Uptick Rule Revival May Fail to Lift Stocks, Curb Volatility

By Edgar Ortega and Jesse Westbrook

Dec. 9 (Bloomberg) -- Resurrecting the “uptick rule,” the 70-year-old restriction on short sellers, would probably fail to curb bets against equities or damp price swings, according to brokers that trade about 25 percent of U.S. stocks.

Members of Congress, T. Rowe Price Group Inc. and the head of NYSE Euronext blame the Securities and Exchange Commission’s 2007 decision to eliminate the regulation for contributing to the worst year for stocks since 1931. New York-based Morgan Stanley, Citigroup Inc. and Lehman Brothers Holdings Inc. blamed short sellers, who profit from declining stock prices, for spreading rumors that drove their shares to their lowest this decade.

Executives at UBS AG, Deutsche Bank AG and Knight Capital Group Inc. say bringing back the rule, which prevented traders from making bets against stocks when they were falling, is unlikely to reduce volatility. Ever since computers started trading millions of shares in seconds and exchanges began quoting stocks in penny increments in 2000, the regulation has become obsolete, they said.

“It was a good rule back when trading was manual, but now that trading is much more automated, I don’t see it as a viable solution,” said C. Thomas Richardson, global head of transaction services for New York-based brokerage Nyfix Inc.

The guideline barred traders at the New York Stock Exchange from driving down prices by shorting a stock unless its price had increased, or remained unchanged in the preceding trade.

Plunging Stocks

The Standard & Poor’s 500 Index tumbled 37 percent since July 6, 2007, when the SEC eliminated the rule, erasing about $5.7 trillion from the value of stocks in the gauge. Volatility, as measured by the average daily change in the index during the past 50 days, flared to a record 79 percent last week amid the worst financial crisis since the Great Depression.

Policymakers from Washington to London and Tokyo have boosted oversight of short selling, which involves the sale of borrowed shares in the hope of profiting by buying them back later for a lower price.

Five members of the House Financial Services Committee are sponsoring a bill that would force the SEC to reinstate the uptick rule. NYSE Euronext CEO Duncan Niederauer also wants it back, an opinion shared by 85 percent of NYSE-listed companies, according to an October survey commissioned by the exchange.

‘Nouveau’ Shorts

“If they brought back the uptick rule, you would see some of the nouveau short sellers and the weaker players close their doors,” said Thomas Sowanick, chief investment officer of Princeton, New Jersey-based Clearbrook Financial LLC, which manages $20 billion and invests in hedge funds that short stocks.

SEC spokesman John Nester declined to comment.

When the uptick rule was first in force, stocks changed hands at minimum intervals of 12.5 cents. Now, they trade in tenths of a penny. Trading has accelerated to speeds more than 10 times faster than the blink of an eye, forcing Nasdaq OMX Group Inc. to start reporting orders last month in nanosecond intervals.

“A lot of views about how the markets work are circa 1960s, when things moved manually and more slowly,” said Ingrid Werner, a professor at Ohio State University in Columbus who was a visiting economist at the NYSE and Nasdaq.

Regulators would have to grapple with increased competition among exchanges, and brokers may take months to comply with the rule. The uptick rule only applied to the NYSE, whose market share of trading of the companies it lists dropped to about 25 percent last month from 52 percent in June 2007.

‘Bigger Undertaking’

“From an operational and technology perspective, it may be a much bigger undertaking than people may think,” said Leonard Amoruso, general counsel of Jersey City, New Jersey-based Knight Capital. “This is not just dusting off old software and dropping it back into your servers.”

Trading data show so-called bear raids that the rule was supposed to stop are infrequent. As stocks plunged in September, fewer than 8 percent of trades for companies in the S&P 500 Financials Index were done on consecutive downticks, according to data compiled by Deutsche Bank.

“There doesn’t seem to be an incredible downward momentum across the financial services industry that the uptick rule would have solved,” said Robert Flatley, global head of the Frankfurt- based bank’s Autobahn electronic stock-trading unit.

When Citigroup plunged 26 percent on Nov. 20, the steepest drop on record for the New York-based bank, downticks represented 7.1 percent of trades, according to exchange data compiled by Bloomberg. On Oct. 9, as both Morgan Stanley and Merrill Lynch & Co. shares had record declines, trades on a downtick represented 16 percent and 11 percent of transactions, respectively.

No Bids

“That suggests that the price is collapsing not so much because sellers are hitting progressively lower bids, but because there are effectively no bids,” said Frank Hathaway, chief economist at New York-based Nasdaq.

The SEC could consider alternatives, including a proposal developed by the stock exchanges in October that would ban short selling for a few days if a stock loses 20 percent. The SEC could also revisit a previously proposed variant of the uptick rule that required short sales to get executed at least 1 cent above the best bid at the time of the trade.

That might prove detrimental by inhibiting firms that buy and short stocks to exploit fleeting, tiny price swings, said William Sterling, Zurich-based UBS’s global head of institutional electronic trading.

“Those short-term traders can be providing important liquidity to the market in many cases,” said Sterling. “Inhibiting them seems like it could increase volatility.”

To contact the reporters on this story: Edgar Ortega in New York at ebarrales@bloomberg.net; Jesse Westbrook in Washington at jwestbrook1@bloomberg.net.