SEC reins in short sellers with new restrictions

25. Feb. 2010

WASHINGTON - Securities regulators adopted a new rule to restrict short selling more than a year after the financial crisis provoked cries to rein in investors who bet on a stock's decline.

The Securities and Exchange Commission voted 3-2 on Wednesday for a rule designed in part to boost investor confidence by braking the precipitous fall of a stock.

The SEC did not exempt option and equity market makers from the curb but said hedging could still occur.

The new rule attempts to bridge the divide between lawmakers and companies who argued a market-wide curb on all short selling was needed, and traders who said that any restrictions would hurt market liquidity.

Under the SEC's rule, if a stock fell by more than 10 percent in a day, a curb would kick in, allowing short selling only above the national best bid.

"The commission was cognizant of the benefits that short selling can provide to the markets," SEC Chairman Mary Schapiro said at a public agency meeting.

However, Schapiro said the SEC was also concerned that excessive downward pressure, accompanied by fear of unconstrained short selling, could destabilize markets and undermine investor confidence.

The SEC's action drew a quick rebuke from famed short seller James Chanos, who said the restrictions would harm investors' interests by driving up transaction costs.

Phillip Goldstein, a hedge fund manager known for a landmark lawsuit that rolled back the SEC's rights to supervise hedge funds, said, "This is a sign that the commissioners who voted for the new rule don't really believe in the free market."

Under the new rule, the restriction would last for the day the stock dropped and the day after.

Short sellers bet on a stock's decline. In a short sale, an investor borrows stock and sells it in the hope that its price will drop. When it does, the seller profits by buying back the stock at the lower price and returning the borrowed shares.

REPUBLICANS DISSENT

During the worst of the financial crisis, lawmakers and companies begged the SEC to clamp down on the short sellers and said the uptick rule should be reinstated.

First adopted after the 1929 market crash, the uptick rule allowed shorting only if the last sale price was higher than the previous price. But the SEC abolished it in 2007 after concluding that it was no longer effective in modern markets.

Democratic SEC Commissioner Luis Aguilar said investor trust in a fair and orderly market was essential to the operation of capital markets. "It would be a mistake to undervalue this trust because we cannot assign a dollar figure to it," he said.

The two Republican commissioners, Kathleen Casey and Troy Paredes, dissented and said there was no firm foundation for adopting the new short sale rule.

Paredes said there was no way to know whether implementation of the rule would boost investor confidence. "Human psychology is difficult to predict," he said.

Casey suggested that those who have been clamoring for the old uptick rule will not be satisfied until the SEC reinstated the Depression-era rule.

Casey and Paredes both raised concerns over potential compliance costs that are estimated to be in the billions of dollars. The SEC estimates that it will cost the average broker dealer or trading center at least $70,000 to comply with the new rule and about $120,000 for annual upkeep.

The new SEC rule goes into effect 60 days after it is published in the government's official federal register. The market will then have six months to comply with requirements.
[Reuters]