According to a recent Wall Street Journal article, the SEC is being deluged with letters supporting the return of the uptick rule. Pressure for the rule has been building since the market melt-down last fall, generating additional interest this spring (see previous post). Let me state upfront that I believe when regulators interfere with the natural flow of the market, as they did when banning the short selling of financial stocks last fall, it does more harm than good - primarily by reducing market efficiency and increasing volatility when temporary restrictions are lifted. Besides the irony of helping to reduce risk management opportunities, adding an uptick rule seems ineffective for liquid markets, for which it is not all that hard to find a plus tick. Nonetheless, I understand and appreciate the arguments on both sides - primarily that we did fine with it for near 70 years. I am also not sure it will make much difference one way or another. Yet the current debate seems to expand the argument, and fall into the trap of assuming correlation implies causation. This is apparent in the following quote:

"Isn't it coincidental that right at the time the uptick rule was abolished, the sharp spiral downturn started."

While we can debate whether the market began falling July 6, 2007, or later that year, does it really matter? Could it also be argued that the rule was artificially propping up a market that should have long since fallen under the weight of a housing bubble? Is it the rule change that caused the market to crash, or did it simply get out of the way of the inevitable pent-up selling? Is there any difference? Was something else at play? One current argument goes on to say that not only should the uptick rule come back, but that naked short selling should be banned, capital ratios should be increased, the CDS market should be regulated, and leveraged ETFs should be examined. All worth examining. But if the CDS market becomes more regulated (a near given), current naked short selling rules are enforced (not such a given), and leveraged ETFs are restricted, is the uptick rule even necessary? Should we require a little more evidence?

As an additional reason for changing the rule, another advisor mentions that the repeal of the rule "drastically changed the outcome of many stocks this past year." Last I saw, so did greedy banks and home owners, yet we seem to be forgiving many of their problems, and even making it easier for them to become whole, but I digress. Yes, when bad companies are sold, they tend to go down. Maybe the market needed to drastically change. Was there overshooting, sure, but markets have a tendency to overshoot, in both directions.

Maybe the real point of contention is given by another advisor quoted in the article, stressing that reinstating the rule will help "investor psychology." Possibly, but is this a reason for bringing the rule back? And which investors are they talking about? Will the psychology of short-sellers or hedge funds be better off? Probably not, and maybe that is the point. Many blame the hedge funds and short sellers specifically for destroying their nest eggs. It only seems natural to want to punish them, but does it solve the problem? Once again, I don't think it does.

We have to be careful when assuming that one thing causes (or doesn't cause) something else. In fact, I know that some will argued that I am falling into the same trap. I agree. In fact, that is the point. When we interfere with and observe one outcome or property, and try to describe what we are seeing, the less we know about the other paired property, not unlike what Hiesenberg observed over 80 years ago. Controlled studies are needed, but as with quantum physics, this is difficult for dynamic markets. Maybe the next time the markets begin to fall we should spend less time assuming it is only caused by a structural flaw in the system, and more time understanding if something fundamental to the market started the selling. The market may be telling us something early on. If we had listen a little earlier, maybe we would be months and years into the next recovery ....... and figuring out when and how to short the next bubble (which if the uptick rule is reinstated, may be more inevitable).

In the wake of a nice bear rally, the SEC is once again discussing the reinstatement of the uptick rule, or some version of it (see Financial Times article). The rule was abolished in July 2007, but now various politicians are writing to SEC chairwoman, Mary Schapiro, asking that the rule be reinstated in order to produce an “unambiguous commitment to promulgate and enforce regulations that put an end to naked short selling”. Of course, naked short selling is already not allowed. While selling on a down-tick may have facilitated naked short selling, reinstating the uptick rule will not by itself rid the market of naked short-sellers. Enforcement of current rules might actually be the place to start. Until the SEC gets serious about investigating delivery failures, naked short selling will continue, regardless of changes in the uptick rule.

