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SEC votes to limit 'short selling' of stocks

February 24, 2010 | 12:20 pm

The Securities and Exchange Commission on Wednesday approved new restrictions on “short sellers” who bet on falling stock prices.

The SEC, which has been wrestling with the issue for nearly two years, voted 3 to 2 to limit short sales in any stock that falls 10% in one session. At that point, and through the following day, a short sale would be permitted only at a price above the stock’s current national best bid price.

SEC Chairwoman Mary Schapiro said in a statement that the new rule reflected the agency’s concern that “excessive downward price pressure on individual securities, accompanied by the fear of unconstrained short selling, can destabilize our markets and undermine investor confidence in our markets.”

The SEC’s two Republican commissioners, Troy Paredes and Kathleen Casey, voted against the rule, questioning the need for it and the compliance costs that the financial industry will bear.

Maryschapiro The commission has been trying to decide whether -- and how -- to restrict short sellers since the credit crisis mushroomed in 2008 and executives of some financial companies complained that their stocks were being targeted for collapse by the shorts.

In a typical short sale a trader borrows stock (usually from a brokerage’s inventory) and sells it, expecting the market price to decline. If the price in fact drops, the short seller can later buy back the stock at a lower price, repay the borrowed shares and pocket the difference between the sale price and the repurchase price.

If the stock rises, however, the short seller’s losses can be unlimited until the trade is closed out.

Critics of short sellers say they can gang up on a stock, driving it relentlessly lower and making their bet self-fulfilling. The shorts say they play the role of market truth-seekers, exposing companies whose shares are inflated, including because of management malfeasance.

The SEC sees its new rule as a compromise between doing nothing and restoring the old “uptick” rule, under which short sellers could make a sale only if a stock’s market price had ticked higher from the last transaction price. The uptick rule, aimed at preventing a cascading effect when a stock was falling, was repealed by the SEC in 2007 after 70 years on the books, after an agency study asserted that the restrictions no longer were needed. . . .

Sens. Ted Kaufman (D-Del.) and Johnny Isakson (R-Ga.), who have argued for tougher restrictions on short sellers, said in a statement that they were “encouraged” by the SEC’s decision Wednesday, but that the rule change “will be of limited use, helping only in the worst-case scenarios that could occur during a terrorist attack or financial crisis.

“The uptick rule worked for 70 years as a systemic check on predatory bear raids; this approach will not provide investors with the same protections,” they said.

But the Coalition of Private Investment Companies, chaired by legendary short seller Jim Chanos, slammed the SEC’s move, saying it would raise transaction costs, reduce market quality and undermine confidence in pricing of shares.

“This puts a government thumb on the scale of stock prices," Chanos said. “Efforts to prop up stock prices where the fundamentals will not sustain them will inevitably fail.”

-- Tom Petruno

Photo: SEC Chairwoman Mary Schapiro. Credit: Manuel Balce Ceneta / Associated Press