Bankers looking for relief from short-sellers won a skirmish Wednesday as the Securities and Exchange Commission agreed to explore ways of restricting short sales of stock. Now comes the real fight: moving beyond the blanket argument that the measures would boost investor confidence and convincing the agency that there is a tangible economic reason to take action.
The agency's commissioners voted unanimously to consider a list of proposals including the return of an uptick rule, which would allow investors to sell a stock short only at a price above the last trade, or establishing a "bid-up" rule, a similar price test that would be based instead on the last bid. But several commissioners indicated that the burden of proof would rest with proponents of the short-selling restrictions, upping the ante as the agency gets set to begin a 60-day public comment period on the proposals.
Commissioner Kathleen Casey said she has "not yet been persuaded" that the absence of an uptick rule or other price test contributed in any way to the market plunge over the past 18 months. Commissioner Elisse Walter called for details on the costs and benefits of imposing new rules, saying regulators "really need concrete analysis and empirical data" as they decide how to proceed.
"You heard it loud and clear: evidence, evidence, evidence," said Sally Miller, a senior vice president with the American Bankers Association.
The trade group will get to work with members immediately to determine how to best present the industry's case for limiting short-selling activity, Miller said.
In addition to price tests based on either the last trade or last bid for a stock, the SEC will consider using so-called circuit breakers, in which a steep decline in a stock would trigger either a price test or an outright ban on short sales of the stock for the rest of the trading session.
The uptick rule had provided a price test for short sales for nearly 70 years until the SEC repealed it in 2007. Most experts say that any reinstatement of a price test would have to be modified to accommodate the faster trading speeds in exchanges around the world. Erik Sirri, the outgoing director of the SEC's division of trading and markets, told the commissioners Wednesday that a price test based on bid levels is more feasible and less costly to implement than a test based on an uptick in price.
Either way, a price test would provide a "speed bump" to slow the potentially damaging downward stock spirals that can occur when short-sellers pile on, the ABA's Miller said.
So-called bear raids can be especially devastating for banks and financial services companies, because depositors and trading partners sometimes view a falling stock price as an indicator of weakness. But that could turn into an asset for the industry as it lobbies for short-selling restrictions, an effort that essentially would require the SEC to disregard the studies and pilot tests that led the agency to repeal the uptick rule in the first place.
"I personally think that all of the data people have been looking at reflect the market as a whole, and industries built on confidence, like financial services, may warrant some specialized studies to look at how short-selling activities impacts them," Miller said.
Still, it is unclear that an uptick rule, or something like it, would be of much help to banks, which continued to suffer losses in market value last fall even after an emergency SEC order temporarily halted short sales of hundreds of financial stocks.
"It is worth recalling that financial sector stocks continued to fall during the short-sale ban of 2008," SEC Commissioner Troy Paredes said in the open meeting.
Once the temporary orders expired, the public calls for short-selling restrictions appeared to quiet down. But in her January confirmation hearings, new SEC Chairwoman Mary Schapiro said she would visit the topic, and a group of exchanges including the Nasdaq and New York Stock Exchange put forth their own proposal for handling the issue.
Recently, six U.S. senators sent Schapiro a letter urging the SEC to reinstate a modified version of the uptick rule and to take other steps to limit abusive short-selling.
The combination of political pressure and public furor over steep stock market losses means regulators will have to tread carefully.
"People are cautious of that issue, but I think there's a view that given what's happened, a certain amount of heightened regulation is inevitable," said Susan Grafton, an attorney with Gibson, Dunn & Crutcher in Washington who has worked on Wall Street and for the SEC.
James Angel, a finance professor at Georgetown University's McDonough School of Business, said the combination of a circuit-breaker rule with a price test would provide the best balance between the efficiencies and liquidity provided by short-sellers and the need to protect investors and companies from stock market death spirals.
"In today's nanosecond world," he said, "a stock can drop 25% before anybody notices what has happened. In that kind of a world, a shock absorber makes sense."