Statement Before the Commission Open Meeting
Commissioner Kathleen L. Casey
U.S. Securities and Exchange Commission
I want to join Chairman Schapiro in commending the Division of Trading and Markets staff for their tremendous efforts in preparing this release for us today. Drafting these proposals was a challenging assignment on many levels and the Division has produced a document that is both extraordinarily well written and meticulously balanced. In particular, I would like to recognize Tory Crane, the primary drafter, and Josephine Tao, for their outstanding work. I would also like to thank the offices of Economic Analysis and General Counsel for their contributions.
April 8, 2009
As the chairman noted, this is Erik Sirri's last open meeting as the Director of the Division of Trading and Markets. His departure is a huge loss for the Commission, and he will be very difficult to replace. I've thoroughly enjoyed working with Erik the past few years, and have greatly benefited from his exceptional intellect and steady and wise counsel. He is exactly the type of person this agency must attract and retain in order to meet the significant challenges of 21st century markets. So, thank you, Erik. I am deeply grateful for your tremendous service.
In June 2007, all five members of the Commission, myself included, unanimously voted to repeal the uptick rule, which was adopted in 1938. We did so after the Office of Economic Analysis conducted an exhaustive eight-year review of the rule, initiated with the publication of a concept release in 1999 that sought public comment on short sale price test regulation, including whether to eliminate such restrictions. The OEA review included a Pilot Order to temporarily suspend price tests in pilot stocks for one year so that the Commission could study the effectiveness of these tests. OEA gathered the data made public during the Pilot, analyzed this data, and provided the Commission with a summary report on its findings.
OEA found that removing price tests had a material effect on short selling volume, the mechanics of short selling, order routing decisions, displayed depth, and intraday volatility, supporting the view that eliminating the price tests would reduce these market distortions. The study also tested for signs of "bear raids," but found no indication that removing the price tests was associated with increased market manipulation. In addition, the Commission encouraged outside researchers to examine the Pilot. In response to this request, the Commission received four completed academic studies that specifically examined the Pilot data. The Commission also held a public roundtable that focused on the empirical evidence obtained from the Pilot data. Generally, the data supported eliminating the uptick rule, which the Commission then proposed to do. We received 27 comment letters on the proposal, most of which supported removing all price test restrictions. Only one commenter questioned the economic evidence supporting the elimination of the uptick rule.
Importantly, OEA's conclusions in 2007 reflected the general consensus of thirteen other analyses of price test restrictions conducted by SEC staff and various third party researchers between 1963 and 2004. Among these were several studies that evaluated short sale price tests during times of severe market decline, including the market break of May 28, 1962, the market decline in September-October 1976, the market break of October 19, 1987, and the Nasdaq market decline of 2000-2001.
The recent global financial crisis, triggered by the bursting of the housing bubble and marked by extreme market volatility and the largest decline in stock prices since the 1930s, has led some to attribute this deterioration of market conditions to manipulative short selling. In response to concerns about certain practices, the Commission adopted significant and dramatic measures last year, including two emergency orders which sought to limit or prohibit the ability to short certain financial stocks, and rules tightening the close-out requirements of Regulation SHO and prohibiting manipulative short selling.
Despite these efforts, there are still some investors, issuers, traders, Members of Congress, trade associations, market commentators, and others who believe the Commission needs to take additional action. These groups have suggested to the Commission that one way to address declining stock prices and restore investor confidence is to reinstate the old uptick rule or some other kind of short selling restriction.
This clamor for action raises an obvious threshold question: Has the repeal of the uptick rule had anything to do with the economic and market conditions of the past 18 months?
From the empirical studies that we have seen to date, I have not yet been persuaded that the answer is yes. But that is one of the critical questions we are asking today by issuing these proposals for public comment, debate, and additional analysis. Fundamentally, the proposals before us today ask whether abusive short selling, or short selling generally, has played a contributing role in the market's recent volatility and decline.
As the chairman and division staff have already described, we are proposing two approaches to restricting short selling: the first approach would impose either a market wide bid or tick test, and the second would impose some type of circuit breaker. I commend the staff for soliciting comments on almost every conceivable question relating to this debate.
Given the intensity of public interest in the function of short selling in the markets, I will vote for the proposing release today, but when deciding whether to support adoption of any type of short sale restriction, I will be guided by the following fundamental regulatory principles:
- First, the regulatory purpose must be clearly defined. What exactly are we trying to achieve? Do we believe that short sale price test restrictions or a circuit breaker would have made any appreciable difference over the past 18 months, or are we engaging in merely a political exercise?
- Second, empirical evidence must guide regulatory decisions. Is there any credible empirical evidence demonstrating that eliminating the uptick rule drove down the price of any security? If the Commission forgets this principle, I suspect that the U.S. Court of Appeals for the District of Columbia stands ready to provide another reminder.
- Third, regulators must always consider the potential for unintended consequences. For example, will the proposed price restrictions have the unintended consequence of affecting short selling in an advancing market?
- Fourth, the benefits of any regulation must exceed the costs. This is not merely a sound regulatory principle; it also is a statutory mandate for the Commission.
- Fifth, regulators must, to the greatest extent possible, provide certainty to market participants. The rules must be clear, and the inspection and enforcement regimes must be rational and consistently applied.
- Finally, what are the opportunity costs in pursuing a particular regulatory approach? Every regulatory agency has only so much staff and so much money. Would investors' interests be better served if the SEC's limited resources were applied to other priorities?
One last point. It is a given that investor confidence is essential for vibrant capital markets. It also is a given that promoting investor confidence is a vital responsibility of the Commission. But if the SEC adopts regulations that cannot withstand scrutiny and cost-benefit analysis, whose only benefits are intangible and ephemeral, yet incur costs both real and long-lasting, are we truly promoting investor confidence and acting as the investor's advocate? The credibility of the Commission's actions derives from the rigor of its rulemaking process.
Madam chairman, I want to commend you on the thoughtful and measured process you have established for considering these controversial proposals. In particular, I want to thank you for the short selling roundtable we will hold next month. I look forward to reviewing the comments with an open mind and evaluating whether the release satisfies the principles I have outlined.