Here we go again. The Securities and Exchange Commission (SEC) is poised to muck up what has worked for many many years.
Short selling has been, and is, a critical part of the markets normal price discovery process. In the midst of every major financial crisis, including the Great Depression, short sellers were viewed as ‘evil doers’. Heck, they had to lay blame somewhere, so why not blame those who profit when the stock market goes down.
Recall that in 2008 the SEC banned all short selling in nearly 1,000 stocks, claiming that the ‘evil doers’ were pushing stock prices down more than they should go. Remember what happened during the duration of the short selling ban? Prices still went down, that is what happened. (see chart on the left).
Ever since the short selling ban was lifted back on October 8, 2008 the SEC has continued to talk about new ways to control or limit short selling from the market. The problem is that history shows us that short selling bring a natural liquidity to the market that provides balance, and more importantly, a critical part of the price discovery process.
Federal regulators, who have vacillated for years over whether to curb short selling, are expected to approve new restrictions Wednesday on the practice of betting that a company’s shares will decline, according to sources familiar with the plans.
Federal regulators, who have vacillated for years over whether to curb short selling, are expected to approve new restrictions Wednesday on the practice of betting that a company’s shares will decline, according to sources familiar with the plans.
The new rules by the Securities and Exchange Commission will seek to strike a middle ground between those who argue that limits on short selling are ineffective and perhaps damaging, and those who argue that they are a necessary measure to prevent speculators from pouncing on a stock when it is quickly declining.
The new restrictions will only affect stocks that have already declined a set amount, probably 10 percent, during any given day, said the sources, who spoke condition of anonymity because the agency hasn’t publicly discussed its final rule. For these stocks, the rules will allow traders to short sell only under certain technical conditions. These restrictions should slow down the decline of a company’s shares if they are already in a tailspin.
The new policy, which is likely to be approved despite the objections of some commissioners, comes after the SEC has gone back and forth on the issue for several years. […] (Washington Post)
If history tells us anything, the SEC’s attempts to play with the playing field may end up resulting in a decline in liquidity. That would ‘not’ be good.
This video is worth watching again -
The following is an article I wrote on March 10 2009 on this very subject:
March 10 2009 : Suddenly there is talk in Washington, D.C. that an effort may be underway to twist the arm of the Securities and Exchange Commission (SEC) to reinstate what is known as the ‘uptick rule’.
The uptick rule was a securities trading rule used to regulate short selling in financial markets. The rule mandated, subject to certain exceptions, that, when sold, a listed security must either be sold short at a price above the price at which the immediately preceding sale was effected or at the last sale price if it is higher than the last different price.
In 1938, the SEC adopted the uptick rule, more formally known as rule 10a-1, after conducting an inquiry into the effects of concentrated short selling during the market break of 1937. The original rule was implemented by Joseph P. Kennedy, Sr., the first SEC commissioner.
The SEC eliminated the uptick rule on July 6, 2007 following a one year pilot program to study the impact of the uptick rule and its removal. The consensus of the study, which the Securities and Exchange (SEC) ordered, said that the uptick rule “modestly reduced liquidity“, and moreover it did not appear that it prevented manipulation.
So following the study it was decided that the rule was of little or no value and it was removed.
Short selling a stock or other traded securities brings a natural balance to the markets. For every bull there must be a proportion of bears to ‘argue’ the price for that stock or security. It is all about fair arbitration over the price. The study that the SEC conducted actually found that the uptick rule reduced liquidity in the overall market. Reduced liquidity means lower volume and that could actually have a net negative impact on the market.
Last year the SEC enacted an emergency order banning all short selling completely in nearly 900 different stocks. The emergency order was put in place as a result of speculation in Washington, D.C. that the free market was actually adding to the problem unfairly by allowing ‘bears’ to short a stock unreasonably.
Well, how did that work out? Not so good! During the ban from September 19, 2008 to October 8, 2008 the financial stocks that were banned from all short selling actually fell more!
A properly working market requires a fair playing field. You never hear anyone talk about placing restrictions on ‘buying’ stocks. So it remains OK for the stock pumpers to run up a thinly traded stock and then sell out and leave numerous bag holders. Restrict short sellers and you aid the fraud that is still rampant in the markets. It’s all about balance.Short selling is the markets natural referee.
Bringing back the uptick rule is all about public perception. It was instituted following the Great Depression in order to restore confidence as some blame for the crash of ‘29 was levied on ’short sellers’. Now here we are again in 2009 finding rules to blame for legitimate problems which the rules did not create.
The same goes with this nonsense about eliminating mark to market account rules.. That is a story for another article.
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Just great, another fine mess the SEC will make.