U.S. securities regulators meet on Wednesday to consider restrictions on short selling, a type of investing blamed by some lawmakers and executives for exacerbating the financial crisis and driving down share prices.
The Securities and Exchange Commission will consider reinstating the uptick rule, which allowed short sales -- a bet that a stock's price will fall -- only when the last sale price was higher than the previous price.
The rule, first adopted after the 1929 stock market crash, is viewed by some as a way to relieve downward pressure on a stock that is dropping precipitously.
The SEC previously concluded that advances in the marketplace had rendered the rule ineffective and abolished it in summer of 2007.
But with the benchmark Standard & Poor's 500 index <.SPX> down roughly 45 percent since the start of 2008 and the Dow Jones Industrial Average <.DJI> down more than 40 percent over the same period, members of Congress and others are demanding restoration of the rule.
I am glad that they are doing the responsible thing and addressing it, said Democratic Representative Gary Ackerman from New York, who has introduced a bill in the U.S. House of Representatives to reinstate the uptick rule.
But short sellers argue that their trading helps keep markets liquid and prevents stocks from becoming overvalued. They also criticize last year's temporary ban on short sales of hundreds of financial stocks.
I am surprised that regulators have not learned from the (short-sale ban) fiasco where it ultimately reduced liquidity in the securities, said Ron Geffner, a partner at law firm Sadis & Goldberg LLP who advises hedge funds.
UPDATED UPTICK PROPOSAL
In a short sale, an investor borrows stock and sells it in the hope that its price will fall. If the price does drop, the seller profits by buying the stock back at the lower price and returning the borrowed shares.
At Wednesday's meeting, the SEC will consider an updated version of the uptick rule, which will apply to all stocks, two sources familiar with the proposal have said.
The original uptick rule only applied to stocks traded on the New York Stock Exchange.
The five SEC commissioners will also consider a bid test, where shorting would only be allowed at a price above the best available bid, the sources said.
They will also weigh three circuit breakers to curb aggressive short selling. Under one proposal, if a stock fell by 10 percent, a circuit breaker would kick in and trigger the application of the 'bid test.' This approach has the support of the largest U.S. exchanges, the New York Stock Exchange, the Nasdaq Stock Market and BATS exchange.
Under a second circuit breaker proposal, short selling in the particular stock would be banned for the rest of the day, the sources said. The third circuit breaker proposal would trigger the application of the updated uptick rule for the rest of the day, the sources said.
The agency will solicit public comment on its proposals and would hold another meeting to decide on final short sale restrictions as part of its normal rulemaking process.
It makes sense to have a shock absorber that will slow things down just a little when a shock hits the market, said James Angel, a Georgetown University associate professor who specializes in regulation of financial markets.
In September, Wall Street executives and U.S. lawmakers pressured the SEC to limit short selling as financial stocks appeared to free-fall and a loss of investor confidence pushed investment bank Lehman Brothers into bankruptcy.
Amid fear that the global financial system was near collapse, the SEC joined other global regulators in imposing a temporary short sale ban on financial stocks.
Preliminary findings have shown the ban produced unintended consequences such as dislocations in the market, officials have said.
(Reporting by Rachelle Younglai; additional reporting by Jennifer Ablan; Editing by Tim Dobbyn)