Short rules

The Securities and Exchange Commission today unanimously approved putting five variations of potential uptick rules to limit short selling out for public comment for the next 60 days.

The proposed rules represent, according to SEC Chairman Mary Schapiro, a reaction to public sentiment that favors greater restrictions on short selling practices.

Among the proposals being considered, one is to reinstate the original rule that was introduced in 1938 and was in place until being repealed in July 2007. The original rule required that a stock’s last trade represent an increase in price before it could be sold short.

Other proposals up for comment include a modified uptick rule that would restrict shorting a stock at a price lower than the last best bid price.

There are also three variations on circuit-breaker rules that would halt short selling of a particular stock once its price has declined more than 10% during a set period.

In asking for public comment, the commission warned that it is interested in views that include evidence of why or why not short selling needs to be restricted.

The commission also acknowledged that, in spite of the public’s focus on short sellers, it has no data showing that short selling played any significant role in creating the current market crisis and economic environment.

"Anyone who is paying attention can't be surprised that the SEC is going to reinstate some form of the uptick rule," said Eric Newman, portfolio manager at TFS Capital LLC, a Richmond, Va.-based hedge fund and mutual fund shop with $500 million under management.

"It intellectually saddens me that even though there is no evidence this will make a difference, people think bringing back the uptick rule is what it will take to restore investor confidence," he added. "Let's pick something that has an actual impact on the market and not just demonize short sellers."

The rule was originally designed to prevent market manipulation and so-called "bear raids" during which short sellers would chase a declining stock, thus exacerbating the decline.

The SEC repealed the rule after its own 2005 study showed the uptick requirement had a negligible impact on stock prices.

Since February 2001, when trading switched from fractional shares to pennies through decimalization, short sellers have had little trouble creating an uptick on a stock they wanted to sell short.

Proponents of more restrictions on short sellers, cite the increased market volatility since the original rule was repealed, suggesting short selling became too easy at the wrong time in the economic cycle.

"It was a very unfortunate reality that the uptick rule was suspended in the first place," said Kurt Schacht, managing director of the CFA Institute in Charlottesville, Va.

"The thinking was that it had become irrelevant in low volatility markets; what a mistake that turned out to be," he added. "The rule was designed to be a circuit breaker in times of market panic and needs to be reinstated."

Those in the short-selling camp, meanwhile, can only wait and hope the growing public outcry and political momentum doesn't lead to overreaching rules.

"Everything we've heard from Mary Schapiro suggests she wants to do this deliberately, but a 60-day comment period is very quick and there's been no indication that any of this research has been done to really consider the impact of short selling on the markets," said Mitchell Nichter, a partner in the investment management practice at the San Francisco law firm of Paul, Hastings, Janofsky & Walker LLP.

"We may end up with the SEC adopting a rule because a handful of senators sent a letter," he said. "The work needs to be done before you start regulating, and there needs to be an empirical study to justify these rules and consideration for the unintended consequences."

Jeff Benjamin is senior editor at InvestmentNews, a sister publication of Pensions & Investments.