In addition politicians, the largest US exchanges have also recently written to the SEC asking that some version of the rule be put back into place, and further suggest that the new rule only allow short selling to be initiated by posting a quote for a short sale order that is priced more than the prevailing national bid. While such a change seems slightly different from the requirement of selling only on a new plus-tick or previous plus-tick (the current price being the same as the last, which was up), the change is significant. A value higher than the bid can still be below the ask. Not only are the prices lower than a plus tick (which is not that difficult to find for highly liquid stocks, even during a sell-off), selling between the bid and ask also makes the transaction less transparent. To make matters worse, the exchanges don't stop here, but also suggest that as an added precaution (guess for who), that a new type of circuit breaker be used that would initiate the rule only when the stock had a precipitous decline - defined as 10 percent. No more killing a stock in one or two days. Now it will take you at least 10 days. Not sure this is much of an improvement.

As for the motivation of the exchanges, you cannot really blame them for being proactive. While it is essential to keep the hedge funds and other drivers of order flow happy, helping to convince individual investors that it is safe to wade back in the waters will also be good for trading and revenue generation. I am sure that it is also hoped that any collaboration will make it more unlikely that the SEC will temporarily change the rules at a later date, selectively deciding what can and cannot be shorted. As for the SEC, they send the message that the days of the wild-west are over, and politicians get to take credit for putting pressure on the regulators and exchanges to look out for the little guy. Yet the changes will be ineffective at best - since naked short selling is not really directly addressed, and will most likely get worse given that shorting on a price higher than the bid is no improvement at all, but simply helps to mask the underlying transaction.

When I began to see the increased focus recently on finally bringing back the uptick rule, my initial thought was that if the rule was so vital, why has it taken this long to get back on the books? Looking at the latest collaborative effort, a little more delay might be in order.

Jim Chanos, the famous short-seller who runs the hedge fund firm Kynikos Associates, was up 25 percent last year betting against equities. Nonetheless, he still found running a successful short fund challenging due to increased client withdraws (see Reuters article). Even with outstanding performance in a down market, investors still withdrew 20 percent of his funds assets. While some withdraws are normal, the percent was probably higher in part due to redemption gates put in place with other funds. After all, if you received margin calls, you have to get the funds from somewhere. As jokingly mentioned by Chanos, "we were like an ATM machine." Fortunately for Chanos and his investors, the Kynikos ATM was being replenished with cash. Given the current market, investors and depositors with some national and regional banks can only hope they are as fortunate.

Fund managers are gearing up for a fight regarding short selling disclosure rules (see Financial Times article). The FT article discusses how the fund industry would be damaged by such timely and public disclosures, basically arguing that no one would pay for investment advice or money management when the relevant information can be had for free a day or so later. Yet, this argument may miss the most interesting point - that a ban or disclosure rule is certain to have some unintended consequences.

Bans on short selling have had a goal of trying to limit funds from manipulating the market, but making short selling positions public could just exacerbate the problem. Non-public disclosure would allow regulators to monitor positions and funds, insuring that market manipulation was not occurring, yet by making the short data public, others would now be tempted to jump on the momentum train, increasing their short positions, and the selling pressure on the shorted security. In the end, this may do nothing to decrease market manipulation, while still allowing the funds to profit from the falling prices.

If increased selling is the potential fall-out of public disclosure, then why should funds care? I suspect there are two reasons. First, if they are taking a large (but allowed) short position, it may take more than a day to enter or exit the position. One day of disclosure could potentially reduce the profitability to the fund as others front-run the trade. Second, and maybe more critical, is that any short momentum trades that result in a large sell-off or company failure will still ultimately get blamed on the funds, causing regulators to once again implement short-selling bans. For the funds that have strategies that rely on being able to take a short position, such a ban affects viability as much as it does profitability.

