Yesterday the Securities and Exchange Commission made a new proposal to curb short-selling. The rule would make it more difficult for short-sellers to quickly execute trades, which might make it more difficult for “bear raids” on faltering stocks to occur. But it’s a dangerous proposition that should be rejected.
Here’s how the new rule works. When a short-seller wants to put on a short trade, he must offer to sell the stock at a penny higher than the highest reported bid for the stock. So if the highest bid on Citigroup’s stock is 3.00 a share, the short-seller can offer to sell it for 3.01.
It’s designed to function as an up to date version of the old uptick rule, which said a stock could only be shorted when its price ticked upward. That rule probably wouldn’t work now because stocks are traded on so many different, mostly electronic exchanges, it’s not really clear where or what the “tick” is.
Many short-sellers are long term investors who won’t be effected by the rule in any obvious way. Some market neutral traders and market makers worry that it could negatively effect liquidity.
But the real problem isn’t with the known effects of the regulation. It’s with the unknown and unanticipated effects. We’re not sure what this rule would do to market efficiency or price discovery. What’s more, we don’t know how this rule will interact with the uncountable past and future rules that regulate the markets. But we do know that new financial regulations have a very messy history of creating perverse results. They should be avoided unless absolutely necessary.
So is this short-selling rule necessary? Certainly not. But don’t take our word for it. Here’s Floyd Norris in the New York Times:
Much of Wall Street has argued that there is no evidence that short-selling caused the plunge last year, and the academic studies available do not support the idea. But the pressure on the commission to do something has been intense.
So we’re being asked to gamble on a short selling regulation aimed at solving a non-problem. Ugh.
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