Who does this ruling pertain to?

• An institutional manager that exercises discretion on accounts with at least $100,000,000 in FMV of 13(f) securities
• An institutional manager that was required to file a form 13(f) for the quarter ended June 30, 2008

What will is required?

• Filing a new form – Form SH

When is filing required?

• 1^st business day of every calendar week in which a short sale of a 13(f) stock was effective.  The rule is effective as of 09/22 and the filing is due on 09/29.  The rule terminates on 10/2 so unless it is extended the only filing due is on 09/29.

What is required on the form?

• Number and value for each security sold short of 13(f) securities
• Does not include short sale of options
• For each day of the week, the following information must be submitted:
  • Name of Issuer
  • CUSIP
  • Short Position (Start of Day)
  • Number of Securities Sold Short (Per Day)
  • Value of Securities Sold Short (Per Day)
  • Short Position (End of Day)
  • Largest Intra-Day Short Position
  • Time of Day of Largest Intra-Day Short Position

Do All Positions Need To Be Reported?

• Do not need to report position if the short position is less than 0.25% of issued 13(f) securities
• And, The FMV of the position is less than $1,000,000

The first question that came to my mind is “Who is going to pay for all this?”  Now after some time to think, it is starting to be clear that the next domino to fall could be many Hedge Funds themselves.  The risks are still very high for lots of reasons – redemptions, writing CDS contracts, horrible YTD performance, and now limitations on short-selling that could take down arbitrage, long-short, and short-biased strategies.  The next few weeks should be interesting.

I will be publishing a summary of the new SEC requirements for disclosure of short-positions…..stay tuned.

Listen, I am all for transparency and will be the first to shout for transparency from every rooftop.   There has been a lack of transparency that built up over time and one day is not going to change this, especially when the transparency proposed could be from “fund to market” as opposed to “fund to investor”.

While the details of the proposed short-selling disclosure requirements are not yet public (I have been trying to find this out from the SEC all morning), I would ask the SEC to define their objectives and tread carefully when implementing these policies.  For example, does daily disclosure mean “publishing” to the SEC daily (in a 13F-like manner) or does it mean handing a list of short sales once per month to the SEC (for non-public consumption).  The consumption of shorting disclosures may create a shorting-rationale among other investors and thereby create mini-runs on company stock based on small relative changes.

If the SEC’s objective is to slow short-selling, then I would first reinstate the uptick rule.  If the SEC’s objective is to end naked short-selling, then they need to make clear the large penalties, both for the broker and the asset manager, that will be imposed for failure of delivery.  Secondly, they need to immediately have resources to investigate and follow-through on this claim and not “look the other way”.  If the SEC wishes to limit short-selling on certain stocks, then let it create a “not to borrow” list for this is certainly cheaper than having to nationalize a company.

Obviously, we are entering a period of regulatory re-design.  Transparency and the re-kindling investor trust are foundational objectives.  Exceptional times call for new approaches and I have no doubt that additional disclosure requirements/timeframes on hedge funds will be added (although with a great deal of whining).  However, the mantra still needs to be Walk Softly and Carry a Big Stick.

 About the author:Seth Berlin is Principal at Performance Thinking & Technologies ( www.p-t-t.com ).    PTT is a consulting firm that focuses on operations, technology integration, and risk management for hedge funds and investors. He can be reached at www.p-t-t.com or at info@p-t-t.com. 

1. 13F is due 45 days after the end of each quarter
2. Long positions only for 13F securities (a list of 13F securities can be found here – http://www.sec.gov/divisions/investment/13flists.htm )
3. Long Call/Put positions need to be included with the value of the security (not the value of the underlying shares)
4. Option positions on 13F securities only
5. Exclude position with < 10,000 shares or < $200,000 in quarterly closing value
6. No foreign shares or ADRs, unless foreign shares are a U.S. 13F listed company.
7. If you have a long and short position in a 13F stock, report the long position.  Don’t net the long and short together.

The format for submitting to Edgar can be found here:  www.sec.gov/about/forms/form13f.pdf

Happy Filing.