Currently, longer disclosure periods are being discussed, such as two weeks or even a month. While this may help with the first problem of having enough time to enter and exit a position, it will do less for the second unless the disclosure period is long enough to limit profit opportunities for those who later try to mimic the trade. Too short a disclosure period, and you encourage copy-cat trades and additional selling pressure. Too long, and the disclosure simply becomes a record of what companies were short. Anything in between provides the potential for market manipulation with little benefit to market efficiency over what non-public disclosure would most likely offer.

Even hedge funds that are doing well are seeing withdraws (see Reuters article). Why sell a good fund? As it turns out, the main sellers could be those that operate fund-of-funds. As a result of other funds (holdings) being down, redemption request at FoF are causing selling across the board, dragging down performing funds as well.

There is an interesting article from Cam Hui at SeekingAlpha discussing the need for hedge funds to return to basics, and for investors to rethink their expectations. Of interest from the article is the quote: "Hedge fund investors found out what they had wasn’t a contract with a hedge fund manager, but a call option on a management contract. When the incentive fees dried up, the manager packed up and went away." This gives me an idea. How about selling an option on ......, never mind.

Rumors of a Goldman / Citi merger have changed to a Goldman / Morgan Stanley merger (see Here Is The City News article). Still waiting for the Goldman / Yahoo / Microsoft rumor to surface.

I was just kidding about the 10 million. I did not want a bonus afterall (see Clusterstock article). Merrill and/or Thain doing damage control.

Fleckenstein, a regular guest on Fast Money, is calling it quits, or at least closing his short-only portfolio (see FINalternatives article). He is planning to open a new fund (not a hedge fund) that would be available to retail investors (ie., everyone). In a blog post, Fleckenstein states "I now (sic) longer want to run a short-only hedge fund, as it is very stressful, nerve-wracking and generally not very much fund (sic)." Then again, the money was nice .........

There is an interesting New York Magazine article on Jim Chanos. Even though he seems to be on CNBC just about every time you turn around, the article provides a little more detail on his background, and provides some insight into his approach. Interesting read.

Japan is the latest country to consider trying to stabilize its markets by banning short selling (see MarketWatch article). The move is being considered after the Nikkei 225 has fallen to its lowest level in 26 years. While potentially propping up the market, the long-term consequences of limiting information, hampering risk management, reducing liquidity, and prevent overall market efficiency may prevent the Japanese markets from reversing anytime soon what has become a generational decline in the Nikkei.

There is an interesting article today in the WSJ regarding the recent short selling ban, along with its unintended consequences. While the effects on hedging, volatility, and widening bid-ask spreads have been discussed at length, what often gets lost in the discussion is the effect on market efficiency (see previous post). As quoted in the recent article:

"Why would regulators ban short selling in nearly 1,000 companies, effectively banning accurate information from the markets? By targeting short sellers as a way to prop up share prices, regulators clearly panicked. This in turn panicked financial professionals and individual investors who saw regulators losing faith in the system they oversee."

In a sense, by trying to stabilize stocks, current actions have made them more volatile. Even worse than affecting individual stocks, such bans have destabilized the confidence and structure of the market itself, and made information flow less transparent. Individual stocks can recover, or can be sacrificed, but confidence must be built. Market structure must be consistent and trusted. Hopefully we have learned our lesson over the last few weeks as we continue to watch greater than 5% daily swings, not to mention material market moves (often down) every time someone from Washington shows up at a press conference.

In a surprising turn of events (for some), the market sold off Monday on news that the TARP bill failed, and again today on the news that the bill passed, even with the ban on financial stocks still in place and extended for another few weeks (see WSJ article here). How could this happen? Isn't the short-selling ban suppose to put a floor on the market? Of course not, but the current sell-off of the market at a time when a ban on short selling exists for over 1,000 stocks illustrates in part how current portfolio positions are still being reduced.

