Tuesday, September 16, 2008

Pining for the Uptick Rule

In July 2007, the Securities and Exchange Commission eliminated the Uptick Rule, which required short sales of stocks at a price above the preceding sale. The rule had been in effect since 1938, and for all financial professionals was an accepted way of preventing market manipulation.

In 2004 the SEC staff conducted a study aimed at finding out whether the practice was effective in preventing the so-called “bear raid.” The conclusion was that the Uptick Rule no impact on manipulation and in fact it reduced in liquidity. The SEC under Chairman Cox was eager to do away with the rule and so out the door it went.

There are many, including me, who believe that study was a whitewash for a commission bent on making the rule change no matter what. Keep in mind the study was completed during a bull market when there was plenty of liquidity and during a period with the housing market was climbing to its peak. It was hardly an objective, vigorous appraisal. I will stop short of pointing a finger of blame at the hedge fund lobby or a Republican administration keenly interested in keeping the country focused on prosperity and not on the very expensive, failing wars in Iraq and Afghanistan.

One year later, short-selling has escalated dramatically as one story of bad news after another has scrolled across stock quote machines in trading rooms around the world. There was some suspicion that unscrupulous short-selling and rumor mongering could have led to the demise of Bear Stearns. Lehman may have been under similar pressure in the hours before it declared bankruptcy. Merrill Lynch had to scramble to get ahead of the steam roller that is roaring down Wall Street.

The Uptick Rule needs to be reinstated to serve as a circuit breaker against free-for-all trading activity. There are many other rules of this sort in place on trading floors around the world, such as the NYSE trading halts in the events of 10% and then 20% drops in the Dow Jones Industrial Average. The idea of such trading halts was to limit the damage of destabilizing program trading schemes.

In the same manner the Uptick Rule just allows time for the flow of information to catch up with trading action. It allows the voracity of information to be confirmed before more trading occurs.

The Uptick Rule was reinstated temporarily for certain financial stocks earlier this year, but the SEC has made no move to take up the topic again. Investors will need to lean hard on the SEC to get any action. At least one influential law firm has already weighed in with a memo sent to clients in July 2008, in which the firm noted record levels of abusive short selling and urged the SEC to reinstate the Uptick Rule.

It is going to take a great many more “urgent” letters and phone calls. You can find contact information for the SEC on its web site. I suggest you send Chairman Cox a note.

1 comment:

Anonymous said...

The removal of the uptick rule by the SEC escalated the loan share program known as NAKED SHORTING - -trillions of ILLEGAL COUNTERFEIT SHARES by hedge funds since 2000 electronic market trading started - with the SEC hiding the massive cheat on public investors - A MARKET WITHOUT SHARE INTEGRITY CAN ONLY FAIL - as crooks run off with all the money -IMO

HH