SEC Plans Massive Restrictions on Short Selling
The US Securities and Exchange Commission is considering landmark changes to rules governing short-selling. Such a move will radically change the way many stocks are traded in the United States and will vastly limit the profits of hedge funds and other traders.
Short selling is a controversial trading practice that has increased to record levels during this bear market according to the Financial Times yesterday.
The FT points out that regulators around the world are under pressure to tighten rules on short-selling, in which traders bet a stock price will fall, amid concern that it is used by professional traders to manipulate share prices, particularly of smaller companies.
Next Week say the FT, it is expected that staff at the SEC will present the new chairman William Donaldson, with far reaching proposals including rules forcing traders to borrow stock to cover their short positions. Under current rules, traders can take out "naked" short positions over an unlimited number of shares, putting huge downward pressure on an illiquid stock.
Regulators are less concerned about short-selling in the most liquid stocks and may even consider loosening the rules for large companies.
The FT goes on to say that officials also want a consistent set of rules across all US markets. For example, traders are forbidden from shorting a stock quoted on the New York Stock Exchange when the price is falling but Nasdaq stocks operate under a separate rule that does not apply to small stocks in the over-the-counter market.
US regulators say they are being pressed to clamp down on short-selling by politicians who complain the practice hurts companies. Allied Capital, MBIA and mortgage lender Farmer Mac are among those claiming their shares have been manipulated by short-sellers. "The time has come to address what to do about short-selling but it is going to be political, controversial and complex," said a securities regulator.
How far the SEC will pursuer this matter is largely up to its new chairman William H Donaldson. Mr Donaldson, 71 is generally accepted to be a more political animal than his predecessor as the former head of the New York Stock Exchange and founder of Wall Street investment house Donaldson Lufkin & Jenrette, he is viewed as something of a Wall Street insider and will certainly understand the issues at hand. .
Short-selling is a trading technique in which one party typically borrows shares from another and then sells them into the market, betting that the price of the stock will fall in the near future when he must buy the same number of shares to repay the original loan. If the share price has fallen by that time, the short-seller has made money.
According to those interviewed by the Financial Times, any attempt to limit short-selling activities will be criticised by traders and economists who argue that it should be less restricted because it makes for a more efficient and liquid market. "Short-selling should not be equated with manipulation," said one head trader in New York.
Market professionals argue that short-selling is an effective way to add legitimate negative sentiment to the market and keep wayward corporate management in line, but others say it is too often abused to corner small companies by controlling most or all of a company's publicly traded shares.
The SEC interest in short-selling is separate from a probe into hedge funds and would apply to all types of investors.
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