Published September 17, 2008

SEC to bar 'naked' short-selling

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(WASHINGTON) With Wall Street engulfed in crisis, the Securities and Exchange Commission is planning measures to rein in aggressive forms of short-selling that were blamed in part for the demise of Lehman Brothers and which some fear could be turned against other vulnerable companies.
Mr Cox: The SEC plans in a few days to impose new permanent protections against abusive 'naked' short-selling

During emergency meetings between federal officials and investment bank executives over the weekend, SEC chairman Christopher Cox indicated to the bankers that the agency plans in a few days to impose new permanent protections against abusive 'naked' short-selling, a person familiar with the matter said Monday.

Unlike the SEC's temporary emergency ban this summer covering naked short-selling in 19 stocks, the new measures will apply to trading in the broader market. The person spoke on condition of anonymity because the SEC actions have not been officially announced.

A critic of the agency said the action comes too late to stem a tide of short-selling attacks that have felled huge companies.

The SEC measures likely would include removing an exception for market makers in options on stocks from rules restricting naked short-selling, and a tightening of anti-fraud rules related to that activity, according to the person familiar with the matter.

Those two measures could be put in place administratively by quick approval of the SEC commissioners. Another change - reducing from 13 to five the number of days short-sellers would have to deliver stocks after an initial failure to do so - would require a public meeting and formal vote to propose it as a new rule.

Short-sellers bet that a stock's price will fall so that they can profit from it. They borrow shares of the stock and sell them. If the price drops, they buy cheaper actual shares to cover the borrowed ones, pocketing the difference.

Naked short-selling occurs when sellers don't even borrow the shares before selling them, and then look to cover positions immediately after the sale.

Jim Hardesty, president and market strategist at Hardesty Capital Management in Baltimore, called the possible reduction of delivery time 'a tepid little measure'. However, he endorsed a ban on all naked short-selling similar to the one the SEC instituted in summer covering stocks of 19 major financial firms.

Hedge funds and other aggressive short-sellers 'are ganging up on one company after another', he said. 'A company the scale of Merrill Lynch got into the clutches of those people.'

Investors like Mr Hardesty contend that naked short-selling, if left unchecked, would give hedge funds and other aggressive short-sellers an unfair advantage to attack other victims after Lehman Brothers Holdings Inc. Merrill Lynch & Co - being bought by Bank of America Corp in a US$50 billion shotgun deal - and insurer American International Group Inc, which reportedly appealed to the Federal Reserve for emergency funding, were said to be among the likely targets.

A spokesman for the Securities Industry and Financial Markets Association, Wall Street's biggest lobby group, declined to comment on Monday. Spokesmen for the Managed Funds Association, a group representing hedge funds, didn't immediately return a call seeking comment.

But Steve Thel, a business law professor at Fordham University who was an attorney at the SEC, said the agency's actions are a way to limit abuses in short-selling in an orderly way without 'making it hard for people to express negative opinion' about companies.

The purpose of market regulations is 'not to protect incumbent management from the market's understanding of bad news', Prof Thel said.

Investors have clamoured for the SEC to institute another emergency order similar to its ban from mid-July to mid-August against naked short-selling of the stocks of mortgage finance companies Fannie Mae and Freddie Mac, and 17 large investment banks - including Lehman and Merrill.

The SEC's temporary order required short-sellers to actually borrow shares before selling them. By law, it could not be extended beyond Aug 12.

Mr Cox has said the order helped prevent potential 'distort and short' manipulation of stocks, which occurs when rumours and misinformation are used to drive down the price of a stock that has been sold short. -- AP