Shhh! SEC Says Loose Lips Might Sink Financial Ships

The SEC issued an “emergency order” yesterday that basically warned investors not to get “naked” if they planned on shorting any one of a list of 19 specific financial company stocks. Naked short that is.

The SEC issued an “emergency order” yesterday that basically warned investors not to get “naked” if they planned on shorting any one of a list of 19 specific financial company stocks. Naked short that is.

According to the order, and due to the current “unusual and extraordinary times,” so-called naked short selling of these companies is no longer allowed until the SEC gives further notice. In conjunction with this stoppage, the SEC’s Office of Compliance and Inspections, along with FINRA and NYSE Regulation, will immediately begin conducting examinations of broker/dealers and investment advisors to make sure they have appropriate rules in place to combat the spread of false information.

“Naked” short selling—executing a short sale without first borrowing or arranging to borrow the shares—is not a violation of federal securities laws or SEC rules and can even contribute to market liquidity, according to the SEC’s “frequently asked questions” section on the subject; nonetheless, the SEC has tried with rulemaking (Regulation SHO, adopted in 2005, tightens the rules) to make life more difficult for those who do it.

Yesterday’s emergency order is in response to “false rumors that can lead to a loss of confidence in our markets.” It continues: “Such loss of confidence can lead to panic selling, which may be further exacerbated by “naked” short selling. The stock prices of targeted firms “may artificially or unnecessarily decline” as a result, it says, and if one of the 19 specific financial firms is involved, “this chain of events can threaten the disruption of our markets.”

The order mentions the fire sale of Bear Stearns to J.P. Morgan Chase and specifically rumors of the firm’s liquidity problems that eroded investor confidence in the firm in weeks prior. The SEC goes on to list the actions it has taken to “address concerns about rumors” including nailing those that profit from them.

One securities industry attorney with a specialty in regulatory matters scoffed at the idea of ferreting out rumors, particularly with regard to Bear Stearns. “I had this conversation with a client yesterday who called to say the SEC was sniffing around his firm about the Bear Stearns rumor,” he says. “Bear Stearns was in trouble, it wasn’t a rumor. I told him not to worry,” he says, laughing.

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