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Chadwick: Bring Back the Uptick Rule!

Thursday, 25 Sep 2008 | 7:45 AM ET

The uptick rule made sense when it was instituted back in 1938 and 70 years later it still makes sense. Simply stated, the rule required that a short sale be executed only if the latest transaction in the stock was at a price higher than the previous trade, (i.e. had been an uptick). The various arguments made for its elimination do not hold water relative to the rationale for its existence — as a check and balance against "bear raids" on stocks. Its elimination was a mistake and the recent rampant and destructive bear raids on more than a handful of financial stocks is evidence of that mistake.

Seasoned and sophisticated investors have voiced opinions on both sides of the issue, but the astonishing swiftness with which Morgan Stanley’s stock fell last week – 40% in a matter of a couple of hours – begs the question of whether that could have happened if there had still been an uptick rule.

Shorting is a legitimate investment practice but unbridled it can be “the tail that wags the dog" and as such should be subject to rules that do not allow it to wantonly destroy capital.

In fact I would argue that in today’s investment environment — where leveraged hedge funds control far more of invested assets than ever before, where foreign capital can attempt to sabotage our markets by committing financial terrorism (YES — think Putin!! think Ahmadinejad!!!) and where the internet is used as an abettor in nefarious schemes designed to destroy stocks — the uptick rule is more useful than ever before.

It adds a small measure of transparency in an otherwise murky investment environment. An uptick indicates that at least for a moment in time the buyers outweigh the sellers and that is very useful information to other potential buyers and/or sellers. Without an uptick rule, there is nothing to keep rogue sellers from borrowing capital and then shorting without actually borrowing the stock (illegal but done) and then blogging rumors and outright lies to panic other long holders into selling their shares, thereby generating a bear raid reaping the benefits of their scheme.

The uptick rule did no harm during its useful life. Hedge funds grew and flourished under its regime. Let’s reinstate it and help to keep a check on those who would wantonly destroy companies for their own gain.

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Patricia W. Chadwick is an asset manager and financial consultant with more than 25 years of investment experience. She is founder and president of Ravengate Partners LLC, a consulting firm that provides advice on financial markets and global economics.

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