Street Gears Up for Short Changes
Brokerages Parse
New Rules' Details;
The 'Naked' No-No
By RANDALL SMITH, JENNY STRASBURG and KARA SCANNELL
July 17, 2008
The federal crackdown on short selling is causing a scramble on Wall Street, with brokerage firms racing to implement new controls before the rules take effect on Monday.
Brokerage firms and floor traders, here at the NYSE, are scrambling to prepare for new short-selling rules.
The unprecedented get-tough action by the Securities and Exchange Commission means that securities firms will have to fine-tune their back-office operations to comply with the requirements.
The biggest potential headache: Existing rules allow brokers to sell stock short as long as they reasonably believe they can locate the needed shares and deliver them on time. Under the new curbs, short sellers will need to make formal arrangements to borrow the shares before selling them.
"You need to have certainty that you have the stock," one Wall Street executive said Wednesday.
The mechanics of such arrangements, as well as the charges likely to be levied for the extra legwork, are still being discussed. Wall Street brokerage executives held a conference call Wednesday morning with the Securities Industry and Financial Markets Association, a trade group, to discuss how to respond to the SEC's new rules and seek clarification from the agency.
SEC Chairman Christopher Cox acknowledged that the crackdown will create additional work for brokerage firms, though he said he sees "no obstacles to implementation." Agency officials delayed the effective date of the stricter short-selling requirements to "provide appropriate operational relief to the exchanges," he added.
In a sign that the plan already is throwing sand in the gears of short sellers, the stock prices of most of the 19 financial companies affected by the new rule soared Wednesday, rising an average of 12%. Fannie Mae jumped 31%, or $2.18, to $9.25, while Freddie Mac was up 30%, or $1.57, to $6.83 in 4 p.m. New York Stock Exchange composite trading. Lehman Brothers Holdings Inc. surged 26%, or $3.43, to $16.65. All three stocks had been thrashed for weeks by nearly relentless selling pressure.
In a short sale, a trader borrows stock and then sells it, in hopes that it will later fall in price so it can be repurchased at a profit. Mr. Cox has insisted he isn't opposed to legitimate short selling -- only "unlawful manipulation through 'naked' short selling that threatens the stability of financial institutions."
While there wasn't an increase in naked short selling ahead of the emergency action, Mr. Cox said the move was "prophylactic" to "remove tools of mischief so that markets can operate efficiently." The 19 companies on the protected list are the same ones that have access to the Federal Reserve's lending facility, he noted.
The curbs -- which terminate on July 29 but can be extended as many as 30 calendar days from the July 15 date of the order if the SEC deems it necessary -- were announced Tuesday before Wall Street firms knew much about how they would work. The exact wording wasn't released until about 8 p.m. that day.
One open issue is whether firms that act as market makers and routinely sell stocks short to accommodate buyers will get an exemption. The SEC is working on "tailored provisions" to provide relief to both stock and options market makers, agency officials said.
In a statement, the SIFMA said it has reviewed the order with its members and "approached the SEC with questions about its scope and application," hoping to "ensure the market continues to operate smoothly and with the necessary liquidity."
One Wall Street executive of a prime brokerage, which caters to fast-trading hedge funds routinely engaging in short selling, said the new rules will prevent multiple brokerage firms "from looking at the same availability" of borrowable stocks from custodial banks such as State Street Corp. and Bank of New York Mellon Corp. Starting on Monday, brokers "actually need to make arrangements to borrow those securities."
Among the firms with the largest prime-brokerage services are Goldman Sachs Group Inc., Morgan Stanley, J.P. Morgan Chase & Co. and Deutsche Bank AG.
Hedge funds and other traders already have numerous alternatives to short selling, including "put" options carrying the right to sell at a preset price, which increase in value as the underlying stock price declines, or so-called "swaps" contracts, which can give the same economic effect as shorting. Traders also can trade with overseas brokers.
But some of the alternatives have limitations. For example, market participants who take the other side of puts and swaps often hedge the exposure via an offsetting short sale. The seven U.S. options exchanges are preparing to ask for an exemption from the changes, people familiar with the effort said Wednesday. The rule disrupts options market makers' hedging strategies, they said. "This affects our book in a big way," said Andy Schwarz, founder of AGS Specialist Partners. His firm "makes a market in nearly every name on [the SEC's] list," he said.
Some hedge-fund experts predicted the new rules will make it more expensive for many hedge funds to borrow stocks. The law firm Schulte Roth & Zabel LLP, which has numerous hedge-fund clients, said the new order "will likely make short selling the specified securities more difficult and more expensive."
Stock-location specialist John Tabacco said the new rules may level the playing field because some big funds get preferential access to borrow scarce shares. "There's been no transparency, which is a tremendous competitive advantage for the larger firms," said Mr. Tabacco, founder and chief executive of LocateStock.com, which helps hedge funds and small brokerages locate hard-to-borrow shares.
Another question is whether the order will be broadened and extended after its initial period, when it applies only to 19 financial stocks. Some companies may prefer to avoid the stigma of appearing to need government protection, some experts said. "There will be issuers who want to be included and some who don't," said Barry Goldsmith, a partner at law firm Gibson, Dunn & Crutcher LLP.
--Mark Gongloff and Tennille Tracy contributed to this article. |
