Published April 10, 2009

SEC outlines moves to curb short selling

Aim is to restore investor confidence in markets

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(NEW YORK) Seeking to restore investor confidence in the markets, securities regulators made several proposals on Wednesday that would restrict investors from betting on a stock's decline at specific times.

Not right up their street: Many market participants, including hedge funds, maintain that short-selling adds liquidity to the market

The proposed rules are meant to curb potentially abusive market activity and have been supported by financial institutions and other companies, which have experienced sharp declines in their shares.

The Securities and Exchange Commission announced five proposals to curb the practice of so-called short-selling, including a modified version of a Depression-era rule that prevents investors from shorting a stock when its price is already declining.

That restriction, known as the uptick rule, was repealed in 2007 after regulators determined that it was not effective at stopping abusive trading practices.

Short-selling involves borrowing stock and selling it in the hope that price declines. If the stock drops, the investor benefits from buying it back at lower price.

One proposal made by the commission resembles the old uptick rule and another imposes a so-called bid test, which would permit short-selling only when the last offer to buy a stock is rising. Another proposal, backed by the nation's major stock exchanges, would impose a 'circuit breaker' that prohibits short-selling for the rest of the day only after a stock's price has declined by 10 per cent or more.

In an open meeting of the SEC on Wednesday, several commissioners said they were not convinced that the repeal of the old uptick rule had anything to do with the current volatility in the market. The commissioners will seek comments from the public over the next 60 days.

'This is an issue that has both strong supporters and detractors, and we will be very deliberative in our effort to determine what is in the best interest of investors,' the SEC's new chairwoman, Mary L Schapiro, said in a speech this week. 'In addition to seeking comments on the new proposals, we will also convene a roundtable to seek a range of views from many experts on the topic.'

Many market participants, including hedge funds and others, have maintained that short-selling adds liquidity to the market and serves an important function in ensuring that stock prices accurately reflect investor demand.

Reinstatement of the prior uptick rule 'is only a partial solution' to abusive short-selling because it does not cover equity swaps and other financial derivatives that provide the same economic benefit as short-selling, said Commissioner Luis A Aguilar.

He called for Congress to give the commission power to oversee such derivatives.

Last year, the commission imposed a series of temporary and hastily drafted bans on short-selling for certain financial companies after pressure from Wall Street firms and the Treasury secretary at the time, Henry M Paulson Jr.

But researchers at the University of Southern California and the University of Alberta argued in a recent study that the short-sale ban caused price inflation of at least US$4.9 billion in the stocks covered, which at the time included Fannie Mae and Freddie Mac. 'The creation of a bias toward long sellers is inconsistent with fair markets,' the researchers wrote. -- NYT