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SEC puts 'naked' short sellers on notice

Regulator enacts new ruling banning 'naked' short selling on all public companies.

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By David Ellis, CNNMoney.com staff writer

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NEW YORK (CNNMoney.com) -- The Securities and Exchange Commission adopted a set of new rules Wednesday which would ultimately ban the practice of so-called "naked" short selling, possibly providing some much-needed comfort for financial markets.

But instead of just shielding the embattled financial services industry this time around, the nation's securities regulator said the prohibition would cover all publicly traded companies.

"These several actions today make it crystal clear that the SEC has zero tolerance for abusive naked short selling," SEC Chairman Christopher Cox said in a statement.

Traditional short sellers borrow stock with the aim of selling it, then buying it back at a lower price, hoping to pocket the difference. In a "naked" short sale, however, investors short the stock without actually borrowing it, making it much easier to drive down the share price of a company.

Dramatic swings

Some market observers have blamed the recent wild swings in financial markets and steep decline in financial stocks on the practice of "naked" short selling. Hoping to stem the sharp selloff that the industry endured back in early July, the SEC enacted a temporary ban on the practice for 17 domestic and international securities firms, along with the twin mortgage giants Freddie Mac (FRE, Fortune 500) and Fannie Mae (FNM, Fortune 500).

The move helped, but financial stocks have come under pressure once again following the dramatic events over the last three days, including the collapse of Lehman Brothers (LEH, Fortune 500), the purchase of Merrill Lynch (MER, Fortune 500) by Bank of America (BAC, Fortune 500) and a government rescue of insurer AIG (AIG, Fortune 500).

Prior to Wednesday's announcement, industry groups like the American Bankers Association feared that the yet-to-be-announced rules may not go far enough to protect the stock price of banks.

Other groups, like the Managed Funds Association and the Coalition of Private Investment Companies, which represent hedge funds and other asset managers, have opposed any permanent changes, fearing that a rule would not only limit legitimate short selling but also give an inaccurate representation of the real price of a stock. To top of page

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