May 2010
Vol. 2 No. 2

Short Circuit:
New Restrictions on Short Selling in U.S. Equity
Markets

I

n February of this year, the U.S. Securities andIn this Market Insights, we consider this SEC rule, the latest

Exchange Commission voted to implement a new rule

U.S. regulatory initiative on short sales since the market

that will reimpose constraints on the execution of shortturmoil of 2008, in the context of the following questions:sales. Dubbed the “alternative uptick rule,” the new rule(1) How does the SEC’s new rule compare in form andhas two major components, a “circuit breaker” and acontent to past rules, such as the “uptick” and “bid-“passive bid test.” The restrictions will be triggered if atest” rules?

stock’s price declines by 10% from its prior closing price.

(2) How does the new rule fit within the existingOver the remainder of that and the following day, shortregulatory structure for short sales in the United States?

sales in that specific name will be permitted only if executed

Although our presentation focuses on the regulatory

at a price above the stock’s then-current national best bid.

landscape in the United States, we’ll also draw some brief

The SEC has given market participants until November

comparisons to short-sale regulations in Europe and Asia.

2010 to comply with the new rule.

Short Circuit
Price-Test Constraints on Short
Selling: The Alternative Uptick Ruleand Its PredecessorsIn the midst of a severe decline in stock prices in 2008, theSEC unveiled a series of new regulatory initiatives,
including temporary measures that imposed “pre-borrow”
requirements on short sales of 19 financial stocks andbanned the shorting of more than 900 stocks. According toa number of analyses, both emergency orders did much toimpair liquidity in equity markets and raise costs for stockbuyers. One academic study found that the quoted bid-ask
spreads for the 19 financial stocks falling under the SEC’s
temporary pre-borrow rule doubled relative to a control
group of stocks.1 Another found that the September 2008
short-sale ban resulted in a $4.9 billion wealth transfer frombuyers to sellers.2
With its February decision on the alternative uptick rule, theSEC has added price-test constraints on the timing andexecution of trades back to the mix of regulations thatgovern short sales. As a reminder, in July 2007, after many
years of analysis, the Commission repealed the old uptick
and bid-test rules, thereby eliminating such price-test
constraints from the array of pre- and post-trade rules on
short selling. After outlining a handful of proposals for new
price-test constraints and soliciting feedback during alengthy comment period in 2009, the SEC has now madethe alternative uptick rule the successor to the uptick andbid-test rules.
At this relatively early date, it appears that the scope of the
SEC’s new alternative uptick rule, in terms of number ofstocks affected, will be far narrower than either the 2008
short-sale ban or previous price-test constraints. Based on
an analysis of trading from April 2001 through September
2009, the SEC estimates that the new rule would haveapplied to approximately 4% of stocks listed on U.S.
exchanges on any given day.3 Given that approximately

1

See Arturo Bris, “Short Selling Activity in Financial Stocks and the SEC July
15th Emergency Order,” Working Paper, August 12, 2008, available at
http://www.imd.ch/news/upload/Report.pdf.

2

See Lawrence Harris, Ethan Namvar, and Blake Phillips, “Price Inflationand Wealth Transfer During the 2008 SEC Short-Sale Ban,” Working Paper,
available at http://ssrn.com/abstract=1364390.

7,000 stocks currently would be covered under the newrule, and extrapolating from the SEC’s historical data, one
might expect that short selling would be constrained in
fewer than 300 stocks on an average day. However, forthose stocks that do trigger the circuit breaker on a given
day, short selling is likely to be far more constrained while
the passive bid test is in force than under the old uptick or
bid-test rule.
Before spelling out the new rule in more detail, it’s worth
briefly reviewing the origins of price-test constraints on theexecution of short sales. We’ve seen this cycle of regulation
before. Past financial crises, like the most recent one,
prompted calls for increased regulation as the public, theirpolitical representatives, and various market watchers
reacted with fear or anger to steep declines in equity
markets.
Prior Price-Test Constraints on Short Selling
Until the end of the 1920s, short selling in the United States
was not limited by formal rules. In the wake of the 1929
stock market crash, with short sellers roundly—and as
academic studies have subsequently shown,4 unfairly—
blamed for causing the collapse, the New York Stock
Exchange imposed a number of new constraints on shorting,including a “downtick” rule that prohibited short sales atprices below the last sale price.
In 1935, the newly established SEC requested that othernational exchanges adopt the NYSE’s downtick rule, which
they quickly did. However, after U.S. stocks sufferedanother crash in 1937, the SEC issued Rule 10a-1, known
more informally as the “uptick rule.” While the originalRule 10a-1 indeed limited short sales on national exchanges
to those executed at an uptick (increase in price) over thelast price at which the preceding sale was executed (a “plustick”), this narrow constraint quickly proved unworkable.
Just over a year after adopting Rule 10a-1, the SEC modified
the rule to allow short sales on either a plus tick or a “zeroplus tick,” the latter being the same price as the previous
sale but higher than the last different sale price.
This basic uptick rule stood alone until 1994, when thegrowth of electronic trading led the SEC to approve a similar
rule for stocks traded on the NASDAQ. This rule,administered by the NASD, relied on a “bid test” rather than3

