Wednesday, April 08, 2009

SEC Set to Propose Modified Uptick and Circuit Breaker Rules

With Congress readying legislation directing the SEC to reinstate the uptick rule, Rule 10a-1, the Commission will consider proposing two approaches to restrictions on short selling. One would apply a modified uptick rule on a market wide and permanent basis, while the other would apply a circuit breaker to a particular security during severe market declines in that security

The proposed modified uptick rule would be based on the national best bid, similar to the former Nasdaq “bid” test. This proposal would require trading centers to establish and enforce policies and procedures reasonably designed to prevent the execution or display of a short sale order of an National Market System stock, absent an exception, at a down-bid price. Trading centers, which include broker-dealers and exchanges that execute short sales, must regularly surveil for effectiveness of policies and procedures and take action to remedy deficiencies.

The proposed uptick rule is similar to former Rule 10a-1, and based on the last sale price. This proposal would prohibit any person from effecting a short sale below the last sale price or at the last sale price, unless such price is above the next preceding different price.

Both the proposed modified uptick rule and the proposed uptick rule include exceptions that are based on exceptions to, or exemptions granted under, former Rule 10a-1. These exceptions would be limited to activities that promote liquidity and foster the workability of the proposed rules without undermining the effectiveness of the proposals. The Commission will seek specific comment regarding how each proposed short sale price test would work in the context of today’s markets.

The proposed circuit breaker rules would be triggered by a specified ten percent decline (as reported in the consolidated system) in a particular NMS stock. Each proposed rule, however, would impose different short sale restrictions when triggered. The proposed circuit breaker halt rule, when triggered, would prohibit any person from selling short in that security for the remainder of the day.

The proposed circuit breaker modified uptick rule, when triggered, would require trading centers to enforce established policies and procedures designed to prevent the execution or display of a short sale order at a down-bid price for the remainder of the day. The proposed circuit breaker uptick rule, when triggered, would prohibit any person from effecting a short sale below the last sale price or at the last sale price, unless such price is above the next preceding different price, for the remainder of the day. To avoid potential market disruption, the proposed rules would not be triggered if the price of a covered security reaches the specified ten percent decline threshold within thirty minutes of the end of regular trading hours.

The proposed circuit breaker rules would include several exceptions. As with the short sale price test proposals, these exceptions would be limited to activities that promote liquidity and foster the workability of the proposed rules without undermining the effectiveness of the proposals. The Commission will seek specific comment regarding how each proposed circuit breaker rule would work in the context of today’s markets.

Recently, six US Senators have written to SEC Chair Mary Schapiro urging the Commission to adopt and enforce regulations putting an end to naked short selling. At a minimum, those regulations should address the need for an uptick rule, as well as a pre-borrow requirement to prevent naked short sellers from artificially depressing or diluting stock values. If the SEC fails to signal clear action at its April 8 meeting, at least to reinstate some form of the uptick rule and impose a pre-borrow requirement on short sellers, said the Senators, Congress will consider legislation directing the Commission to do so. The six Senators are Ted Kaufman (D-DE), Johnny Isakson (R-GA), John Tester (D-MT), Arlen Specter (R-PA), Carl Levin D-MI, and Saxby Chambliss (R-GA).

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