SEC amends emergency short sale rule

WASHINGTON (Reuters) - Securities regulators have modified an emergency rule aimed at curbing manipulative short-selling in 19 major financial firms including Fannie Mae (FNM.N) and Freddie Mac (FRE.N).

Facing complaints from financial industry groups and exchanges, the Securities and Exchange Commission provided guidance and said on Friday it was granting market makers relief to help maintain order and liquidity in the markets.

The market makers affected would not have to pre-borrow shares before shorting the stocks, the SEC said.

The emergency rule, which takes effect on Monday and can last up to 30 days, requires a short seller to borrow the securities before executing the sale. It also requires the investor to deliver the securities on the settlement date.

Short selling is a legitimate strategy where the investor arranges to borrow shares they consider overvalued and sell them in hopes of profiting when the price drops. A naked short occurs when an investor sells stock that has not yet been borrowed.

The rule applies only to the stocks of 17 Wall Street firms, primary dealers that have access to the Federal Reserve's discount window, such as Citigroup Inc (C.N) and Lehman Brothers LEH.N. The SEC also included the biggest mortgage finance companies, Fannie and Freddie, after a week when their shares dived on concerns they were undercapitalized.

Wall Street, which was thrown off guard when the SEC announced the emergency rule on Tuesday, quickly applauded the rule modifications and guidance.

"The guidance is essential for separating legitimate market makers from those who may try to act illegally," said Ira Hammerman, senior managing director of the Securities Industry and Financial Markets Association.

The New York Stock Exchange, International Securities Exchange (DB1Gn.DE), the Philadelphia Stock Exchange and Chicago Board Options Exchange also welcomed the changes.

"The SEC was open minded to constructive input from the options markets. It's a recognition that the markets are highly electronic and that any restrictions that delay hedging would have a negative impact on liquidity," said Ed Joyce, president and chief operating officer at the CBOE, the largest U.S. options market.

The emergency rule is the latest effort by the SEC to crack down on market manipulation. The agency has already announced plans to rein in those that are spreading false information.

Companies and lawmakers have blamed short sellers for recent sharp drops in financial stocks.

During the period of the emergency order, the SEC will consider rules to address short selling problems across the entire stock market.

NYSE Regulation Chief Executive Richard Ketchum said he understood the SEC's desire to extend the rule to all publicly traded companies but cautioned against moving without assessing the impact from the emergency rule.

The SEC said broker dealers did not have to change their processes and procedures used to document compliance with the share-borrowing requirement. However, broker-dealers must still document those arrangements.

The SEC also provided guidance for syndicate stock offerings and restricted stock.

(Reporting by Rachelle Younglai and Doris Frankel in Chicago, editing by Mark Porter and Tim Dobbyn)