See Exchange Act Release No. 61,595 (February 26, 2010), 75 Fed. Reg.
11,232 (March 10, 2010), pp. 78-79, available at http://www.sec.gov/
rules/final/2010/34-61595.pdf.

MARKET INSIGHTS

4

See, for example, Harold Bierman, The Great Myths of 1929 and theLessons to Be Learned (New York: Greenwood Press, 1991), chap. 9.

May 2010 | Vol. 2 No. 2 | Page 2 of 9

Short Circuita price test. This modification was implemented because
NASDAQ trades were not necessarily reported to the tape inchronological order, making it difficult, if not impossible, todetermine an accurate last “price.” Under the NASD bidtest rule, short sales were prohibited at or below the thencurrent best or “inside” bid (the highest bid to buy stock
displayed in the NASDAQ Market Center) when that current
best bid was lower than the previous best bid. This
prohibition was indicated to traders by a red “down” arrowappearing next to the ticker symbol on NASDAQ data feeds
when the bid sequence was declining. When the bid
sequence was advancing, a green “up” arrow appeared as
an indication that a short sale could be entered andexecuted at any level, even below the current best bid.
The SEC’s uptick rule and the NASD bid-test rule, together
with the NYSE’s original downtick rule, were all put in placelargely to combat a presumptive form of market abuse thatis generally referred to as a “bear raid.” In a bear-raid
scenario, a small number of market participants accumulatea large pool of capital to short a stock, perhaps inconjunction with the spreading of rumors intended to put
downward pressure on the stock price. Such actions areintended to cause sufficient panic so that holders of longpositions begin to sell, causing further losses. In theory, thisnot only allows the short sellers to cover their short positions
and realize gains but also permits them to purchase longpositions they’ll hold and sell later at considerable profit if,
once the short-selling and rumor campaigns subside, thestock price trends up.5
After more than 70 years of significant change in equity
markets (including the end of “ticks” altogether with themove to decimalization) and considerable enforcement
efforts to combat market manipulation of all kinds, the SEC
repealed the uptick and bid-test rules in July 2007. This
regulatory change followed a controlled experiment thatwas designed by the Commission to pinpoint the effects ofthe price and bid tests on stock prices and market quality.
The two-year experiment involved ranking the stocks in the
Russell 3000® Index according to average trading volume
and then allowing every third stock (a “pilot”) to trade
without price or bid-test constraints; the remaining stocks
served as natural controls. The SEC staff report on thisstudy, as well as several academic studies analyzing thesame data, concluded that there were no meaningful
differences in volatility, particularly to the downside, acrossthe pilot and control stocks, and no evidence that stocks inthe pilot group were subject to trading suggestive of bearraids.6 With enhanced enforcement tools and no evidence
that the short-sale restrictions benefited the market, the SEC
eliminated those constraints.
The New Alternative Uptick Rule
After the steep losses and equity market volatility of 2008,
many of the same recriminations against short selling madein the 1930s were voiced again. Some market participants
and corporate CEOs charged that short selling had
disproportionately caused the price declines, particularly for
financial stocks. Others, including SEC staff economists
analyzing 2008 market data, contend that the sellingpressures from traditional holders, rather than short sellers,
accounted for the downward movement of stock prices
during the extreme market events.7 In the face of significant
market uncertainty, a newly appointed Commission
considered reinstating some form of price-test constraints on
short sales and proposed several options for publiccomment.
In a split decision reflecting the degree of controversy thatsurrounds short sales, the SEC voted 3 to 2 on February 24,2010 to amend Section 201 of Regulation SHO and to
impose the alternative uptick rule. Here’s a brief outline of
the new rule.
Scope: The new rule applies to all equity securities listed on
U.S. exchanges. It does not apply to options or otherderivative securities.
Price trigger: The circuit breaker is triggered if the price ofan individual stock declines by 10% from its closing price on
the prior trading day.
Duration: From the point at which the circuit breaker istriggered, the new rule applies to a stock for the remainder

