SEC Follow Up Exhibits Part C SEC_OEA_FCIC_001760-2501

Reg SHO Pilot Report 2/12/2007
This results in execution delays and lower fill rates. Tick size changes have lowered these costs,
but short sellers are still precluded from demanding liquidity much of the time.
3. Manipulation
Many of the studies that examine the ability to short in a declining market do not address
the question of whether short selling in a declining market increases the potential for
manipulating a stock price below its fair value, or conversely, whether short selling helps prices
adjust more quickly to their efficient values. Nor do the studies address the question of whether a
tick test or bid test would have been effective at reducing the amount of short selling during
declining markets. A few early studies of short selling in the 1930s concluded that there was no
evidence that short sales had any material effect on the magnitude of price swings. 43
Ferri, Christophe, and Angel (2004) come a little closer to questioning whether the bid
test inhibits trading that may be indicative of manipulation. On days when stock prices are
declining, the degree of short selling is positively related to returns for Nasdaq SmallCap stocks,
which are not subject to the bid test, but not for matching Nasdaq NM stocks, which are subject
to the bid test. This result is the reverse of what one would expect to see if the bid test helps
prevent short sellers from pushing down prices. The authors conclude that “a bid test is
unnecessary for investor protection.”
B. Effect on Market Quality
Because the tick and bid tests appear to have some impact on the execution of short sales,
even though short sales can still execute in declining markets, we might expect the tick and bid
test to affect market quality. In a recent working paper, Jones (2003) re-examines the period
surrounding the initiation of the tick test in the 1930s. He finds a significant reduction in bid ask
43 See Twentieth Century Fund (1935), Macaulay and Durand (1951).
Prepared by the Office of Economic Analysis 20