May 21, 2009
Short-selling, if properly regulated, performs a valuable corrective function in the market, as it can provide both liquidity and an offset to the perpetual bullishness of the professional brokerage community. The past two years have, however, amply demonstrated that massive short-selling in a declining market can be self-reinforcing when engaged in by huge pools of capital, and that it can be a tool of manipulation in the hands of unscrupulous traders. Reinstating the up-tick rule is one step that the Commission should take to counteract these tendencies.
Doing so will not be sufficient, however, unless something is also done to rein in 'naked' short-selling. As is widely recognized, naked short-selling of a stock tends to distort the market by increasing the apparent supply, since no shares are removed from the existing overhang (by being pledged as security) to offset the shares sold short. As is the case when there is no up-tick rule, this effect can be especially damaging in a declining market.
The two problems should be addressed simultaneously.