Subject: File No. S7-08-09
From: Kevin M Zhao, Ph.D.
Affiliation: Professor of Finance, Middle Tennessee State University

May 21, 2009

Kevin M. Zhao
Assistant Professor
Department of Economics and Finance
Middle Tennessee State University
Murfreesboro, TN 37132
(615) 898-5473

Mary L Schapiro
SEC Chair
100 F Street, NE
Washington, DC 20549

Dear Mary Schapiro:
I and Dr. Phillip Daves, a finance professor at the University of Tennessee, have conducted a series of studies on the effect of removing uptick rules on many aspects of market quality and market efficiency.
A two-year uptick rule related market experiment, the Pilot Program, established by the Regulation SHO, provides ground for terminating uptick rules in June 2007. Many researches, such as the Office of Economics Analysis of the SEC (2007), Diether, Lee, and Werner (2006), Alexander and Peterson (2006), and Wu (2007), show that uptick rules have moderate negative effect on market efficiency and have not necessarily led to manipulative (abusive) short sales, thus should be removed. Those studies, however, implicitly assume that the pilot program, which generates the SHO data, was a clean experiment, where short sellers with private information might be on good behavior if they believe that heightened scrutiny during the Pilot increases their chances of getting caught (SEC, 2007).
Our study addresses this issue and shows that the Pilot Program may not be a clean experiment. By comparing short selling prior to changes in buy-side analyst recommendations in pilot stocks and control stocks around the SECs introduction of the pilot program in 2005, We find that short selling became less informative in pilot stocks than in control stocks, indicating that informed short sellers may intentionally altered their shorting behavior to avoid strengthened regulatory scrutiny during that short time period. Therefore, manipulative shorting behavior was not observable during the pilot program, but may reactivate after June 2007 when the uptick rules were permanently removed. Details of this study, entitled as Private Information Driven Short Selling and Uptick Rules, will be provided upon your request.
As a constituent of yours, my opinion is previous research based on the Pilot Program is not sufficient in providing rationality for removing uptick rules, and it is safe to reinstate uptick rules to prevent potential abusive short selling.


Kevin M. Zhao
May 21, 2009