Uptick Rule

The original Rule 10a-1 was eliminated by the SEC in July 2007 following empirical evidence from a pilot programme suggesting it had limited effectiveness in modern electronic markets, and was replaced on February 24, 2010 with the alternative uptick rule — SEC Rule 201 of Regulation SHO at 17 CFR 242.201 — a circuit breaker approach that restricts short selling only when a specific stock has declined ten percent or more from its prior day's closing price, at which point short sales in that security are restricted to prices above the current national best bid for the remainder of the triggering day and the following trading day. 

The uptick rule — both its historical original form and its current alternative incarnation — is directly tested on the Series 7 examination in the context of short selling regulation, Regulation SHO, and the mechanics of the ten percent circuit breaker trigger.

The Original Uptick Rule — Rule 10a-1 and Its Historical Context

The original uptick rule emerged from the regulatory response to the 1929 stock market crash and the congressional investigations of the early 1930s that examined the role of short selling in accelerating market declines. While the empirical evidence linking short selling to the crash's severity was debated among economists and regulators, Congress and the SEC responded to widespread public and political concern about short sellers by creating a framework that would prevent short sellers from relentlessly pushing prices lower by executing sales at successively declining prices.

SEC Rule 10a-1 — adopted under the authority of Section 10(a) of the Securities Exchange Act of 1934 — defined the plus tick and zero-plus tick conditions under which short sales of exchange-listed securities could be executed. A plus tick — also called an uptick — occurred when a short sale was executed at a price strictly above the price of the immediately preceding sale. If the last two trades were at ten dollars and then ten dollars and ten cents, a short sale above ten dollars and ten cents was on a plus tick, while a short sale at ten dollars and ten cents itself was on a zero-plus tick. A zero-plus tick occurred when a short sale was executed at a price equal to the immediately preceding sale price but that price was itself higher than the last different price — if the trade sequence was nine dollars and ninety cents, ten dollars, ten dollars, then a short sale at ten dollars was on a zero-plus tick because the current price of ten dollars is the same as the last trade but higher than the last different price of nine dollars and ninety cents.

Rule 10a-1 applied to securities listed on national securities exchanges — primarily NYSE-listed stocks — but not to Nasdaq National Market stocks, which were governed by a separate bid test under NASD rules prohibiting short sales at or below the current inside bid when that bid was below the previous inside bid. This structural inconsistency between the exchange and NASDAQ short sale rules was one of several issues the SEC addressed when it undertook a comprehensive review of short sale regulation in the mid-2000s.

Exceptions, Elections and Exemptive Relief Under the Former Rule 10a-1

Rule 10a-1 normally measured the tick against the last sale price reported to the consolidated tape, but it did not oblige every market to use that reference. Under paragraph (a)(2) of the rule an exchange could elect to measure the tick of the last trade against executions on its own market rather than against the trades reported to the consolidated tape, and certain exchanges — the New York Stock Exchange among them, through its former Rule 440B — implemented their short sale rules on that basis. Whether a particular short sale stood on a plus tick or a minus tick could therefore depend on which market's last sale the test was using.

The core provisions of Rule 10a-1 remained virtually unchanged for almost seventy years, but a body of exceptions grew up around them. In response to changes in trading strategies and in the systems used in the marketplace, the Commission added exceptions to the rule and granted numerous written requests for relief from its restrictions — requests that increased dramatically in the rule's final years with the spread of matching systems that execute trades at independently derived prices at random times within specified intervals, and of fully automated markets.

The NASD bid test and the tick test also differed in their treatment of market makers. Rule 10a-1 contained no general exception for short selling in connection with bona fide market making — its one market maker provision allowed registered specialists and market makers to sell short at the last sale price to protect customer orders against transactions in other markets, and the exchanges adopted rules barring their own specialists and market makers from using even that. The NASD bid test, by contrast, exempted short sales by qualified market makers engaged in bona fide market making — an exception that the Commission, when it approved the bid test in 1994, noted could create opportunities for abusive short selling, and on which market makers in practice relied for only a small percentage of their volume.

