The US Securities and Exchange Commission (SEC) has adopted a rule to restrict short-selling in a stock if its value has dropped by 10% in a day.
Under the new rule, adopted today by the SEC following a vote, a ‘circuit-breaker’ will be triggered any day in which a stock’s price falls by 10% or more from the previous day’s closing price.
Once the circuit-breaker is triggered, the ‘alternative uptick rule’, first proposed by the SEC in August, will apply to short-sale orders in the affected security for the remainder of that day as well as the following day. The alternative uptick rule only allows short-selling if the stock price is above the current national best bid.
The alternative uptick rule is a simplified version of another uptick rule proposed by the SEC in April last year, which sought to restrict short selling based on either the last sale price or the national best bid.
Critics of the SEC’s proposals had argued that imposing an uptick rule would be a retrograde step. The commission originally adopted an uptick rule in 1938, but abolished it in 2007 after a year-long pilot study determined it was no longer needed. They also contended that short-selling restrictions limit liquidity and increase selling pressure in a falling market.
However, the SEC argues that the global economic environment has changed “dramatically” since it threw out the old rule. “Beginning in 2007, market volatility increased not only in the U.S. but in every major stock market around the world,” said SEC chairman Mary Schapiro in a speech before the new uptick rule was voted on.
The financial crisis of 2008 and the resulting extreme stock price volatility at the end of that year and the beginning of 2009 eroded investor confidence, Schapiro said, prompting the SEC to temporarily ban short-selling in almost 1,000 financial stocks and impose a permanent ban on ‘naked’ short-selling – when a firm short-sells a stock without having borrowed it first.
Schapiro said the new uptick rule was borne of the lessons learned in 2008 when the stock markets began to drop sharply. “I believe it is important for the commission and the markets to have in place a measure that creates certainty about how trading restrictions will operate during periods of stress and volatility,” she commented.
The adoption of the new uptick rule follows a feedback period in which 4,300 comments were received.