Financial regulators in the U.S. and U.K., New York state's attorney general and the three largest U.S. pension funds are cracking down on short sellers in the wake of the collapse of Lehman Brothers Holdings Inc. and American International Group Inc.
Hedge funds and investors who profit from share declines are being scrutinized after a crisis of confidence in the financial industry erased almost $4 trillion from stocks globally this week.
Goldman Sachs Group Inc. and Morgan Stanley, the only remaining independent securities firms on Wall Street, suffered worst-ever declines Wednesday. Morgan Stanley's chief executive officer, John Mack, said short sellers may be spreading false information and using abusive tactics to attack companies.
“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. “Shorts were running amok.”
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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.
The U.S. Securities and Exchange Commission said it may require hedge funds to disclose short-sale positions, while the Financial Services Authority in the U.K. banned short selling financial shares for the rest of the year.
New York Attorney General Andrew Cuomo began an investigation into whether bears illegally drove down stock prices of financial firms. The California Public Employees' Retirement System and the New York State Common Retirement Fund decided to stop lending shares for short sales, after a similar move by the California State Teachers' Retirement System.
U.S. stocks rallied by the most in six years Thursday, with the Dow Jones Industrial Average jumping more than 400 points, on the initiatives and prospects the government is formulating a “permanent” plan to shore up financial markets.
Hedge funds and investors managing more than $100 million in securities would be “required to promptly begin public reporting of their daily short positions,” Chairman Christopher Cox said in a statement Wednesday.
The proposed disclosure is in addition to three SEC rules that took effect Thursday aimed at reducing manipulative trades betting on a drop in share prices.
“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.”
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.
“The federal government has been ineffective when it comes to regulating these markets,” Cuomo said in a conference call Thursday. “We want to stabilize the market. The market needs stability now.”
Morgan Stanley shares advanced for the first time in eight days Thursday, 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. The stocks declined more than a third over the eight-day stretch.