July 22, 2008 / 9:33 PM / in 9 years

UPDATE 1-Short sells drop in firms after SEC rule--S3 data

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(Recasts, adds S3 executive quote, background, byline)

By Emily Chasan

NEW YORK, July 22 (Reuters) - Short sells dropped dramatically in shares of the 19 financial firms targeted by U.S. regulators' emergency short-selling rule this week, a market data company said on Tuesday.

Short sells dropped 90 percent in shares of mortgage finance companies Fannie Mae FNM.N and Freddie Mac FRE.N, and declined 70 percent in shares of the other 17 financial firms affected by the rule, S3 Matching Technologies said, citing a review of data from its clients.

The firm said it compared short sale data from July 14, prior to the U.S. Securities and Exchange Commission emergency rule, with data for Monday, July 21 -- the first day the rule took effect.

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.

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

It affects Fannie and Freddie and major financial firms including Citigroup Inc (C.N), Lehman Brothers Holdings Inc LEH.N, Goldman Sachs (GS.N), Merrill Lynch MER.N, Morgan Stanley (MS.N) and JPMorgan Chase & Co (JPM.N).

While the SEC said last week that its rule was not intended to stop legitimate short selling, S3's data showed that its clients had dramatically altered their strategies.

"The short sell slowdown during the first day was obviously very significant across the targeted symbols," Jack Holt, chief executive of S3, said in a statement. "While there is no way for data to reveal if a short sell is 'naked,' there's no doubt the SEC has put a rule in place that has drastically reduced short selling."

S3 processes data for Wall Street dealers, brokerage houses and financial institutions of all types, seeing about 15 billion financial transactions per day. It said short sales represent about 1 percent of its clients' total volume.

Official short selling data is released twice per month by the exchanges, so firms that process or track trades for brokerages, like S3, are able to see more current data.

Investors who sell securities "short" profit from betting stocks will fall. They borrow shares and then sell them, waiting for the stock to fall so they can buy the shares back at a lower price, return them to the lender, and pocket the difference. (Reporting by Emily Chasan; Editing by Tim Dobbyn, Gary Hill)

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