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April 21, 2009

On or Off, Uptick Rule Brings Modest Results

Catherine New
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The SEC announced on April 8 that it is considering reimposing the uptick rule to limit short selling. The old uptick rule prohibited short sellers from trading in a stock at a price lower than the most recent reported transaction. The concern was that without an uptick rule, short sellers might manipulate a stock by selling aggressively and repeatedly, driving stock prices below fundamental value. The SEC has now proposed five different types of possible rules for comment.

Professor Charles Jones says that while a resurrection of the rule will likely reverse the increase in shorting activity that occurred after the rule was repealed in 2007, its impact will be limited.

“No matter what new rule the SEC chooses, it will be a reversal of what we saw in 2007 when they took it off, and we will see modest effects,” says Jones. “It won’t magically raise stock prices. We will see a modest decline in the amount of shorting, but I don’t think it will be more than a minor nuisance for long-term, fundamental shorts.”

Jones’ research (PDF) on the July 2007 repeal of the uptick rule showed that there was a slight increase in shorting after the repeal. However, Jones says that the bout of market volatility that occurred in August 2007 was not related to the repeal.

“A lot of people think that because the volatility episode was so close on the heels of the repeal the two were related in some way,” says Jones. “But there are two problems with that. First, it didn’t happen right away. The volatility was in August, a full month after the uptick rule was removed.

“Second, when we dig in and look at what happened in that volatile period, it doesn’t look like the short sellers are to blame,” he says. “We have detailed, proprietary data from the exchanges on all shorting activity. They are not piling on stocks that went down. It doesn’t look like they are conducting bear raids or being abusive or pushing prices around in any way. When all is said and done, it doesn’t look like shorts were contributing to this volatility in any way.”

Photo credit: kevingessner