Uptick Rule Showdown Coming Wednesday

Direct Edge says that circuit breaker that would enforce a modified uptick rule after a certain percentage decline would distort price action by creating more selling pressure in a rapidly falling market.

"The existence of short sale circuit breakers, or any trigger based on a market condition for that matter, could artificially increase selling pressure on stocks as their value approached the relevant price level, as sellers would have an incentive to engage in premature selling in anticipation of the restriction becoming active," the company wrote.

Direct Edge did acknowledge that naked short selling, which occurs when a trader sells short a stock without first borrowing shares, is a bigger problem that the SEC should do a better job of enforcing.

"Further, given the enactment of more stringent regulations respecting naked short selling and fraudulent conduct, the Commission now possesses more powerful new tools that it can deploy to surveil, control and combat abusive short selling," Direct Edge said.

Other market participants are more critical in their argument against the need for an uptick rule. Eric Newman, co-portfolio manager with TFS Capital, told TheStreet.com in February that short sellers have been a scapegoat for the real cause of the market's decline, namely that stocks went down because they were overvalued and there was too much leverage.

"People like blaming somebody and they don't like to admit that maybe they made a bad investment," Newman said at the time. "It's like everyone's at a cocktail party, talking about and blaming the short sellers. The rhetoric can get pretty heated. But these stocks are falling because they're losing billions of dollars. At the end of the day, it's business and earnings that drive stock prices."

>To order reprints of this article, click here: Reprints