Banks, Trade Groups Say that SEC Order Does Not Go Far Enough
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Less than a week after Securities and Exchange Commission Chairman Christopher Cox invoked the Commission's emergency powers to regulate short selling of certain stocks including Freddie Mac and Fannie Mae, complaints were surfacing from financial institutions. The complaints were not because those financial institutions were on the list of troubled banks in need of shoring up, but because they were not.
Some background: last Tuesday Cox invoked the emergency powers, which were set to take this past Monday, to change the requirements for short sales of Freddie and Fannie stock as well as that of Lehman Brothers, Goldman Sachs, Merrill Lynch, Morgan Stanley, Bank of America, Citigroup, and 11 other companies' including ten European and Asian financial services companies.
All 19 of the companies have been hard hit in the current bear market but Cox said that the SEC would immediately begin considering rules to extend the new requirements to the rest of the market.
Cox made his announcement in testimony before the Senate Banking Committee.
Short selling is a technique where an investor can sell stock he does not own in anticipation that the price of the stock will drop and he can replace the stock at a lower price, pocketing the difference as profit.
Short selling is a legitimate trading technique but it can contribute to the volatility of the stock market because investors often have to scramble to "cover" short sales if the stock goes up rather than down. Sometimes, if the stock does tumble, investors can be hard pressed to find stock available to make good on the sale. Short selling is often blamed for making the 1929 stock market crash more severe.
Under current SEC rules, short sellers must borrow stock (without actually purchasing it) in order to sell it short. However, there was nothing to preclude the actual owners of the stock from allowing multiple traders to borrow their shares or the same trader to borrow the same shares over and over. When the time comes to cover the short sale such traders are left scrambling.
This so-called "naked" short-selling can add extra downward momentum to a stock because, without being forced to borrow the shares first, traders can short a limitless amount of stock, although short-selling is inherently risky.
Under the proposed emergency rules, traders will be required to borrow the stock pre-short sale, and the owner/lender would have to take it out of the market and not allow other traders to use it to satisfy requirements that they've located stock. This past Friday Cox modified the emergency order to eliminate the pre-borrowing requirement for "market makers," but not the need to deliver the stock within three days.
Wall Street has been asking for reforms in short selling because many believe it is contributing to market volatility and may be being used to manipulate the price of financial stocks. Cox's emergency action, however, is a short term solution as the order expires in 30 days.
And, according to an article in the Wall Street Journal last week, many financial services companies are complaining that the emergency order does not go far enough.
The American Bankers Association which represents the interest of 8,500 banks said, in a letter to the SEC, that it fears that short sellers will now concentrate their efforts on banks that are not covered by the emergency order and asked that the order be expanded to include stocks of banks and bank holding companies.
The WSJ also reports that the Financial Services Roundtable which represents 100 of the largest U.S. financial companies has asked the SEC to extend that order to cover all financial services companies starting this week. Cox had previously said that those 19 companies on the list were originally picked on the basis of which had access to the Federal Reserve's lending facilities.
Other companies which have been under selling pressure but did not make the SEC list have also petitioned Cox for inclusion. These include National City Corp., Wachovia Corporation which announced record losses Tuesday morning and Washington Mutual, Inc., which is said to be high on the FDIC's "watch list."
But, while some troubled banks are looking for whatever protection the SEC provide, others are concerned that being on the list would further stigmatize them.
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