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December 14, 2009

2009 Review: SEC Under the Uptick Gun

Washington Strikes Back

By Peter Chapman

The year 2009 is ending as it began. At least it is on the short-selling front, where angry congressmen are pressuring the Securities and Exchange Commission to put in place restrictions on the practice.

Early in the year, a group of U.S. congressmen, including Sen. Ted Kaufman, D-Del., proposed a bill that would reinstate the SEC's Rule 10A-1, or the "uptick rule."

The move was fueled by the legislators' belief that short selling was behind the collapse of the stock market in 2008. The SEC, feeling the heat, quickly responded with a rule proposal that would require the shorts to operate under some form of price-test regime.

Months later, the SEC still has not acted. Kaufman, for one is getting impatient. "Why has it taken them so long to do it?" he said at a recent Senate hearing on market structure. "When I was at Wharton getting my M.B.A. in the 1960s, the uptick rule was the cornerstone of market regulation."

Kaufman believes short selling helped bring down Lehman Brothers and Bear Stearns in 2008. "The uptick rule made it easier for bear raider traders to no longer be restrained by an uptick in price between each short sale," he said at the hearing.

Behind the SEC's delay, Kaufman suggests, is opposition to a new rule from "high-speed traders." He added: "It has become clear to me that none of the high-frequency traders who now dominate the market--almost 70 percent of the market--want to reprogram their computer algorithms to wait for an uptick in price."

Whatever the reason, the SEC does not appear to be in any hurry. Comments addressing "Amendments to Regulation SHO," as the proposal is called, were due by Sept. 21. In early November, the regulator had not reached a decision, nor announced any course of action.

The market has been without price-test restrictions for the past two years, as the SEC repealed all price tests, including Nasdaq's bid test, in 2007. That move followed eight years of study and debate.

Under the current proposal, the SEC has offered seven possibilities for the industry and the American public to debate. Four of the price tests would be in effect all day long and apply to every security. Three so-called "circuit breaker" approaches would only apply to individual securities for part of the day if their prices dropped by a certain percentage.

Most of the industry is overwhelmingly opposed to any new price tests, calling them unnecessary and outmoded. Traders argue that there is no data proving short selling was behind 2008's market rout. If they had to settle, however, traders say they would accept a circuit-breaker approach.

Nasdaq OMX's response is typical. "There is no compelling evidence upon which to base new restrictions on short selling," the exchange operator informed the SEC in a recent letter. "To the extent it is justified by empirical data, Nasdaq OMX supports imposing a circuit breaker such as Nasdaq OMX proposed in its March 2009 comment letter."

That proposal restricted short selling to one penny above the best bid if a given stock dropped by a certain percent. It is one of the seven approaches under consideration by the SEC.

 

 

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