The SEC warns short sellers, and stocks rally. Good timing?

The Securities and Exchange Commission would never say it wanted the stock market to rally today.

But given the agency’s ramped-up offensive against what it believes to be market manipulation by bearish traders, the session’s spectacular rebound had to be more gratifying to the SEC than, say, another dive.

Wall Street had its biggest one-day gain since April 1, with the Dow Jones industrial average rocketing 276.74 points, or 2.5%, to 11,239.28.

Financial issues, which have been brutalized for the last six weeks, led the way higher. The Standard & Poor’s 500 financial-stock sector soared 12.3%, the biggest advance in its 19-year history.

To put today’s jump in the financials in perspective, though, the S&P’s sector index still is down 33.5% year to date. And it’s just back to where it was five days ago.

Wall Street had virtually the perfect setting for an explosive rally: The gloom had been extreme Tuesday, as financial-system fears sent the Dow to a two-year low and trading volume reached the second-highest-level ever on the New York Stock Exchange. A key measure of investor fear reached its highest since mid-March.

It was "a crescendo on the downside," said John O’Donoghue, head of equities at Cowen & Co. in New York. "The selling became exhausted."

Then, as the market opened today, it had the tailwinds of a better-than-expected second-quarter profit report from banking titan Wells Fargo and another steep drop in the price of oil.

All in all, it was a good moment for short sellers -- traders who’ve been betting on falling stock prices, and who’ve been right for the last six weeks -- to take some profits by buying shares to close out at least some of their bets.

"I would guess most of this was short-covering," said Todd Clark, head of trading at Nollenberger Capital Partners in San Francisco.

For the SEC, this looks like a happy coincidence: On Sunday the agency warned that it would come after people who it says are spreading "false information intended to manipulate securities prices." That’s code for short sellers.

On Tuesday, SEC Chairman Christopher Cox announced a temporary plan to curb what he called illegal short selling in 19 major financial stocks, including mortgage giants Fannie Mae and Freddie Mac. Today, just adding to the confusion over the SEC's move, Cox told reporters that the measure was "prophylactic," not based on an actual jump in abusive shorting of the 19 stocks.

Did the SEC scare some short sellers out of their bets today? Maybe some of them. But as noted above, the market was primed for a rebound anyway. The SEC may just have been very lucky with its timing.

It’s worth remembering that professional short sellers generally aren’t pushovers. If they believe the market is going lower, they’ll be back. As Clark notes, there have been plenty of short-term rallies since this bear market began last fall, but "you haven’t been rewarded for chasing any of them."

And as the SEC fully concedes -- and hopefully truly believes -- as long as short sellers are playing by the rules, the government has no business getting in their way.

Photo: Dakota the Grizzly and challenger. J. Emilio Flores / Los Angeles Times

SEC targets illegal short-selling in Fannie, Freddie and 17 other financial stocks, but risks howls of 'market interference'

In its battle against abusive short sellers, the Securities and Exchange Commission may risk burning down the market in order to save it.

SEC Chairman Christopher Cox today surprised Wall Street with a plan to curb short selling in major financial company shares. In his initial comments he mentioned Fannie Mae and Freddie Mac as two stocks that would get protection under the plan, but a list the SEC released late in the day also included 17 other big financial firms, including Bank of America Corp., Citigroup Inc., Lehman Bros. and Credit Suisse Group.

Short sellers, of course, are traders who bet on falling stock prices. In a short sale a trader borrows stock (usually from an investment firm’s inventory) and sells it, expecting the market price to decline thereafter. If the bet is correct, the trader can buy new shares later at a lower price, repay the borrowed stock, and pocket the difference between the sale price and the repurchase price.

That’s all legal -- unless short sellers are ordering stock sales without having arranged to borrow actual shares. Shorting what you don’t have is “naked” shorting, which can be illegal, says John Coffee, a securities-law professor at Columbia Law School.

But the rules against abusive naked shorting haven’t been enforced much, Coffee adds.

So now comes the SEC to crack down, amid what has been a severe hammering of financial stocks -- to the point where investors are beginning to question the firms’ survival.

