SEC debates restricting short sellers

WASHINGTON (Reuters) - U.S. securities regulators were considering proposed curbs on short selling at a meeting on Wednesday, weighing steps that could restrict a type of investing blamed by some lawmakers and executives for worsening the financial crisis and driving down share prices.

The Securities and Exchange Commission was debating bringing back the "uptick rule," which allowed short sales -- a bet that a stock's price will fall -- only when the last sale price was higher than the previous price.

SEC Chairman Mary Schapiro opened the meeting without tipping whether she definitely favors short-selling restrictions, but acknowledged investor concerns.

"Investors themselves feel less confidence in putting their capital in markets without additional restrictions on short selling," she said, adding the issue had generated more letters and comments in her short time as chairman than any other.

The SEC previously concluded that advances in the marketplace had rendered the rule ineffective and abolished it in summer of 2007.

Kathleen Casey, who was one of five commissioners who voted to abolish the uptick rule in 2007, said she had not yet been persuaded that its repeal had anything to do with the economic and market conditions of the past 18 months.

Nevertheless, Casey said she would support issuing the proposals for public comment.

The five commissioners will also consider a bid test, which would only allow shorting if the best available bid was higher than the last bid, according to SEC staff and a summary of the proposals prepared for the meeting.

Other possible measures would use a circuit breaker approach to trigger a temporary suspension of short selling in a particular stock, or temporary application of the uptick or bid rule in a security.

The SEC was expected to debate and then vote on issuing the proposals for a 60-day public comment period. There will also be an SEC roundtable discussion of the issues on May 5. Any final action is likely months away.

Under one proposal, if a stock fell by 10 percent or some other amount, a circuit breaker would kick in and trigger the application of the "bid test." This approach has the support of the largest U.S. exchanges, the New York Stock Exchange, the Nasdaq Stock Market and BATS exchange.

Another circuit breaker proposal would ban short selling in a particular stock for the rest of the day once triggered. A third circuit breaker proposal would trigger the application of the uptick rule for the rest of the day.

In a short sale, an investor borrows stock and sells it in the hope that its price will fall. If the price does drop, the seller profits by buying the stock back at the lower price and returning the borrowed shares.

Market makers would not be exempt from the proposed short sale restrictions, SEC officials said.

The uptick rule, first adopted after the 1929 stock market crash, is viewed by some as a way to relieve downward pressure on a stock that is dropping precipitously.

With the benchmark Standard & Poor's 500 index down roughly 45 percent since the start of 2008 and the Dow Jones Industrial Average down more than 40 percent over the same period, members of Congress and others are demanding restoration of the rule.

Billionaire investor George Soros said on Monday that he favored a reintroduction of some kind of rule to restrict short selling. "You do need to provide some protection against effectively the bear raids," Soros told Reuters Financial Television in an interview.

But Casey warned fellow commissioner that the courts could overturn a new SEC rule unless there was credible empirical evidence to demonstrate the repeal of the uptick rule, or abusive short selling, drove down the price of any security.

Short sellers argue that their trading helps keep markets liquid and prevents stocks from becoming overvalued. They also criticize last year's temporary ban on short sales of hundreds of financial stocks.

"I am surprised that regulators have not learned from the (short-sale ban) fiasco where it ultimately reduced liquidity in the securities," said Ron Geffner, a partner at law firm Sadis & Goldberg LLP who advises hedge funds.

(Reporting by Rachelle Younglai and Karey Wutkowski; Editing by Tim Dobbyn)