SEC bans short selling in financial firms

In a bid to shore up investor confidence in the face of the spiraling market crisis, the Securities and Exchange Commission temporarily banned all short selling in the shares of 799 financial companies. Short selling is a time-honored method for profiting when a stock drops.

The 799 companies covered by the SEC ban are an A-to-Z of the nation's financial institutions, including the powerhouse investment banks such as Goldman Sachs Group Inc. and Morgan Stanley, and commercial banks from Bank of America Corp. to Cape Fear Bank Corp. SLM Corp., which is known as Sallie Mae and is the biggest U.S. student lender, is on the list, as are Charles Schwab Corp., Berkshire Hathaway Inc. and Principal Financial Group Inc.

Washington Mutual Inc., the nation's largest thrift, which has lost billions from subprime-mortgage exposure and has seen its shares plunge, also is on the SEC list.

The ban took effect immediately Friday and extends through Oct. 2. The SEC said it might extend the ban — so that it would last for as many as 30 calendar days in total — if it deems that necessary.

That window could be enough time to calm the roiling financial markets, with the Bush administration's massive new programs to buy up Wall Street's toxic debt possibly starting to have a salutary effect by then.

The short-selling ban is "kind of a timeout," said John Coffee, a professor of securities law at Columbia University. "In a time of crisis, the dangers of doing too little are far greater than the dangers of doing too much."

But on Wall Street, professional short-sellers said they were being unfairly targeted by the SEC's prohibition. And some analysts warned of possible negative consequences, maintaining that banning short selling could actually distort — not stabilize — edgy markets.

Indeed, hours after the new ban was announced, some of its details appeared to be a work in progress. The SEC said its staff was recommending exemptions from the ban for trades that market professionals make to hedge their investments in stock options or futures.

"I don't think it's going to accomplish what they're after," said Jeff Tjornehoj, senior analyst at Lipper Inc., a fund research firm. Without short-sellers, he said, investors will have a harder time gauging the true value of a stock.

"Most people want to be in a stock for the long run and want to see prices go up. Short-sellers are useful for throwing water in their face and saying, 'Oh, yeah? Think about this,' " Tjornehoj said. As a result, restricting the practice could inflate the value of some stocks, opening the door for a big downward correction later.

Although the practice can make markets more efficient and bring in more capital, the government argues that it has widened the scope of the recent financial crisis and contributed to the collapsing values of investment- and commercial-bank stocks in particular.

Government officials on both sides of the Atlantic have been denouncing hedge funds and other short-sellers they say have swarmed over the limp bodies of venerable investment banks and other big companies. New York Attorney General Andrew Cuomo likened them to "looters after a hurricane," and his office is investigating a possible conspiracy among short-sellers to spread negative rumors to pound down companies' stock prices.

The turmoil in recent weeks has swallowed some of the most storied names on Wall Street. Three of its five major investment banks — Bear Stearns, Lehman Brothers and Merrill Lynch — have either gone out of business or have been driven into the arms of another bank. Many contend that short selling played a key role.

SEC Chairman Christopher Cox, who with Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke met with lawmakers at the Capitol on Thursday night, acknowledged that such extraordinary measures would not be necessary in a well-functioning market and said they are only temporary.

Cox said Friday that his agency "is committed to using every weapon in its arsenal to combat market manipulation that threatens investors and capital markets."

The SEC also imposed a new requirement, also temporary, for investment managers to publicly report their new short sales of stocks. And the agency eased restrictions on the ability of companies to buy back their own shares, also through Oct. 2, another move aimed at helping restore liquidity to the distressed and volatile market.

What is short selling?

Short selling involves borrowing a company's shares, selling them, and then buying them to return them to the lender later, when the stock falls. The short-seller then pockets the difference in price.