Beginning on Monday, the agency will require that “anyone effecting a short sale in these securities arrange beforehand to borrow the securities and deliver them at settlement.” The emergency rule will be in effect through July 29, but could be extended until Aug. 21, the SEC said. And Cox said the agency eventually expects to cover the entire stock market with the new rule.

For the 19 stocks on the list, the change means that brokers no longer will be able to take a short seller’s word that he actually has borrowed the shares he wants sold. (“Sure, I have ’em for you, I’ll deliver ’em later.”) And that, in turn, could curb situations where multiple short sellers are expecting to borrow the same shares for sale -- like, say, five different people all putting the same car up for sale, even though only one of them can deliver the vehicle.

The SEC suspects that some short sellers are ganging up on financial stocks, engaging in naked shorting while spreading rumors that the companies are in dire straits. Bear Stearns Cos.' rapid collapse in March has been Exhibit A for many people who are ranting about short-selling abuses.

The first salvo in the SEC’s latest offensive came Sunday, when it announced that it would “immediately conduct examinations aimed at the prevention of the intentional spread of false information intended to manipulate securities prices.”

It’s part of the SEC’s job to go after people who spread lies about publicy traded companies. But Wall Street can’t help but wonder if this anti-short-seller campaign is about more than just the naked shorts. If the SEC can curb short selling in general -- and trigger a wave of buying to cover outstanding short positions -- imagine what that could do for the stock market’s abysmal mood.

But the longer-term effect could be to raise questions about just how free the U.S. market is from government interference. That kind of stuff is supposed to happen in Third World countries, not in America.

Legitimate short sellers bet against companies whose shares they believe are overvalued. That makes the shorts an important element of what academics call “price discovery” in the market. The shorts find out things companies often would rather that shareholders didn’t know.

For the long-term health of the market, “You don’t want to restrict people’s ability to invest on negative information,” warns Jill Fisch, a securities-law professor at Fordham University.

Photo: Christopher Cox, testifying today on financial markets before a Senate panel today. Also at the table: Federal Reserve Chairman Ben S. Bernanke and Treasury Secretary Henry M. Paulson Jr. Chip Somodevilla/Getty Images

SEC to limit 'short selling' of Fannie Mae, Freddie Mac shares

It's bear-hunting season on Wall Street.

The Securities and Exchange Commission is invoking emergency powers to limit "short selling" in Fannie Mae and Freddie Mac shares, as well as in stocks of major brokerages, Chairman Christopher Cox told Congress today. And the SEC will consider extending the order to the rest of the market as well.

Short sellers borrow stock and sell it, betting the price will drop. If their bet is correct, they can buy new shares later at a lower price, repay the borrowed stock, and pocket the difference between the sale price and the repurchase price.

The SEC will require traders to "pre-borrow" shares of Fannie, Freddie and major brokerages before selling them short, Cox said. That then would lock up those shares, preventing them from being borrowed by other short sellers. In effect the SEC is trying to limit so-called naked shorting, which is selling stock without actually having the shares in hand or located. Naked shorting already can be illegal, depending on the circumstances, but the rules against it haven't been widely enforced.

Cox told the Senate Banking Committee that an emergency order would be released today. UPDATE: Read the SEC's order here.

As the stock market has plunged this year, short sellers have ramped up their bearish bets, increasing the downward pressure on share prices -- and particularly battered financial issues.

“In addition to this emergency order, we will undertake a rulemaking to address the same issues across the entire market,” Cox said.

But so far, Cox's plan doesn't seem to be doing much to lift shares of Fannie or Freddie. Fannie was down $1.61 to $8.12 at 10:45 a.m. PDT; Freddie was down $1.22 to $5.89.

Photo: Christopher Cox. Brendan Smialowski/Bloomberg News

Feds try jawboning to ease crisis over Fannie and Freddie; SEC warns Wall Street against rumor-mongering on stocks

The federal government is doing a lot of jawboning this weekend to try to keep the crisis surrounding mortgage giants Fannie Mae and Freddie Mac from worsening. Still unclear is whether the feds will take specific action to bolster the companies’ finances.

