SEC to grant market makers leniency on short sales

By Svea Herbst-Bayliss and Rachelle Younglai

BOSTON/WASHINGTON (Reuters) - U.S. regulators said they would grant some leniency to certain market makers who sell stocks short, responding to pressure from fund managers and brokerages to clarify how new restrictions on the practice would work.

The guidance came from the Securities and Exchange Commission late on Thursday after it stunned financial markets by announcing unprecedented restrictions on short-selling two days before.

The rule, which takes effect on Monday and is expected to last at least 30 days, is designed to restrict improper short selling of shares in 19 financial firms, including recently battered Fannie Mae (FNM.N), Freddie Mac (FRE.N) and Lehman Brothers Holdings Inc LEH.N.

"The staff is recommending exceptions to the short sale order for market makers of the 19 stocks and their derivatives from arranging to borrow in advance for short sales in their marketmaking and related hedging activities, to avoid constraining the market makers' provision of liquidity," SEC spokesman John Nester said by e-mail.

Separately, the SEC announced plans to crack down on people who may be spreading rumours to manipulate stock prices and dozens of hedge funds and brokerages received requests to turn over e-mails to regulators as they probe the collapse of Bear Stearns and a sharp decline in Lehman's share price.

More than 50 hedge funds and brokerages began receiving subpoenas in recent days, managers and their lawyers said.

Loosely regulated hedge fund managers, who often rely on selling stocks short to make money, complained that the rule would make their work more difficult and expensive.

"This ties both hands behind their backs," Perrie Weiner, co-chairman of the securities group at law firm DLA Piper, said of the new measure. "It has caused an uproar because the government is telling you that an otherwise legal practice is being restrained. It is Big Brother looking over your shoulder."