The Pilot Programme and Elimination of Rule 10a-1

In 2004 and 2005 the SEC implemented a pilot programme — adopted as part of Regulation SHO — that suspended the short sale price test of Rule 10a-1, and any price test of an exchange or of the NASD, for roughly a third of the stocks in the Russell 3000 index — every third stock, ranked by average daily dollar volume, among the NYSE, Amex and Nasdaq National Market securities in the index — allowing researchers to study the actual market impact of the price test restriction by comparing the pilot stocks — for which short selling was unrestricted — with the non-pilot stocks for which Rule 10a-1 or the NASD bid test continued to apply.

The empirical analysis of the pilot programme — conducted by SEC economists and independent academic researchers — found limited evidence that the original uptick rule was materially affecting market quality, liquidity, or price efficiency in the modern electronic trading environment. The markets had changed dramatically since 1938 — the introduction of decimal pricing in 2001 reduced the minimum price increment from one-sixteenth of a dollar to one cent, making the uptick test far easier to satisfy and far less meaningful as a constraint on short selling than when prices moved in fractional increments of an eighth or a sixteenth of a dollar. The growth of electronic trading and algorithmic execution meant that short sellers could satisfy a one-cent uptick essentially immediately in liquid stocks — making the rule more of a technical compliance requirement than a meaningful restriction on short selling activity.

Based on this evidence the SEC voted on June 13, 2007 to eliminate Rule 10a-1, effective July 3, 2007 with compliance required from July 6, 2007, concluding that the original uptick rule was no longer providing meaningful investor protection or market stability benefits in the modern market structure. The elimination of Rule 10a-1 was one of the most significant changes to short selling regulation in the SEC's history — removing a rule that had been in place for nearly seventy years.

The 2008 Financial Crisis and the Return of Short Sale Restrictions

The elimination of Rule 10a-1 in July 2007 was immediately followed by the financial crisis of 2007 through 2009 — during which major financial institution stocks including Lehman Brothers, Bear Stearns, Washington Mutual, Fannie Mae, Freddie Mac, and AIG experienced catastrophic price declines in which aggressive short selling was believed by many market participants and regulators to have played a destabilising role. The political and regulatory pressure to reinstate some form of short sale price restriction became intense.

In September 2008 the SEC took the emergency action of temporarily banning short selling in approximately eight hundred financial company stocks — a blunt prohibition rather than a price test — during the most acute phase of the financial crisis. When this emergency ban expired the SEC began a formal rulemaking process to develop a permanent replacement for the eliminated Rule 10a-1 that would address the market stability concerns exposed by the crisis while being more appropriate for the modern electronic trading environment than the original tick-based rule.

After proposing two approaches in April 2009 — a permanent market-wide price test, in a version based on the national best bid and a version based on the last sale price, and a circuit breaker approach triggered by a significant decline in the price of a particular security — re-opening the comment period in August 2009 to seek further comment on the alternative uptick rule, receiving more than four thousand three hundred unique comment letters and conducting a public roundtable in May 2009, the SEC adopted the alternative uptick rule on February 24, 2010 as Rule 201 of Regulation SHO at 17 CFR 242.201. The alternative uptick rule became effective on May 10, 2010, with compliance required from February 28, 2011.

Why the SEC Chose a Circuit Breaker With an Above-the-Bid Test

Of the rules the SEC proposed in 2009, the one that many commenters favoured as the least disruptive and the easiest to implement was the circuit breaker halt rule, which would have temporarily prohibited short selling in a security, subject to certain exceptions, once a significant decline in its price had occurred. The SEC declined to adopt it. It was concerned that a halt could harm the market by preventing short sellers from providing benefits such as liquidity and price efficiency to the affected security for the duration of the halt, or could harm investor confidence. A rule permitting short sales only above the national best bid instead requires short sellers in a restricted security to act as providers of liquidity rather than takers of it, while long sellers keep preferred access to the bid.

