In the latest move towards soviet style economics, US financial watchdogs today acted to stop aggressive forms of short-selling that they have blamed in part for the demise of Lehman Brothers.
Amid fears they 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 mortgage finance giants Fannie Mae and Freddie Mac and 17 large investment banks, the new rules apply to trading in the entire market.
The new rules 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.
Short sellers bet that a company’s price will fall so that they can profit from it. They borrow shares of the company and sell them. If the price drops, they buy cheaper shares and use them to repay the borrowed ones, pocketing the difference.
Naked short-selling occurs when sellers do not even borrow the shares before selling them, and then look to cover positions immediately after the sale.
Another new rule will require short sellers and their brokers to deliver underlying shares in the transactions by three days after the date of the short sale, or face penalties. That rule takes effect tomorrow but was adopted on an interim basis and the SEC is seeking public comment on it for 30 days.
“These several actions today make it crystal clear that the SEC has zero tolerance for abusive naked short- selling,” SEC Chairman Christopher Cox said in a statement. The agency’s divisions, including enforcement attorneys and market inspectors, “will now have these weapons in their arsenal in their continuing battle to stop unlawful manipulation,” he said.
The new rules take effect at 12.01pm EDT tomorrow.
Some investors contend that naked short-selling, if left unchecked, would have given hedge funds and other aggressive short sellers an unfair advantage to attack other victims after Lehman Brothers, which made the biggest bankruptcy filing in US history on Monday.
Merrill Lynch – being bought by Bank of America Corp. in a $50bn deal – or giant insurer American International Group, rescued with an 85 billion dollar cash injection from the Federal Reserve, were said to be among the likely targets.