Senate Bill Would Direct SEC to Reinstate the Uptick Rule

S.605, a bipartisan bill ordering the SEC to reinstate the uptick rule, has been introduced by Senators Ted Kaufman (D-DE) and Johnny Isakson (R-GA). Since the uptick rule's repeal in July 2007, the senators said the abuse of naked short-selling, which is the selling of stock that the trader does not own, has added fuel to the fire of distressed stocks and markets. Kaufman said that abusive short selling was tantamount to fraud and market manipulation.

There is growing congressional sentiment for the SEC to reinstate the uptick rule. Earlier this year, Rep. Gary Ackerman (D-NY) introduced a bill, H.R. 302, that would order the SEC to reinstate the uptick rule within 90 days.

Rule 10a-1, the uptick rule, required all short sale stock transactions to be conducted at a price that was higher than the price of the previous trade. The SEC fully researched the regulation before it was repealed, but some commenters have noted that the research took place during one of the biggest bull markets in history.

The uptick rule required that, when the price of a stock is falling, short sellers must wait for an increase in price before continuing to sell shares short. Under current rules, short sellers are allowed to sell stocks they haven't actually borrowed in advance of their short sale. When settlement day arrives and the seller doesn't have the necessary shares, it harms the market and market participants, particularly when failures to deliver persist for substantial periods.

The legislation directs the SEC to write regulations within 60 days to end abusive short selling. First, the SEC must reinstate the substance of the uptick rule prohibiting short sales that are not made on an increase in the price of the stock. This is designed to prevent short sellers from piling on to a declining stock, further driving prices down. Second, the SEC must require exchanges and other trading venues to execute the trades of long sellers ahead of short sellers, all other things being equal.

Third, with the concurrence of the Treasury Department and the Federal Reserve Board, the SEC must prohibit short sales of the securities of any financial institution unless that trade is effected at a price, in minimum lots specified by the Commission, of at least five cents higher than the immediately preceding transaction in such securities. If the Treasury and the Fed believe they need additional protection, the legislation permits it since the financial sector is in such a fragile state.

Fourth, SEC rules must prohibit any person from selling securities short unless that person has, at the time of the short sale, a demonstrable legally enforceable right to deliver the securities at the required delivery date. Under current law, many short sellers fail to deliver. Fifth, the SEC will require that all short sales settle on the same time frame employed for long sales of the same securities. There is no reason that short sellers should have 13 days to deliver shares when long sellers have only three days, the senators said.

On March 3, Senator Kaufman sent a letter to SEC Chair Mary Schapiro asking the SEC to reinstate the uptick rule. He said the issue is now bigger than just one rule, however influential that rule is. Markets all over the world continue to tumble because average investors have lost confidence that the markets work for them, he said, and Congress must restore confidence in the markets. One important step in doing so is instituting sensible regulations, and the uptick rule is a sensible time-tested rule, he wrote.