SEC Limits Short Sales, Hedge Funds Cry Foul

Feb 26 2010 | 3:52pm ET

The Securities and Exchange Commission has revived a version of the so-called uptick rule, limiting short-selling of shares in freefall and earning the derision of the hedge fund industry.

The commission voted Wednesday to strictly limit short sales of stocks that drop 10% or more in a single day. Under the rule approved in a 3-2 vote, with both Republican commissioners dissenting, short selling will be permitted only at prices higher than the highest bid price nationally both on the day the stock drops 10% or more and on the following trading day.

“We also are concerned that excessive downward price pressure on individual securities, accompanied by the fear of unconstrained short selling, can destabilize our markets and undermine investor confidence in our markets,” SEC Chairman Mary Schapiro said.

Hedge fund managers were quick to blast the new rule.

“The unintended consequence of this rule will be an erosion of confidence at a critical time when the economic recovery is struggling to take hold,” James Chanos of Kynikos Associates told The Wall Street Journal.

Another short-selling hedge fund manager, William Fleckenstein, who closed his eponymous hedge fund last year, took aim at the rationale for the rule.

“The lack of the uptick rule had nothing to do with the market collapse in 2008,” he told the Journal. “It was bad policies all around that created that disaster. It’s more monkeying with the system and doing things that address issues that have nothing to do with the underlying problem.”

The Managed Funds Association also entered its objection.

“Most market observers agree that price declines and decreased investor confidence during the financial crisis were caused by the sudden and drastic changes in economic fundamentals, including the perceived insolvency of certain companies, and not by any short-selling activity,” the lobbying group said. “M.F.A. fully supports the S.E.C.’s efforts to combat manipulative short-selling and other market abuses, but those activities should not be confused with legitimate short-selling.”

The uptick rule, abolished three years ago, allowed short selling only after stock’s price rose.

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