selling is once again on the rise… and in the headlines.
Surge in activity
“May has started very volatile for the banking sector, with some sharp price drops where short sellers have made very quick and significant profits,” said Peter Hillerberg, co-founder and CTO at financial data and analytics firm Ortex, speaking exclusively to Best Execution.
“Since the beginning of May, short sellers have made over US$3.5 billion in US banks – compared to losses of US$77 million in April.”
Short interest (the number of outstanding shares shorted as a percentage of the current estimated free float) for the top 10 US asset management and custody banks hit 6.37% as of 10 May 2023, according to Ortex data, with T.Rowe Price and Hercules Capital the most heavily shorted at 8.3% and 7.78%, respectively. Investment banks and brokers are also suffering, with B. Riley Financial the hardest hit at 28.36%, while Robinhood Markets is currently shorted 6.32%. Regional banks are the biggest sufferers so far (perhaps unsurprisingly, given the recent collapses and the current liquidity concerns around smaller players in the market) – short interest in San Diego-based fintech and crypto- focused bank Silvergate Capital is up to well over a third (39.84%) of its estimated free float.
ABA anger
The surge in short-selling activity has been met with predictable anger from the banks themselves.
The ABA last week publicly called out “manipulation and abuse” of the markets through the short-selling of bank stocks during the current sector volatility. In a letter sent to the SEC on 4 May, ABA noted that since the bank failures in March, some of its members had experienced “significant” short sales of their publicly traded equity securities that it claimed did not reflect their financial status or indeed the general industry conditions – with some short sales executed even after favourable earnings reports.
“We have also observed extensive social media engagement about the health of various banks and the sector generally that appears disconnected from the underlying financial realities,” said the association. “We urge the SEC to investigate this behavior.”
While ABA acknowledged that short-selling can be a legitimate and important financial tool for generating liquidity and securing price discovery, as well as facilitating risk management, it stressed that “abusive” trading practices could distort the markets and destroy investor confidence.
“Since short selling restrictions were relaxed in 2007, the importance to the markets of such enforcement has only increased. The harm caused by short selling that runs counter to economic fundamentals ultimately falls on small investors, who see value destroyed by others’ predatory behaviour,” said the letter.
In an interview with Yahoo Finance on 8 May, ABA CEO Rob Nichols again reiterated concerns around “market manipulation or any predatory shorting – which would be illegal activity, frankly” because “some of those share price movements just don’t make any sense”.
Regulatory response
SEC chairman Gary Gensler responded with a statement reiterating the regulator’s position and promising to closely monitor activity. “In times of increased volatility and uncertainty, the SEC is particularly focused on identifying and prosecuting any form of misconduct that might threaten investors, capital formation, or the markets more broadly,” he said.
Regulatory reaction to the short-sale controversy remains ongoing. In July 2021, US congresswoman Maxine Waters (D-Calif) proposed the Short Sale Transparency and Market Fairness Act, a proposed amendment to the 1934 Securities Act which, if passed, would mandate the reporting of short positions for institutional asset managers, including for hedge funds. However, the bill is still in its introductory phase and must pass through the House and Senate before being signed into law.
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