SEC restricts short selling of financials

[J]

SEC Press release

SEC Enhances Investor Protections Against Naked Short Selling
FOR IMMEDIATE RELEASE
2008-143

Washington, D.C., July 15, 2008 - The Securities and Exchange Commission today issued an emergency order to enhance investor protections against "naked" short selling in the securities of Fannie Mae, Freddie Mac, and primary dealers at commercial and investment banks.

The SEC's order will require that anyone effecting a short sale in these securities arrange beforehand to borrow the securities and deliver them at settlement. The order will take effect at 12:01 a.m. ET on Monday, July 21. In addition to this emergency order, the SEC will undertake a rulemaking to address these issues across the entire market.

"The SEC's mission to protect investors, maintain orderly markets, and promote capital formation is more important now than it has ever been," said SEC Chairman Christopher Cox. "Today's Commission action aims to stop unlawful manipulation through 'naked' short selling that threatens the stability of financial institutions. We will continue our vigorous commitment to investors by working within the SEC and in close cooperation with our regulatory counterparts to promote the continued health and vibrancy of our markets."

The Commission's emergency order, pursuant to its authority under Section 12(k)(2) of the Securities Exchange Act of 1934, will be effective at 12:01 a.m. ET on July 21, 2008 and will terminate at 11:59 p.m. ET on July 29, 2008. The Commission may extend the order to continue it in effect thereafter if the Commission determines that the continuation of the order is necessary in the public interest and for the protection of investors, but for no more than 30 calendar days in total duration.

# # #

The securities identified in the Commission's order:

Company Ticker Symbol(s)
BNP Paribas Securities Corp. BNPQF or BNPQY
Bank of America Corporation BAC
Barclays PLC BCS
Citigroup Inc. C
Credit Suisse Group CS
Daiwa Securities Group Inc. DSECY
Deutsche Bank Group AG DB
Allianz SE AZ
Goldman, Sachs Group Inc GS
Royal Bank ADS RBS
HSBC Holdings PLC ADS HBC and HSI
J. P. Morgan Chase & Co. JPM
Lehman Brothers Holdings Inc. LEH
Merrill Lynch & Co., Inc. MER
Mizuho Financial Group, Inc. MFG
Morgan Stanley MS
UBS AG UBS
Freddie Mac FRE
Fannie Mae FNM

Commentary from Minyanville:

The rule changes proposed by the SEC for selling stocks short are meant to curtail “naked” short selling, selling stock short without locating a borrow. They tighten up procedure between lender and borrower through broker dealers. For example, in the past a short seller would sell stock and then call the broker for a “locate," a stock available at the dealer to borrow. And even if he called first and the dealer had no “available locate” at the current time, the dealer probably told the seller to go ahead knowing that the locate would come at some point.

It's still not clear how to interpret the new procedure, but it looks like now “the locate” must be currently in the box. This is going to raise the cost of borrowing. In other words, the rebate rate credit to the short sellers account (the interest they earn on the cash they generate by selling the stock) will be less.

In general this will cause those making markets in options, convertible bonds, CDS, and other derivatives where short stock is used to hedge to need better prices. In general, liquidity will go down.

And strangely the SEC chose to start this program with a group of 19 stocks, all financials, that seem especially important to the financial system. They are:


* BNP Paribas (BNPQF) (BNPQY)
* Bank of America (BAC)
* Barclays (BCS)
* Citigroup (C)
* Credit Suisse (CS)
* Daiwa Securities (DSECY)
* Deutsche Bank (DB)
* Allianz SE (AZ)
* Goldman Sachs (GS)
* Royal Banks (RBS)
* HSBC Holdings (HBC) (HSI)
* JPMorgan Chase (JPM)
* Lehman Brothers (LEH)
* Merrill Lynch (MER)
* Mizuho (MFG)
* Morgan Stanley (MS)
* UBS (UBS)
* Freddie Mac (FRE)
* Fannie Mae (FNM)

These companies need their stock prices up so they can sell stock and raise capital. I can tell you that today every “market maker” is a little shy about selling this group of stocks short today until all these things are clarified.

So the SEC has decided to make it harder & less profitable to short their protected list of banks and financials and all of said companies had a nice bounce today, because clearly, the crisis is over and everything is good again.

However, I get the feeling there's going to be some unintended consequences, the SEC has effectively said "these financials are in trouble" and painted a big red bullseye on them, so I suspect once the restrictions are lifted and maybe even before, the shorters may smell blood and start shorting them down to zero.

