Kyle Siskey
Staff writer
The Securities and Exchange Commission (SEC) is changing its tune on the up-tick rule decision from 2007 in the face of a plunging stock market. Chairman Mary Schapiro told a House Appropriation Subcommittee on March 11 she plans to reinstate Rule 10a-1, usually referred to as the up-tick rule, after discussions on "short-sale price tests" scheduled for April 8.
"The Commission will consider other steps necessary to eliminate manipulative and illegal activity in our markets, and limit market volatility," said Schapiro. While Schapiro didn't name the up-tick rule specifically, an SEC press release does confirm the Commission's meeting. And Elizabeth King, Associate Director in the Division of Trading and Markets, confirmed a month earlier to the Security Traders Association of Chicago that the up-tick rule is the SEC's target in price-test rules.
"The SEC's political critics want to limit short selling," says one former SEC regulator. "This isn't going to stop short selling altogether; it's just going to prevent the precipitous decline in stock prices."
Lawyers agree with Schapiro. In IFLR's monthly survey of former regulators, in-house counsel and private practice, 88% want the rule reinstated in some fashion. "Right now, it's the best tested rule that exists to curb piling-on short sales," says one New York lawyer. "In the long term we need a study to determine if it's the right rule, but with stock prices continuing to fall, we need something now."
Still, other lawyers cite the SEC's 2007 elimination of the rule and the extensive research and comment period it had before then as a reason not to bring the rule back. "Some people blame the lack of an up-tick rule for economic failure," says another New York partner. "The rule's disappearance just happened to coincide with the bad economy. It's not the reason."
Should the SEC bring back the up-tick rule? |
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The up-tick rule was first enacted in 1938 to prevent a herd mentality in short selling. The rule requires an up-tick in stock prices before a short sale. It prevents short sellers from repeatedly shorting stock to drive prices down based on market value. It is meant to ensure that stock prices are based on company performance.
In 2004, the SEC launched a one-year pilot programme suspending the up-tick rule in order to determine its effectiveness. The programme showed there was no use for the rule because its elimination had no effect on US stock prices.
It was eliminated on July 3 2007 after the SEC received 27 comment letters calling for its removal. "The proposed amendments were designed to modernise and simplify short-sale regulation and, at the same time, provide greater regulatory consistency by removing restrictions where they no longer appear effective or necessary," the SEC said at the time.
The tests and letters the SEC based its elimination on, however, did not account for the market conditions of 2008 and 2009. "Today's markets are completely different," says one New York attorney. "It's all untested waters."
The April 8 meeting will put the SEC ahead of congressional legislation that calls for the rule's immediate re-introduction. The rule will likely come back with some adaptation from the 1938 version. "The challenge for the SEC will be how it puts the rule in place and what new constraints come with it," says one private-practice partner. "The SEC had better pre-empt Congress on this one so it can make a more flexible rule than the last one."
One of the proposed bills by senator Ted Kaufman from Delaware requires a five-cent up-tick for financial institutions – a direct reaction to markets in 2008. "I'd be interested to see how the SEC will play this," says one New York counsel. "These bills are there to force the SEC's hand. I'd bet there is a good chance the SEC will beat Congress to it."
Another fundamental change will surround what the SEC considers an up-tick. Since the rule's introduction, shares have ceased selling at fractions and moved into decimals or cents. The new rule would have to take this into account.
But the rule's return in any form is still widely praised by the legal community. "In this market, it's probably a good thing to bring it back," another former regulator says. "You could never create a downward spiral if the rule was in place. People couldn't jump on the stock because it wouldn't have an uptick once that bandwagon started rolling."