Oct 25 1999 5:15
By Judith Burns
(This story was originally published Friday.)
WASHINGTON (Dow Jones)--In a move that is expected to generate
lively debate, the Securities and Exchange Commission last week
issued a release seeking comment on whether it should ease longstanding
restrictions on short selling, or perhaps even scrap them altogether.
Short sales occur when an investor sells borrowed stock in
hopes of repurchasing the shares at a lower price. Unlike a buyer,
short sellers profit when shares decline in price.
"It's certainly a provocative release. It will get a lot of
comment and receive a lot of attention," predicts Howard Kramer,
a partner at the Washington law firm of Schiff Harding & Waite,
and formerly an associate director in the SEC's market regulation
division.
"The commission is asking: Is it time to take a second look
at whether regulations put in place to prevent abuses more than
60 years ago still make sense?" Kramer added. Indeed, in its "concept release," the SEC noted that its short-selling
rule has remained fundamentally unchanged since 1938, despite
profound changes in trading and dramatic improvements in market
transparency and surveillance.
"Our goal is to examine ways to modernize our approach to provide
the most appropriate regulatory structure for short sales," the
SEC stated in its release.
Eight concepts deserve consideration, in the SEC's view, including
the possibility of eliminating the short-selling rule altogether.
The agency also is seeking comment on changes that would loosen
restrictions on short selling, such as suspending the rule when
the stock or market is above a certain price, exempting actively
traded stocks or hedging transactions from the rule, or limiting
restrictions to certain market events and trading strategies.
Revising the definition of a "short sale," or changing the rule
in response to certain market developments also warrant consideration,
the agency said.
"It's good that the commission is taking another look at this,"
said Stuart Kaswell, general counsel for the Securities Industry
Association. He said the industry organization will study the
proposal closely.
Among other things, the SEC asked if deregulation might spur
speculation, make prices more volatile, have a "depressing" effect on trading, or lead to an increase in abusive practices or manipulation.
On the other hand, the SEC noted that short selling can have a
positive impact, by contributing to price efficiency.
Current restrictions on short selling have their roots in 1937,
when a concentrated burst of short selling, known as a "bear raid,"
prompted the SEC to adopt rules that generally preclude short
selling as stock prices decline. The "tick test" approach means
stocks may be sold short only if the share's prices are rising.
Although the SEC's rule applies only to short sales of stocks
traded or listed on an exchange, the National Association of Securities
Dealers has its own rules barring members from short sales of
Nasdaq listed stocks below the best displayed bid. A 1996 NASD
study concluded the Nasdaq rule is effective at restricting short
selling during large price declines. In its release, the SEC asked
whether self-regulatory organizations such as the NASD should
keep short-selling rules intact even if the SEC loosens or abolishes
its own restrictions.
"There may be a few reasons why they're rethinking the short-selling
rule," said Cameron Smith, general counsel at Island ECN in New
York.
For starters, Smith some market participants have "a theoretical
problem" with the rule. "Purists think you shouldn't put artificial
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restraints on stocks to prevent them from going down," he noted.
Practical problems also exist in enforcing the rule, Smith
added. "It is not working very well at the moment," he said, frustrating
short sellers who can't execute trades even if the share price
is rising.
Smith said difficulties stem from the fact that the tick test
is based on the last recorded transaction in a stock. Traders
have 90 seconds to report an order, however, and if the sequence
of trade reporting on the consolidated data tape is off, it can
prevent short sales from going through, even if it appeared to
the seller to be on an uptick.
Extended and after-hours trading could create another problem
since the consolidated tape doesn't operate after the exchanges
close. That would mean short sales could only be executed above
the last price recorded in the regular trading session, which
could put a big crimp in nighttime short-selling.
A shift to price stocks in decimals, rather than fractions,
expected in mid-2000, raises other questions for regulators with
regard to short selling. Once stocks start trading in increments
as small as a penny per share, the SEC asked whether short-selling
prohibitions might kick in after tiny price dips.
Given those problems, Smith said, "we certainly hope they get
rid of the short-sale rule."
At the very least, Kramer said the SEC deserves credits for
questioning whether its short-selling rules are still useful.
"It's refreshing to see an agency re-examine longstanding rules,"
he said.
The proposal is fashioned as a "concept release," which could
lead to a proposal to change the SEC rules, but doesn't guarantee
that result. The SEC floated a proposal to refashion its short-selling
rules in 1976, but withdrew it in response to objections from
the New York Stock Exchange and the American Stock Exchange. An
NYSE spokesman said the Big Board had no immediate comment on
the latest concept release.
Any change in SEC rules would require approval of the full
commission.
-Judith Burns, Dow Jones Newswires; 202-862-6692; judith.burns@dowjones.co
(END) DOW JONES NEWS 10-25-99
08:15 AM- - 08 15 AM EDT 10-25-99
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