U.S. Short-Selling Rule Could Hurt Stock Closings, Sifma Says
The lobbying group for banks and brokerages said it opposes new restrictions on short sales being applied to the auctions used to open and close stocks.
Enforcing the so-called alternative uptick rule at those times will make the auctions less reliable, according to the U.S. Securities Industry and Financial Markets Association. The group stated the opinion in a letter to the Securities and Exchange Commission that acknowledged the agency has already indicated it doesn’t plan to grant exemptions.
The rule limiting short sales once a stock declines 10 percent from the previous day is scheduled to begin later this month. Its aim is to avoid plunges driven by bearish bets, which Morgan Stanley Chairman John Mack and Senator Charles Schumer, a Democrat from New York, blamed for worsening the selloff that followed Lehman Brothers Holdings Inc.’s bankruptcy in 2008.
The lack of an exemption “could negatively impact orderly markets by causing increased volatility and uncertainty around the opening and close,” Sifma wrote in a Jan. 19 letter to the SEC. It may force investors “to pay higher prices than they otherwise would have,” Sifma said.
Under the regulation, exchanges and other market centers must have procedures to prevent short sales from occurring at the national best bid price or lower once a security declines 10 percent from the prior day’s close.
The limit applies for the rest of the day once the threshold is reached as well as the entire next day. In a short sale, investors borrow and then sell stock they don’t own with the expectation of repurchasing and returning the shares once the price drops. The trades can be used to make directional bets on securities or hedge positions.
Stocks in the Standard & Poor’s 500 Index would have triggered the short-sale curbs 132 times in January 2008 and 1,850 times in October 2008, according to data Zurich-based Credit Suisse Group AG supplied to the SEC. Stocks in the Russell 2000 Index would have hit the threshold 1,228 times that January and 8,755 times in October.
The SEC delayed the start date for the regulation to Feb. 28 from Nov. 10 to give exchanges more time to alter their auctions, according to a Nov. 4 notice.
“We understand that the commission has chosen at this time not to grant the exchanges’ requested relief,” wrote Sifma, referring to a letter it had expected NYSE Euronext and Nasdaq OMX Group Inc. to send the SEC requesting an exemption. The lobbying group said it may petition the SEC for the exemption after the alternative uptick rule becomes effective.
“It was our understanding that the exchanges were contemplating filing letters last fall expressing concern,” Sifma spokesman Andrew DeSouza said in an e-mailed statement. “We had discussed these concerns with the exchanges, and our letter to the SEC was meant to show we shared the exchanges’ concerns and raised additional concerns with the lack of relief.”
SEC spokesman John Nester declined to comment. NYSE Euronext didn’t send the SEC a letter on this topic, according to spokesman Ray Pellecchia. Nasdaq OMX spokeswoman Silvia Davi said the company hasn’t filed a letter publicly with the SEC.
While Nasdaq OMX would like an exemption for these trades, the new rule restricting short sales “won’t have a major impact on the industry as a whole,” said Brian Hyndman, senior vice president for transaction services at the exchange operator.
Old Uptick Rule
The SEC removed all limits on short sales in 2007 after studies by academics and its own economists established that markets weren’t likely to be hurt. A different uptick rule on the New York Stock Exchange had been in place for almost 70 years. Nasdaq Stock Market employed a similar restriction.
Sifma said the lack of an exemption could keep stocks from finding price levels that reflect sufficient buy and sell demand in the opening and closing periods. Those auctions are used by retail investors and mutual funds that seek to trade at the start of the day or get the closing price at 4 p.m. in New York.
If the number of shares investors want to buy in the closing auction is greater than those being sold, short sellers can offset the imbalance and produce a price reflecting more trading interest, Sifma said. When the short-sale restriction is in effect and the closing price isn’t above the highest national bid just before 4 p.m. New York time, short sales can’t be included. Confusion may be worsened for all investors since short sellers can’t tell when they submit orders at 3:45 p.m. or in response to imbalances whether the final price will allow their trading requests to be executed, Sifma said.
Setting the Price
“There could be a situation in which, for example, a 100- share bid that is submitted near the close sets the price for a security that trades millions of shares per day,” Sifma said. “Because there will be uncertainty as to whether short sales may be included in the disseminated imbalance information, firms may not be able to rely on such information, creating uncertainty and volatility around the close, and overall increasing risk.”
Sifma said the lack of an exemption could also cause problems for market makers who need to sell short baskets of stock to limit the risks they face in connection with the expiration of options. The SEC decided not to grant options market makers a general exemption from the alternative uptick rule over the objections of the Chicago Board Options Exchange and International Securities Exchange, two of the largest U.S. equity derivatives bourses.
The SEC is “concerned that excessive downward price pressure on individual securities, accompanied by the fear of unconstrained short selling, can destabilize our markets and undermine investor confidence,” SEC Chairman Mary Schapiro said on Feb. 24, 2010.
The commission approved the new rule because, it said, investors who own stock should be able to exit positions before short sellers, which would alleviate rapid downward pressure and give investor confidence a boost. The two Republican commissioners, Kathleen Casey and Troy Paredes, voted against the rule. The two Democrats and one Independent voted for it.
Hyndman said he hopes the short-sale rule accomplishes the SEC’s goal of boosting investor confidence.
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