I wonder what's next, an outright ban on short selling followed by a law stating that shares can't be sold for less than what they were bought for?

[CmdrWilkens]

Alternatively this could be the first step towards stopping the shrot selling version of traidng on the margin. These are traders who are shorting the stocks without actually yet having locked up possesion of them. Now it may indeed lock up liquidity BUT it also prevents a run on these stocks (and any stock to which such a rule is ever applied) which I would see as generally beneficial to investors. If it is harder to short stocks then the issue itself is less likely to drastically shift downwards (more short sellers leads to general weakness which leads to sell-offs and rapid price drops if not countered by some other movement or news) and THAT means that casual investors have a greater chance of retaining their capital. This move hurts institutional investors who make there money based on the number of high liquidity transactions they can engage in, the casual investor needs price stability or at least protection from sudden downturns and this rule looks to provide at least some protection.

[The Yosemite Bear]

mind you that was illegal somewhat beforehand because of the tactics of the Robber Barons of the 19th century, and their "Bear Raids".

[J]

Bloomberg update

SEC May Ease `Naked-Short' Sale Ban for Market Makers (Update1)

By Jesse Westbrook and Edgar Ortega

July 18 (Bloomberg) -- The U.S. Securities and Exchange Commission is poised to exempt market makers in stocks from an emergency rule aimed at preventing manipulation in shares of Fannie Mae, Freddie Mac and 17 Wall Street firms.

The agency staff, after conference calls discussing the rule that limits the ability of traders to use abusive tactics when betting on a drop in share prices, agreed to requests from exchanges and brokerages. Exchange officials told regulators that without an exemption, market makers in equities and options responsible for pairing off investor orders would struggle to keep transactions flowing and may raise costs for investors.

The staff recommended exceptions from the requirement to borrow shares in advance of a short sale ``to avoid constraining the market makers' provision of liquidity,'' SEC spokesman John Nester said in an e-mail from Washington. The full commission may vote as soon as today.

SEC Commissioner Christopher Cox, who announced the order July 15, is seeking to make it harder for traders to illegally drive down stocks of the two mortgage buyers and Wall Street firms and prevent another collapse like Bear Stearns Cos. The rule takes effect July 21.

Investors will be required to borrow shares that they plan to sell short as a bet on a decline in prices. Prior to the order, investors were only required to locate shares that they had reason to believe were available for borrowing.

Options Exchanges

Options exchanges asked the SEC to ease the restriction for market makers, who rely on quickly shorting stocks to hedge their trades. The proposal would free them from borrowing shares before a short sale, yet would force them to obtain the loan by the time the transaction is settled a day later, said two people familiar with the matter who declined to be identified.

The New York Stock Exchange told members today that the SEC ``intends to grant limited relief'' from the rule. The SEC may publish guidelines for brokerages today, the NYSE said. Market makers must quote bids to buy and offers to sell contacts on their assigned stocks.

``Without a market-maker exemption, I could see this having a profoundly negative impact on the liquidity that would be provided in stock and derivatives,'' said Steve Sosnick, an equity risk manager in Greenwich, Connecticut, for Timber Hill LLC, one of the largest options market makers in the U.S.

Short Sales

In a short sale, an investor borrows and then sells the shares in anticipation of a price decline. If the trade works as planned, the investor is able to buy back the stock at a lower cost and return the shares to the lender, pocketing the difference as profit.

Traders are sometimes unable to actually borrow the shares and complete a ``naked short-sale.'' If the loaned shares are never repaid, investors can sell more shares short than legally allowed and put pressure on a stocks' price.

Freddie Mac and Fannie Mae shares, the two largest mortgage lenders in the U.S., and Lehman Brothers Holdings Inc., the No. 4 securities firm, have lost more than 70 percent of their market value this year. Citigroup Inc., the largest bank by assets, has lost 43 percent; Merrill Lynch & Co., the No. 3 securities firm by market value, has lost 39 percent.

``Nineteen stocks is going to be a burden, but it's not going to be the onerous burden that it would be if they make it market-wide,'' Robert McBey, chief operating officer at Dallas- based Southwest Securities Inc. ``What Chairman Cox is saying is that locating the shares is no longer good enough; you have to physically have them in your possession. For the confidence of the financial system, I think it's probably a wise decision.''

Remember folks, rules are for the common people. It's ok for major financial institutions to carry out naked shorting on millions of shares in one go on the restricted companies, but I'm prohibited from doing any naked shorting.

[CaptainChewbacca]

I hearby move that 'Naked Shorting' be proclaimed the 'Awesome phrase of the week'!

Who's with me?