Short-sale constraints and short-selling strategies: the case of SEC’s revocation of the uptick rule in 2007

Abstract

The US Securities and Exchange Commission (SEC) revoked the uptick rule in July 2007. The revocation of the uptick rule provides us with a unique setting to investigate the impact of short-sale constraints on various short-selling strategies in a controlled environment. It shows that contrarian short selling and voluntary-liquidity short selling are more profound in uptick-rule-restricted stocks than in unrestricted stock. Market trend chasing short selling is less profound in restricted stocks than in unrestricted stocks. No evidence shows that the uptick rule has material impact on risk-bearing short-selling strategies.

Keywords:

• short-sale constraints
• short-selling strategies
• uptick rule
• sec’s revocation

Jel Classification:

• G14
• G12

Notes

¹  Rule 10a-1 (17 CFR 240.10a-1) under the Securities and Exchange Act was adopted in 1938 and was known as the ‘uptick rule’.

²  For example, Morgan Stanley fell as much as 44% on 17 September 2007, and CEO John Mack told employees in a memo that ‘short sellers are driving our stock down.’ In March 2009, US Senator Ted Kaufman said, ‘Abusive short selling amounts to gasoline on the fire for distressed stocks and distressed markets.’ Bloomberg reported on 19 March 2009 that manipulative shorts contributed to the fall of both Lehman Brothers and Bear Stearns.

³  Representative Gary Ackerman introduced on 8 January 2009, a bill in the US House of Representatives to require the SEC to reinstate the uptick rule on short sales of securities. The SEC announced in August 2009 that it is seeking public comments on the proposals related to restoring the uptick rule.

⁴  While tick-by-tick short-sale data prior to July 2007 were publically available according to Regulation SHO, such data were no longer free to the public after July 2007, when the SEC permanently revoked the uptick rule on the NYSE. However, the NYSE has continued to collect short-sale data since then. I purchased tick-by-tick short-sale data from the NYSE Data Service for a four-month period from July to October 2007.