In a series of Securities and Exchange Commission roundtable discussions yesterday, not a single panelist supported reinstating the uptick rule as it existed on the New York Stock Exchange before the SEC eliminated it in July 2007.
General Electric, Charles Schwab Corp. and Park National Bank, based in Newark, Ohio, all of which advocate SEC action to restrict short sales across the markets, support what’s called a modified uptick based on the national best bid. The former uptick rule used the last sale as the reference to determine the price at which short sales were permitted on the Big Board. Other panelists, from NYSE Euronext to Credit Suisse, pointed out that short-sale restrictions based on the last sale could not efficiently be implemented in the current market in which prices are printed to the tape as they arrive rather than sequentially.
The public roundtable was held to explore issues involving possible new restrictions the SEC is considering around short selling. The SEC last month published a 273-page proposal outlining five potential short-sale restrictions, including two price tests and three circuit breaker tests. The former include the old uptick rule and the modified uptick, or bid test. The circuit breaker rule involves security-specific triggers that, if hit, would lead to either a short-selling halt in that stock for the rest of the day, an uptick requirement or a bid test for short sales.
The SEC itself cast a cold eye on the old uptick rule. In its proposal, it noted that data latencies and reporting requirements made the last price less effective than bids in determining the current market price of a stock. The SEC is under pressure from Congress, publicly traded companies and irate retail investors to reinstate constraints around short-sale trades. Last fall, the SEC imposed new restrictions to prevent abusive naked short selling through stringent delivery requirements and a new anti-fraud rule.
Against this backdrop, Invesco and Fidelity Investments came out against any action. Representatives of the two big mutual fund companies advised the SEC yesterday not to impose any constraints on equity short sales.
“Immediate SEC action is not warranted,” said Kevin Cronin, global head of equity trading at Invesco. Fidelity agreed. The best course of action is “for the Commission to not adopt any of the proposals put out for comment,” said Brian Conroy, head of global trading at Fidelity Investments.
The firms do not think any of the proposed rules would prevent rapid declines in stock prices or improve market quality. These are among the goals for imposing new restrictions around short selling. Another goal is improving investor confidence in the markets, although many panelists said it remained unclear to them exactly how new rules would foster greater confidence.
The SEC eliminated price tests in 2007 after a year-long pilot with almost 1,000 stocks. More than a dozen SEC and academic studies supported the move, finding existing price tests ineffective, and their removal beneficial to overall market quality.
The two big mutual fund companies at the roundtable announced a fallback position if the SEC decides to enact new regulations. In that case, they said, a circuit breaker would be the most preferable among the proposed solutions. “At most, the circuit breaker option should be the only proposal under consideration,” Fidelity’s Conroy said. The Invesco panelist recommended a circuit breaker and bid test, which is the solution most of the other panelists also supported. Some actively advocated this option, while others supported it as the “least harmful,” as one panelist put it.
Richard Ketchum, CEO of the Financial Industry Regulatory Authority, is in the latter camp. If the SEC acts to restrict short selling, he said,” it should be focused on the circuit breaker side….In addition, quotes are certainly better than trades.” He told the SEC he would “strongly recommend you not have a rule in place all the time.” Ketchum said his comments did not necessarily reflect the views of FINRA since the self-regulatory organization’s board had not discussed the issue.
Ketchum also told the SEC commissioners that any potential new restriction should follow a policies and procedures approach, which would be appropriate for broker-dealers, rather than a strict prohibition at the exchange level. A policies and procedures approach to any new rule would enable brokers to seek to comply with a new short-sale rule based on the available quotes when they route orders, without unduly tying their hands because of data latency as orders are shipped to markets. Another panelist noted that quotes may change hundreds of times in the course of one second.
On the elusive issue of whether any new restriction on short selling would improve investor confidence, few of the invited speakers could muster great certainty. Several panelists pointed out that measuring confidence is a fraught task.
Jeff Brown of Charles Schwab made the case that restoring some form of the uptick rule during continuous trading, without a circuit breaker trigger, would boost retail customers’ confidence in the markets. Brown, who heads the Washington, D.C., office for regulatory and legal affairs at the retail brokerage firm, argued that a modified uptick would prevent traders from hitting sequential bids and driving prices down. He added that Schwab’s customers care a great deal about this issue. Brown supported the SEC’s elimination of the uptick two years ago, but said market conditions have now changed.
Larry Leibowitz, head of U.S. markets and global technology at NYSE Euronext, noted that the SEC has a tough job weighing various restrictions around short selling to decide what may help investors. When it comes to confidence, he said, “the gain is somewhat nebulous. It’s just investors going back into the marketplace.”
Several panelists stressed that the SEC should not impair liquidity by taking an action that unnecessarily constrains trading strategies or impacts legitimate short selling, which helps price discovery. The NYSE also recommended caution on this front. “The stronger the medicine, the more careful we should be in applying it to the patient,” Leibowitz said. The exchange supports a circuit breaker with a bid test. He said this option could be effective in decreasing rapid down moves by putting brakes on short sellers when a stock is declining.
Most of the panelists who spoke yesterday support a circuit breaker and bid test. However, Dan Mathisson, head of Advanced Execution Services at Credit Suisse, argued for a circuit breaker that would lead to a halt in short selling for the remainder of the day. He said that would be “much, much cheaper and easier to implement” for broker-dealers.
John Nagel, deputy general counsel at Citadel Group, a large proprietary trading firm, said the SEC should refrain from any new short-selling restrictions without empirical data in hand. Several SEC commissioners, including Chairman Mary Schapiro, repeatedly asked the panelists for data that might shed light on the decisions before them and the potential impact of a new short-sale rule. Nagel also told the SEC that “the silence is deafening” when it comes to looking for data supporting assertions that short sellers were to blame for market declines in specific stocks last fall.
Several participants said the SEC should consider conducting a pilot to test any new rule it proposes to determine its effectiveness. NYSE Euronext and Charles Schwab both supported the idea of a pilot. William O’Brien, CEO of Direct Edge, however, nixed the idea. “The American stock market is not a Petri dish to be experimented with,” he said. He is against any new short-selling restrictions.