New "naked" short rules get mixed reviews
NEW YORK (Reuters) - The Securities and Exchange Commission's new emergency rule against "naked" short-selling in financial stocks drew mixed reactions among hedge funds and traders on Wednesday.
Some said the July 15 rule, one of two new SEC regulations aimed at curbing market abuses, would likely make it harder and more expensive to borrow stock to sell short in the short term. But longer term, they said hedge funds will find ways to bet on declines in stock values, making the rule little more than a minor impediment.
The temporary rule was enacted to protect 19 financial stocks, including battered mortgage guarantors Fannie Mae (FNM.N) and Freddie Mac (FRE.N) and a raft of banks, against "a substantial threat of sudden and excessive" stock price movements, the SEC said.
The agency said naked short selling, which is putting in a short stock order with no intention of actually borrowing it to drive down the price, may have contributed to this year's collapse of Bear Stearns and sharp declines in other financial stocks this year.
The new rule comes in the wake of the U.S. Treasury and Federal Reserve decision on Sunday to provide financial backing to government-sponsored enterprises Fannie Mae (FNM.N) and Freddie Mac (FRE.N), a move that could cost taxpayers untold billions of dollars.
"Short sellers are easy scapegoats, but the government is playing backstop for major financial institutions, so they have a legitimate interest in protecting them," said Steven Persky, managing partner in Dalton Investments, a $900 million Los Angeles-based hedge fund. "The government is protecting the rights of taxpayers."
Hedge funds, which have grown exponentially in recent years to become a $2 trillion industry, are among the largest users of short strategies. Some 30 percent of all U.S. traded stocks are sold short, up from 10 percent in 2000, fueled largely by hedge funds, industry experts say.
Under a typical trade, a broker-dealer accepts a short order and makes bona fide effort to locate and borrow the stock. But under the emergency order, in effect from July 21 through July 29, the 19 financial stocks must actually be borrowed by a settlement date, preventing multiple "borrows" on the same stock certificate.
"It is definitely going to make it harder on the shorts," said Charles Jones, finance professor at Columbia Business School. "It could have some effect on liquidity."
But Jones and others said there are other ways to bet on stock declines, such as trading in overseas markets, or using swaps and options. They said demand will fuel the development of other products to achieve the same aims.
"If there is more shorting going on than should be and the rule is enforced, there should be less short sale volume," said one New York-based broker dealer, who asked to remain unnamed. "But people will always find a way to express negative sentiment if a stock is overvalued."
Looking to prevent a further rout among battered financial stocks, the SEC also announced it would step up measures to stop illegal market manipulation by the spreading of false rumors. The SEC recently sent dozens of subpoenas to hedge funds and broker dealers, requesting trading records and electronic communications to find such violations, sources said.
The new rules "will have the psychological impact of making people stop and think," said Andrew Rabinowitz, chief financial officer at Marathon Asset Management, a $12 billion hedge fund, whose firm trades mainly debt.
"At a minimum, it shows that (Treasury Secretary Henry) Paulson and the Treasury continue to look to support the financial system. It's fantastic," he added.
(Editing by Andre Grenon)
