Short sales in financials dry up after rule

By Kristina Cooke

NEW YORK (Reuters) - Short positions have dropped further in shares of the 19 financial firms targeted by U.S. regulators' emergency short-selling rule this week, a market data company said on Friday.

Short sales, or bets a stock will fall, are now down 98 percent in shares of mortgage finance companies Fannie Mae (FNM.N: Quote, Profile, Research, Stock Buzz) and Freddie Mac (FRE.N: Quote, Profile, Research, Stock Buzz) and have fallen 85 percent for all 19 financial companies, S3 Matching Technologies said, citing data from its clients.

S3's clients are primarily individual investors. Data on short sales by hedge funds, which have been active in this type of trading, is closely guarded by the firms.

S3 said it compared short sale data from July 14, prior to the U.S. Securities and Exchange Commission emergency rule, to the close of trade on Thursday.

The SEC's rule is part of an effort to clamp down on market manipulation that some blame for the sharp declines in financial stocks and the demise of investment bank Bear Stearns in March.

Investors who sell securities "short" borrow shares and then sell them, waiting for the stock the fall so they can buy the shares back at a lower price, return them to the lender and pocket the difference.

The rule is designed to prevent illegal "naked" short selling, which occurs when an investor sells a stock that they have not yet been borrowed.

While the SEC said last week that its rule was not intended to stop legitimate short selling, which can prevent stocks from becoming overvalued, S3's data showed that its clients are dramatically changing their strategies.