6

See U.S. Securities and Exchange Commission, Office of Economic
Analysis, “Economic Analysis of the Short Sale Price Restrictions under the
Regulation SHO Pilot,” February 6, 2007, available at http://www.sec.gov/
news/studies/2007/regshopilot020607.pdf. This report contains asummary of the comparative findings of the SEC staff and those of outsideacademic researchers.
7

5

For accounts of alleged bear raids, see Kathryn E. Staley, The Art of Short
Selling (New York: John Wiley and Sons, 1997), chap. 12.

MARKET INSIGHTS

See Memorandum from Daniel Aromi and Cecilia Caglio, Office of
Economic Analysis, to Chairman Christopher Cox, “Analysis of Short Selling
Activity during the First Weeks of September 2008,” December 16, 2008,
available at http://www.sec.gov/comments/s7-08-09/s70809-369.pdf.

May 2010 | Vol. 2 No. 2 | Page 3 of 9

Short Circuitof the day and the following day.8 If a stock falls by 10% ormore from its prior closing price again when the alternative
uptick rule already applies, the circuit breaker is retriggered
and will remain in effect for that day and the following day.
Passive bid test: For market participants, the new ruleeffectively means that for as long as the circuit breakerapplies to a given stock, implementing a short sale in thatname would generally require entering a passive limit order tosell the security at a price above the current national best bid.
Market centers must implement “policies and procedures”
reasonably designed to prevent, for the relevant period, theexecution or display of short-sale orders at or below thecurrent national best bid for any security that has triggered
the circuit breaker. The rule is thus not a strict prohibition
against display or execution of impermissibly priced shortsales. Rather, exchanges and brokers must undertake
reasonable efforts to prevent display or execution of shortsales that don’t conform to the rule, and those measures
could vary across market centers.

Old and New Price-Test Rules
ComparedW

hen the SEC initially outlined new proposals for
restricting short selling in April 2009, its stated goal
was to improve investor confidence. The intent behind the
new rule is to make short selling more difficult in a declining
market and thus limit downward pressure on stocks that are
already falling in price.9 The SEC did not allege market
manipulation, as it had in previous crises, but seemed totake the view that reinstatement of an old rule couldn’t domuch harm, despite the results of various economic studies.
In selecting the alternative uptick rule, the SEC appears tohave tried to mitigate some of the impact that such a rule
could otherwise have on the efficient functioning of equity
markets, in at least two ways. First, the Commission
recognized that bringing back the old uptick rule or the
NASD bid test was not practical given changes in the8

We’ve opted to use the SEC’s language here, although it’s likely theCommission intended this to mean “following trading day.”9

In this vein, some have asked why the U.S. government has not imposed acorresponding downtick rule that permits buyers to purchase a stock only
when its price is falling. This is perhaps a flippant way of pointing out thatpolicymakers have focused more on the effects of downside volatility andless on the adverse consequences of stock-price bubbles like those seen
during the “dot-com” era.

MARKET INSIGHTS

structure of U.S. equity markets. So, for the majority infavor of reimposing price-test constraints, the passive bid
test may have been attractive because it could be
implemented without radically overhauling the current
market structure or forcing the exchanges and brokers to
implement expensive new systems. Second, a passive bid
test on its own would come perilously close to an outrightban on shorting, an option the Commission had explicitly
rejected. Among other things, the addition of the circuitbreaker feature limits the new rule’s application to individual
stocks (rather than applying it to the entire market) and thus
seeks to counterbalance the adverse consequences of suchan effective ban. Let’s consider both points in a bit moredetail.
Implementation Hurdles
Feasibility of implementation was apparently a major
consideration for the SEC when it considered new
constraints on short sales. Simply reimposing the former
uptick rule would have been virtually impossible given theevolution of market structure in the United States. There
are more than 30 trading venues for U.S. equities, including
national and regional exchanges, dark pools, and electronic
communication networks. The decentralization of themarket for stock trading means that determining the lastsale price (and thus whether any given stock is rising or
falling) across all markets would not be feasible without
significantly restructuring the way these markets reporttrades.
Typically, trade prices are reported simultaneously frommultiple locations using different systems within the required
90-second window, making reported last-sale pricesequencing an unreliable indicator of the actual order oftransactions. Even last-sale prices that are reported
immediately may not be in sequence if executed at different
venues. Under these conditions, putting a limit on shortsales based on the last price, as the SEC explicitly
acknowledged, was not practical.
Reimposing the old NASD bid test also would have posedconsiderable challenges under the current market structure,
though to a lesser extent than the price test. For the mostliquid stocks, exchanges can receive hundreds and eventhousands of orders per second, and consequently bids canmove from up to down hundreds of times per second acrossdozens of market centers. Therefore, the sequencing aspectof the NASD bid test introduced a layer of potential
May 2010 | Vol. 2 No. 2 | Page 4 of 9

