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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Remarks Concerning the Pilot Analysis of Removing Pricing Restrictions on Short Sales:
SEC Open Meeting


Chester S. Spatt

Chief Economist Director, Office of Economic Analysis
U.S. Securities and Exchange Commission

Washington, D.C.
December 4, 2006

Let me start by briefly outlining the Pilot before summarizing the main results. The pilot program used a stratified sample design in which the pricing restrictions were removed for one-third of the Russell 3000 securities. The remaining Russell 3000 provided a natural control sample to control for changes in the underlying markets over time. In addition to the study by the Office of Economic Analysis of the performance of pricing restrictions during the pilot program, a number of academic researchers were able to study this because of the public release of short-selling information. The Commission hosted a Roundtable in September in which several of the outside studies were presented and assessed by academic discussants and a distinguished panel of financial economists. Indeed, the natural experiment structured by the Commission to facilitate evaluation of the pricing restrictions was widely praised by the Roundtable participants as a model for rule-making.

A number of interesting conclusions emerged from the various studies. While short selling increased for the stocks in the experimental sample without the pricing restrictions, the level of short interest was not influenced because the considerable long-term costs of retaining short exposures was not materially altered. The elimination of the pricing restrictions resulted in a balanced use of up ticks and down ticks during the trading process, while only about 46% of the transactions were at down ticks when retaining the pricing restrictions. This highlights that the pricing restrictions imposed an actual friction on the trading process, distorting the provision of liquidity. While there was some increase in intraday volatility from the removal of the pricing restrictions, this was relatively symmetric and the pricing restriction did not affect fundamental volatility across days. The evidence on the impact of the pricing restrictions on spreads was not strong, though quoted depths declined with the removal of the pricing restrictions. The studies also offered evidence that the competitive position of platforms was distorted by inconsistent application of pricing restrictions across platforms. In particular, the NASDAQ's market share increased when the playing field was made level by removal of the pricing restrictions in its market as its trading regime became more competitive with its rivals. Finally, there is not strong evidence of differential effects between large and small stocks.

On the basis of the body of evidence 9 of the 12 outside expert participants at the Roundtable explicitly supported the removal of pricing restrictions then and the remaining three participants did not offer a direct opinion. This reflected the relatively modest changes in the overall set of execution statistics and the potential desirability of easing these trading restrictions given the importance of a vibrant short-selling mechanism to the efficiency of pricing in our capital markets.

Finally, I would like to take a moment to acknowledge the efforts of the Office of Economic Analysis team that studied the pilot-Amy Edwards, Stewart Mayhew, Tim McCormick and Allan Zebedee - and I would like to express our appreciation for the teamwork between the staffs of Market Regulation and the Office of Economic Analysis throughout the Pilot process.


Modified: 12/18/2006