U.S. securities regulators floated five new proposals to curb short selling, drawing fire from short sellers who feel they are being made scapegoats for the financial crisis and stock market plunge.
The five-member Securities and Exchange Commission voted unanimously on Wednesday to seek 60 days of comment on the proposals, including bringing back an uptick rule -- allowing bets that a stock will fall only when the last sale price was higher than the previous price.
Another proposal would allow shorting only if the best available bid on a stock was higher than the last bid. Three other proposed restrictions would be triggered by a steep slide in the price of a security.
The SEC could combine some of the proposals but not all five could work together. Commissioners would have to meet again to decide on any final rule.
Traders and asset managers said short sellers were being targeted unfairly for the plunge in stock prices that occurred as the housing market bubble burst and exposed risky bets by financial institutions.
The problem is that the managements of the banks and brokers screwed themselves up, short sellers did not, said hedge fund manager Doug Kass, who heads Seabreeze Partners Management.
Commissioners such as Kathleen Casey were generally skeptical of linking the 2007 abolition of the uptick rule to the last 18 months of stock market declines.
But SEC Chairman Mary Shapiro acknowledged the intense pressure on the agency to address short selling, telling Wednesday's meeting that no other issue had generated as many emails and comments since she took the position in January.
The commission is keenly aware of the need to balance the potential benefits of its proposed rules against the costs, she said.
Commissioner Luis Aguilar said he feared that even if the SEC adopted more short sale restrictions, the rules may not be effective, because investors who engaged in abusive short selling could shift to unregulated financial products.
Short interest on the New York Stock Exchange and Nasdaq Stock Market had fallen from highs in July until February, when it climbed back along with a rise in stock prices.
The SEC will hold a roundtable discussion of the issues on May 5. Any final action is at least two to three months away.
The uptick rule was first adopted after the 1929 stock market crash but was abolished in 2007 after the SEC concluded that advances in the marketplace had rendered the rule ineffective and obsolete.
With the benchmark Standard & Poor's 500 index <.SPX> down roughly 45 percent since the start of 2008, and the Dow Jones Industrial Average <.DJI> down more than 40 percent over the same period, members of Congress and others have pressed for restoration of the rule.
We are pleased that the SEC has begun action against abusive short selling, said Senators Edward Kaufman, a Democrat, and Johnny Isakson, a Republican, who have introduced a bill requiring the SEC to reinstate the uptick rule and regulate abusive short selling activities.
The SEC last year adopted a number of rules to curb abuses of short selling, including one that requires investors to deliver their shares within three days of shorting a stock. Another rule requires big investors such as hedge funds to disclose their short positions to the agency.
Both rules are set to expire at the end of July and the SEC will have to decide on their future.
SEC staff and commissioners said the delivery rule has helped weed out some abusive forms of short selling; investors believe the agency should do more.
Billionaire investor George Soros said on Monday that he favored a reintroduction of some kind of rule to restrict short selling. You do need to provide some protection against effectively the bear raids, Soros told Reuters Financial Television in an interview.
Short sellers argue that their trading helps keep markets liquid and prevents stocks from becoming overvalued. They also criticize last year's temporary ban on short sales of hundreds of financial stocks.
I am surprised that regulators have not learned from the (short-sale ban) fiasco where it ultimately reduced liquidity in the securities, said Ron Geffner, a partner at law firm Sadis & Goldberg LLP who advises hedge funds.
Market makers are not explicitly exempted under the rules proposed on Wednesday.
We believe that exemptions are vital to proper and legitimate market makers that add liquidity, a NYSE spokesman said, adding the exchange will discuss the issue with the SEC.
The SEC said it would likely include several exceptions to the rules, these exceptions would be limited to activities that promote liquidity and foster the workability of the proposed rules without undermining the effectiveness of the proposals.
SEC STAFF PREFER BID TEST
Erik Sirri, the SEC's trading and markets director, told reporters that the bid test made more sense as the tick test has a problem with getting an accurate tick given how quickly stocks trade.
Three other possible measures would use a circuit breaker approach to trigger either a temporary suspension of short selling in a particular stock, or temporary application of the uptick or bid rule in a security.
The SEC is proposing that a 10 percent decline trigger the circuit breakers but is seeking comment on other thresholds.
The country's largest exchanges, the New York Stock Exchange, the Nasdaq Stock Market and BATS exchange, support a circuit breaker approach where shorting would only be allowed if the price was higher than the best available bid.
The head of BATS exchange, Joe Ratterman, said he was disappointed the SEC had failed to narrow the range of ideas. He told Reuters the agency had failed to put a stake in the ground on a highly political issue.
Casey, one of the commissioners who voted to abolish the uptick rule, said she had not yet been persuaded that its repeal had anything to do with the economic and market conditions of the past 18 months.
She also warned fellow commissioners that the courts could overturn a new SEC rule unless there was credible empirical evidence to demonstrate the repeal of the uptick rule, or abusive short selling, drove down the price of any security.
(Reporting by Rachelle Younglai and Karey Wutkowski; additional reporting by Jennifer Ablan and Jonathan Spicer in New York; Editing by Tim Dobbyn)