The Securities and Exchange Commission has announced that it is extending its temporaryprohibition of the short selling of financial stocks until O

The Securities and Exchange Commission has announced that it is extending its temporaryprohibition of the short selling of financial stocks until October 17, by which time the US legislation making up to USD700bn available for the government's purchase of toxic real estate securities is expected to be in place. The original orders issued by the SEC were due to expire at midnight on Thursday.

The US financial regulator has also said that it plans to replace its temporary requirement that institutional money managers report new short sales of certain publicly-traded securities to the SEC with a permanent measure, and it will also make permanent the rule requiring that short sellers and their broker-dealers deliver securities by the settlement date (three days after the sale transaction date) or face penalties.

The SEC says that its measures to address concerns regarding short sales have focused particularly on the securities of financial institutions whose health may have an impact on financial stability, and that the measures it has taken have been designed to ensure the continued smooth operation of orderly markets.

In extending the measures for up to a further 15 days, the SEC ignored the appeals of the hedge fund industry body Managed Funds Association, which had written to the regulator urging it to let the emergency orders barring short selling of financial stocks and requiring the public disclosure of other short positions to expire on schedule at midnight on Thursday.

"The MFA shares the commission's deep concerns about the crisis in the global financial markets and strongly supports efforts to prevent, detect and punish manipulative conduct," says the association's president and chief executive, Richard H. Baker.

"As witnessed this past week, however, the orders have not prevented price declines of financial institutions, volatility in the securities of these firms, or the failure of a financial institution. The orders have, however, increased volatility, reduced liquidity, and abruptly halted capital-raising including through the issuance of convertible securities.

"We believe the orders may have run counter to their intended objectives by having exacerbated fluctuations in the affected securities' prices and disrupted the functioning of fair, orderly markets."

Perhaps recognising the futility of the MFA's appeal to the SEC, Baker adds: "In the interim, we ask the commission to amend the disclosure order to require non-public reporting of detailed short positions.

"Should the commission choose to extend the order, while opposed to such action, we request that the commission amend the prohibition order to include an exemption for bona fide hedging transactions and a materiality standard in determining whether a company is a 'financial firm' for purposes of the order. We believe such actions will help mitigate the adverse consequences of the orders."

The regulator insists that its actions to bar short selling and financial stock and to require disclosure of other shorting transactions have been taken in concert with its counterparts in other developed securities markets around the world.

"Short selling plays an important role in the market for a variety of reasons, including contributing to efficient price discovery, mitigating market bubbles, increasing market liquidity, promoting capital formation, facilitating hedging and other risk management activities, and importantly, limiting upward market manipulations," the SEC acknowledges.

However, it adds: "There are circumstances in which short selling can be used as a tool to mislead the market. For example, short selling can be used in a downward manipulation whereby a manipulator sells the shares of a company short and then spreads lies about a company's negative prospects. This harms issuers and investors as well as the integrity of the market.

"This kind of manipulative activity is particularly problematic in the midst of a loss in market confidence. For example, in the context of a credit crisis where financial institutions face liquidity challenges, but are otherwise solvent, a decrease in their share price induced by short selling may lead to further credit tightening for these entities, possibly resulting in loss of confidence in these institutions."

The SEC argues that its measures to restrict short selling are designed to provide temporary protection against abusive short selling while the US Congress works to agree a "comprehensive plan to stabilise credit markets and the financial system".

The US House of Representatives is due to vote again on a revised bill on Friday, four days after it threw markets into a renewed tailspin by rejecting the first legislation sent to Congress by Treasury Secretary Hank Paulson.

The commission's authority limits the duration of emergency temporary measures to 30 calendar days, beyond which they may not be extended. The SEC says its temporary prohibition of short selling in financial companies, extended to allow time for completion of work on the anticipated legislation, will expire at 11:59 p.m. ET on the third business day after enactment of the legislation, and at the latest on October 17. ?

The temporary requirement on institutional money managers to report short sales will also be extended until October 17, but the SEC says it intends the order to continue in effect beyond that date without interruption in the form of an interim final rule. It will seek comments on all aspects of the proposed rulemaking. The temporary easing of restrictions on the ability of securities issuers to repurchase their securities will also be extended until October 17.

The regulator says its measures designed to strengthen the existing ban on so-called naked short selling and to increase the applicable penalties will also continue in force following the expiry of its emergency orders.

The Commission has adopted, on an emergency basis, a rule requiring that short sellers and their broker-dealers deliver securities by the settlement date. If a short sale violates this close-out requirement, any broker-dealer acting on the short seller's behalf will be prohibited from further short sales in the same security, for any customer, unless the shares are not only located but also pre-borrowed. This rule will also continue beyond October 17 as the SEC prepares a permanent measure.

The SEC has also implemented a naked short selling anti-fraud rule, covering short sellers who deceive broker-dealers or any other market participants about their intention or ability to deliver securities in time for settlement. The rule makes clear that such persons are violating the law when they fail to deliver.