Short Circuit
complexity to trading and monitoring that was seen bymarket centers as onerous and expensive to implement.
The alternative uptick rule’s approach is believed to be
simpler for market centers to put in place. The test forwhether a stock may be shorted during a circuit-breakercondition is more straightforward. The current national best
bid will provide a bright-line test for market centers to apply,and exchanges have some flexibility in devising appropriate
measures that prevent the execution of short sales at
impermissible prices. However, what the alternative uptick
rule gains in simplicity comes at the expense of precision.
Limiting the Impact of the Passive Bid Test
The simplicity of the alternative uptick rule is rooted in arather draconian approach to limiting short sales. The newrule is far more strict than the old uptick rule or the NASD
bid test because it could apply during declining, static, andadvancing markets for a security. The new rule thus extends
beyond the scope of the SEC’s announced intention to curb
short selling in a declining market. When triggered, the rule
will likely disadvantage purchasers by imposing a premiumon stock made available to the market by short sellers.
Additionally, by discouraging short sales of particular stocks,
liquidity likely will decline, leading to higher bid-ask spreads.
Under certain market conditions, the new rule might
approximate an outright ban on short sales for affected
stocks at a given price.
Consider the following example: The current national best
bid for a stock is $10.00 with a displayed size of 100 shares,
meaning, under the new rule, that short sellers generally
would only be permitted to enter passive limit orders to sell
short at $10.01, even if they judge the stock to be worth
less. Giving long sales priority over short sales when a stock
has triggered the circuit breaker, therefore, could mean thatpurchasers will pay a premium to buy a constrained stock.
It seems clear, then, that without the circuit breaker feature,
the passive bid test on its own could have severely
hampered market liquidity. Given that potential, the circuit
breaker appears to have been included to limit the impact ofthe passive bid test, at least in terms of number of stocks
affected. However, because the restriction carries throughthe next day following a 10% price decline, the alternative
uptick rule will have a more pronounced impact than if theprice-test simply expired at the end of the day. There could
be other distortions in volatile markets. What if a stock
declines by 10% and then rebounds by 5% over the course

MARKET INSIGHTS

of the same trading day, perhaps due to significant news,
such as a merger or an earnings surprise? In such situations,which are not all that rare, the market for the stock is nolonger declining, yet the alternative uptick rule will constrain
short sales and reduce liquidity in that stock for theremainder of that day and the next one.

The Broader U.S. Regulatory Regime
on Short Sales

B

efore it lifted the earlier price and bid tests, the SEC put
in place a number of tools to prevent the sort of market
manipulation that is often cited as the rationale forrestricting short sales more generally. To place thealternative uptick rule in broader context, let’s consider how
the new short-sale constraints fit within the wider set ofrules on short selling in U.S. equity markets.10
Preventing Naked Short Selling
In recent years, much of the public controversy surrounding
shorting of equities has centered on the illegal practice ofabusive “naked” short selling. Traders who act irresponsibly
by selling a stock short without borrowing or arranging toborrow in time for settlement are engaged in illegal naked
short selling. In an abusive naked short transaction, theseller doesn’t actually borrow the stock and intentionally
fails to deliver it to the buyer, with the purpose of driving
down the security’s price. (To be clear, a relatively small
number of delivery failures results from processing errors.)
Whether acting recklessly or with the intent to manipulatemarkets, naked short sellers are violating SEC rules.
Legitimate short sellers must locate a source of borrowing
before entering a short sale and then effect that borrow
after their short sale is executed, so they can deliver thestock to the buyer by the settlement date. Price-test
constraints on the execution of short sales, such as thealternative uptick rule, have no bearing on naked shortselling, whether abusive or not.
Complying with the locate requirement
The SEC enacted Regulation SHO in 2005 with the intent ofadapting regulation to modern market structures andplacing harder limits on the potentially abusive practice of
naked short selling. Among other things and with certain

10

Discussion of margin requirements has been intentionally omitted, as the
topic is outside the scope of this piece.

