THE CONTINUING CONTROVERSY OVER SHORT SELLING
The subject of short selling tends to create controversy. Since at least the abolition in 2007 of the 1930s era uptick rule which was designed to curb abusive short selling, the debate has continued over the merits of short selling. The SEC’s temporary restrictions on the practice as the market crisis unfolded in 2008 for example, provoked strong opinions on both sides of the debate. Since then, the Commission has taken a number of steps regarding short selling.
The tradition of controversy continued this week at the Commission’s open meeting which resulted in the adoption of the “alternative uptick” rule by a 3-2 vote. The Chairman and other members of the SEC such as Commissioners Walter and Aguilar favored adoption of the rule. Commissioners Paredes and Casey on the other hand did not. Each side claimed that investor confidence supported their position. Neither side could definitively prove its point. The new rule, however, is in effect.
The new alternative uptick rule is well summarized in the open meeting remarks of Chairman Schapiro. Briefly, the rule would go into effect when a “circuit breaker” is tripped. That happens where the price of a security declines by 10% or more from the close of the previous day. In that instance, the “alternate uptick rule” goes into effect for the balance of the day and the next. The rule applies generally to all securities traded on a national securities exchange, as well as those in the over-the-counter markets. It also requires traders to establish and maintain certain procedures designed to aid implementation and enforcement of the rule.
Chairman Schapiro endorsed the rule as a product of the market crisis. While short selling clearly has benefits, it also can be destabilizing to the markets, she noted. The new rule will prevent manipulation and, when the circuit breaker is tripped, put long traders at the head of the line according to Ms. Schapiro. Commissioner Aguilar echoed Ms. Schapiro’s support for the rule while prodding Congress to move forward with market reform and fill the gaping hole in current regulation regarding swaps.
Commissioner Walter found the decision most difficult, but ultimately supported the rule as a measured response. After noting that she has been intensely lobbied by both sides of the short selling debate, Ms. Walter went on to state that while short selling can be very beneficial to the markets, it can also have detrimental effects. The numerous studies of those effects are, at best, “mixed” according to the Commissioner. Accordingly, she would not favor short sale restrictions on a market wide basis. Since the rule being adopted is measured and only applies in certain limited circumstances – when the circuit breaker is tripped – Ms. Walter favored adoption.
In contrast, Commissioner Tory Paredes offered a lengthy dissent from the adoption of the rule. In essence, Commissioner Paredes argued that there is no evidence that adopting the rule would bolster investor confidence in the markets, which is one of the main rationales offered in support of the rule. Rather, the Commission is being inconsistent at best with the adoption of this rule according to Mr. Paredes. On the one hand, it has lengthy studies which supported dropping the initial version of the uptick rule. Now, however, it is adopting a modified version of that rule despite the fact that little has changed since the old rule was disregarded. The market crisis, according to Commissioner Paredes, did not change this fact.
In sum, Commissioner Paredes argued: 1) short selling is essential to proper market functioning and price discovery; 2) there are already sufficient restrictions in place; 3) the prior empirical research which supported dropping the old uptick rule is still valid; and 4) the adoption of the rule will be costly in terms of its implementation and its potentially negative impact on proper functioning markets, price discovery and investor confidence.
By the end of the Commission’s open meeting two points were clear: First, the rule was adopted. Second, both sides claim that investor confidence is critical to their position, despite what Commissioner Walter called the “mixed” results of the studies. In the end, there is little doubt that the controversy regarding the impact of short selling will continue.