The top U.S. securities regulator remains steadfast in a plan to broaden an emergency rule to curb abusive short selling despite opposition from the hedge fund industry and other short sellers.
U.S. Securities and Exchange Commission Chairman Christopher Cox told lawmakers Thursday the agency would soon propose expanding the rule covering the shares of 19 major financial firms to the entire market.
"We have immediately pivoted to a broader rule making ... so we can extend this kind of procedural protection to the entire market," SEC Chairman Christopher Cox told a House Financial Services Committee hearing. "I think very soon we will be in a position to issue a proposal on that," he said.
The SEC is also considering other remedies to short selling abuses, such as requiring the reporting of substantial short positions, Cox told reporters after the hearing.
The temporary rule requires investors to borrow stock before executing a short sale in 17 major Wall Street firms such as Citigroup and Lehman Brothers as well as mortgage finance giants Freddie Mac and Fannie Mae .
The emergency rule, which started on Monday, can only last a total of 30 days but the American Bankers Association and former SEC officials have been urging the investor protection agency to extend and expand the rule.
Groups representing short sellers have urged the SEC not to extend the emergency order past July 29, nor beyond the current list of companies.
The SEC has said it is not looking to outlaw short selling, a legitimate form of investing that can keep stocks from becoming overvalued.
Short sellers arrange to borrow shares and sell them in hopes of making a profit when the price drops.
When an investor does not pre-borrow the shares before shorting the stock, it's called naked short selling, which is illegal if done intentionally.
The SEC's emergency rule has exempted market makers from the pre-borrow requirement so they can continue to facilitate trading in certain stocks.
But market makers are still required to deliver securities by the settlement date.
Earlier in the hearing, Federal Reserve Bank of New York President Timothy Geithner said it is critical for policy-makers to help the U.S. financial system adjust during a difficult time, but substantial regulatory reforms are needed to make institutions and markets more resilient.
"The critical imperative today is to help facilitate that adjustment and to cushion its impact on the broader economy," Geithner said. "The forces that made the system vulnerable to this crisis took a long time to build up and the system will need some time to work through their aftermath."
"I believe the most important imperative is to build a financial system that is more robust to very bad outcomes and more resilient to shocks," Geithner said.
Major institutions would have to become less vulnerable to shocks, and the system would need to be less vulnerable to pull-backs in liquidity and be able to withstand the failures of a major financial firm.
The financial system needs better "shock absorbers," such as stronger capital reserves and risk management among institutions, and simplifying and consolidating the regulatory architecture to reduce opportunities for regulatory "arbitrage," he said.
The use of government backstops such as central bank liquidity tools and other emergency powers requires stronger oversight to limit the "moral hazard" that they create by encouraging riskier behavior among institutions.
"To mitigate this effect on risk-taking, strong supervisory authority is required over the consolidated financial entities that are critical to a well-functioning financial system," he said.