So who is doing the selling? It is probably coming a little bit from everywhere, but the hedge funds in particular appear to be taking every market rally as an opportunity to sell into strength. Recent news highlights how hedge funds are experiencing a decade-worst level of performance (see WSJ article), with September possibly being one of the worst months on record for many funds, with losses expected to be between 5-9 percent on average. Such poor performance is also causing an increase in withdraws. In particular, fund-of-funds (FoF), which invest in individual hedge funds in order to diversify risk, are helping to facilitate the hedge fund redemption as some investors are withdrawing up to 20 percent of assets under management (see WSJ article). On average, FoF were down 6.4 percent in August, even worse than the already terrible 4.9 percent loss experience by individual hedge funds. The problem is significant given that FoF account for about 40 percent of the $2 trillion hedge fund market. Many FoF also make it easy to withdraw money, as opposed to most hedge funds that have longer lockups and notification periods. To compound the problem, many hedge funds also became over-weighted in energy and commodity stocks just as the market was topping this summer, and are continuing to unwind these positions. Redemption notices put in near the end of the summer are also now meeting their time restrictions and being executed. Many funds had hoped to see a recovery before any redemption requests came due, but many investors are not having second thoughts, and are going forth with withdraws. The wave of selling may continue for a while, regardless of any short-selling ban.

In an effort to help boost its struggling stock market, the Securities Regulatory Commission in China is scheduled to sign-off on a plan that will allow short selling and margin lending (see Bloomberg article). The government is hoping that the changes will add fresh capital to the equity markets. China has also recently eliminated its tax on stock purchases and has relaxed company buyback rules. The move is in stark comparison to orders in the U.S., Europe, and Australia that have recently placed limits on short-selling. It is ironic that China, often criticized for being less open, appears to be offering free market solutions for its declining markets at the very time other economic superpowers are increasing trading restrictions within their own markets. The next year should be interesting, and telling, as countries about the globe take different approaches towards bolstering their economies and strengthening their capital markets.

As reported at a Financial Times Alphaville blog post, hedge funds are looking for new ways to short securities, including everything from shorting index funds and then buying back every security in the index except one, to restructuring swaps to have the same exposure as a short position. Both techniques will no doubt have an affect on market volatility as more stocks become actively traded. Ironically, derivatives such as swaps, which had their own role in the current financial crisis, are now being used to help get around restrictions imposed as a result of the very same crisis. Where there is a will, there is a way. Innovation and financial engineering never sleeps.

The global federal-induced short-squeeze is now going global, as countries from Australia, Taiwan, and the Netherlands join the U.S. and U.K. in prohibiting some short selling (see WSJ article). Potential problems with the short-sell ban are already becoming evident as those needing to hedge positions, or those making a market in derivative products, are finding it difficult to comply. During the last order the SEC had already considered some restrictions on market makers who need to short stock when making a market in put options. Now, the SEC is also considering allowing short-selling to be used in some cases as a hedge - it is expected that they will allow such shorting.

Of course, where do you draw the line? What about hedge funds that actually hedge their positions? Will they be excluded? What about convertible bond and arbitrage positions? What about allowing investors to hedge their investments when companies raise money in a rights offerings? What if the sale is for risk management purposes? If risk management is considered a viable reason for shorting, couldn't everything be considered risk management to some degree? Isn't shorting an overvalued company a way to take the risk of the overvalued stock out of the marketplace? Yes, this argument is a little much, but the points is that once again it is difficult to know where to draw the line when making exceptions, which only becomes more difficult as the unintended consequences start becoming worst than what the order was hoping to accomplish in the first place.

While the order did seem to stem the selling tide last week, it ultimately makes the stock market more inefficient. If now less efficient, does this mean that the market is in fact now more risky, given that prices are more artificial than before, and that any snap-backs could be worse in the long-run (if the order is removed)? These are questions that will no doubt only be clear with 20-20 hindsight. Extraordinary times do often require extraordinary measures, but eventually we are going to come to regret interfering with a market structure and mechanism that was put in place to keep us all honest, and keep prices as efficient as possible. Finally, I do find it ironic that for the last year or so we have continued to complain about how the prices of all the various credit default swaps and CDOs were difficult to price, making it even more difficult to know their current value and a company's true level of exposure for holding such securities. One can argue that we are now starting to make transparency mistakes with our equities.