The SEC also preferred the alternative uptick rule to both of the price tests it had proposed — the modified uptick rule, based on the national best bid, and the uptick rule, based on the last sale price. Each of those tests would have required monitoring the sequence of bids or of last sale prices, asking whether the current national best bid or last sale price was above or below the previous one. The alternative uptick rule references only the current national best bid, needs no sequencing, and was therefore judged likely to be easier and less costly to implement, to program into trading and surveillance systems, and to monitor.

The ten percent threshold was chosen so that the restriction would reach only a limited part of the market at any one time. The SEC staff found that, over the period from April 9, 2001 to September 30, 2009, the Rule 201 restriction would have been triggered on an average day for approximately four percent of covered securities, and for approximately one point three percent on an average day in the low volatility period from January 2004 to December 2006.

Rule 201 — The Alternative Uptick Rule — The Current Framework

SEC Rule 201 of Regulation SHO is the current regulatory framework governing short sale price restrictions — a circuit breaker approach that applies restrictions only to securities experiencing significant intraday price declines rather than imposing a continuous price test on all short sales at all times.

The circuit breaker trigger is the foundational mechanism of Rule 201 — the rule activates for a specific security when that security's price declines by ten percent or more from its prior trading day's closing price as determined by the security's listing market during any intraday trading session. The ten percent threshold is measured against the prior day's closing price — not against any intraday price — and is monitored continuously throughout the trading day. The circuit breaker can be triggered at any point during the trading session from the market open through the close of regular trading hours.

When the ten percent circuit breaker is triggered for a specific security the alternative uptick rule immediately restricts short selling in that security for the remainder of the triggering day and for the entire following trading day. During this restriction period short sale orders in the affected security may only be displayed or executed at a price that is strictly above the current national best bid — the best bid calculated and disseminated on a current and continuing basis from the quotations of the national securities exchanges and FINRA, measured at the time the order is displayed or executed. The restriction allows short sellers to sell only at prices above the current best bid — giving long sellers who can sell at the bid price priority over short sellers in the declining market.

The rationale for the ten percent threshold and the above-best-bid restriction reflects the SEC's intent to target the rule at securities experiencing significant downward price pressure — situations where the risk of a destabilising short selling cascade is most acute — while leaving unrestricted the normal day-to-day short selling activity in securities not experiencing unusual price declines. The SEC's February 24, 2010 press release stated explicitly that the alternative uptick rule is designed to restrict short selling from further driving down the price of a stock that has dropped more than ten percent in one day and to enable long sellers to stand at the front of the line and sell their shares before short sellers once the circuit breaker is triggered.

Who Rule 201 Binds — Trading Centers and Their Policies and Procedures

Rule 201 is not drafted as a flat prohibition addressed to short sellers. It is addressed to trading centers, each of which must establish, maintain and enforce written policies and procedures reasonably designed to prevent the execution or display of a short sale order of a covered security at a price less than or equal to the current national best bid once the circuit breaker has been triggered — a requirement the SEC described as similar to the policies and procedures already required of trading centers under Regulation NMS. A covered security is any NMS stock.

The term trading center is taken from Regulation NMS and is deliberately broad. It means a national securities exchange or national securities association that operates a trading facility, an alternative trading system, an exchange market maker, an OTC market maker, or any other broker or dealer that executes orders internally by trading as principal or crossing orders as agent. A broker-dealer that internalises its customers' orders therefore carries the same Rule 201 obligation as an exchange does, and the price restriction travels with the security to every venue on which it trades.

Writing the procedures does not complete the obligation. A trading center must regularly surveil to ascertain the effectiveness of its policies and procedures and must take prompt action to remedy any deficiencies in them, so a trading center whose procedures are sound on paper but are never tested against what its systems actually display and execute has not met the rule. The rule also provides that no self-regulatory organisation may have any rule that is not in conformity with, or conflicts with, Rule 201.

