SEC short seller rule change may add to volatility

By Emily Chasan

NEW YORK, Aug 9 (Reuters) - A rule change that has made it easier for short-sellers to execute trades may be partially responsible for wild swings in the stock market over the last several weeks.

While the market is also facing considerable headwind from uncertainty over the housing market and the economy, the removal of the restrictive "uptick rule" for short sellers, may be accelerating market declines, analysts say.

"The market move was not caused by the rule change, but there is little doubt that it made the slide occur faster than it might otherwise," Gregory M. Drahuschak, vice president of Janney Montgomery Scott Inc, wrote in a note to clients this week. "Increased volatility is here to stay as long as the new regulation remains."

Short sellers bet a stock is overvalued and that its price is likely to fall. They borrow shares, sell them and then wait for the stock to fall so they can repurchase the shares at a lower price, return them to the lender, and pocket the difference.

But until last month, short sellers were only allowed to sell at a price above the last price of a stock, or at the price of the stock's last trade if it was higher than the previous price.

The so-called "uptick rule" or "tick test" was implemented in the 1930s after the stock market crash to ensure short sellers were not alone in causing a stock price to fall.

But regulators at the U.S. Securities and Exchange Commission revoked the rule in July, suggesting it modestly hurt liquidity and did not appear necessary to prevent the manipulation of a stock price.

"Because (short sellers) had to chase the last sale in order to be compliant with the uptick rule, it kind of distorted market conditions," said Ingrid Werner, a professor at Ohio State University's Fisher School of Business, who has tracked the effects of the uptick rule.