The latest SEC rule change that restricts the short selling of financial stocks is causing many hedge funds to reconsider some of the models they use (see WSJ article). As an added pressure, some pension funds that invest in hedge funds are asking fund managers if they have strategies that rely on shorting, causing some less diversified pension funds to consider withdrawing hedge fund investments. Many smaller hedge funds with less sophisticated back office operations are also now finding it more difficult to comply with the new SEC regulations and still respond to the market, continuing the recent trend of challenging times for small funds (see previous post). The new rules, if successful in reducing the selling pressure on stocks, may also affect hedge funds that have been profiting recently from volatility (see previous post), although the last short-squeeze and trend reversal was short-lived (yet the rule affected less than 20 companies). Are funds eager to get back to shorting? Of interest is the following:

"Now the market is popping big time, and it's going to frustrate people. Are the short sellers wishing today that they could be shorting at these levels? Yes, they are."

No doubt that some will take this quote as a further indication that the shorts simply want to drive the markets down at the expense of everyone else. Others will see this as further proof that the markets are still over-valued. Of course, such a quote could just be an admission that the new rules have in fact created an artificial SEC-induced short-squeeze. If the natural tendency is towards a reversion to market efficiency, the new rules certainly don't help us achieve this goal over the long-run, even if they do slam the brakes on what some believe might have been an over-reaction in the opposite direction.

The SEC is looking to force hedge funds to disclose their short-sale positions, and further plans to subpoena hedge fund records (see Bloomberg article). Why stop there? Why not just make it more difficult to even short a stock? Oh, never mind (see Reuters article). I suspect that if as much attention was paid to making sure that companies were not leveraging over 50-1 as is being given to finding coordinated short selling (which may be impossible to prove BTW, even with disclosure), that short-sellers might be getting their hat handed to them in a more natural way. By the way, if you know that a famous and successful short seller with deep pockets is taking a short position in a certain company, are you more likely to go long or short? Could extra transparency even cause more traders to jump on the pile, making things worse? Would seeing that multiple funds are short a stock make you assume the stock is being manipulated in a coordinated manner, or would it give you more reason to think the stock had issues? The law of unintended consequences may raise its ugly head once again.

The current market environment is producing difficult decisions for those with both long and short positions. As reported in a recent Reuters article, hedge fund manager and short seller Douglas Kass has been cutting back on his positions. As mentioned by Kass: "It is a dangerous time for the longs and for the shorts. This is a time to watch and not a time to play. It is time to move to cash." Kass has recently said he was still short Fannie and Freddie, even after the government takeover. Watching and not playing may end up being good advice as it certainly is a difficult and dangerous time for both the longs and shorts. As with any panic and sell-off, there is always a desire to lighten up, yet always the worry of selling at the bottom. I must say that it kind of amazes to me that we have not sold off more given some of the news hitting the street, especially when you consider large sell-offs from the recent and not so recent past, such as the 22% sell-off in the DJIA in 1987. No doubt this was a different situation, circumstance, computer network trading system, and general market psychology, but it was also a situation that did not see they types of buyouts and failures (and potential failures) that we have seen with Lehman Brothers, Merrill Lynch, AIG, and Fannie and Freddie, not to mention the on-going housing and credit crisis and previous Bear Stearns failure. Not sure if that means we have responded better this time, or whether the real pain is yet to be felt. The VIX is signaling panic again as it moves significantly above 30, but it did so back in March as well. Time will tell.

Driven by a declining housing market, and aided by the Treasury Secretary's recent decision, hedge funds that bet against Fannie and Freddie racked up big gains on Monday (see Reuters article). Hedge fund Seabreeze Partners, run by short-seller Doug Kass, was short both companies. Kass's big bet has helped his fund to be up over 25% this year. William Ackman's Pershing Square Capital Management has also made money betting against Fannie and Freddie. Short-sellers have often been vilified, but now they have reason to gloat, causing one hedge fund manager to state: "I don't know how they could get it so wrong. There were so many red flags. I feel sorry for them." One trader that was not as fortunate was Legg Mason manager, Bill Miller, who had increased his holding in Freddie to 79.8 million shares, causing his fund to be off 31 percent for the year. Miller had previously beaten the S&P 500 for 15 years. Some speculate that the Freddie Mac losses may put pressure on Miller to step aside. The old saying, "So what have you done for me lately" never seemed so brutal.