How the Trigger Is Determined — The Listing Market and the Reference Price

The decision whether a stock has triggered the circuit breaker is not left to each trading center. Rule 201 assigns it to the listing market — the security's primary listing exchange — which determines whether the price has fallen ten percent or more from the prior day's closing price and, if it has, must immediately make that information available through the consolidated market data system as Regulation NMS provides. The SEC staff's guidance confirms that a trading center's own data showing a ten percent decline does not trigger the restriction, which is not in effect for a security until its listing market has made the determination and the information has been disseminated.

The price compared with the prior day's close is a trade price, not a quotation. According to the staff's guidance the determination is based on trades in the covered security reported in the consolidated system, and the national best bid is not part of the calculation — so the bid that serves as the reference price for the restriction once it is in force plays no part in deciding whether the restriction begins.

The test also needs a prior close to exist. For a security on its first day of trading after an initial offering there is no prior day's closing price, so Rule 201 does not apply until the second day of trading, when the first day's close becomes the reference price. For a security whose trading has been halted or suspended, the listing market uses the last available reference price — the closing price or, if there is none, the last sale price from the last day on which the security traded — and the circuit breaker can be triggered once trading resumes if the price then falls ten percent or more below it.

The Price Restriction — Above the National Best Bid

The specific price restriction imposed by Rule 201 — that short sales must be executed above the current national best bid — is the examination-critical detail that distinguishes the alternative uptick rule from the original uptick rule and that is directly tested on the Series 7 examination.

Under the original Rule 10a-1 the price test was based on the last sale price — the short sale had to be at a price above the last transaction price, or at that price if it was itself above the last different price — a tick-based test that depended on the sequence of actual trades. Under Rule 201 the price test is based on the national best bid — the highest price at which any market participant is currently willing to buy the security across all venues — regardless of the price of the last actual transaction. This shift from last-sale-price to best-bid-price reflects the evolution of market structure — in a modern electronic market with multiple competing trading venues, the national best bid is a more meaningful real-time reference for the market's current buying interest than the last sale price which may have occurred milliseconds ago on a different venue.

When a security is subject to the Rule 201 restriction, a short sale order may be displayed or executed only at a price strictly above the current national best bid at that moment. Rule 201 does not require short sale orders in a restricted security to be limit orders. A trading center that receives a short sale order it cannot display or execute because the order is priced at or below the current national best bid may, under its policies and procedures, re-price the order upward to the lowest permissible price and hold it for execution at that price or better, re-pricing it again as quotations change — down to the order's original limit price or, for a market order, until the order is filled.

The Displayed Order Provision and the Crossed Market

Because the national best bid moves continually, a short sale order that was properly priced when it was posted can find the bid rising to meet it. Rule 201 deals with this directly: a trading center's policies and procedures must be reasonably designed to permit the execution of a displayed short sale order if, at the time of its initial display, the order was at a price above the then current national best bid. A short seller who has posted an offer that complied with the restriction when it was displayed does not lose the ability to be executed on that offer merely because the national best bid has since risen to the offer's price.

The provision turns on display, and it helps only orders that are displayed. An order that is never displayed — a dark order resting in an undisplayed book — has no moment of initial display to rely on, and the staff's guidance states that once the circuit breaker has been triggered such an undisplayed short sale order may be executed only at a price above the national best bid at the time of its execution.

A different practical problem arises when quotations cross — when the national best bid is higher than the national best offer. A requirement to price every short sale above the best bid would then demand a price higher than one at which shares are already being offered. The staff's guidance resolves this: while the national best bid and national best offer are crossed, a short sale order in a security subject to the Rule 201 restriction need not be priced above the national best bid and may be displayed or executed at or below it.

Re-Triggering — The Circuit Breaker Can Be Repeatedly Activated

An important operational detail of Rule 201 confirmed in the SEC's FAQ guidance on the rule is that the circuit breaker can be re-triggered for the same security on consecutive days — there is no limit on the frequency or number of times the circuit breaker can be activated for any specific stock.

