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Comment: Another episode in the short selling saga

The US Securities and Exchange Commission has published and invited comment on a choice of five alternative proposals that it is considering in an effort to restrict what is perceived as abusive or economically damaging short selling.

The proposals include reintroducing the uptick rule, which only allows short sales in stocks when the last sale price was higher than the previous price. The rule was introduced after the 1929 Wall Street crash and was rescinded as recently as July 2007 - just as the current financial crisis was in the process of breaking.

A similar proposal prohibits a trader from conducting a short sale at or below the last sale price, unless the latter price is higher than the next preceding different price. The US regulator also put forward three versions of a circuit-breaker mechanism that would trigger a short sale restriction if a particular stock fell by 10 per cent in a single trading session.

The SEC plans to hold a roundtable discussion of the issues next month. But many industry members question why the regulator should devote time and resources trying to find a solution to what they argue is a phantom problem?

Many politicians - and company executives - have blamed short selling for driving down institutions' share prices and deepening the financial crisis. But there is persuasive evidence that the short selling bans introduced by many regulators last year offered little or no relief from the downward pressure on bank stocks, nor that they reduced volatility.

Traders and hedge fund managers say short sellers are being targeted unfairly. Jim Chanos of Kynikos Associates, who heads the Coalition of Private Investment Companies, insists that proposals to inhibit short selling have the effect of limiting a vital market-based antidote to corporate fraud and speculative bubbles.

As a leading short seller, you'd expect Chanos to say that, but it doesn't mean that he's wrong. On the other hand, the hedge fund industry managed to survive and thrive for many years with the uptick rule in place, so arguably its return should not cramp the industry's style too damagingly.

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