As reported in a Reuters article and elsewhere, the SEC is expected to propose a new short selling rule in the next few weeks that will be broader than the original temporary order that protected 19 financial stocks (17 major Wall Street firms, along with Freddie Mac and Fannie Mae). SEC Chairman Cox is quoted as saying the proposed rule "will focus on market-wide solutions," implying not only larger breadth, but possible other restrictions or changes affecting the markets that reach beyond just widening the number of stocks and sectors affected. One possible change is to require investors to publicly disclose large short positions, similar to the current requirements for disclosing large long positions. Whether a more encompassing rule will prop-up the markets longer-term and give some non-financial stocks a boost is difficult to predict. Even with crude oil continuing to sell-off, the Financial Select Sector SPDR (XLF) has given back some of its gains and is near short-term, yet technically-weak support. With the S&P 500 having trouble getting above 1,300, and the DJIA having difficulty around the 11,750 level, another SEC-induced short covering rally that is now more inclusive may be just what the market needs short-term to break resistance, even if not the original goal of the SEC. While potentially beneficial short-term, one can only hope that any new regulation will not have any harmful or unintended consequences for the market long-term. Then again, sometimes hope is all you have to work with.

Former SEC Chairman, Harvey Pitt, has teamed up with two others to create a web site that provides a real-time electronic stock lending and location service to help sellers and brokerage firms comply with SEC rules on naked short selling. The SEC recently limited the practice for 19 of the larger financial institutions, and there is an expectation the order will increase to more stocks. The web site, called RegSHO.com, matches traders with stock available for borrowing for short sales and provides data on the short-sell market. The creators of the web site believe it will help sellers reduce their costs because transactions are done electronically, and not over the phone as is still often the case. The site also helps to alert subscribers to any possible compliance problems they may be encountering, as well as offering advice and solutions. Access is also given to LocateStock.com, providing a real-time lending and borrow marketplace specializing in hard-to-borrow stocks, and Buyins.net, which helps to identify the demand for borrowed stocks. As mentioned in the Washington Post article, other companies that offer similar services include ShortSqueeze.com and Stock-Borrow.com. What's the kicker? Clients to the RegSHO.com site pay a monthly fee of $995 for standard access, along with an additional per-share fee for locating stock. New regulation? No worry. We can solve your problem ...... for a fee of course. You have to love capitalism.

As somewhat expected, it is being reported at Reuters, the WSJ, and elsewhere that the SEC is planning to extend the temporary curbs on short-selling set to expire Tuesday. Plans are also being made to extend the curbs to cover additional equities, beyond the original 19 financial stocks. New curb limits could now include insurance, housing, and additional financial stocks. The SEC is also apparently considering making the rules permanent, but that would require later finalization, not to mention changes in the way shares are borrowed in order to speed up and automate the process beyond making phone calls for authorization.

Some on Wall Street, including executives and hedge fund participants, are lobbying the SEC in an attempt to get them to reconsider. I would suspect that if the curbs were extended, increased to cover more stocks, or made permanent (which I would assume would include all stocks), then we may get another SEC induced rally that now obviously includes more than just the financial stocks. Or will we? Some, even in the hedge fund industry, have mentioned that it is still easy to borrow anything you want. Others say that while borrowing is still possible, the cost of borrowing has increased, and is having an impact. Due to their size or frequency of trading, the real impact may be on smaller firms and those using programmed trading.

