naked capitalism

OK sports fans, I’m old school. When I grew up, the uptick rule was in place, and no one seemed troubled by it.

The uptick rule simply means that a short sale can be executed only when the last sale of a stock is at a higher price than the immediately preceding sale. It was widely believed to do good job of preventing bear raids. It was repealed in July of 2007 and some noted shortly afterwards that volatility increased (but given that the Great Credit Contraction had just begun, it would be hard to reach definitive conclusions).

Now the SEC took a pretty extreme move during the crisis, that of banning short sales of a long list of financial stocks, which did nothing to arrest their decline. Now it is proposing a bizarrely timid re-introduction of the uptick rule, that of having it take effect only when a stock’s price has fallen 10% in a day.

I’m puzzled as to why the SEC is bothering with something this modest (ie certain to be ineffective). If you believe the uptick rule is a good idea, why not just re-introduce it? The only logic I see is this might be that this is an experiment, that having two data samples (how stock trades on a down day when no uptick rule is in effect, vs. when it is). But this seems implausible. First, you’d want to set the threshold higher (maybe 5%) to produce a more robust sample of trades with the uptick rule in effect. Second, regulators don’t tend to think along those lines.

This move instead has the smell of a peculiar political compromise, and Bloomberg says as much:

Concern that short-sellers accelerate stock declines may prompt the Securities and Exchange Commission to adopt a rule next month aimed at curbing bearish bets when equities are plunging.

The regulation would require the trades be executed above the best existing bid in the market when shares fall 10 percent in a day, said Brian Hyndman, the senior vice president in transaction services at Nasdaq OMX Group Inc. In a short sale, an investor borrows an asset and sells it, hoping to profit from a decrease by repurchasing it later at a lower price.

Forcing short sellers to wait for a stock to rise above the best price bid may prevent them from flooding the market with sell orders and causing losses to multiply. Some exchange officials say the restrictions known as uptick rules don’t work, citing studies that show they may be less effective during panics that drive prices down and volatility up.

“There is no empirical data to support the introduction of a new rule,” Hyndman said yesterday at a securities industry conference in Chicago. “But this is the least intrusive of the proposals the SEC was considering.”

Yves here. So here we have a below-the-radar issue, where there is a constituency for Doing Something about short selling, in particular, retail investors and most corporations (mind you, I’m not at all opposed to short selling in the abstract, but bear raids are a real issue, and some constraints aren’t a bad idea). And what do we see? The industry appears to have gone in and done it usual effective job of lobbying. Potemkin reform prevails yet again.