US SEC abolishes the uptick rule

The US SEC has finally decided to abolish the rule that prohibited shares being shorted except on an uptick. The surprising thing is that it has taken 70 years (almost three generations) to get rid of a stupid idea that entered the statute book in 1938.

Of course, in a balancing act, the SEC also tightened rules on “naked short selling”. There is a genuine problem that these rules are trying to address, but this problem is not short selling, it is failed settlement. Though the US has a three day settlement cycle, an unacceptably large proportion of trades fail to settle for several days beyond that date.

It is really fortunate that India avoided importing the system of “continuous net settlement” which is the root of the settlement problem in the US. The Indian approach of ruthless penalties for settlement failures is the right solution to this problem. Instead the SEC wants to look at the whether the failure was intentional or unintentional. It uses silly notions like “abusive short selling” to decide which settlement failures ought to be penalized. It is much better to focus on consequences and penalize all failures regardless of intention. The Indian system has the additional advantage of using a civil liability to deal with a contractual violation. The US system tries to elevate a contractual violation to the level of a fraud.

At a deeper level, the problem of naked short selling is a failure of the securities lending system. The US has a highly developed system for this, but even this system does not work well for all stocks. India faces the challenge of building a securities lending system from scratch, but without any past baggage, it has the potential to build a system with universal access.

Posted at 2:27 pm IST on Thu, 14 Jun 2007         permanent link

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