The SEC has begun a public comment period over a set of proposed rules set forward in an effort to curb short selling.

The Securities and Exchange Commission has begun a public comment period over a set of proposed rules set forward in an effort to curb short selling.

The SEC has outlined five potential rule changes that vary from reinstating the original uptick rule to circuit-breaker type rules that would impost restrictions if a stock declined by a certain percent.

The uptick rule, which was revoked in July of 2007, was designed to prevent stocks from being shorted unless their last tick in price was up. The SEC will weigh the options after a 60-day comment period.

The proposals fall into two main categories imposing market-wide sales restrictions and targeting particular stocks in rapid decline for restrictions.

The first proposal would be to simply re-instate the uptick rule that was previously in place while another proposal allows short sales after a buy bids at least a penny more than the stock price. This bid test differs from the original uptick rule in requiring only a higher bid, rather than a higher sale price to open up a short sale opportunity.

The remaining 3 proposals are the circuit-breaker tests that limit short sales for a trading day when certain percentage thresholds were met.

At the very least I think the Commission will put into place an uptick rule that kicks into effect once a stock price has fallen by a certain amount which looks to be about ten percent, says Adam Sussman, director of research at the Tabb Group.

Sussman says that the SEC will have to put some form of a short sale restriction in place in part because of political pressure. If they dont do anything then Congress will and its in the best interest of the SEC to take action, even slightly, rather than leaving it for Congress to decide.

The Tabb Group recently surveyed market participants and found the majority viewed any iteration of the uptick rule as negatively impacting liquidity. The Vision Note report. entitled The Uptick Rule: The Industry Perspective, was in anticipation of the SEC’s meeting.

According to the research, hedge funds in particular thought they would be adversely affected by any ruling. Most hedge fund strategies involve some kind of short selling and whether the uptick rule is reinstated or a circuit breaker is put in place, those strategies could be impacted, explains Sussman.

An uptick rule that might slow down the ability to hedge out a position or make an active bet against a company, he says. Obviously as the time it takes to put on a position increases, the likelihood of being negatively impacted by adverse price movements increases.

Alternative trading systems (ATSs) and dark pools thought the short sale restrictions would negatively impact them as well. Some of the dark pools that compete directly against the exchanges, not the block crossing networks, are concerned because in an environment where users are constantly waiting for a published quote in order to execute, they thought maybe that would lead to an overall preference for the lit systems, Sussman says.

Regardless, Sussman says that after todays meeting the SEC will almost certain impose some form of restriction on short selling, most likely in the circuit breaker form and look to implement right away, but they may not stop there.

Then I think they might take a longer look and decide if some kind of uptick rule should be put in place, he adds. Its politically and technologically expedient to implement a circuit breaker rule sooner rather than later and then re-visit the uptick rule.

Sussman says the market could see a series of changes to the short sale rules made over the next six months to a year.