Legal Village

Congress doing more bad than good, says former SEC lawyer

Posted 25/09/2008 by Brian Baxter

Despite a temporary ban on short-selling and a $700bn (£378bn) rescue package snaking its way through Congress, a quick fix to the current economic malaise does not appear to be in the offing. That's partly due, says Bruce Hiler, head of the securities group at Cadwalader Wickersham & Taft and a former associate director of enforcement at the Securities & Exchange Commission (SEC), to the posturing by congressmen looking for a soundbite moment to slam Wall Street.

We talked to Hiler about about short sales and the asset-backed securities bailout plan. The one-time defence lawyer for former Enron CEO Jeffrey Skilling did not hold back.

Short-selling: problem or panacea?
Short-selling definitely serves a purpose and the SEC has said this. In the early 1990s the SEC testified during congressional hearings on short-selling, because corporations and Congress were concerned about these so-called bear raids by people trying to knock down their stock prices. And the SEC said that [short-selling] performs a valuable function for the markets. On the other hand, there can be abusive short-selling, just like there can be manipulative long-buying.

Seems like a catch-22.
The debate that is going on now - and we have clients on both sides of the issue - is over regulating how the markets trade and function. There have always been some restrictions on short-selling, just like there are restrictions on purchasing long. So there are things that can be done on either side, and sometimes irrational exuberance on the upside or downside can be problematic.

What we have seen recently is shorts coming in the market as a result of smelling blood in the water because of all the real estate debt issues. With all of the fear out there, it is clear that people going long have been very tentative. That creates an environment for short sellers to have more of an effect than they usually would. Clearly, if there were unfounded rumors or collusion, that's a problem, but I'm not aware of any cases that the SEC has ever been able to make on that.

And the current short-selling ban is only until the first week of October, correct?
Yes, and they can extend it. But the other thing the SEC can do -and I have seen so many people question why they are not considering it if they really want to deal with the potential effect of some of this unbridled short-selling - is put the Uptick Rule back in place. A day or two ago, when they put these emergency rules in place banning naked short-selling, they put this order out stopping short-selling on 789 financial institution stocks but did nothing on the Uptick Rule. So I'm not sure why that's not another arrow in the quiver.

[Editor's note: The Uptick Rule, eliminated by the SEC on 6 July, 2007, requires that every short sale be entered at a price higher than the price of a previous trade. Says Hiler: "In times where there is panic or fear, there is no breathing room for people seeing a stock to know that that stock might be going down just because of the work of a few traders. So the Uptick Rule is sort of a built-in regulator."]

At least Congress is on the case.
I'm always absolutely amazed and appalled that we Americans repeatedly vote some of these people into office and allow them to speak to us the way that they do. They create the environment in which they play and then they play to that environment. So many of the people running for office say that this is a bailout of Wall Street by Main Street. They've rattled that sword so much that I bet if you interviewed people on Main Street, half of them would think that this bill was to give $700bn (£380bn)  to Wall Street executives when the actual problem itself started on Main Street.

The debt that was wrapped in these ABSs, which Wall Street probably misjudged was not going to default as readily as it did, came out of Main Street people getting loans that they shouldn't have got. It is frustrating to watch the posturing of Congress and the people that are running the show up there. Paulson has done a great job of explaining it, as have some other senators, but some of the rhetoric coming out of there is just appalling.

But it does make for great political theatre.
(Laughing, then sighing.) This is about all of us and hopefully they get this thing done soon before it seizes up even more. Every day that they wait is another day that it will take to get through the system. They have already caused more damage than they have good, as though there is some horrible, terrible problem in having the $700bn out there for Treasury to buy up assets. As if Congress can't watch over that? We need to pass some language saying they're going to look over it now? Hell, they can pass a bill a month from now that says, "Hey, remember that $700bn we gave you? We want you to come up here and show us every penny of it while we create an organisation that appraises and reviews every thing that we buy." Or they can just pass something that says, "with appropriate regulatory oversight to come".

Now they want to eke this out in $150bn (£81bn) portions, so they can roll the cameras in a few months from now, see what the atmosphere is like, and see if they can get in a few more soundbites pounding on Wall Street or the rich versus the poor. Paulson, in my view, is just trying to do the right thing for all parts of America, and these [politicians] act like they're the saviours.

Posted on 25 September by Brian Baxter. This blog first appeared on The AmLaw Daily, the website of Legal Week’s US sister title The American Lawyer.