S.E.C. Floats a Short-Selling Proposal

The commission asked for additional comments on that idea, delaying for at least a month the possibility of commission action.

The proposal would require that short sales be made only at a price higher than the current best price being offered by would-be buyers of the stock. It is similar to the so-called tick-test, which was effective on many stock markets before 2007, but would be more restrictive and could be easier to apply given the current structure of markets. There is now no limit on short-selling, so long as the seller can locate shares to borrow.

Short-sellers trade borrowed shares of a stock, hoping to buy them back later at a lower price and pocket the difference.

The latest proposal is not a completely new idea; the S.E.C. suggested it deep in its earlier proposal, but did not request detailed comment on it. That it is now seeking comment could indicate that at least some members of the commission think the approach could be a good one.

Pressure on the S.E.C. to do something about short-selling grew last year when the stock market nearly collapsed in the wake of the failure of Lehman Brothers. The commission banned short-selling in some financial stocks for a time, and some investors, supported by members of Congress, demanded permanent changes in the rules.

Much of Wall Street has argued that there is no evidence that short-selling caused the plunge last year, and the academic studies available do not support the idea. But the pressure on the commission to do something has been intense. Several stock exchanges suggested a proposal similar to the new one, if the commission felt it had to do something.

The commission asked for comment on whether the latest proposal should become effective for all stocks at all times, or should take effect only after a “circuit breaker” was tripped. Such a circuit breaker could be activated if the stock in question declined by a certain amount — say 10 percent — or for all stocks if a major market average fell by a similarly large percentage. The exchanges said a circuit breaker would be needed.

The old tick-test depended on whether the short sale was executed at a price that was higher than the last different price. Such a rule was relatively easy to impose when virtually all trading in stocks listed on the New York Stock Exchange was done on the exchange.

Now, however, such trades are executed in dozens of locations, and markets can delay reporting trades for up to 90 seconds. As a result, brokerage firms argued, it is virtually impossible to know with certainty what the last trade was, and therefore something based on the old tick-test would be impossible to administer.

The “alternative uptick rule” that the S.E.C. suggested on Monday would be based solely on the current best bid price for a stock — a figure that is kept up to date and is readily accessible. If the best bid for a stock was $20 a share, a short-seller could put in a sell order at $20.01. If someone agreed to buy at that price, the trade could be completed. link....