SEC Extends Ban on Abusive Short Selling

There has been a marked rebound in the financial sector since the announcement by the Securities and Exchange Commission (SEC) on 15 July to implement a temporary ruling on 21 July to curb short selling for nineteen of the financial sector’s biggest players. This has resulted in a mixed reaction from analysts who are left wondering whether this rebound is just coincidence, or is a direct result of the short selling curb.

The SEC initially took this action against short selling in response to a six week downward spiral of bank and brokerage share prices. The temporary ruling should have ended on Tuesday 29 July, but the SEC voted late in the day to extend it through to 12 August, stating that the period would not be extended beyond this date. This extended period will prove to be particularly interesting to analysts and investors alike, as it is likely to establish whether the SEC’s short selling curb is in fact the driving force behind the rebound.

SEC Chairman Christopher Cox has confirmed that the agency is not targeting legitimate short sellers, but wants to put a stop to “naked” short selling, where an investor sells stock without actually having borrowed it, or even confirming through a broker whether it is available to borrow. Prior to the emergency ruling a legitimate short sell trader merely had to prove through his broker that the stock was available to borrow, but did not have to actually borrow it. This has changed under the ruling and short sellers must arrange beforehand to borrow the securities and then must deliver them at settlement. It is also suspected that some short sellers – naked and otherwise – deliberately spread rumors in order to drive stock down so that they can buy back the borrowed stock at a lower price. Although this is often difficult to prove, it is something that the SEC will be paying attention to.

The SEC has the authority to implement an emergency ruling for a period not exceeding thirty days. Any permanent changes to SEC rules must involve public consultation and can take a number of months to approve and put into practice. The SEC is reportedly preparing proposals to prohibit abusive short selling in all listed shares, not just a chosen few, on a permanent basis. One of the reasons for taking this step is to prevent the possible manipulation of the market by unscrupulous short sellers.