By Heather Landy
Special to The Washington Post
Saturday, October 11, 2008

NEW YORK, Oct. 10 -- A temporary ban on short sales of about 1,000 financial stocks expired this week, but U.S. stock exchanges are considering other ways of limiting short-selling in an effort to root out market manipulation.

The recommendation with the most traction calls for a five-day ban on short-selling in any stock that finishes a session down at least 20 percent from the previous day's closing price, according to two sources familiar with the proposal.

The sources, who requested anonymity because the plans are not yet finalized, said the chairman of the Securities and Exchange Commission, Christopher Cox, is receptive to the idea, but other commissioners at the agency want to see alternative proposals from the exchanges, which include the New York Stock Exchange and the Nasdaq.

The proposed measure would apply to all stocks, not just shares of financial firms.

In a short sale, which is a bet that a stock will fall, borrowed shares are sold to another investor. To repay the lender, the short-sellers buy the stock later at what they hope will be a lower price than where they sold it and pocket the difference.

Short-selling often is used as a legitimate hedge against other risks. But regulators are examining whether short-sellers spread false rumors or otherwise manipulated markets in recent weeks to benefit from panicked selling of financial stocks such as Morgan Stanley, which blamed attacks by short-sellers for a rapid plunge in its shares last month.

Proponents of short-selling say that the practice makes markets more liquid and more efficient and provides an important way of raising potential red flags for other investors looking into a company's stock market valuation.