Markets certainly get nervous when regulators start getting more involved, but on the surface this seems more like a way to enforce what should have been done in the first place. Of course, that does not mean it will not impact a market that is used to borrowing now and worrying about that messy back office stuff later, or that it will not negatively affect those that need to provide liquidity to the market (the SEC is already considering market maker exemptions). A more automated system for borrowing will also need to be implement if the rules are extended and expanded. The worst thing would be for the SEC to continue to micro-manage the current sectors in trouble. Where does this end, and is it really the sign of a healthy market, rally or not?

As mentioned in a Bloomberg article, research by BeSpoke Investment Group has found that more than $1.4 trillion of global equities are now on loan. This is a third higher than at the start of 2007. Short selling on the NYSE rose to 4.6% of total shares in June, the highest level since 1931. As the market has sold-off, both short positions and subsequent short profits have increased. In fact, short positions in Frannie Mae and Freddie Mac generated profits of $1.4 billion in July alone.

In addition to recent credit and housing issues, and the higher energy and commodity prices that are fueling inflation and reducing profits, short positions are also increasing in response to extra interest in 130/30 funds. These funds, which often have up to a 30% short position to provide for a higher long exposure, have been on the rise as retail investors look for ways to generate hedge fund-like returns. In fact, investments in such funds are expected to clime to $2 trillion by 2010, from a mere $140 billion last year. This is in addition to other hedge fund replication strategies that also utilize shorting of various securities and products to mimic hedge fund returns.

Of course, just as the SEC is placing restrictions on short selling, other countries are either initiating or increasing access to short selling in a effort to curb rampant long speculation and help contain markets before they reach bubble territory. After the current credit crisis is over, and money begins to flow once again into the financial companies and other securities, don't be surprise if we begin to hear calls from regulators and others looking for ways to pop the bubble and reduce speculation. Ironically, such calls were happening just a few weeks ago in the crude oil markets (and will no doubt begin again in earnest if prices return to over $140 a barrel). When all is said and done, we may end up with trading that restricts short selling in beaten down industries, while encouraging it in those industries with higher valuations. I am not quite sure that helps the markets reach efficient levels, but it is certainly good news to the next Enron.

As is now well known, this week the SEC announced that it plans to tightened short-selling rules on Monday for 19 financial companies, essentially limiting naked short selling by now requiring short-sellers to actually borrow the shares they plan to sell before shorting. The new restrictions were loosen a little on Friday when the SEC said market makers wouldn't have to pre-borrow the stock, but would still need to deliver them within three days. Market makers had complained that the new rules would prevent them from providing the necessary liquidity for making an efficient market.

Upon first hearing of the rule change (or enforcement), in particular the listing of the gang of 19, I wondered in a post whether some companies on the list would prefer to not be included, given the attached stigma of needing Government intervention to prop up their shares. After all, the rule is effectively an SEC induced short-squeeze. Of course, that was 3 days and +20% ago. Now other companies are wondering why they were not included. After all, they like +20% moves as well.

As mentioned in a recent WSJ article, the Financial Services Roundtable, who represents 100 of the largest U.S. financial companies, wants the SEC to extend the order to include companies they represent as well. Companies like Wachovia, reporting next week, are not currently included. Apparently they are either not big enough to fail, or are not yet in poor enough shape to fail. Given the recent investigation of Wachovia, and speculation about poor numbers next week, that may soon change.

If history is any indication, and it usually is - it is rarely different this time - then companies may want to be careful what they wish for. Research by Professor Charles Jones at Columbia Business School has found that similar moves by the SEC have some unhappy precedents. As mentioned in the WSJ article: "In 1932, the New York Stock Exchange announced that, effective April 1, brokers would need written authorization before lending an investor's shares. "This wreaked havoc on the securities lending market, but the effect was completely temporary," he [Jones] said, because the move only added extra hoops, and didn't prevent people from taking bearish positions if they wanted."

More regulation, and temporary results. Not necessarily what we need long-term, but what we will probably get regardless. Maybe with less next quarter, short-term, results-generated management, by both investors and the government, we would not need additional layers of regulation.