The Modified Uptick Rule Debate

Coming Soon!
Coming Soon!

The following is not an argument for or against shorting, as that is a non-debate.   The presence of short-selling is a necessary component of a free, liquid and healthy market.  The question we’ll focus on here is what type of form the safeguards against abusive short-selling should take when the discussion by regulators takes place on April 8th.

First, a bit of background on the uptick rule:

The uptick rule, implemented during the last depression in the 1930’s functioned for 7 decades as a curb against most forms of abusive short-selling tactics.  Essentially, it forced thos who wished to short a stock to wait for a buyer to come in before executing the sale.  For no apparent reason, this rule was done away with at the peak of the 2007 bull market, and the end result was a field day for shorts who were now able to “slam dunk” a stock lower, meaning short more shares on each successive tick.

This led to cascading share prices for many stocks, specifically financials, a sector where the stock price action actually did have a very real effect on the underlying business of the company; if the shares of a fast food restaurant were being pummeled, that wouldn’t stop people from eating there, but would anyone want to deposit money into a bank whose stock was down 50% in a week’s time?

The heads of several regulatory bodies and major exchanges, including the NYSE and the SEC, have issued a joint statement that they will be bringing back some form of the uptick rule, albeit a modified one to take into account the fact that the original was written in a time before electronic order entry and day trading.

The main objection that many trading entities seem to have to the new proposal being kicked around is that there is language in there about restricting shorts from operating when a stock is down 10% or more in a single session.

I happen to agree with the detractors of this proposal.  If you don’t restrict the buying of a stock that is up 10% or more, then imposing price restrictions on shorting would be hypocritical and would probably create more distortions of price and what one skeptic has called “synthetic short activity”.

An alternate proposal would be a push for more disclosure from shorts on their positions and trades so that regulators can detect and punish those with patterns of abuse and manipulation.

One other factor that should probably be included in any serious discussion of abusive short-selling tactics is the role that derivatives play in the manipulation of stocks.  Many players don’t even bother shorting stocks when, with less capital, they can sell S&P futures contracts and e-minis, as well as use the credit default swaps market to produce the same effect.  If you can sell enough call option contracts or spike up the put options, you can create the perception that something is “wrong” with the company.  This leads to panicky shareholders and momentum traders doing the heavy lifting for you by obliterating the stock’s price on the way out of it.

As someone who does business with high net worth retail clients, I am often asked about the mechanics of shorting stocks and even criticized for shorting, as to some, the idea of betting against a company is un-American.  My retort would be that shorting stocks, which theoretically carries a greater degree of risk because of the undefined downside (a stock can go up forever), should only be done by sophisticated investors.  Further, nothing is more American than capitalizing on yur research and beliefs, and if this happens on the short side of a trade, so be it.  Profits are profits so long as you are within the boundaries of good taste and the law.

And for the wingnuts arguing for no uptick rule at all…the Dow lost 8000 points give-or-take since the repeal.  Granted, there were a host of factors involved that had nothing to do with abusive short-selling, but it certainly didn’t help matters that a handful of hedge funds were able to create panic at will.  Don’t be a schmuck, we’ve learned about the consequences of a zero-regulation environment….10% unemployment and a 10 kajillion dollar deficit that your grandchildrens’ sperm and eggs will be paying off long after you’re gone.

I’ll be watching with interest and updating The Reformed Broker as news on the modified uptick rule develops.  In the meantime, feel free to chime in below with your two cents…

Tags: , , , , , , ,

This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment.

The commentary in this “post” (including any related blog, podcasts, videos, and social media) reflects the personal opinions, viewpoints, and analyses of the Ritholtz Wealth Management employees providing such comments, and should not be regarded the views of Ritholtz Wealth Management LLC. or its respective affiliates or as a description of advisory services provided by Ritholtz Wealth Management or performance returns of any Ritholtz Wealth Management Investments client.

References to any securities or digital assets, or performance data, are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

Wealthcast Media, an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. Investments in securities involve the risk of loss. For additional advertisement disclaimers see here: https://www.ritholtzwealth.com/advertising-disclaimers

Please see disclosures here.

What's been said:

Discussions found on the web
  1. John Morrow commented on Apr 08

    I want the uptick rule back.

    Some additional/other ways to put a break on abuses:

    Market makers get the option to short on an unlimited basis. I think that is a problem. It is easy to be a market maker if what you want is that unlimited ability. A solution might be to put a high haircut on short positions, when they are large and/or in the inventory for x days.

    Some who short, shop around for a broker who can lend the stock without really being sure and able to deliver the stock by T+3. So they have a fail. Then the fail starts to age out. It is all too loose. The solution is to have hard delivery (T+0) for short sales.

  2. John Morrow commented on Apr 08

    I want the uptick rule back.

    Some additional/other ways to put a break on abuses:

    Market makers get the option to short on an unlimited basis. I think that is a problem. It is easy to be a market maker if what you want is that unlimited ability. A solution might be to put a high haircut on short positions, when they are large and/or in the inventory for x days.

    Some who short, shop around for a broker who can lend the stock without really being sure and able to deliver the stock by T+3. So they have a fail. Then the fail starts to age out. It is all too loose. The solution is to have hard delivery (T+0) for short sales.

  3. John Morrow commented on Apr 08

    I want the uptick rule back.

    Some additional/other ways to put a break on abuses:

    Market makers get the option to short on an unlimited basis. I think that is a problem. It is easy to be a market maker if what you want is that unlimited ability. A solution might be to put a high haircut on short positions, when they are large and/or in the inventory for x days.

    Some who short, shop around for a broker who can lend the stock without really being sure and able to deliver the stock by T+3. So they have a fail. Then the fail starts to age out. It is all too loose. The solution is to have hard delivery (T+0) for short sales.

  4. Joshua M Brown commented on Apr 09

    agreed, some clearing firms are absurdly strict and some pay no attention to borrowing rules at all…

    it would be nice to see this tightened up.

    thx for reading

    JB

  5. Joshua M Brown commented on Apr 09

    agreed, some clearing firms are absurdly strict and some pay no attention to borrowing rules at all…

    it would be nice to see this tightened up.

    thx for reading

    JB

  6. Joshua M Brown commented on Apr 09

    agreed, some clearing firms are absurdly strict and some pay no attention to borrowing rules at all…

    it would be nice to see this tightened up.

    thx for reading

    JB

  7. Vape Juice commented on Sep 25

    … [Trackback]

    […] Find More to that Topic: thereformedbroker.com/2009/04/06/the-modified-uptick-rule-debate/ […]

  8. strapless strapon commented on Sep 27

    … [Trackback]

    […] Info to that Topic: thereformedbroker.com/2009/04/06/the-modified-uptick-rule-debate/ […]

  9. https://app-bitcoinloophole.com commented on Oct 04

    … [Trackback]

    […] Read More on that Topic: thereformedbroker.com/2009/04/06/the-modified-uptick-rule-debate/ […]

  10. easyweb login td commented on Nov 17

    … [Trackback]

    […] Find More Info here to that Topic: thereformedbroker.com/2009/04/06/the-modified-uptick-rule-debate/ […]

  11. tangerine online signin commented on Nov 27

    … [Trackback]

    […] Find More on on that Topic: thereformedbroker.com/2009/04/06/the-modified-uptick-rule-debate/ […]

  12. Interesting facts about coca tea commented on Dec 11

    … [Trackback]

    […] There you can find 92889 more Information to that Topic: thereformedbroker.com/2009/04/06/the-modified-uptick-rule-debate/ […]