NEW YORK (Reuters) - U.S. securities regulators issued an emergency rule on Tuesday to limit certain types of short selling in major financial firms, including Fannie Mae (FNM.N: Quote, Profile, Research, Stock Buzz) and Freddie Mac (FRE.N: Quote, Profile, Research, Stock Buzz).
Investors who sell securities "short" profit from betting that a stock is overvalued and its price is likely to fall. Short-sellers borrow shares, then sell them, waiting for the stock to fall so that they can buy the shares at the lower price, return them to the lender and pocket the difference.
The emergency rule, which takes effect on Monday and could last up to 30 days, specifically works to prevent investors from making "naked" short sales, which occur when an investor sells stock that has not yet been borrowed. If "naked" shorting is done intentionally it is illegal.
The following explains how a "naked" short sale occurs:
*When investors call a broker to arrange to borrow stock to short, they are aware that short sales are subject to a standard three-day settlement period. This means the sell-side broker has three days to deliver the shares to the investor.
*The broker is supposed to locate shares available to short prior to executing a short sale and make a determination that the shares will be delivered to the investor within the three- day settlement window. However, there are certain exceptions to that rule.
*Some shares are on an "Easy to Borrow" list. For a stock on that list, investors can execute a short sale and the broker does not specifically have to locate, or contact the source of the shares that are being shorted. The broker has a "blanket" assurance about the borrowing capability for that security.
* There is also a "Hard to Borrow" list for securities that are difficult, or unavailable, to borrow. To short stocks on the "Hard to Borrow" list, brokers have to take additional steps to ensure that the stock is available to be shorted.
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