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SEPTEMBER 19, 2008 SEC Is Set to Issue Temporary Ban Against Short Selling
By KARA SCANNELL, DEBORAH SOLOMON, CRAIG KARMIN and GREGORY ZUCKERMANArticle
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The Securities and Exchange Commission prepared an aggressive assault against short-sellers, saying it would temporarily prevent investors from making bets on stock declines in an attempt to stem some of the worst stock-market slides in years, according to people briefed on the proposal.

The SEC was convening a late-night commission meeting to consider several items, some of which could be announced as early as today, a person familiar with the matter said. It's unclear whether the halt will be limited to a certain number of financial stocks or how long it would last.

Following a late meeting with Congress, Mr. Cox said, "We're going back to work tonight and in fact the entire commission is in formal meeting right now."

He declined to comment on a temporary ban on short sales. In short selling, traders borrow shares of stock and sell them, hoping the price of the shares decline and they can profit by buying them back at a lower price. Short-sellers have become scapegoats for the big declines in the share prices of weakened companies including Lehman Brothers Holdings Inc. and American International Group Inc., though it is unclear whether they were the cause of the declines.

Earlier Thursday, the U.K.'s Financial Services Authority said it would ban short selling in financial stocks until January. The FSA said it would review the ban in 30 days. The FSA also announced additional disclosure requirements from hedge funds of short sales if a certain threshold is met.

U.K. Treasury Chief Alistair Darling, who was involved in the FSA's decision, said in a statement Thursday he welcomed the FSA's "decisive action." He said in current market conditions it was in the "interests of financial stability."

At their most draconian, such rules would only allow investors to bet that stocks would rise and would ban the investing strategies used by hundreds of mutual funds, hedge funds, pension funds, endowments and governments. Many organizations use short selling to protect themselves from big unexpected losses, and many financial firms bet against stocks to offset trades made by their clients so they aren't exposed to big market moves.

The U.S. government efforts came after the companies whose stocks have fallen lobbied Washington to limit short selling.

Both Morgan Stanley Chief Executive John Mack and Goldman Sachs Group Inc. Chief Executive Lloyd Blankfein spoke to numerous government officials in the past few days to discuss how to reduce the perceived abuses of short sellers, people familiar with the matter said. The two CEOs have also spoken five or six times about the issue in recent days, one of these people added.

Calpers-California Public Employees' Retirement System, the largest U.S. public pension fund, said it is no longer lending out shares of Goldman, Morgan Stanley or Wachovia. Lending of shares is an essential step in the short-selling process, and the move could help limit negative bets on those stocks. "We share a degree of concern about volatility in financials," says Eric Baggesen, Calpers senior investment officer.

Meanwhile, New York Attorney General Andrew Cuomo said he was opening investigations into short sellers who he believes are trafficking in false rumors to manipulate the market.

"No one is saying short selling caused this crisis," Mr. Cuomo said in an interview. "I believe it's possible that it's been aggravated by illegal short selling -- people passing on fraudulent information and conspiring to drive down the value of a stock."

The multipronged action follows several days of calls among lawmakers, Wall Street executives and regulators as they try to sort out the source of the stocks slide.

Hedge-fund lobbying groups objected to the moves, saying regulators and executives haven't presented any evidence of abusive or manipulative short selling.

"While this is all politically pleasing to the regulatory powers that be, the fact of the matter is that there has been no evidence presented of short sellers circulating false market rumors to drive down the price of stocks," said James Chanos, a well-known short seller and chairman of the Coalition of Private Investment Companies, a hedge-fund lobby group.

He says regulators are missing the point as the rules don't address the large market of credit-default swaps, which are insurance contracts to debt instruments that trade outside of established exchanges and are unregulated. "The trading in those contracts dwarfs the trading in equities in financial firms. Until the SEC or Commodity Futures Trading Commission or whomever gets their hands around that, the banning of the short selling is meaningless," Mr. Chanos said.

In a short sale, a trader sells borrowed stock, hoping it will fall in price. In an abusive short sale, known as naked short selling, a trader never borrows any stock and doesn't intend to deliver it to the buyer at a later date. Executives and regulators believe some traders are abusing the strategy to pummel shares of financial stocks.

The SEC sped up its rule-making and on Wednesday the SEC announced three trading rules that were aimed at curbing abusive short selling. Calls continued that afternoon with New York Sens. Charles Schumer and Hillary Clinton, who urged Mr. Cox to halt all short-selling for financial stock. They reasoned it was necessary to aid their Wall Street constituents. Late Wednesday night the SEC announced intentions to require hedge funds to disclose more information about their short positions.

The reviews of the SEC emergency moves were mixed with many traders saying they led to confusion in the market and could lead to more volatility. Others continued to urge the SEC to reinstate a rule that acted as a speed bump to short sales by prohibiting a new short unless there was a higher bid.

Richard Baker, head of the Managed Funds Association, a hedge fund lobbying group, downplayed the role of short selling in the volatile market, saying that hedge funds short because they identify fundamental problems with a company. "If in fact a company does fail," he said, "it will have nothing to do with the fact that someone on the outside noticed these deficiencies."

The moves by the U.S. and British regulatory agencies to restrict short selling could encourage investors to take other steps to bet against companies, such as using the options market. They also raised questions about the impact on markets that depend on short selling, such as convertible-bond trading, where investors usually buy a convertible bond and then short the same stock, to protect themselves.

Short sellers say that if they have to disclose their short sales it could create more pressure on stock. For example, if a well-known investment firm reported that it was targeting a stock, other investors might panic and sell shares. That doesn't happen very much when they report that they have purchased a stock, however, so it's not clear if there would be more impact on the way down.

Hedge funds expressed concern that short-sale limits could cause investors to panic about the balance of their portfolios, and have the unintended consequence of causing hedge funds to sell so-called long positions -- or bets that companies' shares will rise -- because they'll feel less able to "hedge" those positions through short sales, according to a person who took part in several afternoon phone calls with SEC staff.

—Patrick Yoest and Jenny Strasburg contributed to this article.
Write to Kara Scannell at [e-mail], Deborah Solomon at [e-mail], Craig Karmin at [e-mail] and Gregory Zuckerman at [e-mail]
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