Cramer Versus Cramer Part 3 -- The Uptick Rule

Last blog post, we reviewed some important moments of Jon Stewart's interview of Jim Cramer following their rather public feud. The post was dedicated to amplifying an important question Stewart asked Cramer. Now, it's important to discuss Cramer's response.

Cramer: Okay. First, my first reaction is absolutely we could do better. Absolutely. There's shenanigans and we should call them out. Everyone should. I should do a better job at it. But my second thing is, I talk about the shorts every single night. I got people in Congress who I've been working with trying to get the uptick rule [see first 1:40 of the clip below]. It's a technical thing but it would cut down a lot of the games that you are talking about.

The uptick rule was introduced by Securities and Exchange Commission in 1938 as a solution to the bear raids (see previous post) being used during that period. The intention of the uptick rule was to make it difficult for excessive short selling. An uptick occurs when a stock trades upward. The uptick rule stated that short sales could only be made on stocks with an uptick or if the stock price remained the same provided that it is higher than the last posted price.

This has been helpful because when one trader or hedge fund takes a large short position, nothing will stop the whole group from leaping on board and driving that stock down. With short selling, the investor is selling first and then buying back at a later date. If everybody is short selling, there is a high volume of selling going on, pushing the stock down. The company, which very well might have solid fundamentals, is being reduced to rubble as traders and/or hedge fund managers place their short sales like flies hovering around a steak that has been left outside during a hot summer day. Yes Yes Yes, folks. An awful simile, isn't it? The point is, if the short sellers cannot move when the stock price is going down, the stock's cascading descent is slowed considerably.

It was revoked in 2007. While there is a great deal of conjecture as to why, the official reason was to analyze how the markets did without the uptick rule. The rule had existed for decades, and the underlying rationale was that it quite possible made no difference. Behind the scenes, however, there was a great deal of talk that lobbying from private interest groups were at play. Those against it felt that there was no proof that it prevented a stock from plummeting. Others went further, claiming that it deterred all forms of short selling even during an uptick and prevented proper price discovery, which is considered an abhorrent thought by many.

Although the relevance of the uptick rule on the markets, particularly a bear market is subject to debate. Regardless, the public outcry to reimplement the uptick rule has grown so strong that Congress has no choice but to act. Whether the solution is reimplementing the uptick rule as it was before or in some other form, it has yet to be decided.

I'd like to end this series of posts, which were inspired by the Cramer Vs. Stewart interview, with a clip from Jim Cramer . Like I said, I've never been a fan of his on-screen persona, but this clip contradicts what Jon Stewart was accusing him of, which was basically ignoring the plight of the retail investor. Watch the first 1:40 of the clip. He describes the bear raid and then promotes the use of the uptick rule, an argument he could have presented more passionately on The Daily Show.

No matter how bad his recommendations have been (and trust me, they have been bad), his intentions shouldn't be construed as malicious.

Cramer Versus Cramer Part 2 -- A Bear Raid

In my last post, I expressed a great deal of frustration with the lost opportunity Cramer and Stewart passed up to educate an engaged audience. Probably one of the more notable examples of this came when Jon Stewart presented Jim Cramer with video clips of himself from 2006. The Daily Show pointed out segments like:

Cramer: You know a lot of times when I was short at my hedge fund and I was positioned short, meaning I needed it down, I would create a level of activity beforehand that could drive the futures. It doesn't take much money.

Cramer: I would encourage anyone who is in the hedge fund unit 'do it' because it is legal. It is a very quick way to make the money and very satisfying. By the way, no one else in the world would ever admit that...

What was he talking about? You can tell Stewart's entire 'beef' of the interview lay in getting Cramer to justify such comments. Of coures, Cramer didn't. Neither really explained what he was talking about. It was just assumed it was understood.

I thought it would useful to do a quick breakdown of this dialogue. Stewart was trying to motivate Cramer to discuss a "bear raid." A strategy, although more common during the early 20th century, that involves taking large short positions (and/or colluding with others to take large short positions) and spreading unflattering rumours of the target firm with the set goal of dragging the share price down. The group profits between the original share price and the price that the share price has been dragged down to. This brings a "surer thing" to big-wig traders and hedge funds, while leaving the retail investor, saturated in the buy-and-hold philosophy, out to dry.

A recent example that comes to mind of rumours being spread in the market to get a share price down was when rumours were flying that a healthy Steve Jobs was terminally ill. Every time those rumours gained traction, it sent Apple shares down. There is a great deal of speculation attributing these unsubstantiated rumours to hedge funds. While, today, the poor Jobs has actually taken time off to deal with some sort of illness, traders and hedge funds managers, I believe, have been poking at his health for years.

An unusual thing was that Cramer in the 2006 video commented this behaviour was perfectly legal, which is not entirely true as it might represent securities fraud.

Next blog post we'll review Cramer's response, mentioning a little thing called the "uptick rule." Huh? Uptick rule?