The SEC seems to be moving ahead with plans to place restrictions on short selling. Short selling occurs when Party A borrows a share of a stock from Party B for a fee and sells the borrowed stock to Party C. At some date in the future, Party A must buy a share of the borrowed stock on the market and give it to Party B. If the price of the stock went down between the time of the sale to Party C and the time of Party A’s purchase of the stock on the market, Party A makes a profit.
Some people believe that short selling is bad for the market because short sellers only profit when stock prices go down, and, thus, they have an incentive to spread false rumors about the companies whose stock they short to drive down the stock’s price. Also, in times of high market volatility, increased short selling in a stock could cause a sell-off panic. To combat these problems, the Commission is seeking comment on a proposed circuit-breaker rule and two proposed versions of the uptick rule. A circuit breaker rule would freeze short selling of a specific stock if its price falls a certain amount in a single trading session and the uptick rule would only allow a short sale after a stock’s price has moved up at least one tick.
Although short sellers face much opposition, the SEC is sure to receive many comments against these proposals because many commentors believe that short selling is essential for price discovery. For an in-depth discussion of the proposals, see Jim Hamilton’s and Floyd Norris’s blogs.