Short selling in crosshairs of world market regulators (recapped)

It didn't take long for the government and large financial institutions to respond as I thought they might, to the biggest financial crisis of our lifetime (at least for those of us under 75). There were a lot of actions taken today from the list I posted yesterday, which itself was culled from a number of sources and common sense. I thought this article on short selling was important enough to recap given the current market situation. It sheds a lot of light on the problems of weakened companies that are targeted and attacked by groups of short sellers, punished in spite of strong financials.

Late breaking news, today, has the Congress, Treasury and Fed working together on a plan to implement a modern day RTC, another of the actions I thought were necessary, and likely in the works. I will post more on this once the details are known.


SAN FRANCISCO (MarketWatch) -- Gathering anger over short selling of vulnerable financial stocks exploded into the open Thursday as top market regulators and industry giants took steps to limit the practice and begin investigation into possible abuses. Britain's stock market regulator on Thursday banned short selling in financial companies and said it might extend the ban to other sectors.

The move followed the Securities and Exchange Commission's curbs on the practice that went into effect Thursday morning. Read full story.In other steps aimed squarely at the bearish practice, the country's largest pension fund, the California Public Employees' Retirement System, said it was taking steps to limit the practice on three financial stocks and the New York attorney general called for a wide-ranging investigation of the short selling of some prominent financial companies, including Goldman Sachs (GS) and Morgan Stanley (MS).

The concerted reaction followed two days of sharp declines in global stock markets, triggered by mounting fears that the credit crunch would spin out of control and deepen the financial crisis. As stock declines have deepened, the role of short sellers has come under fire. "The moves should help restrain the abusive short-selling practices lately rampant in the stock market," said analyst Thomas Brown of Bankstocks.com. "Short sellers can no longer deceive their brokers about their intention or ability to deliver shares. "The SEC on Thursday put a ban on so-called "naked" short selling, while Calpers said it won't allow lending of shares of Goldman Sachs, Morgan Stanley, and Wachovia (WB).

The California State Teachers' Retirement System made a similar move and it called on 60 other funds to follow suit. "We don't want to inadvertently contribute to the instability of these companies or the market," Clark McKinley, a Calpers spokesman, told The Wall Street Journal. Calpers has one of the largest securities lending programs in the country, at $38 billion.

Much of the concern in the U.S. focuses on naked short selling. Naked shorting can allow market manipulators to force prices down much lower than would be possible in a legitimate short sale. In an abusive naked short sale, according to the SEC, the seller doesn't borrow a stock, as would happen in an ordinary short sale. The seller also fails to deliver the stock to the buyer.

Bill Stone, chief investment strategist at PNC Wealth Management, supported the SEC ban on naked shorting. "They don't let me go out and buy stocks without paying for them, so they shouldn't be able to do that selling them. Fair is fair," said Stone. Brown and others want the SEC to take its authority even further. They argue the SEC should re-impose the so-called "uptick rule" that prevented traders from selling short unless there was a higher bid price in the stock. "They shouldn't outlaw shorting but putting more controls on it is necessary," said John Langston, analyst at Hodges Capital Management. The SEC repealed that the uptick rule in July 2007.

They also want the SEC to dig into the option and credit default swaps strategies used by short sellers. Short selling itself isn't illegal. Some investors contend short sellers are a reality check for the market, in some cases, shining light on possible accounting shenanigans at corporations. "Short selling provides market liquidity and keeps management honest," said money-manager Russell Glass at RDG Capital.

In a regular short sale, the seller borrows a stock and sells it, with the understanding that the loan has to be repaid by buying the stock. New York Attorney General Andrew Cuomo plans to investigate rumor mongering and illegal conduct. "The markets need to be stabilized," Cuomo said. "One way is to root out short sellers who spread false information."

In further moves that should rattle short sellers, the SEC is expanding its push into the trading records of hedge funds, which are less-regulated than mutual funds. The agency said it is sending subpoenas to at least 50 big hedge funds, seeking trading records and communications about trading in specific companies.

The SEC is considering a rule that would force hedge fund managers with more than $100 million invested in stocks to report their daily short positions. This is drawing the ire of famous short-seller Jim Chanos, who helped expose the accounting gimmicks at Enron. "For investment managers such a requirement is akin to the government suddenly requiring Coca-Cola to disclose their secret formula for free to all their competitors," Chanos said.

SEC Chairman Christopher Cox has been under scrutiny for his handling of the financial crisis sending shockwaves through the market. On Thursday, Republican Presidential candidate John McCain said SEC Chairman Christopher Cox should be fired. McCain said Cox "serves at the appointment of the president and, in my view, has betrayed the public's trust. If I were President today, I would fire him."