Reports are surfacing that the House Financial Services Committee is likely to include in their July 28th markup a bill that would increase regulatory and reporting requirements for institutional investors. Under current law, an institutional investment manager that oversees at least $100 million in securities must disclose the number of shares, total market value, and other criteria to the Securities and Exchange Commission (SEC) through a quarterly report called “Form 13F”. This disclosure must be filed within 45 days of the end of the calendar quarter and the information is generally made publicly available.
The Capital Markets Engagement and Transparency Act of 2021 would impose new mandates on the type of information that is required to be filed and shorten the filing deadline. As a result, investors would be required to file their reports five days after the end of the quarter, down from 45 days, and, in addition to the disclosures already required under current law, qualifying institutional investment managers must also disclose their short and derivative positions. Some experts have argued that 13F disclosures should be expedited, but if lawmakers want to consider this reform, a more reasonable standard than five business days would serve retail and institutional investors better. Overall, these potentially burdensome new business mandates are not just unnecessary but also could be harmful for investors small and large.
The proposed increased transparency reporting requirement is unnecessary. Following the 2008 financial crisis, the Dodd–Frank Wall Street Reform and Consumer Protection Act was signed into law to increase regulation and transparency in financial markets. Title VII of this legislation established a comprehensive framework for regulating the security-based swap market. Specifically, Regulation SBSR (Reporting and Dissemination of Security-Based Swap Information) provides a “framework for the reporting and public dissemination of security-based swaps.” In 2015, the SEC adopted 21 rules to increase transparency and reporting requirements. Policymakers should avoid adding needless regulations in addition to the substantial regulations already in place.
Completing the Form 13F disclosure in the expedited five business days along with mandated disclosures of short and derivative positions would increase compliance costs. These costs would either be absorbed by institutional investors, or more likely, passed along to other smaller investors. In turn, this could lead to higher costs associated with trading for smaller investors. While some may claim the burden would be manageable for these large firms, the regulations themselves are unnecessary, as is the resulting increased burden on investors.
Cutting the reporting requirement from 45 days to five business days may seem like a way to increase transparency, but lawmakers should be wary. Form 13F can provide insights for retail investors looking to see what the “smart money” is investing in. However, such quick turnarounds could lead to smaller investors simply following the investment trends from larger investors rather than relying on underlying data and analysis. This could lead to an abundance of money largely flowing in the same direction, which in turn, could lead to overvaluation of securities and increased market volatility. Similarly, a shortened reporting period could lead to free riders. Deciding where and when to invest can be a drawn out process requiring complicated analysis and industry knowledge. Those who work to achieve positive returns for themselves or others should be rewarded for the risks they take, and lawmakers should be concerned that publishing the full investor playbook within just five business days will allow other investors to simply mimic the activity of other investors who worked for their returns.
The proposed change to force the disclosure of short positions could cause harm for both retail and institutional investors. Short selling allows investors to speculate on the decline in value of a security or stock. Short selling can be an important tool to hedge a bet or diversify an investment portfolio. Short selling can also increase price efficiency in the market by signaling if a stock or security is being overvalued, improving price discovery. While short selling is not without risk, the positives this practice provides outweigh the negatives.
Requiring institutional investor managers to disclose short positions on Form 13F would not have the desired effect that advocates purport. First, knowing that disclosures are mandated on their Form 13F, investors may choose simply not to engage in activity rather than be forced to broadcast their trading strategy. One study states that public short selling disclosures decrease short sellers’ participation in equity markets by roughly 20-25 percent. This could decrease liquidity in the market which would affect retail and institutional investors. With the recent activity surrounding ‘meme stocks’, the disclosure of short positions could be similarly troublesome. It is feasible that retail investors would seek to replicate their activity, driving up the price of certain securities that are being shorted by large investors. This would needlessly cause market disruption, wasting money for retail investors who get swept up in the craze while simultaneously damaging large financial institutions.
The events surrounding GameStop, Robinhood, and ‘meme stocks’ provided some progressive lawmakers with a catalyst to push longstanding and unrelated proposals to supposedly rein-in Wall Street “fat cats.” Divorced from an underlying problem, these unnecessary regulations would only serve to make investing in American companies more difficult. As America looks to compete with China as well as economically recover from the coronavirus pandemic, implementing superfluous regulations is a step in the wrong direction.