June 19, 2009
My comments in favor of restoring some type of uptick rule:
I have read a lot of the comments, and a substantial number of
arguments against bringing back the uptick rule are based on
statistics based on market averages, despite the fact that the
most destructive impact is on individual stocks. Other comments
cite a study made only during a big up move in the market. (But if
you want to see whether the roof leaks, it's wise to look during a
rainstorm.)
Many seem to lose sight of the fact that the primary purpose of
a securities market in the first place is for capital formation.
Securities represent real, actual things. Derivative plays such as
short selling, options, and the like, are all based on the prices of
real, actual things but do not represent ownership of anything.
As far as I'm concerned, the gamblers are welcome to play,
but only until the tail begins to wag the dog.
It can be a free market without providing unlimited rights for
people to sell what they don't own.
I've read arguments that short sellers provide needed liquidity.
These arguments ignore the fact that the only time this liquidity might
be needed is when there is a shortage of sellers (i.e., the price is
moving up). When the price is moving down, there are plenty of
sellers, and short selling at this point just creates an even greater
need for more buyers, the opposite of what would be desired.
The uptick rule permitted short selling whenever its liquidity
would have been helpful.
I've read that it's not fair to have different rules for short
sellers than for buyers, and that buyers can also act to excess.
Buyers, though, are analogous to long sellers, and no one is trying
to restrict long selling. Also, both buyers and sellers of long
positions are limited by the cash or securities they actually possess,
while short sellers have no skin in the game and are only limited by
the quantity they can borrow. Unfortunately, the large players can
keep borrowing and shorting enough to virtually ensure that the
price won't move against them.
Much of the borrowing, I think, is not even from willing lenders.
All brokers require margin account holders to agree to lend their
securities, and then the brokers lend out the securities (and keep
any fees). If given a real choice, most of the beneficial owners
of securities would not be lending them out for free.
Even if short selling doesn't change the level to which a stock price
plunges, it gets it there faster, and holders of long positions will
lose more. I think it's important to remember that every dollar made
by someone shorting Enron was another dollar lost by those who bought
Enron stock.
I am not trying to argue against ALL short selling, but it does
not seem to be appropriate when the stock is moving down. That is
precisely what the old uptick rule addressed.
However, NAKED short selling prohibitions should be more strongly
enforced. I would like to see failure to deliver have real economic
consequences. I suggest that upon failure to deliver, NO extension
is granted. The short sale is canceled, and if there were losses,
the naked seller must keep them, but if there were gains, they are
forfeit, to be distributed ASAP equally among long sellers
who sold during the period between the short sale and the failure to
deliver.
A few specific comments for the new rule:
First, the "tick size" doesn't have to be the same as the trading
increment. Some have argued that with stocks trading in pennies,
the ticks are too small. Yet with computers, it's easy to have
ticks based on nearest nickel or dime while the stock trades in
increments of 1 cent. (And the "tick size" could be a function of
stock price as well, if desired.)
Second, I think it best if sales of long positions would ALWAYS be
filled before short sales at the same price, regardless of arrival
time of the order or size of the order.
Third, I don't think that a test against best bid should be used.
A stock could trade at 10.52, then at 10.51, then bids fall to 10.50,
10.49, 10.48, 10.47 (all with no trades). The bid going back to 10.48
shouldn't signal an "uptick." That should await a trade at 10.52
(which will permit shorting at 10.52 or higher).
A "circuit breaker" rule doesn't really address the issues which
an uptick rule does, although I would, however, be willing to see the
uptick rule waived for stocks trading "up on the day" (i.e., higher
than, say, the 3:00-4:00 average price from the previous day, not just
the "closing" price, which can sometimes be out of line with reality).
If a circuit breaker were imposed IN ADDITION to an uptick rule,
that would also be fine with me, although I don't think it would
be as necessary.