Jesse Westbrook

Feb. 24 (Bloomberg) — The U.S. Securities and Exchange Commission curbed some bearish stock bets, ending a yearlong debate between individual investors and Wall Street with a solution that fails to satisfy anyone.

SEC commissioners voted 3-2 today to restrict short sales of a company’s stock once it falls 10 percent from the previous day’s closing price. When the 10 percent threshold is triggered, traders could only execute short sales for the stock at a price above the market’s best bid. The curb would be in place through the following day.

General Electric Co., Charles Schwab Corp. and more than 5,600 people who signed a petition sent to the SEC wanted a short-selling restriction that was always in effect, similar to the so-called uptick rule the agency abolished in 2007. Goldman Sachs Group Inc. and hedge funds Citadel Investment Group LLC and D.E. Shaw & Co. lobbied against a limit.

“Short selling can play an important and constructive role in the markets, such as by providing market liquidity and pricing efficiency,” SEC Chairman Mary Schapiro said before the vote in Washington. “However, we are also 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.”

S&P Drop

The SEC said in March that it would consider restrictions on short selling, which involves the sale of borrowed stock in the hope of profiting by buying the securities later at a lower price and returning them to the shareholder. The decision followed a 19 percent drop in the Standard & Poor’s 500 Index in the first two months of 2009 and lobbying by 27 members of Congress, including Representative Barney Frank, the Massachusetts Democrat who leads the House Financial Services Committee.

“Nobody is going to be happy,” said James Angel, a finance professor at Georgetown University in Washington who has served as an adviser to stock exchanges. “The benefit of this new rule is that it provides political cover to the SEC so they can say they did something.”

The lawmakers wanted the SEC to bring back the uptick rule, which barred investors from betting against a stock until it sold at a price higher than the preceding trade. The limitation had been in place for almost 70 years before the SEC scrapped it in June 2007. Four months later, the S&P 500 began a 17-month bear market that erased 57 percent of its value.

Commissioners Elisse Walter and Luis Aguilar, both Democrats, joined Schapiro, a political independent, in backing the curbs.

Implementation Costs

Once the rule takes effect in 60 days, securities firms and stock brokers will have another six months to revise their trading systems to implement the changes. The SEC estimates implementation will cost the financial industry about $1 billion, or an average of $70,000 to $90,000 per firm. Ongoing costs will also be about $1 billion a year, or $120,000 per firm, the SEC estimated.

Republican Commissioners Kathleen Casey and Troy Paredes opposed the rules, saying they weren’t convinced the benefits from limits on bearish bets will outweigh the costs.

Casey said the SEC failed to provide empirical data that shows more regulations are needed, giving the impression that the agency’s vote was mostly about public relations.

‘Regulation by Placebo’

“We should resist the urge to act simply to say we have acted,” she said. “This is regulation by placebo.”

The rule is a failed attempt to boost stocks that will increase transaction costs for traders, said James Chanos, chairman of the Coalition of Private Investment Companies, a Washington based hedge-fund group.

“This puts a government thumb on the scale of stock prices,” Chanos said in a statement after the vote. “Efforts to prop up stock prices where the fundamentals will not sustain them will inevitably fail.”

Chanos, who also serves as president of New York-based Kynikos Associates, is a short-seller who was one of the first investors to bet against Enron Corp. The energy company collapsed amid an accounting fraud in 2002.

The SEC ignored a request from trading venues including the Chicago Board Options Exchange to exempt market makers from the new rules.

Brink of Collapse

Short selling was blamed by lawmakers, former Morgan Stanley Chief Executive Officer John Mack and investors for pushing the U.S. economy toward the brink of collapse by driving down bank stocks. Under pressure from politicians, the SEC temporarily banned bearish bets against almost 1,000 financial stocks in September 2008.

Michael McAlevey, a vice president at GE, urged the SEC during a May conference to restrict short selling all the time instead of just enacting circuit breakers following a 10 percent plunge. He said the Fairfield, Connecticut-based company, whose units range from a finance division to a producer of turbines for power plants, was concerned temporary curbs would encourage bearish bets because traders would rush in to execute short sales before the circuit breaker was triggered.

GE spokeswoman Anne Eisele said the company’s stance hasn’t changed.

There’s no evidence the SEC proposals will reduce abusive short selling or boost investors’ confidence, Paul Russo, the head of U.S. equities trading for Goldman Sachs, wrote in a September letter to the SEC. Bearish bets help expose fraud and prevent companies from becoming overvalued, he said. His New York-based employer is the most-profitable securities firm in Wall Street history.

Russo’s letter reflects Goldman Sachs’s current views, company spokesman Ed Canaday said.

Goldman Sachs, Chicago-based Citadel and D.E. Shaw in New York all urged the SEC against restricting short selling. If the SEC determined that new rules were necessary, the three companies encouraged the agency to opt for a circuit breaker.

To contact the reporter on this story: Jesse Westbrook in Washington at jwestbrook1@bloomberg.net.

Last Updated: February 24, 2010 13:14 EST

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