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On February 25, 2022, the U.S. Securities and Exchange Commission (SEC) announced proposed rules aimed at providing additional transparency into the activities of short-selling institutional investors. The proposed rules come largely in response to 2021 market activity in several companies, most notably GameStop, which resulted in skyrocketing stock prices as retail investors took long positions en masse that left institutional investors scrambling to cover short positions, resulting in market volatility and controversial restrictions on retail trading in certain securities.

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In early 2021, a group of retail investors took advantage of the perceived over-shorting of GameStop shares by major institutional investors, turning the stock market on its head and dominating leading news stories for weeks.<a href="#1">(1)</a> Led by several large hedge funds with histories of taking short positions, these institutional investors believed that GameStop, a retailer on the decline, was on the verge of collapse.<a href="#2">(2)</a> The institutional investors consequently shorted roughly 140 percent of GameStop’s outstanding shares in a practice labeled “short selling.”<a href="#3">(3)</a>

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A group of retail investors appeared to take advantage of the institutional investors’ gamble on the expected demise of GameStop and corresponding share price decline. These retail investors did so on a previously unseen scale by banding together and coordinating efforts via online platforms like Reddit.<a href="#4">(4)</a> The retail investors took high volumes of long positions—bets that a share price will rise—in GameStop stock via online brokerages for non-professional investors.<a href="#5">(5)</a> These mass purchases of long positions by retail investors caused the stock price to rapidly and precipitously increase.<a href="#6">(6)</a> The increase forced the hedge funds to cover their short positions with higher priced stock, resulting in massive losses to those funds in many cases.<a href="#7">(7)</a> During this time, GameStop’s stock price increased from roughly $20 to $483.<a href="#8">(8)</a>

At the height of the GameStop frenzy, some brokerages restricted continued purchases of the stock.<a href="#9">(9)</a> These restrictions were at the behest of many institutional investors who feared what they viewed as continued victimization at the hands of the retail investing community. The restrictions also evoked public outcry and led to an investigation and findings by the SEC.<a href="#10">(10)</a>

SEC Action in Response to GameStop Trading

In October 2021, the SEC issued a report concluding that the GameStop stock price increase stemmed from traders’ “positive sentiment” about the company.<a href="#11">(11)</a> This finding was in opposition to a view maintained by many market observers that the skyrocket in GameStop’s share price stemmed from the retail investing community’s massive long positions, which forced the short sellers to try to cover losing positions.<a href="#12">(12)</a> No matter the reasoning, the GameStop frenzy took the investing world by storm and placed a spotlight on the effects of short selling on the market.

The SEC has now taken concrete steps to address the market volatility surrounding short selling and highlighted by the GameStop events of 2021. According to the SEC, the proposed Exchange Act Rule 13f-2 announced in February 2022 includes “changes that would provide greater transparency to investors and regulators by increasing the public availability of short sale-related data.”<a href="#13">(13)</a> Specifically, the proposed rule would require investment managers with discretion over short positions to provide monthly reports on the proposed Form SHO, including end-of-month short positions and certain daily activities affecting the positions.<a href="#14">(14)</a> These requirements would be imposed on investment managers holding short positions exceeding $10 million or the equivalent of at least 2.5% of an issuer’s total outstanding shares.<a href="#15">(15)</a> The SEC would then make aggregate data from these reports available to the public.<a href="#16">(16)</a> The data would supplement, not replace, the public short sale information already available from FINRA and stock exchanges.<a href="#17">(17)</a>

In addition to proposing Exchange Act Rule 13f-2, the SEC also voted to propose a new provision of Rule 205, or Regulation SHO.<a href="#18">(18)</a> Regulation SHO is the SEC’s primary short selling regulation, and it requires broker-dealers to mark purchase orders as “long,” “short,” or “short-exempt.”<a href="#19">(19) </a>The new provision would also require a broker-dealer to mark an order as “buy to cover” in instances where the purchaser has any short position in the same security he or she is purchasing.<a href="#20">(20)</a>

Although many have expressed concern over the years regarding the attendant market manipulation that can result from institutional short selling, the chaos surrounding the GameStop trading events brought short selling, and other related matters, to the forefront. The SEC’s propositions are an attempt to dispel certain market participants’ concerns by providing more visibility into the behavior of large short sellers.<a href="#21">(21)</a> According to the SEC, its goal is to help facilitate better oversight of the markets and provide a better understanding of the role short selling may play in market events.<a href="#22">(22)</a> The public has 60 days to comment on the SEC’s proposal.<a href="#23">(23)</a> Whether the SEC’s new short-selling proposal will strike a balance between the need for transparency and the price discovery process, as intended, remains to be seen.

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(1) Daniel Cooper, ‘Diamond Hands’ offers a good, if narrow portrait of the GameStop stock squeeze, Yahoo! Entertainment (Mar. 15, 2022), <a href="https://www.yahoo.com/entertainment/diamond-hands-msnbc-gamestop-documentary-133100428.html" target="_blank" rel="noreferrer noopener">https://www.yahoo.com/entertainment/diamond-hands-msnbc-gamestop-documentary-133100428.html</a>.

(8) Dean Seal, SEC Proposes Rule To Bolster Short-Seller Disclosures, Law360 (Feb. 25, 2022), <a href="https://www.law360.com/securities/articles/1468504/sec-proposes-rule-to-bolster-short-seller-disclosures" target="_blank" rel="noreferrer noopener">https://www.law360.com/securities/articles/1468504/sec-proposes-rule-to-bolster-short-seller-disclosures</a>.

(9) Dean Seal, Did The SEC Get GameStop Wrong? Some Academics Say Yes, Law360 (Feb. 16, 2022), <a href="https://www.law360.com/articles/1465550?sidebar=true" target="_blank" rel="noreferrer noopener">https://www.law360.com/articles/1465550?sidebar=true</a>; Dean Seal, Robinhood Trading Blocks Draw Lawsuits And Lawmakers’ Ire, Law360 (Jan. 28, 2021), <a href="https://www.law360.com/articles/1349652" target="_blank" rel="noreferrer noopener">https://www.law360.com/articles/1349652</a>.

(11) Press Release, U.S. Secs. &amp; Exch. Comm’n, SEC Staff Releases Report on Equity and Options Market Structure Conditions in Early 2021 (Oct. 18, 2021) (attaching PDF Rep. on Equity and Options Mkt Structure); see also infra note 12.

(13) Press Release, U.S. Secs. &amp; Exch. Comm’n, SEC Proposes Short Sale Disclosure Rule, Order Marking Requirement, and CAT Amendments (Feb. 25, 2022).

(16) Press Release, SEC Proposes Short Sale Disclosure Rule, Order Marking Requirement, and CAT Amendments, supra note 16; SEC Proposes Rule to Bolster Short-Seller Disclosures, supra note 11.

(17) Press Release, SEC Proposes Short Sale Disclosure Rule, Order Marking Requirement, and CAT Amendments, supra note 16; see also FINRA, Short Sale Volume Data, <a href="https://www.finra.org/finra-data/browse-catalog/short-sale-volume-data" target="_blank" rel="noreferrer noopener">https://www.finra.org/finra-data/browse-catalog/short-sale-volume-data</a> (last visited Mar. 17, 2022).

(18) Press Release, SEC Proposes Short Sale Disclosure Rule, Order Marking Requirement, and CAT Amendments, supra note 16.

(21) SEC Proposes Rule to Bolster Short-Seller Disclosures, supra note 11.

SEC Proposes New Rules in Response to GameStop Trading and Related Market Volatility

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