U.S. securities regulators have extended through Aug. 12 an emergency rule aimed at curbing abusive short selling in the stocks of 19 major financial firms, including mortgage giants Freddie Mac and Fannie Mae .
The Securities and Exchange Commission rule is part of an agency crackdown on possible market manipulation that some blame for steep declines in the shares of financial companies.
The emergency measure, that first took effect July 21 and will not be further extended, requires investors to borrow a stock before selling it short and to deliver the stock on the settlement date.
The SEC said it would use the additional time to collect more data on the rule's impact and then start a rule-making aimed at providing additional protections against abusive naked short selling in the broader market.
"The order is designed to protect legitimate short selling in these securities, but helps prevent illegitimate naked short selling and potential 'distort and short' manipulation," SEC Chairman Christopher Cox said in a statement.
Cox told a congressional hearing last week that the agency would soon propose a rule extending the emergency short sale requirements to the entire market.
Short sellers arrange to borrow shares they consider overvalued and sell them in hopes of making 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 temporary rule applies to Lehman Brothers , Goldman Sachs , Merrill Lynch , Morgan Stanley , JPMorgan Chase and Citigroup , among others.
Henry Klehm, a securities lawyer at Jones Day representing financial companies, said it he believed it was important the SEC continue to enforce the rules against naked short selling.
"This orders seems to have dampened the volatility in many of the financial stocks," said Klehm.
The American Bankers Association has been lobbying the SEC to include all publicly traded banks and bank holding companies, such as Washington Mutual and Wachovia , whose stocks have been under selling pressure.
Short sellers, meanwhile, have protested that they are being unfairly scapegoated, although the SEC has said it is not looking to outlaw short selling, a type of investing that can keep stocks from becoming overvalued.
The Securities Industry and Financial Markets Association says a broad expansion of the rule would be burdensome.
"Expanding the requirement to pre-borrow for every one of the thousands and thousands of publicly traded companies would involve serious operational challenges, not to mention a likely impact on liquidity and market performance, all of which we are still quantifying," said Ira Hammerman, SIFMA's general counsel, in an e-mailed statement.
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.