SEC Bars Naked Short Sales of Major Financial Firms; More is Needed

This post is from Edward D. Herlihy, Wachtell, Lipton, Rosen & Katz. SEC Release No. 34-55970 (2007), under which the SEC abolished the “Uptick” rule, is available here. In making its decision, the SEC considered its own economic analysis, available here, and four academic studies, three of which are available here, here and here.

In response to the SEC’s emergency rule, issued Tuesday evening, barring short sales of stock in Fannie Mae, Freddy Mac and seventeen primary dealers, my colleagues Theodore A. Levine, Caitlin S. Hall and I have issued a memorandum entitled “SEC Bars Naked Short Sales of Major Financial Firms; More is Needed.” The emergency rule, which takes force July 21 and will be in effect for thirty days, comes on the heels of a week in which Fannie Mae and Freddie Mac stocks were battered by unsubstantiated rumors. In the memorandum, available here, we urge the SEC to take immediate strong action, including expanding the temporary rule beyond its initial thirty-day period and extending its coverage to all publicly traded securities.

The emergency rule follows the unusual statement on Sunday evening by the SEC that it, FINRA and NYSE Regulation would immediately begin examinations of broker-dealer and investment adviser supervisory and compliance controls, with the goal of stemming the spread of false rumors intended to manipulate security prices. Our memorandum on this development, entitled “SEC Takes First Step to Address Manipulative Rumor-Mongering; More Aggressive Action Still Needed,” is available here.

Although these regulatory developments are commendable, we believe that the SEC should immediately re-impose the “Uptick” Rule, a 70-year-old regulation that constrained short selling in declining markets by requiring that listed securities be sold short only at a price above their last different sale price. In a memorandum on July 1, available here, we discussed the rationale for the Uptick Rule, the Commission’s reasons for abolishing it, and the limitations of the pilot program undertaken by the Commission prior to its decision to abandon the rule. On an urgent basis, we urged the SEC to consider re-imposing the Uptick Rule, or to take alternative measures, in these extraordinary times to dampen volatility and address abusive and manipulative short selling.

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  1. Babak
    Posted Saturday, July 19, 2008 at 6:21 pm | Permalink

    In my recent blog post [ ], I propose a hopefully more efficient tactic for shorting involving setting up a net hedged position in 2 separate brokerage accounts. The tactic is designed to mitigate the regulatory hurdles that make it difficult to time the short sale of a hard-to-borrow stock.

    Short sellers might find the idea useful.

  2. don frank
    Posted Sunday, August 3, 2008 at 12:36 am | Permalink

    I am at a loss as to why one who owns a stock with the intent for it to gain in price, is put in a position to let the broker loan that stock to someone else for the purpose of selling it short and causing the stock price to go down.

    I think anyone who own a stock which is held by a broker should be able to tell the broker that the stock they own cannot be loaned to anyone unless they agree and are compensated.