The clock is ticking: Asian financial markets will open later this afternoon, U.S. time, and a massive sell-off in Asian stocks, or in the dollar, could set the scene for another harrowing day in Europe on Monday and then on Wall Street.

Here’s what’s going on so far:

--U.S. cash infusion for Fannie and Freddie? The Times of London reported that the Treasury is working on a plan to inject up to $15 billion of capital into Fannie Mae and Freddie Mac. The government would make the infusion in return for a new class of shares in the companies, the newspaper said.

But the Times is alone on this report, at least among major news organizations. The Wall Street Journal, in a short dispatch on its website, says the Treasury today is expected to make a statement "supportive" of the companies, but that it is merely expected to be "a statement of facts designed to reassure markets."

The problem is that "facts" about the companies, including their regulators’ assertion that they are adequately capitalized, did nothing to halt the collapse of their stocks last week.

--Please buy this debt: Treasury officials on Saturday were calling major financial institutions to try to assure there would be plenty of buyers for Freddie Mac’s offering of $3 billion of short-term debt Monday, the Washington Post reported.

The debt sale is a routine offering by Freddie Mac, but given the heightened fears about the company’s solvency the sale looms as a crucial test of the markets' faith in the company.

Sen. Jon Kyl (R-Ariz.) told CNN today that the government had "a  lot of different options" to ensure that the companies could meet their obligations. Many on Wall Street expect the Federal Reserve to invoke emergency powers to allow Fannie and Freddie to borrow directly from the central bank if investors balk at providing the short-term funding the companies need in their day-to-day operations.

--Rumor-mongers put on notice: The Securities and Exchange Commission today signaled a fresh crackdown on the spreading of "false information" aimed at driving down stock prices. The clear target: "short" sellers, traders who borrow stock and sell it, hoping the price plunges.

Shares of financial firms, including Fannie and Freddie, have become favorite targets of short sellers this year.

The SEC, in a rare weekend announcement, said it and other regulators would "immediately conduct examinations aimed at the prevention of the intentional spread of false information intended to manipulate securities prices."

The timing of the SEC’s announcement also seemed to be aimed at bolstering confidence in U.S. markets ahead of Asian markets’ opening today.

American Funds says 'no deal' to settlement in broker case

Once again, the L.A.-based American Funds mutual fund group is refusing to settle federal regulators’ three-year-old case against the company involving revenue-sharing deals with brokerages.

The giant firm now has appealed the case to the Securities and Exchange Commission, a company spokesman confirmed today.

The Financial Industry Regulatory Authority (FINRA), the securities industry's self-policing agency (and successor to the old NASD), in 2005 accused American Funds of making nearly $100 million in improper payments to about 50 brokerages from 2001-2003 as an incentive to get them to pitch its funds to investors.

Dozens of other fund companies have faced similar "pay-to-play" cases in recent years, and nearly all of them have done what financial firms normally do when their watchdogs allege wrongdoing: quickly settle by paying a fine, without conceding the charges.

But privately held American Funds, the biggest U.S. stock and bond fund manager (assets: $1.1 trillion), has refused to cave. After two separate FINRA panels rejected the firm’s appeal -- the latest rejection came April 30 -- the company had one venue left: the SEC. So on they go, to Washington. This fight could keep lawyers on both sides busy into 2009.

I explained in this column why American Funds just won’t let this matter pass, even though the rest of the fund industry has moved on.

SEC's Cox (at last) picks chiefs for L.A. and San Fran offices

Securities and Exchange Commission Chairman Christopher Cox has finally picked new chiefs for the agency’s L.A. and San Francisco regional offices. He didn’t have to look far.

Rosalind Tyson, who has been interim director of the Los Angeles office since July, got the nod to stay in the post, the SEC announced today.

In San Francisco the regional-director job went to Marc Fagel, who has been co-acting chief since October.