May 2010 | Vol. 2 No. 2 | Page 5 of 9

Short Circuit
exceptions, Regulation SHO stipulates that no broker may
accept a short sale from a client or enter a short sale for its
own account without first making an “affirmative
determination” on the availability of stock to borrow.
Fulfilling this locate requirement entails borrowing the stock,having an agreement in place to borrow the stock, or having
a reasonable belief that the stock can be borrowed anddelivered by the settlement date.
What does this mean in practical terms for a firm like ours?
Each morning our computers tell our prime brokers’
computers which stocks we might short that day. The prime
brokers search their own inventory and also daily data feeds
from banks that custody securities for clients like pension
and mutual funds. When the stocks available for borrow are
found, we’re given a “locate” to prove we have access toborrowable stock. Our trading systems are programmed not
to allow a stock to be shorted unless a locate has beenobtained.
Brokers estimate that the percentage of shares borrowed iswell below 10% of all shares for which they provide locates,
and they use sophisticated analyses to manage inventory
and prevent failures. Most stocks are easy to borrow, butsome aren’t—a relatively large number of traders may, forexample, wish to hedge a convertible issue or pursue
merger- or event-arbitrage trades—so brokers don’t enable
their systems to automatically confirm a locate for such
“hard-to-borrow” stocks. Instead, we have to call brokers
to find available borrow. Whether borrowable stock islocated automatically or over the phone, no capital changes
hands until the trade’s settlement day.
As a technical matter, this locate requirement is more or lessspecific to current U.S. short-sale regulations and should not
be confused with certain pre-borrow requirements that were
temporarily implemented by the SEC and other regulators
around the world in 2008. Such pre-borrow rules are far
more onerous and costly than a locate requirement because
pre-borrow dictates that a stock must actually be borrowed
prior to the entry of a short sale order in that name on an
exchange, regardless of whether the contemplated shortsale ultimately occurs. Pre-borrow thus requires the fundingof the borrow to begin on the trade date of a short sale,instead of the settlement date. Since the proceeds of a shortsale are not available to clearing brokers until the settlement
date, such a requirement means that brokers would need tofund the pre-borrow out of their own capital (the cost ofwhich brokers are likely to pass on to their customers).

MARKET INSIGHTS

Tightening fail-to-deliver rules
Under the original version of Regulation SHO, clearing
brokers were generally obligated to “close out” fail-todeliver positions that had remained open for at least 13
consecutive settlement days (i.e., trades that had failed for
10 days beyond the typical 3-day settlement period) in
certain securities that were determined to have large andpersistent fails-to-deliver. (Regulation SHO defines stocks
with persistent failed trades as “threshold securities.”) To
close out a position within the required timeframe, brokers
must purchase securities of like kind and quantity in order todeliver them to the party who had purchased and expected
to receive them. In September 2008, the SEC significantly
tightened its close-out rule on an interim basis by requiring
close-outs of short sales at or before the open of trading on
the day after the settlement date and by extending thescope of the requirement to apply to all equity securities.11
The upshot of the SEC’s temporary rule was that by the
beginning of the fourth trading day after a short sale
experienced a failure-to-deliver, the broker handling thetransaction must have borrowed or purchased the security
to close out the failing trade. If not, the broker is not
permitted to execute additional short sales in that name forany party. In July 2009, the Commission made this interim
rule permanent.
The SEC previously estimated that, as a percentage of thetotal dollar value of trades conducted over nearly 200
trading days on major U.S. exchanges, less than 1% of allequity trades failed to settle within three days after the tradedate.12 The relative proportion of fails-to-deliver was
therefore already small, and the new rule has proveneffective in driving down the number of failed stock
deliveries even farther. The SEC found that after tightening
its delivery rule in September 2008, fails-to-deliver for all
stocks declined by over 50% in the subsequent six months.13

11

The SEC also eliminated the existing exemption from the close-out
requirement that had been available to options market makers. However,certain market makers are currently provided with some additional flexibility
on when they must close out positions.
12

See Memorandum from Office of Economic Analysis to File, “Fails to
Deliver Statistics in Threshold Securities,” March 3, 2008, p. 1, available at
http://www.sec.gov/about/economic/threshholdfailsmemo.pdf.
13

See Memorandum from Office of Economic Analysis to File, “Impact ofRecent SHO Rule Changes on Fails to Deliver,” April 16, 2009, p. 3,
available at http://www.sec.gov/comments/s7-30-08/s73008-121.pdf.

