Is the SEC Contributing to a Rigged Market?
Ron DeLegge
March 5, 2010

SAN DIEGO (ETFguide.com) – The Securities and Exchange Commission (SEC) recently passed new rules that restrict short selling in stocks. Will these regulatory moves stabilize financial markets? Or are they contributing to a rigged stock market?

Let’s examine these questions. 

The Rule
Both securities and futures exchanges have coordinated trading halts designed to counteract severe market declines that threaten market liquidity. These procedures are known as “circuit breakers” and aim to quell downside volatility through temporary suspensions in trading or in extreme cases, closing the markets before the end of the normal close of the trading session.

The circuit breakers are measured by a single day decrease in the Dow Jones Industrial Average (NYSEArca: DIA). There are three circuit breaker thresholds - 10%, 20%, and 30% - set by the markets at point levels that are calculated at the beginning of each quarter. The New York Stock Exchange (NYSE) establishes the formulas for these market thresholds.

How does this affect short sellers?

The SEC’s new short selling curbs apply once a circuit breaker has been triggered. Short selling in stocks that have fallen 10% or more is now only allowed above the best bid price for the stock. This trading restriction would be in force for the remaining trading session including the following day’s session.

Scandalous Questions
Given that the SEC’s new short selling rule was only narrowly passed with a 3-2 vote, suggests gaping dissension among the acting commissioners. Good thing there aren’t six commissioners or it could’ve resulted in a tied vote!

The facts are that unfettered short selling, love it or hate it, is a vital exercise to the operation of free capital markets. All opinions, both good and bad, should be reflected in a stock’s price to achieve a more efficient marketplace. Only gullible suckers or brainwashed citizen prisoners believe in the false authenticity of a rigged one-way stock market. That's their definition of free capital markets, but should it be ours? 

This raises several scandalous questions.

During the 2008 credit crisis, who caused more damage to stock prices and who almost tipped the financial system into oblivion? Was it short sellers? Or was it the corporate executives who made dumb headed decisions that drove their companies and the system to the brink? Furthermore, why is the SEC only concerned about stock prices that fall too much too fast? How about some curbs on stock prices that go up too much too fast? Isn’t that just as dangerous? And finally, is there an outside chance that Wall Street’s cop has a bullish bias that governs its rule-making decisions?   

The Original Plunge Protection Team
One year after the 1987 stock market crash Ronald Reagan signed an executive order to establish a secretive committee designed to prevent major market collapses.

Under the arrangement, the Treasury Secretary, the Federal Reserve’s chairman, the SEC’s chairman and the chairman of the commodity futures trading commission make up the core of this team. By extension, major financial institutions like JP Morgan Chase and Goldman Sachs are used to execute their orders.

The existence of this team is said to have been confirmed by former Clinton advisor George Stephanopoulos on Good Morning America. Last year, former Treasury Secretary Hank Paulson called for this “financial fraternity” to meet with greater frequency and set up a command center at the U.S. Treasury designed to track global markets and serve as headquarter for the next crisis.

There is much more to this unique arrangement designed to keep a lid potential market meltdowns and use major Wall Street firms as marionettes to accomplish this goal. A detailed report about this secret team is available in the January 2009 issue of the ETF Profit Strategy Newsletter.

Manipulating the Market Up
Today, there’s around $20 billion invested in short ETFs that are designed to increase in value when securities fall. And investors that use short ETFs should be aware of the potential hazards of regulatory manipulation. “The SEC rule will introduce tracking error for short or bear ETFs when the rule is triggered since the ETF may have difficulty getting exposure to that security, states Daniel O'Neill, President and CIO Direxion Funds.

This phenomenon occurred in 2008 when the SEC’s temporary ban on short selling in financial stocks caused havoc for products like the ProShares UltraShort Financials (NYSEArca: SKF). The March 2009 ETF Profit Strategy Newsletter provides a detailed report about the assault on short or inverse performing ETFs and potential remedies.

Nevertheless, the fairyland view that market prices can be stabilized with organized committees or regulatory tactics is still alive and strong.

Despite these efforts, in 2000, 2002, 2008 and 2009, major stock indexes like the S&P 500 (NYSEArca: SPY), DJIA (NYSEArca: DIA) and Nasdaq (Nasdaq: QQQQ) still declined 30% or more.

It is now known, as it was back then, that this nation’s most powerful financiers got together on October 24th, 1929 to prevent a major meltdown. Their plan succeeded, but only temporarily.

We can conclude that there seems to be an organized effort with the specific job description of lifting markets. Quite likely, their efforts have contributed to the protracted rally in stock prices that we’ve recently had. But is it sustainable?

The stock market, as we’ve seen, is a wild beast capable of just about anything. And it will not be dictated to. The market will do whatever it wants, regardless of what plunge protection teams want it to do.