The Securities and Exchange Commission’s ban on short sales may be a distant memory at this point, but that doesn’t mean new short-sale rules aren’t in the offing.
The regulator’s emergency ban on the shorting of nearly 1,000 securities lasted for a few weeks, between Sept. 19 and Oct. 8, and by many accounts wreaked havoc on the market. Liquidity dried up, spreads widened, and volatility surged.
Whether or not the ban “restored equilibrium” in the markets for securities issued by the nation’s banks, as the SEC intended, will probably never be known. But it did temporarily silence critics of the SEC who said it was not doing enough during a time of national crisis.
While SEC economists were studying data from the time of the ban to try to determine its impact, the Division of Trading and Markets was considering future rule-making. It turned to a group of industry executives for help, asking them to offer some ideas on future short-sale rules.
As Traders Magazine was going to press, the working group had just presented the regulator with some thoughts as to what type of regulation would work best if the SEC did decide to push for new short-sale rules. The group included executives from NYSE Euronext, Nasdaq OMX Group, BATS Trading, UBS, Goldman Sachs, Morgan Stanley and the Financial Industry Regulatory Authority.
Any new rules apparently boil down to two choices: (a) a price-test rule and/or (b) a circuit-breaker temporary ban. The group unanimously rejected the idea of a price test such as the recently decommissioned uptick rule. Instead, it suggested some kind of circuit breaker would be most effective.
Many issuers, members of Congress and the American public had been calling for a reinstatement of the uptick rule, which banned shorting if the last sale was lower than the previous sale, and which had been mothballed by the SEC in 2007. The SEC had spent four years studying the issue before deciding to kill the uptick rule and is said to be loath to bring it back.
Still, public statements by SEC officials are keeping the dream alive for some fans of the rule. Erik Sirri, director of the Division of Trading and Markets, told conference-goers at an Investment Company Institute forum on Oct. 6 the SEC was considering bringing it back.
The reality is probably different. NYSE Euronext chief executive Duncan Niederauer, in a letter to NYSE issuers, said the idea of an uptick rule was dead. “After a few weeks of trying to build consensus on this issue,” Niederauer said, “it is clear to me we are in the minority. We support it and many of our issuers support it. The SEC staff and most of the commissioners do not appear to support a return to an uptick rule, nor do the other U.S. exchanges or a majority of the leading market participants.”
Niederauer has portrayed himself as a champion of the reinstatement of the uptick rule in meetings with issuers, but sources say privately his organization is opposed. Both exchange and brokerage executives alike contend price tests would be ineffective. “Upticks are much more frequent in a pennywide market,” said Joe Ratterman, chief executive of BATS Trading. “There isn’t really a braking mechanism there, because there are too many opportunities for an uptick in today’s automated markets with pennywide spreads.”
After four or five meetings of the working group, “Nobody really believed [the rule] would be effective and it wasn’t worth the trouble to suggest it,” Ratterman said. “So we discussed it and rejected it.”
What the group did offer up to the SEC as worthwhile, Ratterman said, was the idea of a circuit breaker. Any rule could apply to both individual securities and the market as a whole. If a particular stock dropped by some large amount, then, under the proposal, short selling in the stock would be banned for the rest of the day. Also, if some index such as the S&P 500 dropped by a large amount, then short selling would be halted in all securities for the rest of the day.
“We have circuit breakers that protect the market against violent swings,” Bob Greifeld, Nasdaq’s chief executive, told Traders Magazine, “and we are recommending to the SEC that there be circuit breakers to provide protections related to short selling.”
The working group, Ratterman said, did not specify in its communiqué to the SEC how much of a drop in a security or index would trigger the circuit breaker. But its intention was to limit the use of such an instrument to very large drops, such as 10, 15 or 20 percent. “It would be restricted for some kind of panic situation,” he said. The idea was to rarely, if ever, need to halt short selling.
The concept of a circuit breaker is not foreign to the markets, as both the NYSE and Nasdaq incorporate circuit-breaker rules. If the Dow Jones Industrial Average falls by a certain amount, then the exchanges will halt trading for some specified time period.
A circuit-breaker rule covering short sales could include exemptions for firms, order types or trading activity such as market making, Ratterman said. Enforcement of the ban would rest either with the exchanges or the brokers, Ratterman added.
The group declined to provide the SEC with too many specifics, preferring to open the issue up to discussion with the other market participants. The Security Traders Association has also asked the SEC to refrain from further rule-making unless it is open to public comment.
The STA, which in general is in favor of unfettered short selling, had not taken a position on a circuit-breaker rule or a price-test rule as Traders Magazine was going to press. But John Giesea, STA president and CEO, said his personal opinion was that there “should be some provision for an extreme circumstance. I don’t think we are reckless enough to suggest that under any condition no action should be taken, ever.”
(c) 2008 Traders Magazine and SourceMedia, Inc. All Rights Reserved.
http://www.tradersmagazine.com http://www.sourcemedia.com/