Short-sellers in focus in crisis
19/09/2008 7:31:01 AM
Australian market update
Market Indices 19 September,2008
19/09/2008 08:32 Sydney, Australia.
Index Value Change
All Ordinaries 4651.9 +0.0
S&P/ASX 200 4607.3 +0.0
New rules aimed at curbing speculative "naked short" sales that aim to profit from falling share prices have taken effect on Wall Street as a probe was launched into market manipulation.
The focus Thursday on so-called "short-sellers" came after brutal losses in global markets that some analysts argued were the result of short sales by speculative players betting on declining share value.
New York state attorney general Andrew Cuomo announced a probe into illegal short-selling practices that may have hurt finance firms including Lehman Brothers and Morgan Stanley.
Cuomo said that short-selling itself is legal but that "what is illegal is if you are spreading false information, rumours, and you join a conspiracy to purposely drive down the price of a stock, and you are profiting from the decline," he said in an interview with CNN.
Cuomo said the manipulation of the price of a stock with false information is securities fraud.
"Companies like Lehman, companies like Morgan Stanley, companies like Goldman Sachs who are seeing the rapid (share) declines, we have complaints that there are episodes of illegal short-selling, and that is what we are investigating."
Rules ordered by the Securities and Exchange Commission that ban so-called "naked" short sales were seen as helping to ease volatility that has been roiling the market, analysts said.
"Implementation of the new rules, effective today, should stem the massive bear raids that dramatically accelerated the huge drop in share price of several financial institutions," said Fred Dickson, chief market strategist at DA Davidson & Co.
Dickson said the massive speculation by short-sellers contributed to driving Lehman Brothers into bankruptcy, and may have played a role in the failure of Bear Stearns and the near-collapse of AIG, Fannie Mae and Freddie Mac.
Short sales are designed to profit from a declining share price by an investor or broker arranging a sale of a share he does not own but which has been "borrowed" on an agreement to return the share at a future date.
The new SEC rule is aimed at "naked short" sales in which the investor has not borrowed the sale but intends to do so.
Most short sales are not illegal but some naked short sales can allow traders to manipulate the market to force down prices, according to the SEC.
An internal memo from John Mack, chief executive at Morgan Stanley, blamed short-sellers for the massive losses suffered by his Wall Street investment firm this week.
"It's very clear to me - we're in the midst of a market controlled by fear and rumours, and short-sellers are driving our stock down," he said in the memo, reproduced on the Wall Street Journal website.
Peter Cohan, a consultant and professor at Babson College, said the new rules might ease some pressure but do not appear to address the issue of hedge funds that withdraw large sums from brokerages at the same time they "short" the stock.
"These funds are taking away millions of dollars in business and then shorting the stock - that should be illegal," he told AFP.
He added that these short sales are part of "a brilliant negative feedback loop that short sellers are exploiting to enrich themselves as Wall Street collapses."
"This short-selling work is very profitable, but it is also destroying the global financial system," Cohan said.
David DeRosa, a former hedge fund trader and current Yale University faculty member, said the rules may be counterproductive.
"I am not a big fan of trading restrictions of any kind," he said. "Saying you can't do a naked short sale is like saying the market is too fragile to stand up to the speculators. Not a ringing endorsement."
The Managed Funds Association, which represents alternative investment groups, said the "hastily developed rules will not solve the challenges rippling through the financial sector of the economy, but they could inflict long-term damage on the markets by reducing liquidity and may well further market instability".