June 10, 2009
I recently had the pleasure of reviewing substantially all the research by academics and by SEC staff on the effects of the uptick rule, including the transcripts of the Reg SHO roundtable and the recent roundtable discussions on the uptick rule. I urge the commissioners to pay attention to the conclusions of that research. I summarize it here and add a few of my thoughts as a stock trader.
None of the data from any of the research support the view that the uptick rule prevents so-called 'bear raids'. In fact, I could find evidence of only one proven instance in modern US stock market history of illegal and manipulative short selling, that being the case of Robert Todd Beardsley and George Lindenberg (who were prosecuted by the SEC see litigation release 21032 for the most recent update on their case) the defining fact about that case is that their manipulation was possible only because of the uptick rule Other cases the SEC has prosecuted involving illegal acts by short sellers involved either insider trading (such was the case of Anthony Elgindy) or publishing false information (such was the case of Mark Jakob). Simply put, there is no evidence that any market manipulation happens that would be prevented by reinstating the uptick rule.
While there was no evidence that the uptick rule was effective in preventing manipulative or harmful short selling, there was clear evidence that the uptick rule made all short selling more difficult. Academic research has consistently shown that short selling helps price discovery (and the SEC commissioners have agreed with that statement) the SEC should thus only hinder short selling if it is clear that doing so will clearly prevent harm to the markets.
There is no evidence that the uptick rule prevents market manipulation while there is clear evidence that it restricts shorts sellers, reducing market efficiency. Some have argued that the SEC should reinstate the uptick rule to increase investor morale. This would be foolish and ultimately counter-productive. The SEC should instead focus on regulations that could clearly benefit the markets rather than wasting time trying to make people feel good.
For example, I believe the SEC could better spend its time changing rules to make pump and dump stock manipulation more difficult. One way to do this would be to change margin rules to make it easier for short sellers to sell short low-priced stocks. Specifically, I recommend that the SEC force the NYSE to change rule 431(c)2, which requires that short sellers have $2.50 in cash to short sell one share of stock priced under $5, no matter how low-priced the stock is. I believe this rule explains why most pump and dumps are perpetrated upon penny stocks. One recent example, Uomo Media (OTC: UOMO), saw multiple stock touts drive the price up from 20 cents to $1.00. Over $30m in trades took place at elevated prices. Restricting such manipulation would yield clear benefits, unlike reinstating the uptick rule.