Many businesses include risk disclosure that they are subject to the risk of changed regulations, but relatively few actually experience a sudden prohibition on core activities. In 2008, investment firms that relied on short selling both to speculate in the markets and hedge other positions saw just such an emergency prohibition by US and UK regulators on shorting financial stocks.

These prohibitions accompanied efforts around the world to clamp down on short selling (to read more about these, click here). Other restrictions included strict new disclosure and reporting requirements. For example, certain institutional managers must prepare and file with the Securities and Exchange Commission (SEC) a weekly, non-public disclosure statement, on the newly-created Form SH, disclosing short positions (to read more about this, click here).

The US prohibitions, now lifted, are notable because they represent a regulatory u-turn, following the SEC's June 2007 repeal of the 70-year-old "uptick rule" (which generally prevented selling short many US stocks except at a price higher than the last reported sale price, or at the last reported sale price if that price is itself higher than the preceding sale price).

Moreover, there is a move afoot for another u-turn, with legislation proposed in Congress to re-establish the uptick rule. The bill (H.R. 302) is sponsored by a senior Democratic member of the House Financial Services Committee and is a follow-up to a failed bill with the same goal introduced in July 2008. It could have fresh traction, however, given the newly seated Congress, the sharp declines in the markets over the autumn of 2008, and criticism of the SEC studies that were cited by the agency in support of its repeal of the old rule. Those studies centred on pilot programs that lifted the uptick restrictions on a limited number of stocks and have been called both too narrow in scope and, given that they tested the waters at a time of steadily rising stock prices and low market volatility, ill-timed. President Barack Obama's newly-appointed SEC Chair likewise supports a re-examination of the decision to repeal the rule.

Going forward, regulation of short selling may remain in flux as regulators continue to gather information to determine the best course of action. Just recently the UK Parliament's Treasury Committee held hearings to question prominent hedge fund managers about the industry's role in the declining values of UK banks. Among the topics discussed was the role of short selling, a hot topic in the UK press following a recent profit of Paulson & Co of at least GB£270 million from the short sale of Royal Bank of Scotland (RBS) stock before its rapid decline in value.

Meanwhile, many short sellers seem to have adapted handily to the panoply of newly-imposed restrictions. Short-biased hedge funds are reported to have gained 34% on average in 2008, compared to a decline of 39% in the Standard & Poor's 500 Stock Index. That said, at least one noted short seller, David Rocker and his firm Copper River Management, shut down last year, with some of the firm's difficulties attributed to the ban on shorting financial stocks.