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December 5, 2008

Citi Exec's New Short-Sale Solution

By Nina Mehta

In the wake of the Securities and Exchange Commission's temporary ban on short sales in financial stocks in September, the Commission this fall began pondering new rules to regulate short selling. On the table is a price-test rule, as well as a circuit breaker that might temporarily ban or restrict short sales. Much of the industry is opposed to a price-test rule, but might be able to live with a circuit breaker in times of crisis.

Traders Magazine spoke with one market expert whose solution could be palatable to those on various sides of the issue. Dave Weisberger, a longtime employee of Salomon Smith Barney who is now head of global electronic market access at Citi, suggested a circuit-breaker-based solution, but one that doesn't ban short selling, in contrast to the main circuit-breaker idea now being batted around.

Weisberger's solution also gets around the difficulty of implementing an uptick or price-based rule. The Citi exec noted that a basic drawback with an uptick requirement or price-based rule is that it could slow down trading. Most matching engines at exchanges and ECNs, he explained, don't capture trades on other markets before executing, and would need to do so to employ a tick test. If market centers had to consume this additional data and validate each individual match involving a short seller against other venues, he added, the resulting processing requirements "could cause the engines to slow significantly" during high-volume periods.

In addition, Weisberger said, if that validation used the securities information processor, or SIP, to check the ticks on other venues, there could be a half-second delay from the actual sequence of events. "And it could be a full second in spiky times," he added.

Exchange executives have so far not managed to come to an agreement on their own about what they would like to see implemented. The decision is therefore in the SEC's lap. The SEC has indicated that it is not eager to consider reinstating the uptick rule, which it scrapped in July 2007.

Weisberger's circuit-breaker-based solution is to allow short sellers to only add liquidity when a circuit breaker has been hit. Once that's triggered, short sellers would have to submit orders tagged "add only." That means their orders would not hit bids but would instead provide liquidity to the market.

Customers could still short stock, as they could with an uptick rule or price test, but they would only be able to do so by placing limit orders on the offer side. That would halt momentum selling that rapidly drives down the price of a falling stock. Buyers would have to lift those offers from the short sellers.

The benefit of this idea is that the circuit breaker could operate intraday (as opposed to the next day, which is what some exchanges have suggested) and with minimal new systems work by exchanges and brokers. "All exchanges already take add-only orders, and all brokers understand the difference between adding liquidity and taking it," Weisberger said. "As a result, brokers could develop surveillance processes and exchanges could build edits far easier than requiring changes to the core matching engines."

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