If a security triggers the circuit breaker on Monday — declining ten percent from Friday's close — the Rule 201 restriction applies for the remainder of Monday and all of Tuesday. If on Tuesday the security again declines ten percent from Monday's close — while already subject to the restriction — the circuit breaker re-triggers and the restriction extends through Wednesday as well. Each successive ten percent intraday decline from the prior day's close resets the restriction period forward by one additional day.

This re-triggering capability ensures that the restriction remains in effect throughout a sustained price decline rather than expiring after a single day if the price decline continues on the day following the initial trigger. A stock experiencing a multi-day severe decline — such as a company facing a catastrophic news event — remains subject to the alternative uptick rule throughout the decline as long as it continues to trigger the ten percent threshold each day.

Exemptions From Rule 201 — When the Restriction Does Not Apply

Rule 201 of Regulation SHO includes specific exceptions, set out in paragraphs (c) and (d) of the rule, under which a broker-dealer may mark a short sale order short exempt so that it can proceed without the price restriction even when the circuit breaker has been triggered for a specific security.

Rule 201 has no market maker exception. Although many commenters asked for one, the SEC specifically declined to permit a broker-dealer to mark a short sale order short exempt because it is made in connection with bona fide market making, in either the equity or the options markets. Its reasons were that equity market makers typically sell at their offer, which Rule 201 permits, that most covered securities are not subject to the restriction most of the time, and that the riskless principal exception remains available — so that Rule 201 generally will not restrict short selling by equity market makers engaged in bona fide market making.

The odd-lot exception is narrower than its name suggests. It does not exempt every short sale of fewer than one round lot; it allows a broker-dealer to mark short exempt a short sale order by a market maker to offset customer odd-lot orders or to liquidate an odd-lot position that changes the broker-dealer's position by no more than a unit of trading.

The volume-weighted average price exemption — for certain VWAP transactions — allows short sales at the VWAP of a security during a trading session to proceed without the Rule 201 restriction if the transaction meets the specific conditions of the exemption.

Claiming an Exception — The Short Exempt Marking

A short sale that relies on one of Rule 201's exceptions travels with a mark. Rule 200(g) of Regulation SHO requires a broker-dealer to mark every sell order of an equity security long, short or short exempt, and an order may be marked short exempt only where the conditions of paragraph (c) or paragraph (d) of Rule 201 are met. The marking has a history of its own: the SEC removed the short exempt marking requirement in 2007, when it eliminated Rule 10a-1 together with every other price test, and restored it in 2010, explaining that the marking would aid surveillance by the self-regulatory organisations and the Commission for compliance with Rule 201.

Paragraph (c), often called the broker-dealer provision, allows a broker-dealer submitting a short sale order to a trading center to mark it short exempt if the broker-dealer itself identifies the order as being at a price above the current national best bid at the time of submission; the trading center may then display or execute the order without regard to the national best bid. A broker-dealer that uses the provision must establish, maintain and enforce its own written policies and procedures reasonably designed to prevent incorrect identification of orders and must regularly surveil their effectiveness — so the price check moves from the trading center to the broker-dealer rather than disappearing.

The paragraph (d) exceptions turn instead on the broker-dealer's reasonable basis to believe that the order qualifies, and the staff's guidance places that judgement on the broker-dealer that originates the order. An originating broker-dealer with a reasonable basis may mark the order short exempt whether it sends the order directly to a trading center, routes it through another broker-dealer or executes it itself as principal, and it must be able to demonstrate that its reliance on the exception was reasonable. A broker-dealer further along the routing chain, or a trading center that routes the order on, may pass a short exempt order along without independently re-evaluating the marking.

When a Short Exempt Marking May Be Used

The two routes to a short exempt marking behave differently on a day when the circuit breaker is not in force. Paragraph (d) of Rule 201 is written to apply following a determination that the price of the security has fallen ten percent or more, but the staff's guidance allows a broker-dealer to mark a short sale order short exempt under paragraph (d) even when the restriction is not in effect, provided the broker-dealer has a reasonable basis to believe at that time that the order meets the requirements of the exception — an approach the staff considers reasonable given the nature of the paragraph (d) exceptions. The broker-dealer provision in paragraph (c) does not work that way: an order may not be marked short exempt under paragraph (c) when the restriction is not in effect.

