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February 18, 2010

Congress Readies Short-Sale Rules

By Peter Chapman

Congress is likely to add at least three new short-sale rules to the Securities Exchange Act of 1934 as part of its overhaul of financial services regulation.

Ed Johnsen

As part of H.R. 4173, the "Wall Street Reform and Consumer Protection Act of 2009," the sweeping overhaul of regulation of the financial services industry, Rep. Barney Frank, D-Mass., has added a little-noted amendment targeting short sellers.

The so-called Managers Amendment, which came out of Frank's office, would add three new rules to the '34 Act. The first would require every institutional investment manager that shorts stock to disclose its short positions to the Securities and Exchange Commission every week, much as these organizations disclose their long positions every quarter.

The SEC would then be required to make the information public every month. The amendment does not direct the regulator to disclose the identity of the short seller. It did, however, leave room for the SEC to provide "additional information."

If the SEC did decide to disclose the identity of the short seller, "that would seriously affect what people do," said Ed Johnsen, a partner with Winston & Strawn.

The SEC instituted a similar rule mandating disclosure for one year between summer 2008 and summer 2009 before letting it expire. It then said it was working with the nation's exchanges to come up with a disclosure plan.

The second amendment rule would add a clause to the Act that makes it illegal for someone to effect a "manipulative short sale of any security." In addition, the clause prods the SEC to add its own rules enforcing the new amendment.

The third amendment could potentially have the biggest impact on short sellers. It requires broker-dealers to instruct their customers that they have the right to refuse to lend their stocks for short-selling purposes.

Because stocks sold short are typically borrowed from investors, a refusal on the part of the shareholder to lend would make it impossible for traders to effect a short sale.

Most stocks, however, are owned by institutions, while the anti-short-selling backlash has come mostly from the American public. Large institutions make money lending their securities and so far have shown little appetite for eliminating the practice.

Where the new regulation may have an impact is on less liquid, hard-to-borrow stocks owned by the retail public. "There may be certain short selling that can't get done because the stocks that had been hard to borrow are now harder to borrow," Johnsen said.

The Frank amendment is part of the House version of the bill. The Senate is still working on its version. The two must ultimately be reconciled before the bill becomes law. While it is possible the Frank amendment could be dropped from the final bill, Johnsen, for one, believes that to be unlikely.


As Traders Magazine was going to press, the Senate had yet to take up the bill. The Senate's Banking Committee Chairman, Chris Dodd, D-Conn., has proposed an overhaul that's considerably different from what President Barack Obama and the House have discussed. The Senate version is expected to be very different.


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