SEC May Require Hedge Funds to Reveal Short Positions (Update3)
By Jesse Westbrook
Sept. 18 (Bloomberg) -- The U.S. Securities and Exchange Commission may require hedge funds to disclose their short-sale positions and plans to subpoena the funds' communication records in an effort to stem turmoil in stock markets.
Hedge funds and investors managing more than $100 million in securities would be ``required to promptly begin public reporting of their daily short positions,'' Chairman Christopher Cox said in a statement yesterday. The proposed disclosure is in addition to three SEC rules that took effect today aimed at reducing manipulative trades betting on a drop in share prices.
Lawmakers including U.S. Senate Banking Committee Chairman Christopher Dodd and executives such as Morgan Stanley Chief Executive Officer John Mack say short sellers may be spreading false information and using abusive tactics to attack companies. Hedge funds say poor business strategies are to blame and an industry spokesman said the SEC announcement was ``abrupt.''
``The consequences of a hasty or ill-considered rule in this environment could be extremely harmful to the capital markets,'' said Jim Chanos, chairman of the Coalition of Private Investment Companies, which represents 20 funds with assets in excess of $120 billion. ``Such a requirement is akin to the government suddenly requiring Coca-Cola to disclose their secret formula for free to all their competitors.''
Separately, New York Attorney General Andrew Cuomo today said he will investigate share sales of Lehman Brothers Holdings Inc., American International Group Inc. and other companies to see if investors spread rumors to drive down stock prices. Cuomo said federal regulation of markets has been ``ineffective.''
Emergency Basis
The five SEC commissioners must approve the disclosure rule, which Cox said will be adopted on an emergency basis without holding a public meeting. Hedge funds, private pools of capital whose managers participate substantially from any profits on invested money, prefer to keep their positions secret to prevent other traders from stealing their strategies.
Short sellers try to profit by betting stock prices will fall. In a short sale, traders borrow shares from their broker that they then sell. If the price drops, they buy back the stock, return it to their broker and pocket the difference.
``The temptation during times like this is to be seen doing something,'' said Andrew Baker, deputy chief executive of the London-based Alternative Investment Management Association, representing 1,300 funds in the $1.9 trillion industry. ``The risk is they get out the bazooka and shoot the wrong target.'' The rules are ``very wide sweeping,'' he said in a telephone interview from Greenwich, Connecticut.
New Rules
The commission put into place today two rules that stiffen prohibitions against abusive shorting. A third rule makes it a securities fraud when sellers deceive brokers about delivering shares to buyers.
The rules eliminate the exemption for options market-makers to deliver shares of companies on so-called threshold lists. Companies are listed when they have a high number of borrowed shares that haven't been delivered. The SEC also will impose penalties on brokers if their clients haven't delivered shares to buyers three days after a short sale.
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 be sold short. Currently, brokers are able to rely on their customers' assurance that they had located shares that could be used to cover a sale.
The SEC is targeting so-called naked shorting, in which traders never borrow shares from brokers, amid concern investors are flooding markets with sell orders to drive down prices.
`Scapegoat'
``Naked short-selling has become the scapegoat, but the fundamentals of how these businesses were run is what caused these issues,'' said Stephen Ehrlich, CEO of New York-based Lightspeed Professional Trading LLC, which makes trading systems for hedge funds and professional traders. ``The problems roiling the market and financial stocks are not going to change with less short-selling.''
Morgan Stanley, the second largest U.S. securities firm, tumbled the most ever in New York trading yesterday after a government rescue of American International Group Inc. failed to ease the credit crisis. In a memo to employees, Mack, 63, said the management committee is ``taking every step possible to stop this irresponsible action in the market.''
``There is no rational basis for the movements in our stock,'' wrote Mack, who added that he contacted Cox and Treasury Secretary Henry Paulson. ``We're in the midst of a market controlled by fear and rumors, and short sellers are driving our stock down.''
The SEC didn't say whether the proposed hedge-fund disclosure would apply only to common shares or whether it would affect options and other securities holdings. SEC spokesman John Nester didn't return an e-mail seeking comment.
Disclosure Sought
In his statement last night, Cox also said the SEC will obtain ``disclosure from significant hedge funds'' regarding ``past trading positions in specific securities,'' Cox said.
The agency's plan to subpoena communication records will mark the second time the regulator has sent information requests to hedge funds in three months. In July, the SEC subpoenaed hedge-fund managers and Wall Street's biggest firms seeking evidence they were manipulating shares of financial companies.
``A lot of hedge funds don't like being forced to disclose their long portfolios, so they're really not going to like this,'' said Sean O'Malley, a former SEC lawyer and now a partner at Goodwin Procter LLP in New York. ``There is going to be some push back from hedge funds, but they may not get any sympathy in the current market environment.''
U.K. Actions
The U.K. Financial Services Authority in June required hedge funds and other speculators to reveal short positions equaling 0.25 percent or more of a company's shares during rights offering. The regulator today temporarily halted short- selling in financial institutions and required daily disclosure of positions when they exceed limit.
Morgan Stanley and Goldman Sachs Group Inc., both based in New York, are seeking to avoid runs on their shares that helped trigger emergency sales of Merrill Lynch & Co. and Bear Stearns Cos., and the bankruptcy of Lehman Brothers Holdings Inc.
In July, the SEC instituted an ``emergency'' order that restricted short-selling in Lehman, Fannie Mae, Freddie Mac and 16 securities firms. The order, which expired last month, required investors betting on a decline in stock prices to arrange to borrow shares before completing a short sale.
To contact the reporter on this story: Jesse Westbrook in Washington at jwestbrook1@bloomberg.net.
Last Updated: September 18, 2008 14:25 EDT |
