Associated Press | Federal regulators on Wednesday imposed new
curbs on the practice of short-selling, hoping to prevent spiraling
sales sprees in a stock that can stoke market turmoil.
The Securities and Exchange Commission, divided along party lines,
voted 3-2 at a public meeting to adopt a new rule. Investors and
lawmakers have clamored for the agency to put such brakes on trading
moves they say worsened the market’s downturn in the fall of 2008.
The rule puts in a so-called circuit breaker for stock prices, restricting for the rest of a trading session and the next one any short-selling of a stock that has dropped 10 percent or more. The new curbs take effect in about 60 days but stock exchanges have six months after that to implement them.
Short-sellers bet against a stock, in a practice that is legal and widely used on Wall Street. They borrow a company’s shares, sell them and then buy them when the stock falls and return them to the lender — pocketing the difference in price.
The SEC move followed months of wrestling with the controversial issue. The SEC asked for public comment last April on several alternative approaches to restraining short-selling, and a bipartisan group of senators have pushed the agency to act or face legislation. The agency got more than 4,300 comments on the issue.
Sens. Ted Kaufman, D-Del., and Johnny Isakson, R-Ga., who head the group, called Wednesday’s action by the SEC “a step forward” but said its effect will be limited, “helping only in the worst-case scenarios that could occur during a terrorist attack or financial crisis.”
What is needed, they said, is restoration of the Depression-era uptick rule, a permanent constraint allowing short-sellers to come in only at a price above the highest current bid for a stock. The SEC abolished the uptick rule in July 2007, when the stock market was near its peak.
The SEC staff estimates that only 1.3 percent of all stocks hit the 10 percent decline threshold during normal trading days without wild market swings.
Investor confidence was shaken as the market plunged amid the financial crisis in late 2008, and proponents of restoring restraints said they were needed to prevent abusive trading. They maintained that the absence of restraints fanned market volatility, prompting hedge funds and other aggressive investors to target weak companies with an avalanche of short-selling.
But opponents said new restrictions could eliminate the benefits of short-selling — bringing capital into the markets and accurate stock prices to the surface — and actually hurt investor confidence.
That debate was mirrored among the SEC commissioners at Wednesday’s meeting. The two Republicans, Kathleen Casey and Troy Paredes, disputed that the curbs would bolster investor confidence and said they could hurt the market’s efficiency.
Casey said she was “deeply concerned” that the action seemed to be guided more by “public relations” than evidence of the benefit of the rule. It could “undermine our credibility in the long run,” she said.
Under the new rule, once a “circuit breaker” has been triggered, short-selling in the affected stock will be permitted only if the price is above the current highest bid for the stock. That restriction would apply for the rest of the trading session and the next day’s session.
The SEC said the rule strikes a balance between two objectives: preventing short sellers from driving the price of a gutted stock even lower and preserving the benefits to investors from legitimate short-selling, such as pumping cash into the market. The balance comes, the agency said, because the “circuit breaker” restrictions are temporary and are applied to a specific trading session, in contrast to other alternatives such as the uptick rule that would institute permanent constraints.
“The reason this rule makes sense is because it recognizes that short-selling can potentially have both a beneficial and a harmful impact on the market — depending on the circumstances,” SEC Chairman Mary Schapiro said.
Schapiro said it’s important for the SEC and the markets “to have in place a measure that creates certainty about how trading restrictions will operate during periods of stress and volatility.”
Jack A. Ablin, chief investment officer at Harris Private Bank in Chicago, said the new rule would only come into play during extreme cases and wouldn’t dramatically impact trading.
“I get a little squeamish when the SEC tries to restrict short-selling, but I think at least in this case they’re likely to steer clear of a lot of unintended consequences,” Ablin said. “By requiring a 10 percent drop in the stock, they’re going after the outliers.”
Still, some financial industry players said the new rule would disrupt the markets.
The Coalition of Private Investment Companies, an influential hedge fund lobby group, said the new short-selling curbs “will harm investors’ interests by raising transaction costs, reducing market quality, and undermining confidence in the markets’ ability to determine prices fairly and efficiently.”
Scott Talbott, chief lobbyist for the Financial Services Roundtable, whose members include the largest banks, said the group supports the rule. “It attempts to provide certainty to investors during an uncertain period,” he said.
Big banks including Bear Stearns, Lehman Brothers and Merrill Lynch were among the companies that, critics said, were victims of “bear raids” by short sellers that played a key role in forcing their collapse during the market turmoil.
In a separate, 5-0 vote Wednesday, the SEC commissioners adopted a statement laying out the agency’s support for global accounting standards and its belief that they would benefit U.S. investors. The statement says the SEC continues to encourage the convergence of U.S. accounting standards with the norms known as International Financial Reporting Standards.
In 2008, the SEC proposed a plan allowing public companies to begin using international accounting standards for reporting financial results this year. The push by the agency toward acceptance of a single, global set of accounting standards has raised objections from some investor advocates and lawmakers but has been welcomed by Wall Street interests and the accounting industry.
