Speech by SEC Chairman:
Statement at SEC Open Meeting — Short Sale Restrictions
Chairman Mary L. Schapiro
U.S. Securities and Exchange Commission
Feb. 24, 2010
Good Morning. This is an open meeting of the U.S. Securities and Exchange Commission on February 24, 2010.
Today the Commission is considering a rule that would restrict short selling when a stock is experiencing significant downward price pressure.
It is a rule that is designed to preserve investor confidence and promote market efficiency.
Today's rule grows out of the lessons learned two years ago when the market began to drop precipitously. At that time, the Commission took a series of emergency and temporary actions over a three month span in part to respond to the market volatility and rapid and steep price declines in securities.
While we must always be prepared to take additional action in the future, I believe it is important for the Commission and the markets to have in place a measure that creates certainty about how trading restrictions will operate during periods of stress and volatility.
Under today's proposed rule, a circuit breaker would be triggered any time a stock has dropped 10 percent in one day. At that point, short selling would only be permitted in a security if the price is above the current national best bid.
The reason this rule makes sense is because it recognizes that short selling can potentially have both a beneficial and a harmful impact on the market — depending on the circumstances.
When investors engage in short selling, they are in effect borrowing a stock to sell it to another investor. At a later time, they must buy back the stock to replace the one they sold. Instead of the usual order for a transaction, where an investor wants to buy low and sell high, a short seller wants to sell high and later buy back low.
In arriving at the rule we are considering, the Commission was cognizant of the benefits that short selling can provide to the markets. As we have noted many times, short selling can play an important and constructive role in the markets, such as by providing market liquidity and pricing efficiency.
However, we also are concerned that excessive downward price pressure on individual securities, accompanied by the fear of unconstrained short selling, can destabilize our markets and undermine investor confidence in our markets.
Today's rule, which we refer to as the alternative uptick rule, addresses these concerns.
First, it will prevent short selling, including potentially manipulative or abusive short selling, from further driving down the price of a security that has experienced a 10 percent price decline. Limiting the potential for abuse is an important goal of these rules.
And, second, it will enable long sellers to stand in the front of the line, and sell their shares before any short sellers once the circuit breaker is triggered.
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During the Commission's history, the practice of short selling has garnered a great deal of interest. In 1938, the Commission enacted former Rule 10a-1, commonly known as the "uptick rule." That rule prohibited investors from short selling an exchange-listed security unless the sale price of the security had previously ticked upward. The former uptick rule remained virtually unchanged until the Commission authorized a study in 2004. That study assessed the functionality and necessity of the price tests restrictions in place at that time. Following the year-long pilot study, the Commission ultimately eliminated all short sale price test restrictions in 2007.
Since that time, the global economic environment has changed dramatically and the markets have experienced extreme volatility. Beginning in 2007, market volatility increased not only in the U.S. but in every major stock market around the world.
With worsening market conditions came an erosion in investor confidence, which in turn triggered calls for renewed short selling restrictions, including from investors and issuers. In 2008, the Commission then passed four temporary emergency orders, including orders that imposed pre-borrow requirements on short-sales for 19 different stocks, a ban on short sales for almost 1,000 financial stocks, certain short sale disclosure requirements, and certain measures related to "naked" short selling.
In addition, the Commission subsequently adopted certain of these measures as final rules, in part, to further the Commission's goals of addressing potentially abusive "naked" short selling. For example, we adopted a "naked" short selling anti-fraud rule. We also adopted a rule that requires broker-dealers to promptly purchase or borrow securities to deliver on a short sale.
Even with all of these final actions, concerns regarding short selling persist. With these concerns in mind, the Commission is today considering whether to impose certain short selling restrictions.
Specifically, the alternative uptick rule the Commission is considering would work as follows:
- A circuit breaker would be triggered for a security any day in which the price declines by 10 percent or more from the prior day’s closing price.
- Once the circuit breaker has been triggered, the alternative uptick rule would apply to short sale orders in that security for the remainder of the day as well as the following day.
- The alternative uptick rule generally would apply to equity securities that are listed on a national securities exchange, whether traded on an exchange or in the over-the-counter market.
- Under the rule, trading centers would be required to establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent the execution or display of a prohibited short sale.
The rule the Commission is considering today is the result of a thorough and deliberative process. We proposed a set of price test restrictions last April for public comment. We held a Roundtable in May. And, we put out a subsequent request for additional comment last August. All of this resulted in more than 4,300 comments discussing both the merits and shortcomings of each of the proposals.
I believe the alternative uptick rule strikes the right balance.
I would like to thank the staff of the Division of Trading and Markets for their commendable work on this matter, specifically Director Robert Cook, Deputy Director Jamie Brigagliano, Josephine Tao, Victoria Crane, Katrina Wilson, and Angela Moudy. I would also like to thank their colleagues in the Office of the General Counsel, specifically David Becker, Meridith Mitchell, Janice Mitnick, and Cynthia Ginsberg, as well as the Division of Risk, Strategy, and Financial Innovation, specifically Henry Hu, Bruce Kraus, Amy Edwards, Tim McCormick, and Cecilia Caglio.
Now I'll turn the meeting over to Robert Cook, Director of the Division of Trading and Markets, to hear more about the Division's recommendation.