Destructive short selling spurs investigation
— -- Efforts to stop suspected illegal short selling of stocks intensified Thursday as a top state law enforcer announced an investigation and the nation's three largest public pension funds said they would stop lending some financial stocks to short sellers.
New York Attorney General Andrew Cuomo said his office is investigating "a significant number" of complaints about improper short selling in shares of Lehman Bros., AIG, Morgan Stanley, Goldman Sachs and other financial firms whose stocks have been battered this week.
It is legal to sell short — to borrow stock and sell it with the understanding the loan must be repaid with similar shares bought in the market at what the buyer bets will be a lower price. But it is illegal to spread false information or rumors in a bid to drive down the stock price. It is also illegal to sell short without first borrowing shares.
Cuomo said his investigation would use the state's Martin Act, which subjects violators to criminal as well as civil penalties, to combat the illegal practices.
"The markets need to be stabilized," Cuomo said. "And one way to bring about such stability is to root out and deter short selling that is based on the spread of false information."
The investigation comes one day after the Securities and Exchange Commission adopted rules aimed at forcing traders and brokers to actually borrow shares used in short selling. The SEC also banned sellers from deceiving brokers about delivering borrowed shares to buyers.
SEC Chairman Christopher Cox also proposed requiring large investors, including hedge funds, to issue public reports about their short-selling positions.
Cuomo said the SEC should temporarily freeze short selling of financial-sector stocks — a step taken Thursday by Britain's Financial Services Authority.
Separately, the California Public Employees' Retirement System, the New York State Common Retirement Fund and the California State Teachers' Retirement System said they would stop lending Morgan Stanley and Goldman Sachs shares to short sellers. The New York pension system will apply that policy to 17 other banks and brokerages.
