Wednesday, February 24, 2010

Federal regulators on Wednesday imposed new curbs on the practice of short-selling, hoping to prevent spiraling sales sprees in a stock that can stoke market turmoil.

The Securities and Exchange Commission, divided along party lines, voted 3-2 at a public meeting to adopt new rules.

The rules put in a so-called “circuit breaker” for stock prices, restricting for the rest of a trading session and the next one any short-selling of a stock that has dropped 10 percent or more.

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

The SEC move followed months of wrestling with the controversial issue. 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 agency got more than 4,300 comments on the issue.

Investor confidence was shaken as the market plunged amid the financial crisis in the fall of 2008, and proponents of restoring restraints said they were needed to prevent abusive trading. They maintained that the absence of restraints fanned market volatility, prompting 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.

Under the new rule, once a circuit breaker has been triggered, short-selling in the affected stock will be permitted only if the price is above the current highest bid for the stock. That restriction would apply for the rest of the trading session and the next day’s session.

The SEC said the rule strikes a balance between two objectives: preventing short-sellers from driving the price of a gutted stock even lower and preserving the benefits to investors from legitimate short-selling, such as pumping cash into the market. The balance comes, the agency said, because the circuit-breaker restrictions are temporary and are applied to a specific trading session, in contrast to other alternatives that would institute permanent constraints.

“The reason this rule makes sense is because it recognizes that short-selling can potentially have both a beneficial and a harmful impact on the market, depending on the circumstances,” SEC Chairman Mary Schapiro said before the vote.

MS. Schapiro said it is important for the SEC and the markets “to have in place a measure that creates certainty about how trading restrictions will operate during periods of stress and volatility.”

But the two Republican commissioners, Kathleen Casey and Troy Paredes, disputed that the curbs would bolster investor confidence and said they could hurt the market’s efficiency.

MS. Casey said she was “deeply concerned” that the action seemed to be guided more by “public relations” than evidence of the benefit of the rules. It could “undermine our credibility in the long run,” she said.

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.

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.

That 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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