May 5, 2009
There is only one reason to prefer other alternatives to curbing the practice of short selling rather than supporting an "uptick rule": protect the profit potential of short selling. U.S. shareholders invest in the economic prospects of the United States. Traders and hedge funds invest in themselves. In deciding on the "uptick rule" versus its alternatives to curb short selling, the SEC must decide what interests it represents: the long term economic interests of the United States or the short term profit interests of hedge funds, traders and investment banks.
While the cost to brokerages to implement the "uptick rule" is often cited as a rationale against its implementation, the more genuine reason is the diminished capability for the traders of brokerage houses, hedge funds and investment banks to short in volume in a very small time period. Any rule that effectively curbs this capability affects potential profits that are made at the expense of shareholders, the holders of shares in companies that, for the most part, comprise the U.S. economy.
While a circuit breaker for stocks that have declined 10% or more appears useful, this type of curb does not shift the market more toward shareholding (i.e investing) and further away from trading. Nor does it make it difficult for the short seller to establish a large short position in illiquid stocks during a very short period of time.
Furthermore, while the downtrend created by massive short selling can be interrupted by the circuit breaker, the knowledge that the circuit breaker interrupted the down trend acts psychologically to push buyers away during the next trading session in order to observe and determine the trend. By establishing a large short position very quickly at a time when volume is low and buying interest has ebbed (the classic definition of an illiquid market), a short seller can push any stock down precipitously, creating the very emotion of fear that is needed to draw sellers into the market and push buyers further away.
Thus, if the short sellers act in volume swiftly in the consecutive sessions, a down trend is easily established over a two session period rather than over one session. This curbs the amount of short selling profits that can be made in a single session. It does not tilt the market toward investing (owning and selling shares that are owned) and away from leveraged trading.
The shareholder is at a disadvantage to the trader with every alternative to the "uptick rule". For example, once a 10% decline has occured, traders are taught to cut losses quickly and use mental stops, typically at losses of no more than 10%, to get out of a position. In order to protect capital, the savy shareholder must perforce act like a trader and sell on a 10% decline or risk a further decline the next session. A shareholder will eventually come to the conclusion that holding shares beyond a 10% decline is too great a risk: why risk further loss to capital when short sellers can push the price down at will? Thus, the 10% short selling curb has the potential to exacerbate volatility and diminish shareholding. This reinforces the trend established by the short seller and places shareholders who do not sell at an even greater disadvantage.
While both the short seller and the shareholder seek to profit, the shareholder seeks to profit from the strength of the U.S. economy. The short seller seeks to profit not only at the expense of poorly managed and ecomomically weak companies but at the expense of the shareholder, by borrowing his shares. Why would a shareholder willingly loan out his shares without compensaton to a short seller whose very short sale acts against the shareholder's own interest?
The SEC should not only promulgate the "uptick rule", but should consider enhancing the "uptick rule" at a future date, by empowering the shareholder to easily restrict the available shares for shorting. This can be done by requring brokerage houses to(a)enable the shareholder to designate (e.g. with a click of the mouse) shares held as restricted from lending to short sellers, and (b)inform the account owner and shareholder with a highlighted symbol any shares that have not been so restricted by the accountholder and have been loaned out for a short sale.
After all, the brokage house does not own the shares that it is lending to short sellers, so why should it be able to loan out these shares to the disadvantage of the shareholder who is not profited by it and stands to lose a great deal?