CrackedWorld

On Tuesday,Chairman Mary Schapiro of the SEC (Securities and Exchange Commission), has said it is considering reinstating the Uptick Rule; possibly as soon as April of this year. Designed to prevent short sellers from driving down the price of a stock or security for their own profit, the uptick rule was removed from use in the summer of 2007.

The uptick rule as defined by Investopedia:

A former rule established by the SEC that requires that every short sale transaction be entered at a price that is higher than the price of the previous trade. This rule was introduced in the Securities Exchange Act of 1934 as Rule 10a-1 and was implemented in 1938. The uptick rule prevents short sellers from adding to the downward momentum when the price of an asset is already experiencing sharp declines.

Lately the Members of Congress have been applying pressure to the SEC to reinstate the uptick rule to hamper short selling stocks which is detrimental to a down market because it fuels the fire of a downward spiral. Rep. Gary Ackerman (D-N.Y.), a member of the House Financial Services Committee, reintroduced legislation that would reinstate the uptick rule within 90 days of the signing. He had  introduced thebill in July 2008 also.

According to Washington policy analyst Tom Gallagher, most likely some variant of the old uptick rule will be reinstated but in its original state the measure is some what irrelevant.

As stated in a Foxbusiness article:

In his research note, Gallagher said “simply reinstating the old uptick rule” — when stocks traded in 12.5-cent or 25-cent increments — “isn’t regarded as feasible…With the move to decimal trading (in which stocks can trade at penny increments) and the higher volume of trading, it would be very hard to know if one was shorting on an uptick.”

Rather, Gallagher said, one option for the SEC is a “price test” in which a price of a stock would have to increase by, say, three cents or five cents before it could be sold short. Another option, he said, would be a “circuit-breaker approach” to halt shorting when a company’s stock had fallen by a “certain magnitude.”

So what is short selling? This is when an investor borrows shares of a stock from a broker, sells it to others, and then hopes to buy it back at a lower price before returning it to the lender. The difference is the borrowers profit in this little deal. It sounds kind of shady but it actually is legal and not at all an uncommon practice in securities investment.

Here is an example put forth by The Huffington Post of selling a stock short:

Short-sellers bet against a stock. The practice, which is legal and widely used on Wall Street, involves borrowing a company’s shares, selling them, and then buying them when the stock falls and returning them to the lender. The short-seller pockets the difference in price.

If a company stock was trading at $50 and a trader anticipated that it would decline, he could borrow shares but couldn’t sell them until after the stock traded higher, or “ticked up.” If the shares had fallen to $40, for example, they couldn’t be sold until the price had risen to at least $40.01.

According to a Reuters report today, Sen. Christopher Dodd (D-Conn.), chairman of the Senate Banking Committee, wants the uptick rule reinstalled with haste.

Although research on the effectiveness of the uptick rule is inconclusive, it would instill some confidence in the market and at least make it look like the feds have some answers to the plunging markets. The uptick rule may also create some stability to the markets and help stave off the steep drops that stocks have been experiencing for the last several months.

Tags: Investing, Money, Politics
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