A separate permission concerns intermarket sweep orders. The staff's guidance allows a broker-dealer to mark intermarket sweep orders short exempt where they are routed solely to facilitate the execution of a customer long sale in compliance with Rule 611 of Regulation NMS, the order protection rule, and it allows that marking whether or not the Rule 201 restriction is in effect in the security.

Beyond the exceptions written into the rule, paragraph (f) of Rule 201 allows the Commission, on written application or on its own motion, to grant an exemption from the rule, either unconditionally or on specified terms and conditions, to any person or class of persons, to any transaction or class of transactions, or to any security or class of securities, to the extent that the exemption is necessary or appropriate in the public interest and consistent with the protection of investors. The staff's answers to frequently asked questions, by contrast, represent the views of the Division of Trading and Markets and are not rules of the Commission.

Exceptions for Sellers Who Own, or Can Acquire, the Shares Sold

Several of Rule 201's exceptions protect sellers whose sale is short only in a technical sense. Under paragraph (d)(1) a broker-dealer may mark an order short exempt if it has a reasonable basis to believe that the seller is deemed to own the security under Rule 200 of Regulation SHO and intends to deliver it as soon as all restrictions on delivery have been removed.

Paragraph (d)(3) is the domestic arbitrage exception. It covers a short sale for a good faith account of a person who then owns another security — for example a security convertible into the shares sold — by virtue of which that person is, or presently will be, entitled to acquire an equivalent number of securities of the same class, provided the sale, or the purchase it offsets, is made for the bona fide purpose of profiting from a current difference between the prices of the two securities, and the right of acquisition was originally attached to or represented by another security or was issued to all holders of the issuer's securities. The staff's guidance makes clear that the exception does not reach arbitrage between the shares of an exchange-traded fund and the securities underlying the fund. The Commission declined to adopt a general exception for exchange-traded funds, reasoning that most are diversified and so will generally not trigger the circuit breaker, and that any restriction that does apply lasts for a limited time and still permits short selling.

Paragraph (d)(4) is the international arbitrage exception: a short sale for a good faith account submitted to profit from a current price difference between a security on a foreign securities market and a security on a United States market, provided the short seller has an offer to buy on the foreign market that allows it to cover the short sale immediately at the time it was made. For this purpose a depositary receipt is treated as the same security as the security it represents.

Exceptions for Distributions and Riskless Principal Trades

Paragraph (d)(5) protects the mechanics of underwriting. A broker-dealer may mark short exempt a short sale by an underwriter, or by a member of a syndicate or group participating in the distribution of a security, in connection with an over-allotment of securities, and a lay-off sale by an underwriter or syndicate member in connection with a distribution of securities through a rights or standby underwriting commitment.

Paragraph (d)(6) covers a broker-dealer that sells short as principal in order to fill a customer's purchase, or a customer's long sale, on a riskless principal basis — selling or buying as principal at the same price to satisfy the customer's order, exclusive of any explicitly disclosed markup, markdown, commission equivalent or other fee. The exception carries conditions of its own. The broker-dealer must have written policies and procedures in place to assure, at a minimum, that the customer order was received before the offsetting transaction, that the offsetting transaction is allocated to a riskless principal or customer account within sixty seconds of execution, and that the broker-dealer has supervisory systems able to produce records from which it can accurately and readily reconstruct, in a time-sequenced manner, every order on which it relies for the exception.

The paragraph (d)(6) exception is written for customer purchases and customer long sales. Where it is the customer who sells short and the broker-dealer fills the order on a riskless principal basis, the staff's guidance treats the transaction differently: if the broker-dealer's first, principal leg complied with Rule 201 and the execution is allocated to a riskless principal or customer account within sixty seconds, the second leg, the allocation to the customer, does not have to comply separately with the price test, though the locate requirement of Rule 203(b)(1) still applies.

