Backgrounder: Regulation SHO and the Uptick Rule

Want to know more about how the uptick rule became history?
The SEC comissioned a study conducted by three economists, known as the Reg SHO Pilot:

We examine the effects of the SEC mandated temporary suspension of short-sale pricetests for a set of Pilot securities. While short-selling activity increased both for NYSE and Nasdaq-listed Pilot stocks, returns and volatility at the daily level are unaffected. NYSE-listed Pilot stocks experience slightly wider spreads, more symmetric trading patterns, and higher short-term volatility after the suspension while there is a much smaller effect on market quality for Nasdaq-listed Pilot stocks. There is no consistent evidence suggesting that market quality deteriorates more for less liquid stocks. The results suggest that existing price-tests have relatively limited effects on the markets, and could safely be permanently suspended. — Diether, Karl B., Lee, Kuan-Hui and Werner, Ingrid M., “It’s SHO Time! Short-Sale Price-Tests and Market Quality” (January 25, 2007). Fisher College of Business Working Paper No. 2007-03-002

The results were discussed at the Roundtable on the Reg SHO Pilot [Transcript, Slides]:

On September 15, 2006, the Securities and Exchange Commission (the “SEC” or the“Commission”) conducted a full-day roundtable discussion (the “Roundtable”) to focus on theresults thus far of the Commission’s Regulation SHO “Pilot,” which suspended application of price restrictions on short sales for nearly one thousand exchange and Nasdaq listed securities.The Roundtable included panel discussions by leading independent economic experts and thepresentation of a number of research papers.
While the economists looked at the data generated by the Pilot in a number of different ways,and expressed varying opinions regarding the Pilot’s overall market impact, there appeared to be general agreement that price restrictions on short sales are unnecessary in today’s markets and may in fact distort the market by preventing legitimate negative information from being reflected in the price of a stock. Whether this will lead to the end of short sale price restrictions remains to be seen. It will be interesting to watch over the next several months to see if the Commissiontakes steps in that direction, or whether it chooses to maintain short sale price restrictions. — October 2006 Clients Briefing, Winston & Strawn LLP

Other papers of interest:

  • Before You Drive That Hot ETF…
    Wall Street Journal, June 4, 2007
  • [DOWNLOAD] Which Shorts are Informed?
    Boehmer, Ekkehart, Jones, Charles M. and Zhang, Xiaoyan, “Which Shorts are Informed?” (February 4, 2007). AFA 2007 Chicago Meetings
  • [DOWNLOAD] On Distinguishing Between Valuation and Arbitrage Motivated Short Selling
    Desai, Hemang, Krishnamurthy, Srinivasan and Venkataraman, Kumar, “On Distinguishing Between Valuation and Arbitrage Motivated Short Selling” (October 10, 2006).
  • [DOWNLOAD] Does Removing the Short-sale Constraint Improve Liquidity? Evidence from Hong Kong
    Pengjie Gao, Jia Hao, and Tongshu Ma (March 2006)