Emergency guidelines aimed at tightening the rules surrounding the short selling of US stocks and clamping down on financial market rumour mongerers left lawyers and their clients scrambling to comply yesterday (Monday 21 July).
The Securities & Exchange Commission’s rules are so far limited to 19 financial institutions, including the world’s largest investment and commercial banks and beleagured US mortgage issuers Freddie Mac and Fannie Mae.
Although lawyers had been bracing themselves since last week for yesterday’s change, the unusual speed with which the new rules were brought in still created an atmosphere of uncertainty on day one.
“The typical process when the SEC revises a rule, including allowing a comment period for the industry to give its feedback, means it can take months or years before the rule is adopted,” said Schulte Roth & Zabel partner Marc Elovitz. “This is in very sharp contrast to that approach. To come out and not do a proposal, not give the industry a chance to comment, it’s quite shocking.”
In a short sale, stock is borrowed and sold with the expectation that its price will fall, allowing it to be bought back at a profit. The new rules are aimed at limiting the levels of so-called ‘naked’ short selling, when investors looking to place an order for a short sale do so without a commitment that they can borrow the stock.
From yesterday, the SEC’s order means that any trader effecting a short sale in the securities of the 19 listed companies must arrange beforehand to borrow the securities and deliver them at settlement.
Clifford Chance partner George Schieren argued that naked shorting was less of a problem with most of the SEC’s 19 stocks because of the amount of available stock. The problem, he said, was for more thinly capitalised issuers.
“But the SEC’s move is highly symbolic,” Schieren added. “It is saying ‘we’re looking into the rumours and doing something about it’. It’s sending a very clear message to the financial community that the SEC is doing something.”
John Maalouf, senior partner of US finance and securities boutique Maalouf Law Firm, said the new rules were “a very necessary” first step by the SEC to constrain abusive naked short selling and address the rumour mongering in the market. He added that there was an expectation the SEC’s new rules would be extended.
“Over the next few months we would anticipate more bold and decisive action to extend the rules to all banks and then possibly to all publicly traded companies,” said Maalouf. “There is also a need for more stringent investigation into the intentional spread of false information that has the specific intent of manipulating securities prices, as well as closer cooperation with the Department of Justice and the US attorney’s office with a view to bringing criminal charges against the rumour mongerers.”