SEC Restricts Short Sales

(February 25, 2010) – The US Securities and Exchange Commission (SEC) narrowly approved a plan that imposes new curbs on short-selling, which some consider a possible cause of the 2008 economic meltdown.

The SEC voted 3-2 along party lines at a public meeting to adopt new rules that would implement a so-called circuit breaker for stock prices.

“The reason this rule makes sense is because it recognizes that short-selling can potentially have both a beneficial and a harmful impact on the market,” said S.E.C. chairwoman Mary L. Schapiro in a statement.

Under the new Rule 201, short-selling will be limited on the day that a company’s stock drops more than 10% and for the following day. For such stocks, the SEC will permit short selling if the price of the sale is above the highest bid price nationally. At that point, short sellers will have to pay a small premium to bet against a stock. The rule will apply to all equities listed on exchanges and in the over-the-counter market, and will take eight months to come into effect.

The rule follows the SEC’s decision during the financial crisis to temporarily ban short selling on almost 1,000 stocks. The regulator’s step was spurred by claims by some on Wall Street that short-selling accelerated the financial downturn. The practice occurs when investors profit from betting against a stock by borrowing shares and then selling them in the hopes the price will fall.

“With all regulatory initiatives, only time and the markets will tell us how this fares,” said Andrew Actman, chief strategy officer at Lightspeed Financial, to the Financial Times. “If a company has poor earnings and/or other bad news, a limit on short selling may only drag out the stock’s price decline. The flipside is whether this helps companies, whose stock price is falling for no logical reason,” he said.