May 2010 | Vol. 2 No. 2 | Page 6 of 9

Short Circuit
Reporting and Disclosure Requirements
When looking across major jurisdictions, it’s notable that
although uptick and bid tests have been imposed byregulators in the United States and certain countries in Asia,
such price-test constraints have generally not been imposedin European countries. This may be due to the absence of a
trade-marking infrastructure at the exchange level in thosejurisdictions. European exchanges historically have notrequired that trades be marked “long” or “short” whenorders are entered, and regulators typically haven’t imposed
price-test constraints on short sales, since they can’t beidentified. Consequently, regulators in those jurisdictions
have leaned more heavily in the direction of short-saledisclosure rules. Once again, it may be instructive to see
how SEC rules have evolved in this area and how they haveaffected our firm.
After the 1929 crash, the NYSE required its members toprovide data on their short positions and privately
encouraged them to minimize their shorting activities. Notlong thereafter, the NYSE implemented a requirement thatall sell orders be marked long or short. And in 1932, theU.S. Senate subpoenaed the president of the NYSE tofurnish data on the identities and positions of all accounts
with open short positions as of the end of a trading day in
April of that year. The Senate then released that
information to the public. These disclosures caused atemporary reduction in short selling activity.14
The recent market crisis once again prompted regulators to
impose new reporting requirements on short selling activity.
In September 2008, the SEC issued an emergency order
requiring “institutional money managers” with assets undermanagement of $100 million or more to report certain of
their short sales and positions. Under the original
emergency order, such managers were required to report to
the SEC new short positions acquired and short transactions
executed after the effective date. The emergency order was
replaced by a temporary order that simplified therequirement in a number of ways but also required thereporting of short positions acquired prior to the emergency
order. Under both the emergency and temporary orders,the information that we and other managers reported to the
SEC was not disclosed to the public. In the aftermath of thefinancial crisis, regulators in the United Kingdom and other
14

See J. Edward Meeker, Short Selling (New York: Harper & Brothers,
1932); and Jones, “Shorting Restrictions.”

MARKET INSIGHTS

countries have adopted or considered reporting anddisclosure requirements for short positions. The United
Kingdom now requires that investors publicly disclose all net
short positions that exceed 0.25% of a given stock’s market
capitalization. Other European Union countries are currently
considering a public reporting requirement for net-shortpositions that exceed 0.50%. However, if other EU
regulators follow Germany’s lead, such public disclosureswould remain anonymous with respect to the identity of theshort seller. Hong Kong’s financial regulator is also
considering a short-position reporting regime, but unlike thecurrent U.K. requirement, all reporting would, like the SEC’s
2008 temporary rule and the German reporting rule, bemade privately to the regulator, and any public disclosureswould consist of anonymized data to better protect investor
trading strategies.15
The SEC allowed its temporary order requiring short-sale
reporting to expire without renewal in August 2009.
Without finding any concrete benefits to the collection ofthis immense volume of data, the SEC opted to pursue a
different path toward greater transparency for all market
participants regarding the aggregate level of short selling on
national exchanges. The Commission announced that it wasworking with self-regulatory organizations (“SROs”) to
provide public disclosure on the volume of daily short sales
for individual securities, as well as making public information
on short-sale transactions with a one-month lag.16 Since
2005, SROs like the NYSE and NASDAQ have released bimonthly reports showing the number of shares in individualnames that have been sold short and not repurchased. U.S.
exchanges began reporting daily volume of short sales inindividual names in August 2009. In April 2010, the SEC
proposed a “large-trader” reporting rule that would requirelarge traders to notify the SEC and receive a unique
identifier. That identifier would be attached to all of the

15

When investors are compelled to publicly disclose short positions, they
may refrain from trading as often given concerns that disclosure could
subject them to the risk of front-running or compromise proprietaryinvestment strategies. At least one study finds that public-disclosure rules
materially compromise the market quality of affected stocks. See Oliver
Wyman, “The Effects of Short-Selling Public Disclosure Regimes on Equity
Markets: A Comparative Analysis of US and European Markets,” 2010,
available at http://www.oliverwyman.com/ow/pdf_files/OW_EN_FS_PUBL_2010_Short_Selling.pdf.
16This information is based on trade marking data collected by exchanges.
See U.S. Securities and Exchange Commission, “SEC Takes Steps to Curtail
Abusive Short Sales and Increase Market Transparency,” Press Release,
July 27, 2009, available at http://www.sec.gov/news/press/2009/2009172.htm.

