Short Selling: We Want Protection Too

As is now well known, this week the SEC announced that it plans to tightened short-selling rules on Monday for 19 financial companies, essentially limiting naked short selling by now requiring short-sellers to actually borrow the shares they plan to sell before shorting. The new restrictions were loosen a little on Friday when the SEC said market makers wouldn't have to pre-borrow the stock, but would still need to deliver them within three days. Market makers had complained that the new rules would prevent them from providing the necessary liquidity for making an efficient market.

Upon first hearing of the rule change (or enforcement), in particular the listing of the gang of 19, I wondered in a post whether some companies on the list would prefer to not be included, given the attached stigma of needing Government intervention to prop up their shares. After all, the rule is effectively an SEC induced short-squeeze. Of course, that was 3 days and +20% ago. Now other companies are wondering why they were not included. After all, they like +20% moves as well.

As mentioned in a recent WSJ article, the Financial Services Roundtable, who represents 100 of the largest U.S. financial companies, wants the SEC to extend the order to include companies they represent as well. Companies like Wachovia, reporting next week, are not currently included. Apparently they are either not big enough to fail, or are not yet in poor enough shape to fail. Given the recent investigation of Wachovia, and speculation about poor numbers next week, that may soon change.

If history is any indication, and it usually is - it is rarely different this time - then companies may want to be careful what they wish for. Research by Professor Charles Jones at Columbia Business School has found that similar moves by the SEC have some unhappy precedents. As mentioned in the WSJ article: "In 1932, the New York Stock Exchange announced that, effective April 1, brokers would need written authorization before lending an investor's shares. "This wreaked havoc on the securities lending market, but the effect was completely temporary," he [Jones] said, because the move only added extra hoops, and didn't prevent people from taking bearish positions if they wanted."

More regulation, and temporary results. Not necessarily what we need long-term, but what we will probably get regardless. Maybe with less next quarter, short-term, results-generated management, by both investors and the government, we would not need additional layers of regulation.