SEC follows FSA lead with second ban on short selling in 24 hours

The SEC has announced its second ban on short selling in 24 hours after being somewhat upstaged by the actions of the FSA overnight. 

Both the SEC and the FSA adopted emergency measures which came into effect at midnight last night, but until this morning that is where the similarities ended.  The SEC was first to the stalls by announcing its planned measures yesterday which introduced a ban on “naked” short selling, the practice of selling a stock you neither own nor have borrowed.  The FSA on the other hand went one step further a few hours later by announcing a ban on all short selling in financial stocks, including ‘covered’ short selling, a practice which the FSA acknowledges as “a legitimate investment technique in normal market conditions”.  Overnight, the SEC followed the FSA’s line by also introducing a ban on covered short selling of financial stocks.  Rarely has the panic and confusion in the regulatory markets matched those of the financial markets.

Until this morning, it appeared that the SEC and FSA had different agendas.  Naked short selling clearly has great potential to be an abusive and unethical practice and the SEC’s approach, which was to ban the practice across the board and apply it to all quoted companies, suggests a general health motive to stamp out potentially abusive practices which may give rise to disorderly markets anywhere.  The FSA’s covered short selling ban on the other hand, only applies to UK incorporated banks and insurers, suggesting an immediate healing motive by prohibiting a legitimate practice during a specific disorderly market event.  Overnight, the SEC seems to have decided to follow the FSA line and at 8am this morning extended its ban to also include covered short sales of 799 US financial companies, thus demonstrating a long awaited and somewhat more joined up approach by the regulators to restoring equilibrium to markets.

The emergency actions by the SEC and FSA are significant given both regulators acknowledgement of the legitimacy of covered short selling and its role in the efficient formation of market prices.  Whether the bans will achieve their objective, remains to be seen.  Early trading might suggest initial success although there are significant other factors in play in early trading and it is dangerous to draw early conclusions.

It should be noted that the ban effectively amounts to an intervention in the normal mechanics of the marketplace.  If the regulators accept, and they do, that short selling is a legitimate component of an orderly market, by banning covered short sales, the regulators have removed one of the forces which contribute to this order and which helps share prices find their natural level.  In other words, one might argue that the regulators are intervening to influence the movement of share prices.  The regulators counter that recent unbridled short selling has contributed to the recent, sudden price declines in the securities of financial institutions, which they feel are unrelated to their true price valuation.

Details of the SEC’s latest announcement can be viewed at http://www.sec.gov/news/press/2008/2008-211.htm

Further enquiries to Chris Rexworthy, Scott Wilson or Stephen Burke at IMS on 0207 408 2448

19th September 2008

Disclaimer