CalPERS, CalSTRS, Others Cut Lending

SAN FRANCISCO-Pension fund managers CalPERS, CalSTRS and NY Common have temporarily halted their lending of certain financial services securities so that they cannot be abused by short sellers. All three said the shares would be lent again when once the volatility ends.

The New York Common Retirement Fund, the most recent addition to the list, went the furthest, removing 105 million shares in 19 banks and lending companies from the pool of available securities under the Fund’s Securities Lending Program “so they can’t be used by short sellers.”

“The financial services industry has experienced declines in public equity values that in some cases are unconnected to the long-term financial health of the industry,” New York State Comptroller Thomas DiNapoli said in a statement. “By removing some of the fuel that is feeding this speculative fire, my action is intended to bring stability and rationality back to our equity markets.”

A CalSTRS source told GlobeSt.com Thursday that it halted the lending of shares of only Morgan Stanley and Goldman Sachs yesterday at 4:30 p.m. EST. They also informed 60 peers of their actions, which like CalPERS and NY Common may react more broadly.

CalPERS stopped lending shares in four companies, adding State Street and Wachovia Bank to CalSTRS’ list, a company source tells GlobeSt.com. “We are doing this to bring calm to the markets and will lift the restriction once market volatility abates,” the source adds.

NY Common’s DiNapoli said that combined with the SEC rules curbing short selling, which were strengthened as of Thursday morning, he believes the actions will “restore fundamentals–-earnings power and long-term franchise value–-as the key drivers of stock prices.”

The firms whose shares DiNapoli removed from the program are those identified by the SEC in its July 15 emergency order aimed at “naked” short selling: BNP Paribas Securities Corp., Bank of America Corporation, Barclays PLC, Citigroup Inc., Credit Suisse Group, Daiwa Securities Group Inc., Deutsche Bank Group AG, Allianz SE, Goldman Sachs Group Inc, Royal Bank ADS, HSBC Holdings PLC ADS, JP Morgan Chase & Co., Lehman Brothers Holdings Inc., Merrill Lynch & Co. Inc., Mizuho Financial Group, Inc., Morgan Stanley, UBS AG, Freddie Mac and Fannie Mae.

In an ordinary short sale, the short seller borrows a stock and sells it, with the understanding that the loan must be repaid by buying the stock in the market [hopefully at a lower price]. But in an abusive naked short transaction, the seller doesn’t actually borrow the stock and fails to deliver it to the buyer. For this reason, naked shorting can allow manipulators to force prices down far lower than would be possible in legitimate short-selling conditions.

The SEC’s July emergency order required anyone effecting a short sale in the aforementioned securities to arrange beforehand to borrow the securities and deliver them at settlement. Yesterday, in an order that immediately became effective, the SEC went a step further than its previous order, which was limited to the securities of financial firms with access to the Federal Reserve’s Primary Dealer Credit Facility and, because the agency’s exercise of its emergency authority is limited to 30 days, expired Aug. 12.

The new rule requires that short sellers and their broker-dealers deliver securities by the close of business on the settlement date [three days after the sale transaction date] and imposing penalties for failure to do so. If a short sale violates this close-out requirement, then any broker-dealer acting on the short seller’s behalf will be prohibited from further short sales in the same security unless the shares are not only located but also pre-borrowed. The prohibition on the broker-dealer’s activity applies not only to short sales for the particular naked short seller, but to all short sales for any customer.

The SEC also removed its exception of options market makers from the new rules and adopted a rule that “expressly targets fraudulent short selling transactions” by making clear that “those who lie about their intention or ability to deliver securities in time for settlement are violating the law when they fail to deliver.”