SEC bashed over short-selling ban

Hedge funds will have to reveal short positions

By Matt Andrejczak, MarketWatch

Last update: 4:54 p.m. EDT Sept. 19, 2008

Comments: 10

SAN FRANCISCO (MarketWatch) -- The Securities and Exchange Commission drew sharp criticism Friday for putting a stranglehold on short sellers, a move that will force hedge funds to reveal short positions. It also could sap market liquidity and create more selling pressure.

Eric Newman, portfolio manager at TFS Capital (TFSMX:

 

13.35, -0.27, -2.0%) , said the SEC is blaming short sellers for almost every problem in the financial markets.

"It isn't the fault of the short sellers that Morgan Stanley was leveraged 30 to 1 . . . and it isn't the fault of short sellers that AIG (AIG:, , ) assumed home prices would rise forever," said Newman.

On Friday, the SEC -- claiming rampant short selling has triggered a steep decline in financial stocks -- banned short sales in 799 financial stocks through Oct. 2. The SEC's emergency move may be extended but won't last more than 30 days.

The Managed Funds Association, which represents the hedge fund industry in Washington, D.C., said it is seeking exemptions from the rule and a rewrite of the short-sale ban. It hasn't ruled out legal action but filing a lawsuit would be a last resort measure, the group said.

"This crisis is the result of risk management failures and disclosures by the investment firms and banks that are collapsing, not the actions of hedge fund managers," said MFA President and former congressman Richard Baker.

A short sale is a bet that a stock price will decline over time, not go up. It isn't an illegal trading strategy. In a regular short sale, the seller borrows a stock and sells it, with the understanding that the loan has to be repaid by buying the stock.

Some investors argue short sellers keep corporate management teams honest, shining light on possible accounting gimmicks or undisclosed business problems.

"We are concerned with their decision to ban legitimate short selling," said Josh Galper, managing principal of the Vodia Group LLC. "We have seen no evidence or data to support the notion that the banning of short sales in financial stocks will provide anything other than a short-term price stimulus."

Financial stocks jumped Friday, lead by shares of Goldman Sachs (GS:, , ) , Morgan Stanley (MS:, , ) , and Citigroup (C:, , ) -- all names on the SEC's short-sale ban list.

SEC wants hedge funds to 'fess up

Starting Monday, the SEC wants hedge funds to 'fess up to short sales.

If an institutional money-manager takes a short position in a stock valued at more than $1 million, it will be required to report that investment to the SEC in a "Form SH" document. Those documents will be made public on SEC's Edgar database starting Sept. 29.

Hedge funds and others will be required to make those disclosures as long as the SEC's short-sale ban is in place. The rule applies to stocks shorted starting Monday.

The SEC said "such disclosure requirements are in the public interest for the protection of investors and will insure transparency in short selling." See SEC order.

On Thursday, Britain's stock market regulator banned short selling in financial companies and said it might extend the ban to other sectors. French regulators are stepping up their efforts to monitor short sales, too.

In July, the SEC took steps to restrict short selling in financial stocks. The emergency measure helped propped up ailing financial stocks but those stocks later fell after the order was lifted. 

Matt Andrejczak is a reporter for MarketWatch in San Francisco.