By James Hamilton, J.D., LL.M.
On the heels of the expiration of the SEC’s emergency order banning short selling in hundreds of financial companies, the listed company community favors the implementation of new rules and enhanced disclosure. An overwhelming number of companies urged the SEC to reinstitute the uptick rule, as well as place restrictions on short selling during periods of market volatility. Greater transparency in short-selling is also essential. These views surfaced in a recently released NYSE Euronext study.
Three in four companies believe that short selling should be temporarily prohibited when a stock experiences a certain level of volatility. Of those who favor a temporary prohibition, 24% say short selling activity should be stopped after less than a 10% market decline, while 54% seek a halt to short selling after a 10%-20% decline.
The listed companies also want investment managers to disclose their short selling activity. The lack of short selling disclosure requirements, as well as the support received from regulatory entities by some institutions engaged in short selling, feeds the resentment of companies that believe there are different sets of rules for different businesses.
The almost unanimous desire to bring back the uptick rule is based on a belief that the rule worked for decades to control the ability of short sellers to overwhelm market sentiment. The SEC rescinded the rule in 2007. While it should be re-instituted, issuers also said that the rule must include both on-exchange trading, as well as off-exchange trading and dark pools.
The uptick rule, Rule 10a-1, required that all short sale stock transactions be conducted at a price that was higher than the price of the previous trade. The SEC claims that its staff fully researched the regulation before it was repealed; but some commenters have noted that the research took place during one of the biggest bull markets in history.
There is a growing consensus in Congress to bring back the uptick rule. A House bill, HR 6517, would order the SEC to reinstate the uptick rule within 90 days. In the wake of the elimination of the uptick rule, noted bill sponsor Gary Ackerman, many volatile stocks that the regulation was designed to protect are being driven down as a result of manipulative short sale practices. He believes that the reinstatement of the uptick rule would help curb these abuses and ensure greater stability and confidence in the market. Under a reinstated uptick rule, he continued, fewer companies would fail, less investors would be driven out of the market, and more capital would remain in the stock markets.In a short sale, an investor borrows shares of a stock from a broker, sells it to others, and then hopes to buy it back at a lower price before returning it to the lender.
The difference, if any, is kept as a profit. The uptick rule was designed to prevent short sellers from being the only investors to cause a stock price to decline. Under the rule, a short sale could only be entered after a trade that caused the last price to increase. The uptick rule had been in place since 1938, and Rep. Ackerman does not fully understand why the SEC rescinded
The core provisions of Rule 10a-1 had remained virtually unchanged since its adoption 70 years ago. Over the years, however, in response to changes in the securities markets, including changes in trading strategies and systems used in the marketplace, the SEC had added exceptions to Rule 10a-1 and granted numerous requests for relief from the rule’s restrictions In addition, in rescinding the rule, the SEC noted that decimal pricing increments had substantially reduced the difficulty of short selling on an uptick.