SEC May Delay Short-Sale Curbs by Reopening Comments on Rules

By Jesse Westbrook

Aug. 6 (Bloomberg) -- The U.S. Securities and Exchange Commission may seek additional feedback on whether to limit short-selling, people familiar with the issue said, prolonging a debate between hedge funds and banks whose shares slid in the financial crisis.

The SEC is considering re-opening the comment period on proposals that include reviving the so-called uptick rule, said the people, who declined to be identified before a public announcement. The SEC in April proposed five options to regulate bearish bets against stocks and gave investors and companies until June 19 to comment.

Lawmakers including House Financial Services Chairman Barney Frank pressured the SEC to impose restrictions on short- selling after the Standard & Poor’s 500 Index fell 38 percent last year. The agency responded by imposing temporary curbs.

“It’s very difficult to find a solution because there are very good arguments on all sides,” said Sean O’Malley, a former attorney in the SEC’s division of trading and markets, now a partner at Goodwin Procter LLP in New York. “Whatever the SEC comes up with has to actually work. It can’t just be a response to a populist outcry.”

SEC Chairman Mary Schapiro told cable channel CNBC in an interview yesterday that she intends to have short-selling rules in place by the end of the year. She said the agency hasn’t determined what measures it may impose.

SEC spokesman John Nester declined to comment on re-opening the comment period on the uptick rule. The SEC received more than 5,000 comments, according to its Web site.

Economic Data

“The SEC might re-open the comment period if it felt that it had not received sufficient comment or economic data in response to its questions,” said K. Susan Grafton, a former SEC attorney now at Gibson Dunn & Crutcher LLP in Washington. The agency may be weighing “another approach that it did not feel had been sufficiently” covered in its proposal, she said.

In a short sale, traders ask brokers to lend them stock and then sell it. They aim to profit by repurchasing the shares at a lower price, repaying the loan and pocketing the difference. Traders lose money if the share price rises.

The practice drew criticism from Morgan Stanley Chief Executive Officer John Mack and former Lehman Brothers Holdings Inc. CEO Richard Fuld, who accused short-sellers of attacking their companies.

Hedge fund managers, including James Chanos, founder of New York-based Kynikos Associates Ltd., countered that bank share prices fell because they had borrowed too much money and held mortgage securities whose values plunged when credit markets dried up. Financial companies worldwide have reported $1.55 trillion of writedowns and losses since 2007.

Uptick Rule

The SEC’s proposals include a measure that resembles the uptick rule, which barred short-selling until a stock brings a price at least one penny higher than the preceding trade. The SEC scrapped the almost 70-year-old provision in July 2007 after agency studies determined it wasn’t relevant in markets dominated by fast-paced trading.

An alternative the SEC is considering would allow short- sales only at prices exceeding the best bid. A bid represents the price investors are willing to pay for a stock.

The agency is also considering multiple circuit breakers, which impose restrictions on bets against individual stocks that have fallen by a certain percentage.

Schapiro, in issuing the proposals in April, said the SEC wasn’t aware of any “empirical evidence” showing the elimination of the uptick rule contributed to last year’s stock- price volatility. Still, “many members of the public have come to associate short-selling with that volatility and with a loss of investor confidence,” she said.

To contact the reporter on this story: Jesse Westbrook in Washington at jwestbrook1@bloomberg.net.