New SEC Regulation on Short-Selling Causing a Stir

The SEC has recently come out with an emergency order to curb "naked short selling" of certain stocks (19 in all) that include Freddie Mac, Fannie Mae, Morgan Stanley, Goldman, Lehman, etc. The motivation is to alleviate the unrelenting short selling of these "vulnerable" stocks. Currently, brokers and banks are not allowed to short sell without already having borrowed stock to cover the position. However, the precise terms of the timing of the "borrow" has been a little vague up until now. The new SEC order forces the short seller to formally borrow the stock before the short sell can occur. This has all the major dealing houses scrambling to get these new controls in place before Monday. Additionally, it will make it more expensive to trade, and could impact the ability to trade options: traders often short-sell to hedge put option contracts they have sold. And if options traders can't hedge themselves, they can't sell put or buy call options. One of the actual issues is that short sellers will often locate the stock to be borrowed on trade date, but not actually borrow it until settlement date (T+3). That can be problematic as multiple dealers can locate the same stock from the same source so when it comes to borrow, someone is left "naked". The solution would therefore to secure the borrow on trade date, not settlement date.