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'Short sellers' in SEC's cross hairs as it votes new rules

July 27, 2009 |  3:44 pm

The Securities and Exchange Commission today announced plans to shine more light on "short selling" of stocks and to make permanent a rule change aimed at restricting so-called naked shorting.

Still on the agency’s table are much weightier issues -- including whether to bring back the "uptick rule" as a way to curb potential short-selling abuses.

Short sellers typically borrow stock from a brokerage’s inventory and sell it, betting the price will drop. If the market price declines, the shorts can later buy stock in the market, replace the borrowed shares and pocket the difference between the sale price and the repurchase price.

Although shorting is perfectly legal as long as traders follow the rules, the shorts got blamed last year for worsening the collapse of many financial stocks. That fueled Congress’ ire and triggered the SEC to take the unprecedented step of temporarily restricting shorting in hundreds of financial issues.

MarysSEC Since then the agency has been under intense pressure from Congress to do more to rein in abusive shorting.

"Today's actions demonstrate the commission's determination to address short selling abuses while at the same time increasing public disclosure of short selling activities that affect our markets," SEC Chairwoman Mary Schapiro said in a statement. The full text of the agency's announcement is here.

In one new move the SEC said companies and investors would be able to see the aggregate volume of shorted shares for each individual stock each day. That would let a company know if bearish bets on its shares suddenly were rising. The New York Stock Exchange and Nasdaq currently disclose twice a month the total number of shorted shares for each listed company.

In another decision, the SEC voted to make permanent penalties it imposed last year in cases in which short sellers sell shares they haven’t yet borrowed and then are unable to promptly deliver the stock to the buyer. The penalties are imposed on the brokerages that short sellers employ for their trades.

Shorting without first borrowing the stock is known as naked shorting. For reasons related to normal market function, the practice isn’t illegal. But the SEC imposed the prompt-delivery rule last year to keep short sellers from driving down a stock’s price without any intention of actually borrowing shares for sale.

Since the rule was put in place the number of cases in which traders failed to deliver shares has tumbled 57%, the SEC said. That presumably means that many abusive short sellers were pushed out of the market (although not everyone is so convinced).

Lastly, the agency still hasn’t decided whether to bring back the "uptick rule" as a way to further limit the potential for abusive shorting.

The rule historically had been a barrier to rampant short selling by banning short sales on "downticks" in stock prices. Instead, a short seller would have to wait for a stock’s price to move up at least slightly before shorting it. The idea was to prevent a cascading effect by short sellers that could drive a stock mercilessly lower (a so-called bear raid).

The SEC got rid of the rule in 2007 after finding that it hurt liquidity in the market (by keeping some traders away) and wasn’t necessary to prevent manipulation of stocks.

But the uptick rule still has a special place in the hearts of investors who hate short sellers and want to make their trading as difficult as possible.

-- Tom Petruno

Photo: SEC Chairwoman Mary Schapiro. Credit: Jay Mallin / Bloomberg News