New SEC Rules Target 'Naked' Short-Selling

SEC Chairman Christopher Cox said the agency
SEC Chairman Christopher Cox said the agency "has zero tolerance for abusive naked short-selling." (Brendan Smialowski - Bloomberg News)
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By Marcy Gordon
Associated Press
Thursday, September 18, 2008

Federal regulators yesterday took measures aimed at reining in aggressive forms of short-selling that were blamed in part for the demise of Lehman Brothers and that some feared could be used against other vulnerable companies in a turbulent market.

The Securities and Exchange Commission adopted rules it said would provide permanent protections against abusive "naked" short-selling. Unlike the SEC's temporary emergency ban this summer covering naked short-selling in the stocks of mortgage finance giants Fannie Mae and Freddie Mac and 17 large investment banks, the new rules apply to trading in the broader market.

In a further move, SEC Chairman Christopher Cox said he planned to ask his four fellow commissioners to consider on an emergency basis a new rule that would require hedge funds and other large-scale investors to disclose their short positions -- the stocks they have borrowed and sold but not yet replaced.

The rule would be designed to ensure transparency in short-selling in general, beyond the practice of naked short-selling, Cox said in a statement last night. Investment managers with more than $100 million in securities would be required to promptly begin public reporting of their daily short positions.

Sens. Charles E. Schumer and Hillary Rodham Clinton (D-N.Y.) asked the SEC to temporarily ban all short-selling, not just naked short-selling, of stocks of major financial companies.

The SEC rules adopted yesterday remove an exception for market makers in options on stocks from rules restricting naked short-selling and tighten anti-fraud regulations related to that activity. The changes make clear that those who lie about their intention or ability to deliver the stocks underlying a short-sale transaction in time for settlement violate the law if they fail to deliver them.

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.

Critics say the SEC action comes too late to stem a tide of short-selling attacks that have felled huge, venerable companies. They want a prohibition on all naked short-selling similar to the emergency ban this summer covering the stocks of the 19 big financial companies.

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