Keith Fitz-Gerald

A Day Late and $2 Trillion 'Short'

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Undoing the Uptick Rule

On July 6, 2007, in its infinite wisdom, the SEC eliminated the so-called "uptick" rule. Citing a 2004 study by the SEC's Office of Economic Analysis, academic researchers concluded that the uptick rule "modestly reduced liquidity and does not appear necessary to prevent manipulation," the SEC rescinded the order.

Since that fateful ruling, as a look at any trading chart will show you, the markets have largely been on a one-way trip -- south. That's led the SEC to conclude that it didn't like the fact that -- absent the uptick requirement -- investors and traders can utilize unlimited short orders any time they feel like it. In short, they realized they opened the door to the abusive short-selling of stocks.

Ostensibly, the SEC is worried about price manipulation and so-called "short attacks," where hedge funds and other investors can boost their own short-selling profits by ganging up on weak companies and driving their prices lower.

While I laud the SEC's concerns, the current rule change is both a day late, and about $2 trillion short.

It's not like SEC's experts didn't see this coming and it's not like potentially unlimited short selling was some sort of revelation after the dust settled two days ago. SEC insiders had to know this was happening. What's more, they've known it was going to happen – since 1938.

Still, as we study the fallout from this past week's near-collapse of the financial markets, it's worth looking at the newest changes as they affect short selling.

The Short-Selling Ban

On Friday, Sept. 19 , the SEC issued an emergency order banning the short selling of 799 individual stocks through midnight Oct. 2. The SEC reserved the right to extend the ban, but promised it would not stay in place longer than 30 days.

In the United Kingdom, the Financial Services Authority put a similar ban in effect on Thursday, Sept. 18.

The SEC said the move was needed "to protect the integrity and quality of the securities market and strengthen investor confidence."

"The commission is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets," said SEC Chairman Christopher Cox, according to a MarketWatch report.

"The emergency order temporarily banning short selling of financial stocks will restore equilibrium to markets. This action, which would not be necessary in a well-functioning market, is temporary in nature and part of the comprehensive set of steps being taken by the Federal Reserve, the Treasury and the Congress," he added.

In addition to the ban, the SEC has also required money managers to disclose their short positions in the securities affected by the ban. The securities agency also eased restrictions in order to make it easier for a securities issuer to re-purchase its own shares, which the SEC feels will restore liquidity to the market.