In July 2007, the U.S. Securities and Exchange Commission announced that it was canceling the “Uptick Rule,” a cost-free protection that had been in place for almost 70 years. Installed in 1938 as the United States was emerging from the Great Depression, the rule protected the stock market from “bear raids” by short sellers by providing that a short sale can only take place after an “uptick,” a purchase that results in a price rise.
The Commission announced in July 2007 that it was canceling the rule following analysis that showed it was no longer necessary, deferring at the time to arguments that “sharp market declines, such as those induced by ‘bear raids,’ are highly unlikely to occur in today’s markets which are characterized by much smaller spreads, higher liquidity, and greater transparency than when the rule was adopted almost 70 years ago.”1
As demonstrated by the rapid market declines following the Lehman bankruptcy; the nearly instantaneous declines in shares of AIG, Lehman Brothers, and Citigroup which ushered in the crisis; and the failures in transparency by systemically critical institutions, the methodology of the SEC’s analysis and its basic assumptions about today’s securities markets were flawed. A growing crescendo of commentators called for reviving the rule, including Jim Cramer of CNBC2. Writing in The Wall Street Journal, Robert C. Pozen and Yaneer Bar-Yam exposed that the SEC’s study was deficient on various fronts, including the length of the review and its statistical assumptions, and that market behavior after the rule was repealed proved that the prospect of bear raids had risen. 3
Even the New York Stock Exchange (NYSE) conducted an opinion survey of corporate executives on the issue. The vast majority thought that reinstating the Uptick Rule would increase market confidence. 4 Finally, former SEC Chair Christopher Cox has declared his support for the rule, blaming the failure to reinstate it on the other members of the Commission5
Now the SEC is considering reinstating the rule in some form,6 raising the question of what this means for investors, and the answer is arguably different than had the rule been reinstated in the early days of the crisis. If the hypothesis justifying the rule’s return is correct—that bear raids that would have been thwarted (or at least diluted) by the rule accelerated the market’s decline beyond the speed that policy-makers and other stabilizing market participants could respond—reinstating the rule early on may have softened the blow of the crisis. But this hypothesis does not hold once the damage is done, the bear raids have run their course, and the perpetrators are hiding under the bed.
In fact history shows that the short-term impact of reinstating the Uptick Rule is not likely, in the context of all that has happened, to be dramatic. The SEC announced the adoption of the rule in its original form on January 26, 1938, with an effective date of February 8, 1938.7 There was a brief upward bounce in the month the rule became effective, with the Dow rising from 123.97 on February 1, 1938 to 130.47 on March 1, 1938. Ultimately, however, the slide that occurred throughout 1937 continued, with the market falling from 186.61 on February 1, 1937 to 103.02 in April 1, 1938. Despite a recovery to the middle part of this range by the second half of 1938, the markets hit a post-Depression low of 92.92 on April 28, 1942 in the midst of World War II.8
So while the Uptick Rule may be a necessary part of the foundation to rebuild the burned-down house and is ultimately good news for rebuilding long-term market confidence, it’s not likely to be the overall fix. Given the publicity contributed by Cramer and others on the rule’s importance, a short-term bounce precipitated by the rule’s return may be in the works. But ultimately the recovery will be dependent on more fundamental economic forces.
- Federal Register, Vol. 72, No. 127, July 3, 2007, page 36350. [↩]
- Stan Yee, “Out with Cox, in with Uptick Rule,” November 21, 2008, http://www.cnbc.com/id/27850397 [↩]
- Robert C. Pozen and Yaneer Bar-Yem, “There’s a Better Way to Prevent ‘Bear Raids,’ http://online.wsj.com/article/SB122697410070336091.html?mod=googlenews_wsj. [↩]
- Short Selling Study: The Views of Corporate Issuers, http://www.nyse.com/pdfs/ShortSellingStudy10212008.pdf. [↩]
- “Ackerman Urges New SEC Chief to Restore Uptick Rule to Regulate Short Sales of Stocks,” January 27, 2009, http://www.house.gov/list/press/ny05_ackerman/PR_012709.html. [↩]
- See Open Meeting Agenda, Wednesday, April 8,2009, http://www.sec.gov/news/openmeetings/2009/agenda040809.htm. [↩]
- Federal Register, Volume 3, January 26, 1938, page 213. [↩]
- http://www.djindexes.com/DJIA110/learning-center/ [↩]