Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Wednesday, February 24, 2010

SEC Adopts New Restrictions on Short Selling

Short selling is a convenient scape goat for market volatility and downward spiraling of stock prices, so it was to be expected that the SEC would adopt new restrictions on the practice, which it did at today's open meeting.  The SEC's new rule will place certain restrictions on short selling when a stock is experiencing significant downward price pressure and is intended to promote market stability and preserve investor confidence.  According to SEC Chair Mary Schapiro, "the rule is designed to preserve investor confidence and promote market efficiency, recognizing short selling can potentially have both a beneficial and a harmful impact on the market.  It is important for the Commission and the markets to have in place a measure that creates certainty about how trading restrictions will operate during periods of stress and volatility."

This alternative uptick rule (Rule 201) is designed to restrict short selling from further driving down the price of a stock that has dropped more than 10 percent in one day. It will enable long sellers to stand in the front of the line and sell their shares before any short sellers once the circuit breaker is triggered.  Rule 201 imposes restrictions on short selling only when a stock has triggered a circuit breaker by experiencing a price decline of at least 10 percent in one day. At that point, short selling would be permitted if the price of the security is above the current national best bid.

Commissioner Paredes dissented with a thoughtful statement:

 My comments center around two related themes. First, the essential rationale behind the rule is that the short sale restriction, if implemented, will bolster investor confidence. This claim is rooted in conjecture and is too speculative to form a properly cognizable basis for adopting the alternative uptick rule. Indeed, a more thorough analysis indicates that the rule amendments are just as likely, if not more so, to erode investor confidence instead of boosting it. Second, there is an insubstantial empirical basis to support the Commission in adopting the rule, especially in light of the rigorous economic analysis that led the SEC to repeal the “original” uptick rule in 2007 after years of study. The Commission bears the burden to justify its rules. It has not done so in this instance.

Rule 201 includes the following features:

Short Sale-Related Circuit Breaker: The circuit breaker would be triggered for a security any day in which the price declines by 10 percent or more from the prior day's closing price.

Duration of Price Test Restriction: Once the circuit breaker has been triggered, the alternative uptick rule would apply to short sale orders in that security for the remainder of the day as well as the following day.

Securities Covered by Price Test Restriction: The rule generally applies to all equity securities that are listed on a national securities exchange, whether traded on an exchange or in the over-the-counter market.

Implementation: The rule requires trading centers to establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent the execution or display of a prohibited short sale.

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Alternative to circuit breakers on short sales may include a restriction that the clearing house must prioritize longs over shorts on a daily basis. The shorts can trade to the limit of the circuit breaker.

Posted by: chris beckman | Apr 19, 2010 7:47:19 AM

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