The Edmond Sun

Business

March 29, 2008

Short selling rule change hurts market

EDMOND — Does it seem like the stock market has gotten more volatile than usual in the past year? It may not be your imagination. There was an important rule change last summer that you and most others probably never even noticed. But the result certainly has been noticed. On July 6, the SEC repealed the “uptick rule.” You probably never heard of this rule and don’t care. But you should care because you just got cheated by the big guys once again.

Short sellers bet a stock is overvalued and that its price is likely to fall. They borrow shares, sell them and then wait for the stock to fall so they can repurchase the shares at a lower price, return them to the lender and pocket the difference. Done correctly, this is a perfectly legitimate activity.

Back in the roaring 20s and Depression-era 30s, there were a number of wealthy investors who played all types of “games” to manipulate the stock market. One of these manipulations was where a number of large investors simultaneously would sell a stock short in an attempt to drive the price down. They often were successful. Of course, all the people who owned the stock suffered great losses.

Under the Securities Exchange Act of 1934, one of the new rules was designed to eliminate this sort of illegal activity. It was called the “uptick rule.” What this rule basically said was that before your order to sell short was executed, the last trade had to be an uptick, i.e. a price higher than the last one. That meant in order to sell short, a stock had to go up before it could be brought down. This prevented short sellers from selling in massive quantities to drive the price down.

Of course, this didn’t completely solve the problem. A common practice for “big money” on Wall Street was to craftily put in a significant amount of buy orders to move a stock to an uptick before then placing their real short sale order. But now that the SEC has eliminated the uptick rule, short selling is now more efficient for these institutions and funds.

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