We have all seen what has happened to the financials over the past few weeks. One after the other they began to fall, merge, or became pressured to make moves that they normally would not make. The crisis had many worried about not only the economy, but where their money was, and whether it was safe. In response to all of this the government set up a few firewalls, one of which was to suspend short selling on certain equities.
Immediately after the government announced the ban on shorting, the market responded with positive waves, but they were short lived. The reason that the ban had little impact is because smart investors, and even the street KNOW that the move is temporary, and any gain as a result of the rule can be wiped out as soon as the shorts are allowed to work their magic again. What we have left are investors refusing to go long, and shorts unable to do anything.
Among the many news reports on the subject is a theory that if the uptick rule were put back into place that it would begin to level the playing field to at least some extent. Is it enough? Likely not, but it would at least give some measure of control into the markets.
The uptick rule is was adopted in 1938 and was designed to help regulate short selling in financial markets. Typically the rule mandated that when sold, a listed security must either be sold short at a price above the price at which the immediately preceding sale was effected, or at the last sale price if it is higher than the last different price.
In July of 2007 the uptick rule was removed, giving short traders a free reign on shorting without any real mechanism to mitigate. Personally, I feel that something as simple as bringing back the uptick rule will not solve the overall problem. The problem runs deeper, and there is a systemic issue at hand that needs to be addressed. Borrowed shares for the purpose of shorting is one thing. Naked shorting is where the issue comes to a head. Investors who short a stock, but the shares never get borrowed, are actually diluting the overall stock of the company because they are profiting from share that do not exist.
Bring back the uptick rule would only be a start, but what other solutions can exist that will have enough teeth to curb the problem? To be fair, short selling should indeed be allowed. It is something that helps cash flow through the markets. The issue is, in my opinion, reaching a fair balance for those on both sides of the trade.
- One possible solution that may mitigate the unfair advantage enjoyed by the short side is giving investors have a mechanism to specify that their shares can not be borrowed, and that investors who are long a position benefit from allowing their shares to be borrowed. Some brokerages already pay longs to allow them to borrow shares, but the mechanism to do so across the board is not available. In keeping things fair for the brokerages, perhaps a trade that carries a "no-borrow" provision would have a higher price (i.e. instead of a $9.95 trade, the no borrow provision would be $12.95)
- Make strict and stringent penalties. Brokerages seem to be able to figure out how to restrict you from selling one equity, using those funds in buying another equity, and selling too soon. Put the onus on the brokerages to ensure that shares sold short get borrowed, and failure to deliver will penalize not only the investor, but the brokerage house as well. This will make the brokerages be SURE that they can borrow prior to executing the trade.
- Make the REGSHO failure to deliver list VERY PUBLIC. Name the firms that are not following the rules, and give them a set time-frame to get off of the list. Institute fines that accrue on a DAILY BASIS for however long the firm is on the list for failing to deliver.
- Strengthen the requirements that will place an equity on the REGSHO list. As it is currently done, the damage caused by failures to deliver is already done by the time an equity gets on the list. Consider an all out ban on shorting any equity on the REGSHO list until 30 after the company comes off of the list.
I am not saying that all of these ideas should happen, or even that these ideas are prudent for a long term solution (these are after all simply quick thoughts tossed at a massive problem). However something other than the selective ban on shorting needs to happen, and it all can start with bringing back the uptick rule, and then adding some long term strategies that level the playing field between going long and shorting. Now is the time when the SEC has a chance to make meaningful change that can help restore confidence in the market.