U.S. SEC mulls securities lending as risks exposed

September 29, 2009

Mary Schapiro, chairman of the Securities and Exchange Commission (file photo) By Rachelle Younglai
WASHINGTON, Sept 29 (Reuters) – U.S. securities regulators are eyeing new restrictions on the multi-trillion dollar securities lending market used by short-sellers after the credit crisis revealed the industry was “anything but low risk.”

Some pension funds, mutual funds and foundations that loaned their securities were “significantly harmed,” Mary Schapiro, chairman of the Securities and Exchange Commission, said at the start of a two-day public meeting on the matter.

(To view a live Webcast of the event, click here, between 9:30 a.m. and 4:00 p.m. Eastern time (1330-2000 GMT) Tuesday, or 9:30 a.m. and 12:30 p.m. (1330-1630 GMT) Wednesday)

Historically, institutional investors viewed securities lending as a way to put their dormant assets to work. But during the financial crisis many of them lost money from their cash collateral reinvestment programs that invested money received from stock lending.

“For a long time, securities lending was regarded and described as a relatively low risk venture, but the recent credit crisis revealed that it can be anything but low risk,” Schapiro said.

Securities that are loaned are often used by short sellers, who make profits on a stock’s decline. Short selling has been blamed by some lawmakers and corporate executives for last year’s dramatic drop in stock prices.

Short selling, a legitimate investment strategy, is when an investor borrows stock and sells it in the hope that its price will fall. If the price does drop, the seller profits by buying the stock back at the lower price.

Some funds now feel burned by the middlemen who borrowed their securities, then loaned them to short-sellers.

“We seem to be the big loser and it was our money that was put out there to buy the stock that then went out on loan,” said Jerry Davis, chairman of the board of trustees at the New Orleans Employees’ Retirement System.

“We have suffered real cash losses and the interests seem to be out of balance in the … agreements,” Davis said.

The public meeting was the latest in a series of steps the SEC has taken to broadly address the issue of short-selling.

The agency has already proposed reinstating a version of the uptick rule, which could curb short selling. That has been opposed by big Wall Street players such as Goldman Sachs Group Inc <GS.N> and Vanguard Group Inc.

Schapiro previously said the SEC aims to finish work on the uptick rule by the end of the year.

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