SEC Follow Up Exhibits Part C SEC_OEA_FCIC_001760-2501

Reg SHO Pilot Report DRAFT 9/14/2006
While studying order data from the NYSE, Angel (1997) and Alexander and Peterson
(1999) find that the tick test prevents short sales from demanding liquidity more than 90% of the
time. As expected, the degree to which the tick test is binding depends on whether the market is
rising or falling. Likewise, McCormick and Reilly (1996) find that the Nasdaq bid test prevents
short sellers from demanding liquidity roughly 35% of the time. This proportion was found to be
an increasing function of trading volume and, not surprisingly, a decreasing function of the day’s
stock return.
Both Angel (1997) and Alexander and Peterson (1999) conclude that Rule 10a-1
significantly impedes order execution quality for short sales, even in rising markets. For those
cases where the stock price increased, short sellers can trade at the bid less than fifteen percent of
the time. According to Alexander and Peterson (1999), the tick test appears to contradict the
Commission’s first stated objective for short selling regulation, to “allow relatively unrestricted
short selling in an advancing market.”
In addition, Alexander and Peterson (1999) also found that short sale orders have
significantly lower execution rates and significantly longer times to execution than regular sales.
Alexander and Peterson (2002) study how the tick test was affected by the reduction of the tick
size from 1/8 to 1/16 in June 1997. As predicted, their evidence suggests that short sales were
executed faster and at better prices after the reduction in tick size, confirming that the tick test is
less binding when the tick size is smaller.
In summary, previous research shows that short sellers can receive better prices as a
result of the tick test and that the tick test does not impede profit opportunities. However, the
tick test and bid test restrict the ability of short sellers to demand liquidity even in rising markets.
Prepared by the Office of Economic Analysis 19
DRAFT