SEC to limit short sales of Fannie, Freddie, brokers

The Securities and Exchange Commission will limit the ability of traders to bet on a drop in shares of brokerage firms, Freddie Mac and Fannie Mae as part of a crackdown on stock manipulation, the agency's chairman said.

Christopher Cox told the Senate Banking Committee that the agency will require traders to hold shares of the two mortgage buyers and the brokerages before they execute a short sale.

The emergency order, to be in effect for 30 days, will bar the practice called naked short selling, in which traders avoid the financial cost of borrowing shares when betting they'll fall.

“Since it's impossible to police false rumors, the next best option for protecting fragile financial institutions is to halt short-selling for a time being,” said David Trone, analyst at Fox-Pitt Kelton Cochran Caronia Waller. “The SEC's action is at least a partial measure.”

The SEC is investigating whether trading abuses contributed to the collapse of Bear Stearns Cos. in March and the 80 percent drop in the market value of larger rival Lehman Brothers Holdings Inc. this year. Fannie Mae and Freddie Mac have each lost about 80 percent of their value amid speculation the mortgage-market crisis may push the firms into insolvency.

Hedge-fund manager William Ackman, who oversees $6 billion at Pershing Square Capital Management, is among those betting shares of Fannie Mae and Freddie Mac will fall. There's no indication he is engaging in naked short selling, in which traders never borrow shares from their broker or deliver the stock to buyers.

The SEC had been reluctant to curb short sales “because it would require a major retooling of the plumbing of Wall Street,” said James Angel, a professor at Georgetown University studying short sales. “It's only when the big Wall Street firms are threatened that the SEC does something about it.”

Cox said the SEC also will draft rules “to address these same issues across the entire market.”

Short-sellers, who borrow shares betting that they'll decline, are spreading rumors about Lehman in an organized attempt to depress the stock, according to Richard Bove, bank analyst at Ladenburg Thalmann & Co. in Lutz, Florida.

“As with Bear Stearns, Lehman has been targeted by the fear-trade,” Fox-Pitt's Trone said in a report Monday. Lehman should go private to avoid attacks by short-sellers, he said.

Freddie Mac, down as much as 34 percent today before Cox's comments, fell 26 percent to $5.26 in New York Stock Exchange composite trading. Fannie Mae tumbled 27 percent. Lehman rose 82 cents, or 6.6 percent, to $13.22, ending a four-day slide.