Tyson, a Stanford Law School grad (class of ’78) is a career SEC lawyer. She joined the L.A. office in 1982 in the enforcement unit. Since 1993 she has headed the examinations unit, which inspects brokerages, investment advisors and mutual funds.

The 41-year-old Fagel, who got his law degree from the University of Chicago Law School in 1991, joined the SEC’s San Francisco office in 1997. He has been regional enforcement chief since 2005.

The L.A. office’s territory is Southern California, Arizona, Nevada and Hawaii. San Francisco oversees Northern California and the Pacific Northwest.

Tyson, 60, said her emphasis would be on "swift and vigorous enforcement of the securities laws and to reinforce our cooperative working relationships with our fellow regulators at the federal, state and local levels."

The last L.A. and San Francisco office chiefs had fairly long tenures before making the inevitable hop to private-sector jobs. Randall Lee headed the SEC’s L.A. office from 2001 to last July. He has since opened an L.A. office for Washington law firm WilmerHale. Helane Morrison was San Francisco office chief from 1999 until October, when she departed to become general counsel at Hall Capital Partners, a $22-billion-asset investment management firm in San Fran.

Tyson and Fagel should have job security, even though Cox is almost sure to be replaced by the next occupant of the White House: New SEC chairmen historically haven't summarily replaced the regional chiefs.

Photos: Rosalind Tyson, Marc Fagel. SEC

SEC launches first test of Web mutual fund analyzer

From Times staff writer Walter Hamilton:

It may get a little easier for mutual-fund buyers to sift through the thousands of offerings out there.

The Securities and Exchange Commission is proposing that fund companies electronically "tag" key information such as investment objectives, risks and fees in their fund prospectuses and annual reports. The goal is to help investors zero-in on key information and easily analyze funds side-by-side using standardized data.

A quick spin through a test page on the SEC's website shows the service is helpful as far as it goes -- but there’s a lot it doesn't do.

Investors can view basic features of up to three funds at a time. It's easy, for example, to compare the fees of the Vanguard S&P 500 fund versus the Federated Capital Appreciation fund. (Only a limited number of funds are available in the test phase.)

But the site only goes so far. It lists annual returns for each fund, but doesn't calculate average annual returns over time or offer comparisons to broad market indexes or general fund categories in the way that, say, Morningstar does.

More than that, the site isn't a true mutual-fund screener and can’t be used to select funds based on broad criteria such as investment objective or asset size.

The site still is in the works and there is a lot of time for investors to offer the SEC their suggestions: The agency isn’t proposing to require companies to tag reports until Dec. 31, 2009.

A market fear gauge slides further, and SEC touts XBRL

A few items of note from the markets today:

     --Investors’ mood about the stock market has reached its best level since October, as measured by the so-called Volatility Index, or VIX. The index, which tracks activity in Standard & Poor’s 500 index put and call options, is a gauge of investors’ expectations of near-term volatility in the market. I wrote more about it in this post on April 28. The VIX closed at 17.66 today, its lowest since Oct. 10, indicating relatively little fear that the market could face a serious sell-off ahead. What’s significant about Oct. 10: The Dow Jones industrial average and S&P 500 both reached their all-time highs on Oct. 9, then began to slide in the second wave of selling triggered by the sub-prime mortgage crisis. So the question is whether investors now, as then, have been lulled into a false sense of security about the bullish trend in share prices.

    --Corporate financial documents would get easier for investors to read and analyze under a new filing system the Securities and Exchange Commission proposed. SEC commissioners voted today to propose requiring large companies to use Extensible Business Reporting Language, or XBRL, in their quarterly and annual reports. The technology uses data tags that allow investors to conduct fast searches of financial figures and compare results across companies and industries. Reuters has a good explainer here. XBRL has long been a pet project of SEC Chairman Christopher Cox.

    --Struggling IndyMac Bancorp got more bad news: Standard & Poor’s decided to kick the stock out of the S&P 400 index of mid-size companies, effective at the close of business on Thursday. That will cause funds that track the S&P 400 to jettison the shares. The Pasadena-based lender's stock ended today at a record low of $2.01, down 31 cents, or 13%. More on IndyMac's woes here.