Tuesday, July 10, 2007

Gee, How Is This Going To Affect Us?


Proposed Changes to Act of 1934

Tuesday, July 10, 2007
After the stock market crash in 1929, Congress passed the Securities Exchange Act of 1934. The SEC is recommending two of the provisions in the act, the "up-tick" and the "zero plus tick" be changed after 70+ years.
Congress and bureaucrats don't like speculators, those that bring liquidity to markets, so after the 1929 crash, they changed the rules.
Prior to the act of 1934, if you wanted to short a stock, you arranged to borrow a stock and then you sold it. To avoid bear raids and piling on in a down or falling market, Congress ruled that you needed an up-tick, a slight move up in price to sell short. Stocks traded in 1/8ths then, so you needed the stock to move up an eighth (up-tick) or if the last trade when your order arrived at the trading post was an up-tick you needed the stock to trade again at that same price (zero-plus-tick) to sell short. You can imagine how hard that was in a falling market when there was a panic to sell. Congress didn't want additional selling on top of the panic selling.
Now this rule change only applied to listed stocks and it did not apply to commodities. Commodities had daily trading limits. A commodity could trade up or down the limit every day for some time, before you could get a trade off in the trending direction. When I was a broker, I did not like these particular rules of the 1934 Act. I wanted to get the trade off as rapidly as possible, in either direction, to take advantage of the trend.
Now, I have mixed feelings about the rule change. I'm not on the side of government rules that get passed after a crisis. What good are they after the horse has escaped the barn? On the other hand, I have posted a number of times about Reg SHO. I have written the SEC has allowed numerous naked shorts to occur, by that I mean the shares were never borrowed before the short sale and the SEC has allowed those trades to be open for months, meaning the seller never had to deliver shares to the buyer. Now, when markets collapse, there will be no restrictions on these same sellers to feed on the panic.
The Securities Exchange Act of 1934 and all its provisions, which I was tested on as part of the Series 7 Test, was passed to safeguard investors. Maybe, technology has made the need for the Act, obsolete, but we have eliminated many of the rules that were passed at that time, such as Glass-Steagall of 1933, which separated investment and commercial banking activities.
It's interesting that this proposed rule change comes at a time when the DJIA is very extended and the S&P has never confirmed the highs put in by the Dow.

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