The Uptick Rule: Empty Symbol or Effective Regulation?

Table of Contents

Uptick Rule

What is the Uptick Rule? 

The uptick rule (a.k.a. the “plus tick rule“) refers to a Securities and Exchange Commission (SEC) rule mandating that investors execute short sales at a higher price than the previous trade. 

In the finance industry, short selling involves selling high and buying low. Investors, expecting the price of a security to fall, borrow and immediately sell the asset at a high price. Then comes the waiting game, where they hope that the security’s price does indeed decrease before they must buy back and return the security in the agreed-upon period.

what is short selling

Source: SpeedTrader


The SEC’s official definition for the uptick rule reads as follows:

“Rule 10a-1(a)(1) provided that, subject to certain exceptions, a listed security may be sold short (A) at a price above the price at which the immediately preceding sale was effected (plus tick), or (B) at the last sale price if it is higher than the last different price (zero-plus tick). Short sales were not permitted on minus ticks or zero-minus ticks, subject to narrow exceptions.”

First introduced in the Securities Exchange Act of 1934, the Uptick Rule remained in effect until it was replaced in 2007 by Rule 201 Regulation SHO. Nevertheless, the SEC controversially reinstituted the rule, albeit in an alternative form, in 2010. 

The Zero Theft Movement is working to eliminate rigging of the stock market so the playing field is level. In this article, we will take a look at the uptick rule and examine whether it has proven effective in limiting short selling.

Understanding the Alternative Uptick Rule

The Uptick Rule essentially prevents sellers from accelerating the fall in price of a security already on the decline. The seller must order the asset at a price above the current bid, ensuring that it retains some stability and investor confidence. 

As it pertains specifically to the 2010 alternative uptick rule (Rule 201), it enables investors to exit long positions before short selling occurs. The rule goes into effect only when the asset triggers a ‘circuit breaker’—i.e. the price falls at least 10% in a single day. At that point, short selling would be permitted if the price of the security is above the current national best bid.

It has three main features, other than circuit breaker:

  • Duration of Rule: The alternative uptick rule applies to short sale orders in that security for the remainder of the trading day as well as the following day
  • Securities Covered by Price Test Restriction: The uptick rule applies to all equity securities listed on a national securities exchange, whether traded on an exchange or in the over-the-counter market

Implementation: The rule requires trading centers to establish, maintain, and enforce  reasonably designed written policies and procedures precluding the execution or display of a prohibited short sale

The Savings and Loan Crisis in the 70s resulted in the failure of nearly a third of 3,234 S&Ls and reportedly cost taxpayers $132 billion. Was economic foul play involved?

 

Applying the Short Sale Rule

Here’s a hypothetical example of how the SEC applies the uptick rule. Let’s say shares of ABC close at $100 on Monday and open the next day at $93. A few minutes later, the shares fall to $90—a drop of 10% since Monday’s close. The alternative uptick rule is, therefore, triggered. 

Investors who wish to hold on to ABC (i.e. not short the shares) can trade as normal. However, those who want to short sell cannot do so until the shares trade above the current national highest bid. Say ABC trades down to $85 by 10:00 AM but then shoots up to $91 by 10:05 AM. Only at 10:05 AM, when the price of the security has  exceeded the national best bid ($90), can traders execute their short sales.

In essence, the alternative uptick rule prevents short sellers from boosting their profits by tanking the value of a stock. 

Exemptions to the Rule

The uptick rule makes limited exemptions for futures, derivative financial contracts that require asset transactions to occur at a predetermined date and price. The SEC allows traders to short sell futures on a downtick as these financial instruments likely won’t fall to unjustifiably low prices. The security of futures comes from their high liquidity and tendency to attract long-term investors. 

Futures contracts qualify for the exemption if the SEC deems they are owned by the seller. According to the Agency’s official definition, the person must “[hold] a security futures contract to purchase it and has received notice that the position will be physically settled and is irrevocably bound to receive the underlying security.” 

Why was the Uptick Rule Initially Eliminated

In 2004, the SEC put the uptick rule through a battery of tests to determine its efficacy and see what effects its absence would have on markets. The Agency gave the third-party researchers over a year to study approximately 4,000 exchange-listed securities (or 68 million short sales).

