Report from IMD Professor Arturo Bris shows market quality worsened for 19 financial stocks under SEC Emergency Order

August 13, 2008

A study of the impact that an emergency order by the Securities and Exchange Commission had on the 19 financial stocks covered by that order, shows that market quality deteriorated for those stocks during the order’s 23-day term.

“Our preliminary findings show that the impetus for the SEC’s emergency order – that short selling was adversely affecting the performance of the 19 financial stocks – is groundless,” said Arturo Bris, a professor of finance at IMD and an associate with the Yale International Center for Finance. “Worse, the order has resulted in a decline in market quality for the EO-covered securities compared to comparable financial stocks. As a consequence, the EO restraints on short selling contributed to a decline in share prices for the 19 stocks.”

Although the performance of the 19 stocks (G19) has been significantly worse than that for comparable firms, “the negative returns of G19 stocks cannot be attributed to short selling activities,” the study found. Non-G19 stocks have been shorted more heavily both in 2007 and 2008 than G19 stocks. Further, the study’s analysis shows an insignificant effect of measures of shorting activity on weekly stock returns, once we control for firm and market characteristics.

“After controlling for short sales, the performance of G19 stocks is still worse than for comparable firms,” the study says. “The efficiency of G19 stocks has [also] deteriorated more than the efficiency of comparable U.S. financial stocks.”

The 19 stocks lost 3.83 percent in value compared to their peers between July 21 and August 4. With $1,540bn in total market capitalization for the G19 stocks, a negative 3.83 percent loss relative to peers is equivalent to about US$60 billion loss for the G19 shareholders.

Bris conducted the study by comparing stock returns, firm fundamentals, measures of market quality and pricing efficiency of the 19 stocks to a matching sample of financial stocks from the U.S. and abroad, all listed in U.S. stock exchanges. The control sample of U.S. financial institutions included 59 companies and the control sample of non-U.S. financial institutions included 73 companies. Data was collected for the period July 1, 2006 through August 8, 2008.

The SEC emergency order went into effect on July 21 and was extended through to August 13.

Read the entire report in PDF.

Watch Professor Bris' interview on CNBC's Squawk Box Europe from Friday, August 15th.