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Regulator to weigh return of uptick rule

Short-sellers unfazed by the possibility of more regulation, see move as sign of times

Apr 5, 2009 @ 12:01 am

By Jeff Benjamin

Short-sellers could find themselves back in the spotlight when the Securities and Exchange Commission meets Wednesday to consider reinstating the controversial uptick rule.

The rule, which prohibits a short sale unless the share price is higher than the last trade, was repealed in July 2007. The move to reinstate the rule comes as investors who bet against stock prices increasingly are blamed for exacerbating the stock market's downward spiral.

Short-sellers, meanwhile, which include hedge funds, institutional investors and independent traders, dismiss the likely reinstatement of the decades-old rule as part and parcel of the push by regulators and politicians to find an easy scapegoat for the economic crisis.

"Right now, people are looking for places to point fingers, and hedge funds and short-sellers are on the short list," said Lee Schultheis, founder and chief investment officer of Alternative Investment Partners LLC. The White Plains, N.Y., firm has $270 million under management.

Last month, NYSE Euronext Inc. and The Nasdaq OMX Group Inc., both of New York, proposed a modified version of the uptick rule, one they said that would put less burden on short-sellers and be easier to implement and execute.

Regardless, many short-sellers are unfazed by the possibility that the rule will be reinstated. That in part stems from the fact that many had found ways to skirt the rule when it was in place.

"With the way we trade and what we trade, the uptick rule didn't change much of how we do things," said Geoffrey Gerber, president of Twin Capital Management Inc., a McMurray, Pa.-based hedge fund firm with $560 million under management.

The uptick rule, which was implemented in 1938 by then-SEC Chairman Joseph Kennedy, required that a stock move upward in price by at least 1 cent before it can be sold short. The rule was designed to prevent market manipulation and "bear raids," during which short- sellers would chase a declining stock, thus accelerating the decline.

The main reason that short-sellers, including much of the $1.2 trillion hedge fund industry, aren't up in arms over talk of reinstating the rule is because the evolution of technology and other rule changes during the past seven decades essentially diluted the effectiveness of the rule, according to industry sources.

Since February 2001, for example, when trading switched from fractional shares to pennies through decimalization, short-sellers have had little trouble creating an uptick on a stock that they wanted to sell short.

"You just buy 100 shares for the uptick in order to short 1 million shares," said Charles Crow, partner at Princeton, N.J.-based law firm Crow & Associates.

Proponents of reinstating the uptick rule are overlooking how difficult the rule is to enforce, said Mr. Crow, who last week published a research paper on the rule.

"It's very hard to enforce this rule with exchanges all over the world and decimalization having Balkanized the markets," he said. "Who is keeping the comprehensive tape of all transactions worldwide?"

SEC spokesman Kevin Callahan declined to comment on the possible reinstatement of the rule.

No matter what happens this week, some traders have figured out ways to sidestep short-selling rules.

One method involves selling a call and buying a put — creating what is called a "synthetic short" position.

Then there are exchange traded funds that short indexes.

The ProShares Short S&P500 (SH), for example, shorts the Standard & Poor's 500 stock index. Shares of the ETF gained 38.8% last year, compared with a 38.5% drop in the index.

The ETF is run by ProShare Advisors LLC of Bethesda, Md.


"I saw the repeal of the uptick rule in 2007 as a non-event, and having traded during that period, I didn't mind the rule," said Mark Hill, who worked as a trader for various Wall Street brokerage firms from 1983 through 2007.

He is co-principal of G2 Systems LLC, a Boston-based financial services industry consulting firm.

"Unless you've only been in the business for the past 18 months, this [reinstatement of the uptick rule] is just going to be back to the future for traders," Mr. Hill said.

Even some proponents of reinstating the rule see it as too weak and difficult to enforce.

"If I was the SEC, I would make the uptick requirement 10 cents instead of a penny, because with decimalization, reinstating the rule will not make any difference," said Charles Gradante, co-founder of Hennessee Group LLC, a New York-based hedge fund advisory firm.

The SEC repealed the rule after its own 2005 study showed that the uptick requirement had a negligible impact on stock prices.

At this point, most short-sellers are more concerned about more extreme regulatory moves, including the temporary ban on shorting financial-sector stocks when the stock market started dropping in September.

Academic studies found that the price of the "protected" stocks actually declined more than did the overall market during the short-sale-ban period.

"Short selling is not the enemy, which is why the uptick rule is just a solution in search of a problem," Mr. Crow said. "Anything that looks like an impediment to the evil short-sellers is considered to be a good thing, but if the markets are really about fairness and price discovery then let the short-sellers drive the price down, and I'll just go in and buy more stock."

E-mail Jeff Benjamin at jbenjamin@investmentnews.com.


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