SEC poised to adopt curbs on short-selling after long study; bid to prevent market turmoil

Federal regulators are poised to rein in the practice of short-selling, restoring Depression-era restraints, in a bid to prevent stock-selling sprees that feed on themselves and can heighten market turmoil.

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The Securities and Exchange Commission is scheduled to vote Wednesday at a public meeting to adopt new rules, following months of consideration by the commissioners. The SEC asked for public comment last April on several alternative approaches to restraining short-selling, and a bipartisan group of senators have been pushing the agency to act or face legislation.

The meeting begins at 10:00 a.m. EST.

The commissioners are expected to adopt a so-called circuit breaker for stock prices, restricting short-selling of an extremely fast-dropping stock for the rest of a trading session based on its highest bid.

Short-sellers bet against a stock, in a practice that is legal and widely used on Wall Street. They generally 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.

In July 2007, when the stock market was near its peak, the SEC abolished a 70-year-old uptick rule, put in during the Depression that followed the 1929 market crash that allowed short-sellers to come in only at a price above the highest current bid for the stock. Investor confidence was shaken as the market plunged in the fall of 2008 and proponents of restoring restraints said they were needed to prevent abusive trading. They maintained that the absence of the rule fanned market volatility, prompting bands of 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.

Last July, the SEC made permanent an emergency rule enacted at the height of the fall 2008 tumult that targets so-called “naked” short-selling — when sellers don’t even borrow the shares before selling them, and look to cover positions after the sale.

The SEC rule includes a requirement that brokers must promptly buy or borrow securities to deliver on a short sale.

Brokers acting for short-sellers must find a party believed to be able to deliver the shares within three days after the short-sale trade. If the shares aren’t delivered within that time, there is deemed to be a “failure to deliver.” Brokers can be subject to penalties if the failure to deliver isn’t resolved by the start of trading on the following day.

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