The Securities and Exchange Commission (SEC) continued its crackdown on short selling by imposing a restriction that options industry leaders say could dampen liquidity in the market. On Feb. 24, the SEC approved the alternative uptick rule, designed to stop short selling from further driving down the price of a stock that has dropped more than 10% in one day. When a circuit breaker is triggered, long sellers will now be able to stand in the front of the line and sell their shares before any short sellers. The rule will become effective 60 days after the date of publication in the Federal Register, and market participants will have six months to comply with the requirements.
“The rule is designed to preserve investor confidence and promote market efficiency, recognizing short selling can potentially have both a beneficial and a harmful impact on the market,” said SEC Chairman Mary Schapiro in a statement.
In September 2008, the SEC enacted a temporary emergency ban on short sales, and in July 2009, the agency made permanent Rule 204, which requires broker-dealers to purchase or borrow securities to deliver on a short sale.
Peter Bottini, vice president of trading at optionsXpress, says the new rule went through a long, deliberative process and the SEC chose one of the least impactful changes, which is positive, but because the rule doesn’t include an exemption for market makers, “if stocks hit the 10% threshold and [end users are] trying to hedge their positions and limit losses, they’re going to have a hard time buy[ing] puts. Without the exemption we [could] see a real loss of liquidity when this 10% threshold is met.”
In an e-mailed statement, CBOE Chairman and CEO William Brodsky said, “We’re disappointed because of the potential impact on the options markets. Nonetheless, we are heartened by Commissioner Aguilar’s remarks that the staff is expected to study the impact of the rule on the options markets and make adjustments to the rule, if warranted. Hopefully, if there are harmful impacts, the SEC will also take quick action to provide an exemption.”
Bottini agrees, saying that the industry will be examining bid-ask spreads and if they see a dramatic loss of liquidity, they will notify the SEC. “The [SEC] did promise they’d review that. If the liquidity’s not there, [investors] are going to be pretty frustrated,” he says.
The rule was approved in a 3-2 vote that broke down along political party lines, with both Republican commissioners voting against it.