Hoping to prevent stock meltdowns, SEC passes short-selling rules

By Zachary A. Goldfarb
Washington Post Staff Writer
Thursday, February 25, 2010

The Securities and Exchange Commission enacted new restrictions on short selling on Wednesday aimed at restoring investor confidence by preventing speculators from pouncing on stocks already in a tailspin.

The rules, which were approved in a 3 to 2 party-line vote, come as the agency has faced intense pressure from lawmakers and investors to crack down on the practice, which some on Wall Street have blamed for crashing the stock values of major financial companies during the 2008 market crisis.

SEC officials don't know how effective the rules will be at stopping stocks from falling fast when short sellers target them. But officials are looking to assure investors that when stocks fall, they are not falling simply because of the tactics of sophisticated traders looking to make a quick buck, but because investors believe that the shares are worth less than they are priced.

"Excessive downward price pressure on individual securities, accompanied by the fear of unconstrained short selling, can destabilize our markets and undermine investor confidence in our markets," SEC Chairman Mary L. Schapiro said on Wednesday.

Schapiro and two other Democratic commissioners voted to approve the rules over the objections of two Republican commissioners, who called the measures unnecessary.

"The essential rationale behind the rule is that the short-sale restriction, if implemented, will bolster investor confidence," said Commissioner Troy Paredes, a Republican. "This claim is rooted in conjecture and is too speculative."

In short selling, a trader borrows shares from other investors and then sells them. If the stock declines, the trader then buys the shares back at a lower price, making a profit. The shares are then returned.

The new restrictions, which will take eight months to put into effect, only affect stocks that have declined at least 10 percent since the previous day. At that point, short sellers essentially will have to pay a small premium to bet against a stock. They'll have to pay a slightly higher price for transactions than investors who are simply looking to buy shares or sell shares they already own.

During calm market times, the rules would affect only a small portion of stocks traded -- fewer than one in 50. But during turbulent times, such as the market crisis of fall 2008, many more stocks could fall under the rules.

The SEC has gone back and forth on the issue for several years. The agency abandoned limits on the practice in July 2007, concluding that curbs were unnecessary.

Then, as markets plunged in fall 2008, the agency banned short sales of shares of many financial companies. The ban expired, and then-SEC Chairman Christopher Cox has since said he regretted the decision as an emotional response to political pressure.

A set of short-selling restrictions was the first proposal to be made by the agency under Schapiro's tenure. The SEC is still considering other proposals to shed light on short selling, including more daily updates on short transactions and wider disclosure of short positions.

Also on Wednesday, the SEC said it will continue to press forward with plans to move U.S. companies to international accounting standards within four years.

The SEC and global accounting bodies want a uniform set of codes. Many accounting experts in the United States worry that international standards are too flexible. But many big companies say the difference in accounting standards leaves U.S. firms operating abroad at a disadvantage.

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