Exchanges Propose Weakened Uptick Rule

Since the rescinding of uptick rule in late 2007, companies like Bear Stearns, Lehman Brothers (LEHMQ.PK), Wachovia, Washington Mutual, IndyMac (IDMCQ.PK), Fannie Mae (FNM), Freddie Mac (FRE), AIG, etc. have either been killed or shareholder equity has been decimated. Many of the other financial companies such as Bank of America (BAC), Citigroup (C), Wells Fargo (WFC), E*Trade Financial (ETFC), etc seem to be under constant struggle to fight continuous downward pressure on their stock price which further weaken their core business and shareholder and customer confidence.

Recently, the TOP three exchanges in US -- NYSE Euronext, Nasdaq OMX and BATS Trading -- submitted a modified version of uptick rule to the SEC that they want want the SEC to consider in place of reinstating original uptick rule.

It is important to try to understand what these modifications are and what exactly they mean.

The old uptick rule was simple: a short sale can occur only after an uptick.

The modifications the exchanges have suggested are:

1. A short sale can be executed at any time as long as the price is higher than the highest bid price.
2. Such a rule should trigger only if the price has dropped by certain percentage during a day (e.g., 10%)

Since the exchanges are trying to put the modification in context of bid/ask prices, let us understand the difference between the proposed uptick rule and the original uptick rule in the context of ask/bid prices.

With the old uptick rule, for someone to be able to short a stock, suppose the last trade was at the bid price, the NEXT trade MUST be at ask price and must be a non-short. Once this trade takes place, the shorts can short the share. Clearly, once ONE such short trade is executed and if it was at market price (i.e., at the bid price), it would be at a lower price. So the shorts have to wait again for ONE non-short trade at the ask price before they can execute one more short sale. Thus, under the old rule, in most cases each short trade would act as a self-protection against further short trades and would require at least ONE non-short trade at a higher price.

Under the proposed rule, the share can be shorted at a price higher than highest bid price. What does this mean? It means that shorts can short the share AT THE ASK price ANYTIME. In the previous uptick rule, there has to be at least ONE non-short trade at the ask price (i.e. only the SECOND trade after a trade at the ask price can be a short-sale). Under the modified rule, there has to be ZERO trades at the ask price before shorts can short the share (i.e. the FIRST trade at the ask price itself can be a short trade).

Also, under the previous rule, each short sale at market essentially created a requirement of uptick before the next short sale. Under the proposed modification, an infinite number of short trades can be made as long as they are above the highest bid price.

What this means is that shorts can pretty much short against any market order under the new uptick rule. This modification weakens the original uptick rule substantially.

Why is this modification necessary?

All this time, the argument we heard was that the original uptick rule is not effective anyway -- but now they are saying that by weakening it, it will become MORE effective? Looks like all this time they were fighting it because it was TOO EFFECTIVE. Have they been lying all this time?

Another argument they use is that it is technically difficult to implement the old uptick rule. Did they forget that it was implemented for decades until late 2007? Are they saying that since computer technology has deteriorated so much in last two years, they can not implement the same rule that was implemented so successfully before (including in 1930s paper-trade days)? Once again, who are they fooling?

The second modification is even worse than the first one; the modified (i.e. weakened) uptick rule should not be triggered until the price has dropped by 10% for the day.

Isn't this another way of saying "instead of killing a company in one day -- we agree to do it in 10 days"?

As an individual investor and a common citizen, I find it hard to believe that our exchanges are actually proposing this. As in the movie Godfather, "the guy who comes with the proposal is the traitor." Are exchanges part of the scam?

One has to really step back and try to see if corruption and greed has not only taken over Wall Street, but also the exchanges, the regulators and even politicians to such an extent that national interest is a distant second to "self-interest".

The original article about uptick rule modification can be accessed here.

I sincerely hope that the SEC does not accept any suggestion which weakens the old uptick rule in the national interest and even long-term interests of Wall Streeters themselves.

A better approach would be to reinstate the original uptick rule and add the current proposal of short selling only higher than the highest bid price in addition to requiring an uptick (and dropping the 10% price decrease trigger completely).

Disclosure: Author holds long positions in ETFC and FRE. No positions in the other stocks mentioned.

Comments

[athena:]

The short sellers have taken over the markets. It is a very big business, the largest hedge firms do this routinely to make money.
The naked short selling, the manipulation will not stop as long as it is profitable.

Mar 25 09:22 AM

[dandyapple:]

This proposal is a loser. It would truly have no effect on the ability of Hedgefunds to short at will. This market will not recover until the Investors sitting on the sidelines return. Shorting provides nothing positive for the market other than large profits for the Hedgefunds and Day Traders. When a holding in your 401K has lost 10% in a day, the purpose of an up-tick rule on the next asking price is mute! The Shorts want to keep running their favorite tactic which is to start a stock down with a bad news rumor and then everyone piles on in concert.

Mar 25 09:35 AM

[kgeechee:]

Ban Naked Shorts; you must hold the number of shares you are shorting in the account you are using for the transaction. Next step: hang the 'shorts.' Enmasse while singing "hang a Noose around the old oak tree!"

Mar 25 09:35 AM

[holmesnmanny:]

I think I need to know just how exactly the exchanges make their money before I can understand how bad this upstick rule is. I mean, how would this rule benefit the exchanges in particular?

