SEC Reconsiders Short-Sale Rules

The Securities and Exchange Commission is seeking comment on whether to loosen or eliminate 61-year-old rules that restrict “short selling,” a trading technique that generates profits when stock prices fall.

The SEC last proposed changes to the short-sale rules in 1976, only to withdraw the plan after meeting opposition from the New York Stock Exchange and companies whose shares trade on exchanges.

Critics argue that, without Rule 10a-1, speculators could conduct “bear raids” in which they artificially drive down a stock, fueling a cascading effect. Some, in fact, even blamed bear raids for the 1929 stock market crash.

The most common method of short selling is for traders to borrow shares from brokerages and then sell them in the open market. The hope: that the market price will then fall, allowing the trader to repurchase shares at a lower price and repay the borrowed stock.

The profit is the difference between the sale price and the ultimate repurchase price.

But to prevent short sellers from ganging up on a stock, there is a “tick test.” One of the rule’s key provisions limits short sales to a so-called uptick--meaning a price that is higher than the last reported sale on an exchange.

Thus, if the last reported sale of a share was $10, a trader could short the stock at $10.13, but not lower.

The SEC noted that the short-sale rule was adopted when markets had smaller trading volumes and simpler trading strategies. The present rule “may inject unnecessary inefficiencies” into various trading strategies, the SEC said.