The SEC, in 2007, issued a press release detailing their conclusions and plan moving forward. It claims: “The general consensus from these analyses and the roundtable was that the Commission should remove price test restrictions because they modestly reduce liquidity and do not appear necessary to prevent manipulation. In addition, the empirical evidence did not provide strong support for extending a price test to either small or thinly-traded securities not currently subject to a price test.”

In lieu of the uptick rule, the SEC established Regulation SHO. It most notably targets naked short selling, which involves traders shorting shares they do not actually own and have not verified their ability to possess.

Reasons for the Reinstatement

As we mentioned in the introduction, the SEC reinstated the uptick rule (in an alternative form) in 2010. Considering the results of the extensive studies performed in 2004, the Agency’s decision does not exactly make much sense. Nevertheless, a bit of context should shed some light on the reasons behind the reinstatement. 

2010 was a year of wholesale change in financial regulation. Still reeling from the 2008 subprime mortgage crisis, the public needed to see reform in order to regain confidence in Wall Street.

The subprime mortgage crisis has reportedly cost upwards of $20 trillion, per a Better Markets report. Do you think investment banks knowingly took on way too much risk to boost their profits at all costs? Did regulators fail the public?

 

From 2007-2009, many economists, legislators, regulators, and Wall Street insiders publicly called for the reinstatement of the rule. We have compiled a few examples to show the pressure being put on the SEC to restore the uptick rule. 

  1. Muriel Siebert, former state banking superintendent of New York, was interviewed for a 2007 article in The New York Times. She raises serious concerns about market volatility: “We’ve never seen volatility like this. We’re watching history being made..The S.E.C. took away the short-sale rule and when the markets were falling, institutional investors just pounded stocks because they didn’t need an uptick.”
  2. On September 18, 2008, presidential candidate and Senator John McCain (R-AZ) pointedly claimed the SEC enabled short-selling to transform U.S. markets into a casino. He stated, “[The SEC] allowed naked short selling—which simply means that you can sell stock without ever owning it. They eliminated last year the uptick rule that has protected investors for 70 years. Speculators pounded the shares of even good companies into the ground.”
  3. Congressman Gary Ackerman (D-NY) received a parting letter from then-SEC Chairman Charles Christopher Cox in early 2009. The letter states, “I have been interested in proposing an updated uptick rule. However, as you know, the SEC is a commission of five members. Throughout 2008 there was not a majority interested in reconsidering the 2007 decision to repeal the uptick rule, or in proposing some modernized variant of it. I sincerely hope that the commission, in the year ahead, continues to reassess this issue in light of the extraordinary market events of the last several months, with a view to implementing a modernized version of the uptick rule.”

Is the Uptick Rule Necessary? 

The fervor against Wall Street appears to have fueled the reinstatement of the uptick rule, despite the results of not only the SEC’s tests but independent research as well. Granted, the findings applied specifically to the original uptick rule and not the alternative one currently instated. 

Short selling remains a hotly contested issue, as seen in the 2020 GameStop short squeeze. In general though, market manipulation understandably remains a major point of concern for economists, lawmakers, and the public alike. Undue advantages and clandestine influences on the market can cause main street investors to unfairly experience huge losses. We must work to keep stock markets free and fair, and here’s what you can do. 

We at the Zero Theft Movement are working to achieve economic justice by holding Congress accountable with facts and evidence. On our independent voting platform, our community collaborates to calculate the best estimate for the monetary costs of corruption in the U.S.

Citizens investigators research potential cases of ‘theft’ (unethical, not necessarily illegal, actions that have ripped off the public) and author proposals. The community votes on  whether (1) theft is or isn’t occurring in a specific area of the economy, and (2) how much is being stolen or possibly saved. Through direct democracy, we can collectively decide where the problem areas are and start working on addressing them systematically. 

Many ethical businesses and corporate executives exist. The Zero Theft Movement just wants to eliminate the ill-gotten gains that should be going directly to citizens or indirectly to them through proper, high-quality government services.

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The Zero Theft Movement does not have any interest in partisan politics/competition or attacking/defending one side. We seek to eradicate theft from the U.S economy. In other words, how the wealthy and powerful rig the system to steal money from us, the everyday citizen. We need to collectively fight against crony capitalism in order for us to all profit from an ethical economy.   

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