Thursday, April 9, 2009

Would New Rule Ease Stock Drops?

Would New Rule Ease Stock Drops?
SEC Proposes Reinstating Uptick Rule to Rein in Short Selling
WASHINGTON, April 8, 2009

Short selling is commonly defined as the practice of selling borrowed stocks, and then attempting to purchase them later at a lower price, thereby profiting from the drop in price.

SEC chief Mary Schapiro warned at this morning's open meeting in Washington that "Short selling may also be used to illegally manipulate stock prices. ... In addition, unrestricted short selling can exacerbate a declining market in a security.

"In the past 18 months, we have seen every major stock market around the world experience steep declines and extreme volatility in securities prices," she said. "Although we are not aware of specific empirical evidence that the 2007 elimination of short sale price tests contributed to this volatility in the U.S. markets, many members of the public have come to associate short selling with that volatility, and with a loss of investor confidence."
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To address the problem, the SEC today made five proposals, including reinstating the uptick rule, which makes short sellers wait to sell shares until a stock trades at least a penny above its previous trading price.

"This is a very good rule," said Hugh Johnson, chairman of Johnson Illington Advisors in Albany, N.Y. "It's very favorable, it's very positive, but it's long overdue. It prevents aggressive speculators who don't even own the stock from selling the stock or driving it down without any constraints or limitations or rules."

The uptick rule was originally established in 1938 during the Great Depression as a reaction to the stock market crash of 1929, but the SEC repealed it about two years ago.

"It caused a lot of problems," Johnson said of the rule's absence. "If you continue to drive the price of, say, Citigroup, down, that's got to scare the depositors and short-term lenders. They start to ask the question 'Will this company stay in business?' And if their answer is, 'Well, I'm not sure,' then as a depositor you may pull your money and as an investor or short-term lender you may refuse to roll over your loans to Citigroup, which puts Citigroup in a very tough spot."
The New Uptick Rule

Today's five proposals also include another version of the uptick rule and three versions of a kind of "circuit breaker" for stock prices.

The variation of the uptick rule, known as the upbid rule, would make short-sellers only able to come in at a price above the existing highest bid for the stock.

The "circuit breaker" variations would be like a "time-out," halting short-selling on a stock for a period of time, such as the remainder of a trading day, when there is a severe decline in its price.

The new uptick rule would be broader than the old one because it would now apply to stocks traded on all exchanges, rather than only the New York Stock Exchange, as with the original rule did.

"It's about time," Johnson said of the proposals. "It's almost as though, like a lot of regulation, it comes after the crisis, not when it should come, which is before or at least during the crisis."

After this morning's vote, the five new SEC measures now get posted for 60 days of public comment before any final rules are applied or implemented, so it will be months before any proposal ultimately takes effect.

Along with last week's changes to the mark-to-market accounting rule by the Financial Accounting Standards Board, today's uptick rule changes will come as welcome news to the markets.

"You can't quantify how much of a part of this crisis they were but, at a minimum, you can say they aggravated the crisis and that's really putting it very politely and very mildly," Johnson of Johnson Illington Advisors said. "The crisis was worsened by the failure of SEC to change the uptick rule and the failure of the FASB to change the mark-to-market rule. These guys just didn't respond to the crisis."