SEC Follow Up Exhibits Part C SEC_OEA_FCIC_001760-2501

Reg SHO Pilot Report 2/12/2007
market quality. We are unaware of a previous study that compares the tick test to the bid test.
Several concurrent studies also examine the effect of the Pilot on the tick and bid tests
(Alexander and Peterson (2006), Bai (2006), Diether, Lee, and Werner (2006), and Wu (2006)).
These studies are summarized on Appendix A.
A. Effectiveness of the Rule
1. Shorting in a Declining Market
Several studies examine whether the rules appear to keep short sales from executing in
declining markets. When Rule 10a-1 was adopted in 1938, it was motivated in part by a
Commission study of short selling, based on two weeks of data in 1937. This study found that
when a downtick rule applied, a substantial amount of short selling occurred during periods
when the market was declining. 40 Two subsequent studies produced by staff at the Commission
found that the tick test allows short selling in declining markets. 41 The Commission’s 1963
Special Study concluded that Rule 10a-1 was not effective at achieving its objectives, stating that
[p]resent rules appear inadequate to relieve the added pressure that short selling
may create during a severe decline in the general market or a declining price trend
in a particular security. Despite the rules, a relatively large volume of short selling
occurred in particular stocks, including "market leaders" and "trading favorites,"
during the period of decline preceding the market break of May 28, 1962, and at
critical junctures on that day, and many additional opportunities existed when
short selling could have occurred. 42
In a more recent study, Ferri, Christophe, and Angel (2004) examine short selling in a
matched sample of Nasdaq National Market stocks, which were subject to the bid test, and
Nasdaq SmallCap stocks, which were not, during a period of high volatility and rapidly declining
40 The NYSE had a downtick rule prior to the Commission’s tick test. A downtick rule is a weaker form of the tick
test because it allows trading at the most recent price even if that price was a downtick.
41 The Securities and Exchange Commission (1963), in the Special Study, examined the trading activity leading up
to and during the market break of May 28, 1962. In a working paper by SEC staff, Marcotte and Martin (1977)
study the tick test for the period from September 20 through October 15, 1976, during which time the Dow Jones
Industrial Average fell by 8.12%. The results are summarized in Pollack (1986).
42 88 th Congress, HR Doc No 88-95 (1 st session, 1963), pp. 293-294.
Prepared by the Office of Economic Analysis 17