April 9, 2009

The SEC Proposes Short Sale Restrictions: The Race is On!

Reminiscent of the competing proposal approach that the Commission took a couple of years ago on shareholder access, yesterday the SEC voted to propose several alternative ways of addressing the widespread public nostalgia for the only recently abandoned uptick rule. As noted in the press release announcing the proposals, the SEC proposed either: (1) a market-wide permanent return of the uptick rule or a modified version of the uptick rule; or (2) a security specific circuit breaker approach, which could come in the form of: (i) an outright ban for the rest of the trading day when the price of a security drops precipitously; (ii) imposition of a modified uptick rule on the trading in a security for the rest of the day when there is a significant price decline; or (iii) imposition of an uptick rule on the trading in a security for the rest of the day following a big price drop. Got that? Commissioner Aguilar, Commissioner Parades and Chairman Schapiro each released their opening statements, providing more details.

I think that the competing proposal approach largely reflects the level of complexity and concern about unintended consequences arising with short sale regulation. The Commission has to walk a fine line here when seeking to perhaps reinstate a rule that was abandoned only a few years ago, and at the time based on extensive study and public comment. Much is often made of how different the market is today compared to when the tick test pilot was conducted, but it really seems that the principal differences are between a market trending up and a market trending down and the relatively obvious effects of government-induced panic, plus the attention of the public and Congress to an issue that was once largely relegated to the darker corners of the regulatory landscape.

With all of the pressure for SEC action, it is going to be a difficult task ahead for the Staff to weigh the responses to the over 200 questions included in the proposing release and narrow the field of potential rules down to just one approach. Further, they will have to do so under a new Director of the Division of Trading Markets, as yesterday’s Open Meeting marked Eric Sirri’s last as Director of the Division.

Comments will be due within 60 days of publication in the Federal Register. The roundtable on short selling is tentatively scheduled for May 5.

The “R” Word and Venture Capital Funds

An interesting opinion piece in today’s Wall Street Journal discusses the outrage that has erupted over the notion of having venture capital funds register with the SEC so that information about the funds can be passed on to the Great Systemic Regulator envisioned in the Administration’s recent regulatory reform proposals. As we tend to see time and time again, over-reaction to crises tends to sweep in things that probably don’t need the benefit of regulation or are in fact not systemically dangerous. I think that James Freeman makes a good case for why venture capital, which is vital to our capital-raising system, does not actually pose the sorts of systemic risks that we should all be concerned about.

Now that the “R” word – risk – is thrown around as being something that needs the closest attention from regulators, it is perhaps a good idea to step back and note that it was really the mispricing and mismanagement of risk (in particular with respect to financial instruments and trading strategies), as opposed to the taking of risk itself, which got us into this mess. For technology companies, for instance, who have benefited greatly from the risk tolerance of venture capital investors, every day in business is the riskiest of endeavors, which is typically reflected in their public or private valuations. But we wouldn’t want them – as a result of regulation arising from a financial crisis – to stop taking risk, or to discourage their management from pursuing risky new ideas, or discourage their venture capital backers from taking a flyer on their risky prospects, so long as those risks are all fully disclosed and properly reflected in the price of their securities.

A Bernanke Green Shoot?

For the first time in more than a year, confidence among venture capitalists has inched upward, according to a recent survey of 30 San Francisco Bay Area VC’s. The latest results show a confidence level of 3.03 on a 5-point scale during the first quarter of 2009, up from a 5-year low of 2.77 last quarter. Might a more positive outlook by traditionally optimistic VC’s be one of Ben Bernanke’s “green shoots” of economic recovery? There’s a long way to go yet – there were only 50 IPOs worldwide during the first quarter of 2009, down 80% from the first quarter of 2008. More significantly for venture capital, the first quarter of 2009 marked the second consecutive quarter with no venture-backed IPOs. As Broc noted in the blog towards the end of last year, IPOs are a traditional exit strategy for VCs – until the IPO market opens up, VC’s can’t deliver returns to their investors. So if the uptick in VC confidence is a green shoot, it’s an exceedingly small one – but at least it’s pointing up. Thanks go out to Linda DeMelis for these thoughts.

– Dave Lynn