This is a story I see played over and over again.  Analysis, analysis, analysis, and then the DDQ.  For some reason the analysis stops at the DDQ and the DDQ is accepted as-is (or with a few minor follow-up questions).  The worst part of the story is that one message is extremely clear.  IF FUNDS OPERATE LIKE THEY PROMISED, MOST WOULD NOT HAVE FAILED.  This is true regardless of the firm’s ability to generate a high-yielding return stream.

Think of the irony here.  You have a DDQ on paper that spells out an operating model and operating principles, but rather than explore these with the same rigor of a return stream, you simply accept the DDQ as is.  Remember Neville Chamberlain and the “Peace For Our Time”  DDQ that Hitler signed prior to WWII.  Just because it is on paper does not mean the practices stated are the true operating model.  This leads me to my second conclusion – Review of a DDQ is not Operational Due Diligence.

The same rigor, investigative analysis, and modeling can be applied to an operational analysis.  This rigor involves analyzing the intersection of people, process, systems, and data in three dimensions – investment management, risk management, and operations management.   “Trust, but Verify” is the mantra that should be followed regarding fund operations.

For more information on Operational Due Diligence, please see my website at www.p-t-t.com.

Although only a mathematical model, this is interesting to me.  The key here is the definition of low vs high level of copying behavior.  If an inflection points exists for copying behavior, then what is that inflection point and how does it reflect itself in the market.  For example, can large changes in volume or open interest reflect mimicking behavior? Or do you need to look at  bid volume on the upside or short lending on the downside?

Again, just a mathematical model, but another sign that clustering behavior is an important aspect of modeling.

Everyone knows this price discovery and stock locate mechanism is time-intensive.  The question is will it ever change.   In a world, where you can use E-bay to buy a vintage Superman T-shirt from Bangkok, you would think a better way exists to manage the black-hole of securities lending.  However, guaranteeing the delivery of a T-shirt and a hard-to-borrow stock are about as similar as ant and a whale.

With this in mind, I have been reviewing securities lending models from upstart securities lending portals.  My goal in this review was to understand if these electronic marketplaces can succeed in changing the current lend-to-borrow process while creating a transparent price discovery mechanism. 

 Inventory, Culture, and Switching Costs 

The $5 trillion securities market is an attractive unbundling play because of the opaque nature and the intrinsic value of bringing buyers and sellers together electronically (think Nasdaq in the late 1980’s).  While, in theory, the automated matching of borrows and lenders is a given.  In practice, it is not so easy.  Inventory, Inventory, and more Inventory.  Without it, these marketplaces are nothing but an E-bay without the cool stuff.  Who controls most of the inventory…large Prime Brokerages who have an interest in not cannibalizing their existing revenue streams. 

While some believe competition will lower the rate for securities lending even without an electronic marketplace, today’s model has benefits for borrowers that go beyond the lowest rate.  Culturally, even the largest hedge funds need to maintain good relationships with Prime Brokers that in many cases provide a variety of services from research to trade data aggregation.  In addition, switching from a Prime Broker to an electronic marketplace is operationally expensive.  In today’s model, the Prime Broker maintains reporting mechanisms on lending and borrow.  Unbundling this relationship and potentially moving more of these operational costs to a fund may be more hassle than having a marginally lower rate on a hard-to-borrow security.

 Who’s out there? 

A number of online marketplaces exist.  Each site has a different model and potentially a different audience.  The maturity of these sites vary.  Some marketplaces  are in early production or a beta stage.  Others have been in production for a while.  Most sites are still early in the adoption cycle.  This review will include Lendex/LocateStock.com,  Quadriserve’s Aquas, eSecLending, ICAP’s I-sec, One-Chicago’s single stock futures market, and other players in the market.

Note:  This is the first of a multi-part series on Securities Lending Models.  The next entry will focus on regulation, price-discovery evolution, and trading/settlement models.

For more information on Securities Lending Research, please go to www.p-t-t.com or contact Seth Berlin at info@p-t-t.com.