Mar 25 09:48 AM

[dandyapple:]

Another thought on this proposed rule. Since it would operate on bid price instead of last sale, regular investors without direct access to Level II Quotes would not have any information on what was happening to them. The Hedgefunds always want to operate in secret. They fight any attempt to make their short positions public, and the SEC has been a willing co-conspirator. The exchanges report up and down volume, and they should report short sales as a separate entity. The purpose of the market should not be profit for traders, but growth and prosperity for the Country. our Listed Public Companys, and their Stockholders,

Mar 25 10:12 AM

[velez113:]

The uptick rule is killing many companies by allowing sellers to sell stock out of thin air. Re establish the uptick rule. Right now, any pack of wolves can drive a company stock into the ground just for fun.

Mar 25 01:52 PM

[LCM:]

why should we be surprised??? it's obvious there will never be any SIGNIFCANT REFORM, as long as "Jr. Paulson" is at the helm....just a slightly "lighter" version of the same CORRUPTION

Mar 25 02:10 PM

[User 382961:]

The SEC should simply ban short selling. Without shorts we probably wouldn't be in a recession now and companies might actually be valued by how profitable they are instead of what the latest BS internet rumor is.

Mar 25 03:04 PM

[Jim Rich:]

I don't recall when the original was created. It may have actually meant something back when an uptick meant a full 1/16th of a dollar -- how many remember just a few years ago when you couldn't just bid to the nearest penny. If you are going to short you should have to pay a premium for the privilege of trying to affect something you don't own. The proposal suggests an uptick rule only be active if the stock is already down 10% for the day? LOLx10. I counter that you should have to pay a 1% premium to the current price for the privilege of shorting.

Mar 25 04:46 PM

[holmesnmanny:]

The only sound plan would be to force short sellers to sell the borrowed stock only at a price higher than the current asking price, that way they aren't affecting the price in a negative way in their attempt to make a profit, which is certainly counterproductive to the viability of the stock price itself.

Mar 25 05:26 PM

[Sigmax:]

The SEC must restore the Uptick Rule in its original format as suggested by the author and state that enforcement will be extremely vigilant for those violating the rule and for those not legally borrowing securities prior to a legal short sale. The legal plus "illegal" short interest acts as an increase in the float on the sell side only and dilutes the interest of the buyers. That dynamic and the lack of enforcement has led us to where we are today and makes it impossible for a buyer of any securities to have any confidence to stay invested in the markets

Mar 26 11:40 AM

[enoughalready:]

Strengthen the Uptick, if anything:
-There has been NO enforcement of Naked Shorting. Prosecute delivery failures as a criminal act, fraud and theft.
-There has been an explosion of platforms which don't conform technologically to the uptick. Shut them down, until they conform.
-Remove the Madoff exemption for market makers.

Mar 27 07:55 AM

[Tradermike:]

Your explanation of the old uptick rule is totally wrong, it was not that restrictive, once an uptick was established an infinite number of short sales could be initiated at that price, on the ask or bid, as long as the stock never traded above that sale price, and there was no restriction on shortsellers making the first sale on an uptick

Mar 27 06:02 PM

[Travelin:]

I think that the ban naked short selling should be enforced with an iron hand. If a broker cannot find shares int their inventory to short, then no shorting. If a hedge fund cannot locate real shares from a affiliates inventroy to sell, the no shorts. However, I think that the uptick rule is useless. The companies and ignorant investors blame the drop in share prices on the loss uptick rule, rather than than blame the companies for being poorly run companies that should no longer exist. Perhaps we should have a downtick rule as well to prevent speculators from driving stocks up past their inherent values. The uptick rule was in place during the first leg of this bear market in 2000-2002. Did it prevent the Nasdaq from going down 80% then? Absolutely not! Did it prevent phony poorly run companies from being sold out of existence? Absolutely not!

Let the market decide what a company is worth and focus all regulatory efforts on preventing naked shorts.

Mar 30 02:10 AM

[Hirendu Vai...:]

On Mar 27 06:02 PM Tradermike wrote:

> Your explanation of the old uptick rule is totally wrong, it was
> not that restrictive, once an uptick was established an infinite
> number of short sales could be initiated at that price, on the ask
> or bid, as long as the stock never traded above that sale price,
> and there was no restriction on shortsellers making the first sale
> on an uptick

I believe you are mistaken with the details. Once an uptick was established, an infinite number of shorts sales would be allowed as long as there was no "downtick". The moment there was a downtick, one would have to wait for an uptick before shorting more. In the world of ask/bid price -- if the ask and bid price did not move, every market buy order followed by a market sell order will create a downtick which will stop short-selling. So in the original uptick rule if the short-seller executes a market sell order; it will automatically establish a down-tick. The only way this could have been avoided under original uptick rule was to short-sell with a limit order on the ask price and then front-run other limit orders (another illegal activitity - which also happens quite frequently).

Apr 01 01:35 PM

[jaytrade:]

Wall St is where average Joe puts his money, hoping that it will grow with time, while he is busy taking care of other stuff in life. But Wall St. is periodically raided by crooks, and their "gun" is short selling. It's the same old story of the Old West, just different looks - the culture lives on.
Short selling absolutely needs strict regulation - anybody saying otherwise suffers from weak conscience, and probably wants to eat your lunch !!

If you, my friend, are an average Joe, please make every effort to get your voice heard !!

Apr 08 12:21 PM