By Amanda Maine, J.D.
Writing on behalf of his company, Urban Outfitters Chairman and CEO Richard A. Hayne submitted a petition to the SEC requesting that the Commission consider reinstitute former rule 10a-1 relating to short selling in response to the market impact of COVID-19. While returning to the original uptick rule would not prevent further market volatility, it would limit the ability of short sellers to sell into negative market trends, according to Hayne.
Original and alternative uptick rule. Short selling involves a sale of a security that the seller does not own or a sale that is consummated by the delivery of a security borrowed by, or for the account of, the seller. Short selling, in addition to being used to provide liquidity in response to unanticipated demand or to hedge the risk of an economic long position in the same security or in a related security, can be used to profit from an expected downward price movement.
In 1938, the SEC adopted Rule 10a-1 to restrict short selling in a declining market, and the rule remained mostly unchanged for nearly 70 years. After implementing a pilot program in 2004 that temporarily suspended the Rule 10a-1 tick test, the SEC found little empirical justification for maintaining short sale price test restrictions, especially for actively traded securities.
In 2007, after reviewing comment letters and the results of the pilot, as well as and taking into account the market developments that had occurred in the securities industry, the SEC eliminated former Rule 10a-1 and added Rule 201 of Regulation SHO, prohibiting any SRO from having a short sale price test.
In light of the financial crisis of 2008 and the market volatility that followed, the SEC in 2010 adopted an "alternative uptick rule," which imposed restrictions on short selling only when a stock has triggered a circuit breaker by experiencing a price decline of at least 10 percent in one day. At that point, short selling would be permitted if the price of the security is above the current national best bid.
Urban Outfitters petition. Hayne’s petition to the SEC recommends that the Commission reinstitute the original uptick rule as provided in former Rule 10a-1. The original rule stated that a listed security may be sold short: (1) at a price above the price at which the immediately preceding sale was effected (plus tick); or (2) at the last sale price if it is higher than the last different price (zero-plus tick). According to the petition, reinstituting the rule would mean that short sales are not permitted on minus ticks or zero-minus ticks, subject to narrow exceptions.
Hayne stressed that his company does not think the practice of short selling itself should be banned but expressed that reinstituting the Rule 10a-1 uptick rule would improve the regulation of short selling. While Rule 10a-1 would not, by itself, prevent further market volatility, certain safeguards should be put in place during these uncertain times, he wrote.
Financial regulators on short selling. SEC Chairman Jay Clayton, in an interview with CNBC last month, said that the agency would not ban short selling, advising that short selling can be used "to facilitate ordinary market trading." In the same interview, Clayton voiced support for the 2010 alternative uptick rule, which "closely matches the electronic trading environment of today."
The European Securities and Markets Authority (ESMA) in March temporarily required the holders of net short positions in shares traded on an EU regulated market to notify the relevant national competent authority if the position reaches or exceeds 0.1 percent (down from the earlier threshold of 0.2 percent) of the issued share capital after the entry into force of the decision. ESMA stated that lowering the reporting threshold is a precautionary action due to the "exceptional circumstances" linked to the COVID-19 pandemic. The U.K.’s Financial Conduct Authority (FCA) confirmed that ESMA’s decision applied to the U.K. during the Brexit transition period. The FCA also confirmed that the required changes to its systems have been made to comply with the decision.
ESMA also approved a ban on short selling by the French securities regulator, the Autorite des marches financiers (AMF). The French emergency prohibition is set to expire on April 16.