SEC may require short-sale disclosures

The U.S. Securities and Exchange Commission may force investors to disclose bets on falling stocks and may take additional steps to rein in rapid-fire short sales, Chairman Christopher Cox said.

The SEC is examining whether to require short sellers to reveal "substantial" stakes, just as investors must disclose significant positions in companies, Cox told reporters Thursday. The agency may also reinstate a version of the so-called uptick rule, which barred short sales of stocks when prices are falling, he said Thursday in testimony to the House Financial Services Committee.

The regulator is trying to strike a balance between installing a "circuit breaker, or something that keeps things from running away," and providing trading liquidity, Cox told the House panel.

The SEC announced temporary rules last week to thwart so-called naked short sales in Fannie Mae, Freddie Mac and 17 brokerages, citing concerns that stock manipulators may fuel false rumors about companies' stability and profit by driving down stocks. The agency is considering permanent measures to prevent abuses throughout financial markets, Cox said.

In traditional short selling, traders borrow shares through a broker and sell them. If the price falls, they profit by buying them back for less money and repaying the loan.

Naked shorting, which can be illegal, occurs when short sellers fail to borrow the stock by the settlement date. Traders can use that method to drive down prices by flooding the market with sell orders. The temporary rule, which took effect July 21, allows most traders to sell short only if they have already arranged to borrow the stock.

"Manipulative naked short-selling is one worry investors shouldn't have," Cox wrote Thursday in The Wall Street Journal. The sales are "far different from ordinary short selling, which is a healthy and necessary part of a free market."

Cox may well face a battle with hedge-fund managers if he tries to institute a disclosure rule.

"Many short-sellers will object to disclosure because there is such a stigma associated with short selling," said Whitney Tilson, founder of New York-based hedge fund T2 Partners, who said his firm is generally open about the stocks it bets against.

Disclosure might have the unintended consequence of causing investors to pile into the same short sales, he said. It also might hurt investors' relationships with company executives, who sometimes refuse to answer questions from money managers they suspect are wagering on a fall in share price.