The SEC's new short sale rule has triggered a larger-than-expected number of circuit breakers, Traders Magazine Online reports.  This has forced broker-dealers to make extra sure they're in compliance with the Commission's regulations on shorting, according to Michael O'Conor, director of management consulting for Jordan & Jordan. The short sale rule applies to all listed equities, whether traded on its listing exchange or in the OTC market.

Since passing the rule last year, a volatile market has caused some stock prices to drop 10% or more in a day, which under the rule, triggers a circuit breaker and imposes added restrictions on traders wanting to short the stock.  Mr. O'Connor notes that circuit breakers have been triggered every day in March and April.    On some days it's fewer than 100 stocks;  on others, 300 or more stocks hit the 10% trigger.  "That's more than I thought there'd be, and more than a lot of clients thought there would be."

    Smaller-cap Nasdaq stocks most often trigger the circuit breakers.  They have low prices and  tend to be more volatile - making it easier for them to move 10% in a day.  Nasdaq computed that a daily average of 88 stocks triggered circuit breakers on that exchange alone;  126 circuit breakers were triggered on single day.  On 3/15, Nasdaq-listed stocks experienced 220 circuit breakers.

Once a circuit breaker goes into effect, short sellers must comply with a short sale price test, demonstrating that when they short the security they are selling it for a price above the current national best bid - i.e., the "alternative uptick rule."  The original uptick rule required all short sales to beat or at least match the last price of a security, but that requirement was dropped in 2007.  The alternative uptick rule applies only to stocks that fall by 10% or more from the previous day's close - and the restriction remains in effect for the remainder of the trading day and for the entirety of the following day.  Some transactions are exempt from circuit breakers under the rule - e.g., if a short sale is associated with certain bona fide arbitrage transactions.

While Len Amoruso, general counsel for Knight Capital Group, isn't shocked by the large number of stocks triggering the rule, he's also not happy about how many securities are getting snagged:  "When these things trigger, it brings about inefficiencies.  It also inhibits the way you can pair off trades."   He adds that there's not much empirical evidence showing whether or not the rule is working, and said he looks forward to the SEC re-examining the rule when more data is available.

In the meantime, firms are evaluating their control, surveillance and supervisory structures and making improvements, where needed.   For further details, go to:   [Traders Magazine, 5/9/11, Short Sale Rule .."]