May 2010 | Vol. 2 No. 2 | Page 7 of 9

Short Circuitlarge trader’s trades in its brokers’ records so that alltransaction data (including the identifier) could be madeavailable privately to the SEC by brokers upon request themorning after the day on which transactions (long or short)
were effected. The SEC has also discussed the possibility ofreinstituting a reporting requirement for individual large
short positions.
Additionally, the SEC has worked to provide the public withshort-sale data in two other areas. In July 2009, the SEC
began releasing fail-to-deliver data for individual stocks.
The aggregate number of fails for each stock is posted to
the SEC’s Web site twice monthly.17 The SEC has also
coordinated with SROs to provide a trade-by-trade record ofshort-sale transactions for each stock listed on U.S.
exchanges, including the transaction time, price, andnumber of shares.

illegal naked short selling can only benefit markets and ruleabiding investors.
More generally, we don’t anticipate that the regulatory
regimes in the United States and other jurisdictions—
whether related to short selling or not—will remain static. It
remains to be seen, for example, whether short-sale
reporting rules in major equity markets will broadly converge
or whether national regulators will follow independent
paths, as they largely have on price-test constraints. Given
our global trading footprint, we’ll follow regulatory
developments in a number of jurisdictions quite closely.

ConclusionAstrong consensus has developed among various
experts—including brokers, exchange officials,
institutional investors, and academics—that short selling
contributes liquidity and price discovery to equity markets
and ultimately makes those markets more competitive andefficient for all who trade in them. At the same time,
regulatory oversight is also clearly essential to the promotionof fair and orderly trading in equity markets. Althoughsomething of a stable equilibrium generally seems to prevail
between these twin objectives in normal markets, threesevere market crises in 80 years have prompted calls fortighter restrictions on short selling, including some thatmaterially compromised the efficiency of equity markets.
It will be some time before the markets can fully gauge theimpact of the SEC’s alternative uptick rule. In the coming
months, as the exchanges clarify the policies and procedureswith which they will implement the new rule, our firm
expects to coordinate with our trading counterparties andmodify our trading infrastructure to adapt to those changes.
We don’t believe the new price-test rule will have a material
impact on our investment activities. The number of stocks
affected under the alternative uptick rule is expected to belimited. In addition, we believe the tightening of delivery
standards and other 2009 regulatory reforms to prevent

17

This data is available at http://www.sec.gov/foia/docs/failsdata.htm.

MARKET INSIGHTS

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Short Circuit
The views expressed in this commentary are solely those of
the D. E. Shaw group as of the date of this commentary.
The views expressed in this commentary are subject tochange without notice, and may not reflect the criteria
employed by any company in the D. E. Shaw group toevaluate investments or investment strategies. This
commentary is provided to you for informational purposes
only. This commentary does not and is not intended toconstitute investment advice, nor does it constitute an offer
to sell or provide or a solicitation of an offer to buy any
security, investment product, or service. This commentary
does not take into account any particular investor’s
investment objectives or tolerance for risk. The information
contained in this commentary is presented solely withrespect to the date of the preparation of this commentary,or as of such earlier date specified in this commentary, andmay be changed or updated at any time without notice toany of the recipients of this commentary (whether or notsome other recipients receive changes or updates to theinformation in this commentary).
No assurances can be made that any aims, assumptions,
expectations, and/or objectives described in thiscommentary would be realized or that the investment
strategies described in this commentary would meet theirobjectives. None of the companies in the D. E. Shaw group;
nor their affiliates; nor any shareholders, partners,
members, managers, directors, principals, personnel,
trustees, or agents of any of the foregoing shall be liable forany errors (to the fullest extent permitted by law and in theabsence of willful misconduct) in the information, beliefs,
and/or opinions included in this commentary, or for theconsequences of relying on such information, beliefs,
and/or opinions.

MARKET INSIGHTS

May 2010 | Vol. 2 No. 2 | Page 9 of 9