The Uptick Rule and Regulation SHO — The Broader Framework

Rule 201 exists within the comprehensive short selling regulatory framework of Regulation SHO — 17 CFR Part 242 Rules 200 through 204 — which covers the full range of short selling obligations including the marking requirements for short sale orders, the locate requirement prohibiting naked short selling, the close-out requirement for fails-to-deliver, and, in Rule 201 itself, the written policies and procedures through which trading centers apply the price restriction.

The Regulation SHO framework is discussed comprehensively in the Short Selling and Regulation SHO entries of this dictionary. The uptick rule — as Rule 201 of Regulation SHO — is one component of this larger framework, specifically addressing the price restriction aspect of short sale regulation while the other provisions of Regulation SHO address the delivery and locate dimensions of short selling compliance.

Rule 201 in Practice — Extended Hours, Customer Orders and Execution Statistics

The circuit breaker can be triggered only during regular trading hours, but the restriction it imposes is not confined to them. The staff's guidance states that, once triggered, the Rule 201 restriction applies at all times during the remainder of that day and the following trading day when quotation information is being collected and disseminated under an effective national market system plan — so a short sale in the pre-market or after-hours session of the following day is subject to the restriction for as long as a national best bid is being published.

The restriction also bears on a firm's obligations to protect resting customer orders. Where a firm sells shares it holds long at the national best bid, and that sale would ordinarily oblige it under self-regulatory organisation order protection rules to fill a resting customer order to sell short at the same price, the staff's guidance concludes that the firm is not required to execute the customer's short sale limit order, because a customer short sale at the national best bid would not be executable under Rule 201. In the reverse case, where a firm's purchase activates a customer's resting buy limit order and the firm can fill it only by selling short, the guidance permits the firm to mark that short sale short exempt and fill the customer's order, subject to the conditions the guidance sets.

Rule 201 reaches the execution quality statistics as well. Because a short sale that is not marked short exempt may be subject to the price test — a status that varies from security to security and from day to day — the staff treats every non-exempt short sale order as an order requiring special handling, outside the definition of a covered order in Rule 600 of Regulation NMS, so that such orders are excluded from the monthly execution quality reports market centers publish under Rule 605. Short exempt orders are not subject to the price test and are not excluded on that ground.

Examination Relevance and Key Takeaways

The uptick rule is tested on the Series 7 examination in the context of short selling regulation, Regulation SHO, the circuit breaker trigger mechanism, and the specific price restriction imposed when the circuit breaker is activated.

The key points to retain are these.

The original uptick rule — SEC Rule 10a-1 adopted in 1938 — required short sales of exchange-listed securities to be executed at a price above the last sale price — a plus tick — or at the last sale price if it was higher than the last different price — a zero-plus tick. Rule 10a-1 was eliminated in July 2007, with compliance required from July 6, 2007, following an SEC pilot programme demonstrating limited effectiveness in the modern electronic decimal-pricing environment.

The current alternative uptick rule — SEC Rule 201 of Regulation SHO at 17 CFR 242.201 — adopted February 24, 2010 effective May 10, 2010 — uses a circuit breaker approach triggered when a specific security's price declines ten percent or more from its prior day's closing price during any intraday trading session. When the ten percent circuit breaker is triggered, short selling in that security is restricted to prices strictly above the current national best bid — the above-best-bid restriction — for the remainder of the triggering day and the entire following trading day. The restriction gives long sellers priority over short sellers in a declining market by allowing long sellers to execute at the bid while restricting short sellers to prices above the bid.

The circuit breaker can be re-triggered for the same security on consecutive days with no limit on frequency — each successive ten percent intraday decline from the prior day's close extends the restriction by one additional trading day. The above-best-bid price restriction does not require limit orders — a trading center may re-price a short sale order priced at or below the national best bid, including a market order, up to the lowest permissible price. Rule 201 has no exception for bona fide market making; its exceptions, claimed by marking an order short exempt, are narrower — among them a market maker's short sales to offset customer odd-lot orders or to liquidate an odd-lot position, and certain VWAP transactions.