Uptick Rule, Plus Frills

Story Highlights:

• The SEC announced on Wednesday it's considering reinstating the uptick rule and several other proposals to limit short selling.
• There's nothing wrong with short selling. But reinstating short-selling curbs could help prevent "bear raids" and likely wouldn't be a material negative.
• Simply reinstating the uptick rule seems the most straightforward way to go, but it'll be some time before things are concrete.

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Can repackaging an old product make it more appealing? The folks at the Securities and Exchange Commission (SEC) seem to think so. Hence the announcement Wednesday they are considering reinstating the uptick rule and several other proposals to limit short selling.

The uptick rule isn't new. Before being shelved in July 2007, it had been in place continuously since 1938. The uptick rule requires a stock price to move higher before the stock can be sold short. But studies deemed the 70-year old rule irrelevant in today's fast-paced electronic markets, so the uptick rule was scrapped.

Last year's financial panic and violent market dives called that view into question, and now lawmakers are pressing the SEC to reconsider reinstatement. The SEC is fully aware of the uptick rule's ardent detractors and, perhaps in a bid to gain broader acceptance, is offering dressed-up versions.

A brief summary of the SEC's proposed short-selling curbs:

1. Reinstate the uptick provision removed in 2007.
2. Instate an "up-bid" rule. This rule would allow short sales only after a potential buyer bid at least a penny more than the previous share price. This differs from the uptick rule because it allows a short sale after a higher bid rather than higher sale price.
3. A circuit breaker that would altogether ban short selling a stock for the rest of the trading day if the stock fell 10%.
4. A circuit breaker that would trigger the uptick rule for a particular stock for the rest of the trading day if the stock fell 10%.
5. A circuit breaker that would trigger the "up-bid" rule for a particular stock for the rest of the trading day if the stock fell 10%, only allowing a short sale at a price above the highest available bid.

There's nothing wrong with short selling. In fact, the ability to sell shares short helps investors control risk, increases market liquidity, and improves price discovery. But unfettered short selling can result in "bear raids," which can have market-wide implications if the targeted company has systemic importance (think Lehman Brothers in 2008). Banning short selling altogether could have very negative implications, but reinstating short-selling curbs likely wouldn't be a material negative and could help prevent cascading short sales on specific companies from affecting the entire market.

Simply reinstating the uptick rule seems the most straightforward way to go. It worked for 70 years without any observable damaging effects on the markets or economy. The "up-bid" rule is a nuanced version of the uptick rule, and the circuit breaker approaches seem unnecessarily complicated. Inhibiting short selling won't prevent another bear market—after all, a dozen or so bear markets occurred while the uptick rule was in place. But preventing normal bear markets isn't the goal, so perhaps there's no need to over-think and over-dress this issue.

The SEC is allowing a 60-day public comment period, and the new rules will likely take months to approve. It'll be some time before things are concrete. Frills are nice when it comes to autos and air travel, but when it comes to government rules, simpler is often better.