(RTTNews) - SEC Chairman Christopher Cox attempted to clarify his agency’s somewhat confusing emergency order designed to halt naked short selling, an effort to assist financial institutions that are “uniquely vulnerable in the current climate.” In an op-ed piece appearing Friday in Investor’s Business Daily, Cox explained why naked short selling isn’t already illegal and what the order will do to protect markets.

There was some confusion at the time of the declaration of the SEC’s intention to halt naked short selling earlier this week, due to the widespread belief that naked short selling was already illegal. Cox attempted to clarify this point that had befuddled so many economists and analysts alike.

“Many people think naked short selling is already illegal, but that isn’t true,” Cox wrote.

He explained that shares are usually delivered to buyers within a three day period following the trade. However, for Fannie and Freddie and other stocks covered by the order (those with access to the primary lending window) that three-day grace period can be “extended indefinitely.”

“Even without these extensions, and even when a short seller locates shares that can be borrowed, there can be problems because the short seller is not currently required to actually borrow those shares until settlement,” Cox explained.

Therefore, he explained, lenders can tell more than one short seller that they can borrow the same stock, resulting in “a sure recipe for a failure to deliver,” Cox said. The new order eliminates the possibility, in essence halting naked short selling.

Citing the collapse of IndyMac and Bear Stearns as “a sure sign of the fragility of today’s markets,” the SEC Chairman called for investor responsibility, harping on the need for increased confidence in the market.

This shaky confidence has left financial institutions “uniquely vulnerable in the current climate,” Cox said.

Last week, images of depositors lining up outside IndyMac in California to withdraw their funds from the defunct bank sent ripples of concern throughout the country, reminiscent of bank runs that brought the financial system to its knees in the Great Depression. The current financial crisis has been called the worst since the Great Depression, as consumers from Wall Street to Main Street remain jittery about the resiliency of a strained financial system. Although in light of the serious disruptions in financials such concerns may seem warranted, Cox cautioned against “irrational panic.”

“When an irrational panic is fueled by a sense of urgency, false rumors that must be acted on immediately and the fear that everyone else may get out first, market integrity is threatened,” he wrote.

In order to shore up confidence the SEC is intervening, with a goal to “punish those responsible” for fanning the flames of irrational fear for their own gain. Namely, Cox said the SEC is actively searching for those who propagate false information, placing a special focus on naked short selling.

“In a naked short, the usual process of short selling is circumvented, because the seller doesn’t actually borrow the stock and simply fails to deliver it,” Cox wrote. “For this reason, naked shorting can occur even when actual shares aren’t available in the market. It allows manipulators to force prices down without regard to supply and demand.”

In response to this market manipulation tactic, the Cox announced on Tuesday during testimony before the Senate Banking Committee that the SEC is issuing an emergency order that would prevent naked short selling of embattled mortgage lenders Fannie Mae (FNM) and Freddie Mac (FRE), which has been cited as a possible cause of their swift plunge in stock price to multi-decade lows following a declaration from former St. Louis Fed President William Poole that Freddie was technically insolvent.

“Eliminating the prospect of naked short selling will help assure investors that it is safe for them to participate, and that the current declining market is not the product of unseen manipulators and ‘distort and short” artists,’ Cox wrote.

The order is directed only at naked short sellers, Cox said, recognizing the important market role “legitimate” short selling occupies as a “healthy and necessary part of a free market.”

The order is a part of the SEC’s responsibility as “market referee” to bolster confidence in the markets by ensuring that liquidity continues to flow between markets and participants, Cox said.

“Naked short selling can undermine the market’s integrity,” he concluded. “For the financial sector in this crisis, certainly, but as soon as possible for the entire market, this is one worry investors shouldn’t have.”

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Posted in Categories: Economy, Releases, USA.

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