SEC moves to curb stock manipulation
The Securities and Exchange Commission on Tuesday stepped up its war against what it believes is manipulation of stocks by "short sellers" -- traders who bet on falling share prices.
SEC Chairman Christopher Cox surprised Wall Street with a plan to curb illegal short selling in 19 major financial company shares, including embattled mortgage titans Fannie Mae and Freddie Mac. Shares of Fannie and Freddie have been big targets of bearish traders this year.
With the nation's financial system under enormous strain and the stock market in its worst slump since 2000-02, federal regulators are facing pressure to show they're on top of the situation. Cox unveiled the agency's plan to limit short selling at a Senate Banking Committee hearing on financial market concerns.
The SEC chief said the agency was taking action to stop what he said was stock manipulation "that threatens the stability of financial institutions."
In a short sale, a trader borrows stock, usually from a brokerage's inventory, and sells it, expecting the price to decline. 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.
Shorting is legal -- unless traders are ordering stock sales without having arranged to borrow actual shares. That would be "naked" shorting, which is illegal, says John Coffee, a securities-law professor at Columbia Law School.
But the rule against such stock plays hasn't been enforced much, Coffee said.
The SEC's new plan is a crackdown on naked shorting of major financial stocks amid what has been a severe hammering of the shares -- to the point where investors are beginning to question the firms' survival.
Beginning on Monday, the SEC 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.
What's more, 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 brokerages no longer will be able to take a short seller's word that he actually has borrowed the shares he wants sold. And that, in turn, could curb situations in which multiple short sellers are expecting to borrow the same shares for sale -- similar, say, to five different people putting the same car up for sale, knowing that only one of them can deliver the vehicle.
