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Short Sellers Under Fire in U.S., U.K. After AIG Fall (Update1)
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 http://www.bloomberg.com/apps/news?pid=20601087&sid=aBXk2Zku0B.Y&refer=home
By Michael Tsang
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Sept. 19 (Bloomberg) -- The Securities and Exchange Commission halted short selling of 799 financial companies, pressing an assault on speculators after the collapse of Lehman Brothers Holdings Inc. and American International Group Inc.

Futures on the Standard & Poor's 500 Index surged 2.9 percent following the announcement. U.S. equities staged the biggest rally in six years yesterday after the SEC stiffened other regulations aimed at curbing manipulative trading.

``The shorting rules gave investors the belief the world is not coming to an end,'' said Phil Orlando, New York-based chief equity strategist at Federated Investors Inc., which oversees $334 billion. ``You had a lot of the hedge funds ganging up on these financial companies and putting them out of business.''

Hedge funds and investors who profit from share declines are being scrutinized after $3 trillion was wiped from stocks globally this week as financial shares swooned. Goldman Sachs Group Inc. and Morgan Stanley, the remaining independent securities firms on Wall Street, plunged by the most ever, prompting Morgan Stanley Chief Executive Officer John Mack to say short sellers are using abusive tactics to attack companies.

Financial regulators in the U.S. and U.K., attorneys general in New York, Texas and Connecticut, and the three largest U.S. pension funds all began cracking down on short sellers this week.

The SEC said today that it will halt short selling of U.S. banks, insurance companies and securities firms through Oct. 2, while the Financial Services Authority in the U.K. banned short sales of financial shares for the rest of the year.

Banning Shorts

New York Attorney General Andrew Cuomo started an investigation into whether investors illegally drove down stock prices of financial firms. The California Public Employees' Retirement System, California State Teachers' Retirement System and the New York State Common Retirement Fund decided to stop lending shares for short sales.

Short sellers try to profit by betting stock prices will fall. In a short sale, traders borrow shares from their broker that they then sell. If the price drops, they buy back the stock, return it to their broker and pocket the difference.

In a practice called naked short selling, traders never borrow the shares, raising concerns that investors are flooding markets with sell orders to drive down prices.

Market Disinfectant

Earlier this week, Chairman Christopher Cox proposed hedge funds and investors managing more than $100 million ``promptly begin public reporting of their daily short positions.''

``It's a reflection of the view that disclosure is the best disinfectant,'' said Barry Barbash, a partner at Willkie Farr & Gallagher LLP in Washington, who previously headed the SEC division that oversees investment funds. ``If a person needs to disclose an abusive practice, it's likely the person is going to stop engaging in the practice.''

Additional SEC rules also took effect to halt manipulative trading. They extend to the options market rules governing the prompt delivery of borrowed shares, impose penalties on brokers if their clients haven't delivered shares to buyers three days after a short sale, and make it a fraud for investors to lie to brokers about locating shares to be sold short.

Cuomo said he'll use the state securities-fraud law, the Martin Act, to pursue investors for illegal sales. The law permits criminal and civil actions.

Watching Short Sellers

``The federal government has been ineffective when it comes to regulating these markets,'' he said. ``I want the short sellers to know today that I am watching.''

In Connecticut, Attorney General Richard Blumenthal said he has been investigating allegations of false information being spread about financial companies. He declined to identify them.

Texas Attorney General Greg Abbott said in a telephone interview he issued letters to the states' two largest public employee pension plans -- the Teachers Retirement System of Texas and the Employees Retirement System of Texas -- asking that they halt the lending of their shares for short selling.

``You have to enforce the rules with regards to short selling,'' said Mario Gabelli, who oversees about $28 billion as chairman and chief executive officer of Gamco Investors Inc. in Rye, New York. ``Shorts were running amok.''

In a memo to employees, Morgan Stanley's Mack, 63, lambasted short sellers for allegedly pushing his firm's shares lower and said the management committee is ``taking every step possible to stop this irresponsible action in the market.''

`Fear and Rumors'

``There is no rational basis for the movements in our stock,'' wrote Mack, who contacted Cox and Treasury Secretary Henry Paulson. ``We're in the midst of a market controlled by fear and rumors, and short sellers are driving our stock down.''

Shares of Morgan Stanley sold short reached 45 million at the end of August, 25 percent more than at the end of the second quarter and almost triple the amount a year ago.

James Chanos, president at Kynikos Associates Ltd., the $7 billion hedge fund based in New York that specializes in short selling, opposes the regulations and said poor business strategies are to blame for the decline in company share prices.

Hedge funds, private pools of capital whose managers participate substantially from any profits on invested money, prefer to keep their positions secret to prevent other traders from stealing their strategies.

Funds that specialize in shorting stocks returned 9.4 percent this year, the biggest gain among strategies tracked by Hedge Fund Research Inc. in Chicago. The Standard & Poor's 500 Index declined 17 percent, including dividends.

Chanos's Response

``We seem to have capitalism on the upside and socialism on the downside,'' Chanos, one of the first to raise questions about Enron Corp.'s accounting, said on Bloomberg Television. ``That's a pretty heady brew for country that holds itself out as a free market paragon.'' Chanos said his firm isn't shorting any of Wall Street's largest investment banks and is the ``least short the financial sector as we have been in three years.''

Morgan Stanley shares advanced for the first time in eight days yesterday, gaining 3.7 percent to $22.55 after earlier falling as much as 46 percent. Goldman slid for an eighth day, dropping 5.7 percent to $108 after losing 25 percent at midday.

The stocks declined more than a third over the eight-day stretch amid a crisis on confidence in the financial industry. In a span of less than a week, Lehman filed for bankruptcy protection, the government took control of AIG and Merrill Lynch & Co. sold itself to Bank of America Corp.

Shorts Squeezed

Wachovia Corp., which is discussing a combination with Morgan Stanley, surged more than 50 percent after U.S. and U.K. regulators announced curbs on short sales. Nineteen financial firms in the KBW Bank Index, including Regions Financial Corp. and National City Corp., gained more than 10 percent.

``So many shorts were pushed into covering,'' said Jean- Marie Eveillard, who manages $35 billion at First Eagle Funds in New York.

The FSA ban on short sales of financial shares came after U.K. politicians and some investors blamed short sellers for HBOS Plc's plunge before it agreed to a 10.4 billion-pound ($18.9 billion) takeover by Lloyds TSB Group Plc. The regulator will also require daily disclosure of existing short positions in financial companies of more than 0.25 percent, it said yesterday. The rules will remain in effect until Jan. 16.

Meanwhile, Paulson and Federal Reserve Chairman Ben S. Bernanke proposed moving troubled assets from the balance sheets of American financial companies into a new institution.

``Regulators are stepping in and saying, `This needs to come to a stop and this is how we're going to fix it,''' said Kelli Hill at Ashfield Capital Partners in San Francisco, which oversees $4 billion. ``This is the thing the market needed.''


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