Tuesday, September 19, 2006


Last Friday the Securities and Exchange Commission staged a roundtable discussion on the Reg SHO Pilot. The purpose of the roundtable was to evaluate the pilot project for its success in creating greater trading efficiency by suspending price restrictions on short-sale orders – the Uptick Rule - on a set of “pilot” stocks. See the post “On the Calendar” for my advance review of comments received from interested parties.

The day before the meeting the SEC released its own analysis of the pilot project entitled “
Economic Analysis of the Short Sale Price Restrictions Under the Regulation SHO Pilot.”

One of the conclusions of SEC's study is that “…some short sellers are routing orders to avoid price restrictions.” While this may not be news to active traders, some of the other conclusions of the study are eye-openers. For example, for Nasdaq National Market listed securities, “downbid” occurrences decline when the bid test required by the Uptick Rule is suspended.

Indeed price restrictions inhibit the free movement of stock prices, i.e. reduce liquidity. This puts short-sellers in the position of liquidity suppliers. Nonetheless, by comparing stocks in the Pilot Project with those to which the Uptick Rule still applied, the study found that “realized” liquidity is unaffected by price restrictions.

Another surprise is the Uptick Rule may cause stocks to be slightly overvalued. The SEC staff reached this conclusion by comparing stocks in the Pilot Project with stocks for which the price restrictions still applied.

Of course, one of the original purposes behind the Uptick Rule was to prevent “bear raids,” i.e. manipulation to drive prices down to their true values. Surprisingly, after three different tests, the SEC study found little evidence to support this hypothesis.

The study holds other conclusions, making the eighty-eight page document worth your time to read.

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