On 18 September 2008, amidst worsening market turmoil following the recent bankruptcy filing of Lehman Brothers, the US government bail-out of AIG, and the impending rescue takeover of the UK’s largest mortgage lender HBOS by Lloyds TSB, the UK’s Financial Services Authority (FSA) announced1 an emergency ban on all short-selling in publicly quoted UK financial sector companies2 (i.e., UK banks or insurers, or their UKincorporated parent companies) in effect from midnight on 18 September 2008.

Whilst still regarding short-selling as “a legitimate investment technique in normal market conditions,” the FSA has determined that the current “extreme circumstances” necessitate the ban and a heightened disclosure obligation in order to forestall any further instability and loss of confidence in the financial sector.

Background

“Short-selling” refers to an investment technique whereby the investor agrees to sell shares in the future at a preagreed price, betting that the share price will fall, which would then allow him to buy the shares at a lower price when he actually delivers them to the buyer and to pocket the difference. In most cases, the short seller will have a “covered” short position, i.e., he will have borrowed the underlying shares at the time he entered into the sale, in order to ensure that he can fulfil his obligation to deliver the shares.

Recent sharp falls in the share prices of HBOS (as well as those of Lehman Brothers and AIG) have been blamed on the spreading of malicious rumours designed to drive share prices down, and since short-sellers are the parties who most obviously gain from falls in share prices, this has stirred up a degree of political backlash against shortselling and hedge funds and other institutional traders who typically employ these techniques (whether legitimately or otherwise).

Certain politicians and investors have recently called for greater regulation and transparency of short-selling, particularly in bank shares, in view of the fact that the stability of retail savings banks and other financial institutions is critical to maintaining (or restoring) confidence in the overall financial system.

On 17 September 2008, the US Securities and Exchange Commission (SEC) strengthened its own rules against abusive “naked short-selling,” which refers to a fraudulent practice of short-selling where the seller does not have the intention or the ability to deliver the shares.3 On 19 September 2008, the SEC launched an emergency temporary ban on covered short-selling in 799 financial company shares in a move similar to the FSA’s latest action.

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