May 15, 2009
Mary L Schapiro
100 F Street, NE
Washington, DC 20549
Dear Mary Schapiro:
In June 2007, the SEC eliminated the so-called uptick rule, which was established in 1938 as a way to prevent disorderly selling during market downturns.
The SEC had considered eliminating the rule for years, and ran tests in the period leading up to June 2007 to see how individual stocks would trade if the rule was removed. It found then that there was no substantial difference in performance so it eliminated the restriction.
I believe that the original purpose of the uptick rule was sound and that an effective version of the uptick rule should be reinstated. There are at least two possible reasons why the uptick rule was ineffectual in SEC tests.
First, changes in market pricing (decimalization) may have changed the effectiveness of the rule by reducing the size of the increment used in the implementation of the uptick rule. Based on this reasoning, a version of the uptick rule should be reinstated more closely mimicking the original rule using a similarly sized increment (comparable to the increment prior to decimalization).
Second, the SEC study may have been flawed. In the same way that the financial industry conducted flawed research that used short and non-representative historical periods to evaluate the risk of many types of derivative products in the period leading up to the recent crisis that began in July 2007, it is likely that the SEC study was similarly flawed.
The fact that the current crisis began immediately following the change in the SEC's uptick rule is a coincidence that cannot be entirely ignored. A single event cannot prove that the removal of the uptick rule provided a catalyst for the current crisis in financial markets however, this "coincidence" must be added to the preponderance of evidence that regulation of short selling is critical to orderly market functions.
Many short sellers glowingly describe the benefits of short selling and decry current efforts to curb abuses. The issue is not that short selling is without merit -- but that panicked selling incited by short sellers creates disorderly markets. The fact that securities markets overheated rather than freezing does not mitigate the harm to investors and markets created by short sellers during a crisis.