Feds Weigh Options To Limit Short-Selling

Federal securities regulators are considering several ways to place restrictions on traders who bet that stock prices will fall, as investors and lawmakers clamor for brakes on moves they say worsened the market's downturn.

One option the Securities and Exchange Commission advanced Wednesday is restoring a Depression-era rule that prohibits short sellers from making their trades until a stock ticks at least one penny above its previous trading price. The goal of the so-called uptick rule is to prevent selling sprees that feed upon themselves - actions that battered the stocks of banks and other companies over the last year.

The SEC commissioners, who voted 5-0 to open the alternatives to public debate, could settle on one short-selling plan among the five put forward and formally approve it sometime after a 60-day comment period.

SEC Chairman Mary Schapiro said the agency was beginning "a thoughtful, deliberative process to determine what is in the best interests of investors" before taking final action.

Short-selling is legal and widely used on Wall Street. But as the market has plunged, investors and lawmakers have pressed the SEC to reinstate the uptick rule. They say its absence since mid-2007 fanned market volatility, prompting bands of hedge funds and other investors to target weak companies with an avalanche of short-selling.

The SEC meeting marked the second time in less than a week that financial relief measures pressed by Congress were taken up by independent overseers. The Financial Accounting Standards Board on April 2 gave companies more leeway in valuing assets and reporting losses, a move that sent financial stocks and the broader market soaring.

Both sets of changes would especially benefit banks and other financial institutions, whose balance sheets have been battered in the financial crisis and whose stocks have been targeted by short sellers.

At the same time, the Obama administration has proposed to Congress a sweeping overhaul of the nation's financial rule book meant to prevent a repeat of the banking crisis that toppled iconic institutions and wiped out trillions of dollars in investor wealth. It includes requiring larger hedge funds, and other private pools of capital, to register with the SEC and open their books to federal inspection. Credit default swaps also would come under federal regulation for the first time.

Schapiro acknowledged the SEC's difficulty in striking a balance between stemming market abuses to bolster investors' confidence and stifling the legitimate benefits of short-selling. Other commissioners warned of possible unintended negative consequences of short-selling restraints.

Although many in the public blame short-selling for enflaming market volatility over the past 18 months, Schapiro said there is no "specific empirical evidence" that the absence of the uptick rule fueled it.

Commissioner Luis Aguilar suggested that curbs on short-selling could push market players into other, unregulated areas - such as credit default swaps - as a way of trading to benefit from companies' weakness.

The swaps, a form of insurance against loan defaults, are traded in a secretive market valued at around $60 trillion and figured prominently in the credit crisis that brought the downfall of Lehman Brothers, a government bailout of insurer American International Group Inc. and the sale of Merrill Lynch & Co. to Bank of America Corp.

The short-selling move is the first major SEC initiative under Schapiro, who was appointed by President Barack Obama and assumed the position in January.

The practice involves borrowing a company's shares, selling them, then buying them back when the stock falls and returning them to the lender. The short seller pockets the difference in price.

Proponents of short-selling say it can make markets more efficient, bring in more capital and raise warning signs about weak or badly managed companies. Professional short sellers and some analysts also have warned that restricting short-selling could actually distort - not stabilize - edgy markets.

But companies and regulators maintain the practice widened the scope of the financial crisis and contributed to the collapse in value last fall of a number of bank stocks and the demise of Lehman Brothers.

Another option floated Wednesday by the SEC, besides reinstating the uptick rule, is a sort of "circuit breaker" for stock prices. That approach, in three variations, would force short sellers to sell shares above the going market rate when they execute a short trade - it would only go into effect after a stock price has had a decline of 10 percent.

The fifth alternative, known as an upbid rule, would allow short sellers to come in only at a price above the highest current bid for the stock.

The SEC repealed the uptick rule, which was established in 1938 during the Depression that followed the 1929 market crash, nearly two years ago when the stock market was near its peak. A test by the SEC earlier in 2007, removing the uptick rule for one-third of the stocks in the Russell 3000 index, found it could be eliminated without causing significant harm.