The Market Crisis, Short Selling And The Uptick Rule

Earlier this year, the SEC lifted its ban on short selling without restoring the “uptick” rule which it abolished over a year ago. Last summer the SEC initially imposed a ban on short selling in the securities of certain financial institutions as the market crisis began to unfold as discussed here. That ban was later expanded and disclosure obligations were added, as discussed here. At the beginning of October however, the SEC lifted its short selling ban (here).

All of these actions followed the termination of the uptick rule last year. That rule essentially prevented short sellers from piling on as the price of a security tumbled down – a short sale could only be made when the price was going up or on an “uptick” in the price. The SEC concluded that the depression era rule was unnecessary.

While other market regulators, such as the UK’s Financial Services Authority joined the SEC in its market crisis short sale ban, all of those regulators did not agree with the Commission’s decision to lift the ban. The UK’s ban, and that of others, is still in place as discussed here.

Now, there are reports that financial institutions are lobbying the SEC to bring back the uptick rule. Citi, whose shares have been trading at penny stock levels, and others are apparently concerned that short sellers will push their share price even lower. According to some reports, short sellers significantly contributed to the demise of Bear Stearns. Others, such as the SEC’s inspector general (discussed here), seem to suggest different theories for the demise of the one-time Wall Street giant.

Regardless of the merits of the debate Bear Stearns, it is clear that executives on Wall Street are concerned about the impact of short selling. SEC Chairman Cox has in recent weeks called for additional regulation in view of the market crisis. To date, however the SEC has not indicated whether it will reconsider its position on the uptick rule.

DC Circuit Affirms Permanent Bar Against Investment Advisor

On Friday, the D.C. Circuit rejected claims by an investment advisor that an SEC order permanently barring him from future association with any investment advisor should be overturned. The order, entered in an administrative proceeding, was based on findings by a district court in an enforcement action. In affirming the Commission order, the D.C. Circuit held that “disproportionate penalties are irrelevant to the appropriateness of a sanction if the sanction is within the SEC’s discretion.” Seghers v. SEC, Case No. 07-1478 (D.C. Cir. Nov. 21, 2008).

Appellant Conrad Seghers had been named as a defendant in an SEC enforcement action. There, the Commission claimed that he participated in misrepresentations made to investors in three hedge funds. Specifically, the complaint claimed that the value of the three funds was significantly overstated. Mr. Seghers, who acted as an investment advisor, knew that they were overstated. Nevertheless, he sent investors a letter stating that there were positive developments concerning the funds.

After a jury trial, the court entered a permanent injunction prohibiting future violations of the securities laws by Mr. Seghers and imposed a fine. The court refused an SEC request for disgorgement since Mr. Seghers also lost money in the funds. The Fifth Circuit rejected an appeal by Mr. Seghers while this case was pending.

Subsequently, the Commission initiated an administrative proceeding against Mr. Seghers based on the findings in the enforcement action. Both sides moved for summary disposition. The ALJ granted the Division’s motion, which was based on the district court findings and rejected Mr. Seghers’ motion, which was supported by affidavits.

Before the D.C. Circuit, Mr. Seghers claimed that there were material factual issues which precluded summary disposition of the administrative proceeding. These issues were based on his affidavit in which he essentially disputed the factual findings of the district court in the enforcement action. The court rejected these arguments, concluding that the points raised did not constitute material factual disputes.

The court also rejected the claim by Mr. Seghers that a permanent bar was a disproportionate sanction for a first time offender where the conduct was not that severe. Citing the Supreme Court’s decision in Butz v. Glover Livestock Comm’n Co., 411 U.S. 182, 187 (1973), the court noted that an “administrative sanction is ‘not rendered invalid in a particular case because it is more severe than sanctions imposed in other cases.'” Indeed, the court noted that disproportionate penalties are irrelevant to the appropriateness of a sanction as long as the Commission is authorized to impose the particular sanction.

Finally, the court rejected claims that the SEC failed to sufficiently articulate reasons for the permanent bar. The SEC noted that it considered the egregiousness of the defendant’s actions, the degree of scienter involved and the sincerity of defendant’s assurances against future violations. These facts, coupled with a finding that Mr. Seghers did not adequately understand his duties as an investment advisor, are sufficient, the court concluded.