Measures to Limit Short-Selling

Excerpt:  "The Securities and Exchange Commission, under pressure to respond to the tumult in the financial industry, announced emergency measures on Tuesday to curb certain kinds of short-selling that aims at Fannie Mae and Freddie Mac, as well as Wall Street banks.

The chairman of the S.E.C., Christopher Cox, said the commission would institute an order to limit the ability of traders to bet against the shares of Fannie and Freddie, the mortgage finance giants, which plunged again on Tuesday.

The measures are the S.E.C.’s second attempt in less than a week to combat market manipulation, and they will make it harder to short the stocks of 19 financial institutions, including brokerage firms like Lehman Brothers and Morgan Stanley.

Short sellers borrow shares from brokers or institutional investors and sell them, hoping to buy them back later at a lower price and profit from the difference. The order aims at so-called naked short-selling, or selling shares short without first borrowing the shares or ensuring that they can be borrowed. The commission’s 30-day emergency measure aims to make abusive naked shorting harder by holding the brokers — or anyone involved in processing a short sale — responsible for any failure to deliver the borrowed shares within a mandated three-day period.

The hastily adopted measures — the S.E.C. was still working on the rules late Tuesday, hours after Mr. Cox announced them in a Congressional hearing — underscored the pressure the agency faces to combat market abuses related to short sales.

Though legal, short-selling is highly contentious in a bear market and particularly in this market, with Wall Street’s own stocks on the firing line.

Since Bear Stearns collapsed and was acquired by JPMorgan Chase, many Wall Street executives have argued that short sellers are going beyond legitimate methods and planting false information to cause shares to fall so that they can profit. Proffering false information or manipulating the market is illegal.

James Dimon, chief executive of JPMorgan, expressed concern about the issue during an interview with Charlie Rose. “I would say, ‘Where there is smoke there’s fire,’ ” he said when asked if there was a “premeditated” attack on Bear Stearns. 

“I don’t have evidence of it. I think the Securities and Exchange Commission should investigate it. I think that if that — if someone knowingly starts a rumor or passes on a rumor, they should go to jail,” he said talking about intentionally false rumors.

But proving that traders are planting false rumors with the intent to drive down a stock price has been virtually impossible…

….Now, those acting for short sellers have to generally locate but not exactly pinpoint the shares traders wish to borrow. As of Monday, brokers will have to hold the shares and deliver them within a three-day period or risk being in violation of the securities laws.

The reason the commission is adopting this tougher stand is that there is significant systemic risk involved in the collapse of financial institutions like the 19 identified, and these companies are more prone to collapse if confidence evaporates.

The measure will last 30 days and can be extended if necessary. Mr. Cox said the S.E.C. would draft rules “to address the same issues across the entire market.”

The idea of short sellers spreading false information has inflamed strong opinions in the market. ‘This is even worse than insider trading,’ Mr. Dimon said on Charlie Rose’s show. He called it a ‘deliberate and malicious destruction of value and people’s lives.’"  Continue here.