SEC Stiffens Short-Selling Rules Amid Market Turmoil

       

SEC Stiffens Short-Selling Rules Amid Market Turmoil (Update1)

By Jesse Westbrook and Edgar Ortega

Sept. 17 (Bloomberg) -- The U.S. Securities and Exchange Commission stiffened rules against manipulative short-selling after a market rout pushed American International Group Inc. to the brink of collapse and triggered Lehman Brothers Holdings Inc.'s bankruptcy.

The SEC adopted two regulations today forcing traders and brokers to close out short sales on all stocks, amid concern investors are driving down prices by flooding markets with sell orders. A third rule makes it a securities fraud when sellers deceive brokers about delivering borrowed shares to buyers.

``These several actions today make it crystal clear that the SEC has zero tolerance for abusive'' short-selling, SEC Chairman Christopher Cox said in a statement on the rules that take effect tomorrow.

Lawmakers and regulators are questioning whether short sellers have contributed to a crisis by spreading false information and using abusive tactics to attack companies. Hedge funds and other investors argue that poor business strategies are to blame, not short sellers.

In traditional short sales, traders borrow shares that they then sell. If the price drops, they profit by buying back the stock, repaying the loan and pocketing the difference.

The SEC rules approved today target so-called naked short- selling, in which traders never borrow shares from their brokers. The agency is concerned that such a strategy can free investors to manipulate prices by placing unlimited sell orders.

Market-Makers

One SEC regulation eliminates an exemption for options market-makers to deliver shares of companies placed on so-called threshold lists. Companies are listed when they have a high number of borrowed shares that haven't been delivered.

The rule will make it harder for options market-makers to hedge trades when they sell put contracts, said Stephen J. Nelson, a securities lawyer in White Plains, New York.

``If you want to short the stock you're going to have to deliver it, and the only way to really do that is to pre- borrow,'' Nelson said. `Professional traders are not in the business of taking that kind of risk. They would be very reluctant to face the five-day window because buy-in can be very expensive.''

A second SEC rule imposes penalties on brokers if their clients haven't delivered shares to buyers three days after a short sale. For the specific security that hasn't been delivered, the mandate restricts brokers from conducting additional short sales on behalf of all their customers. The SEC will seek public comment on the change for 30 days.

Fraud

The SEC also approved a rule drafted in March that would make it a fraud for investors to lie to their broker about locating shares to sell short. Currently, brokers are able to rely on their customers' assurance that they had located shares that could be used to cover a short sale.

The SEC rules don't reinstitute an ``emergency'' order that expired last month, which placed restrictions on short-selling in Lehman, Fannie Mae, Freddie Mac and 16 securities firms. The order required investors betting on a decline in stock prices to arrange to borrow the shares before completing a sale.

The SEC also declined to bring back the so-called uptick rule, which allowed short sales only if a preceding trade boosted a company's stock price. Lawmakers such as U.S. Senator Charles Schumer, a New York Democrat, have questioned the agency's June 2007 decision to remove the rule.

To contact the reporter on this story: Jesse Westbrook in Washington at jwestbrook1@bloomberg.net; Edgar Ortega in New York at ebarrales@bloomberg.net.

Last Updated: September 17, 2008 10:36 EDT