July 18 (Bloomberg) -- The U.S. Securities and Exchange Commission exempted market makers in stocks from the emergency rule aimed at preventing manipulation in shares of Fannie Mae, Freddie Mac and 17 Wall Street firms.

The SEC granted relief for equity and option traders responsible for pairing off orders from a rule that seeks to bar the use of abusive tactics when betting on a drop in share prices. Exchange officials said limits on ``naked-short'' sales would inhibit the flow of transactions and raise costs for investors.

``The purpose of this accommodation is to permit market makers to facilitate customer orders in a fast-moving market,'' the SEC said in the amendment.

SEC Commissioner Christopher Cox announced the order July 15 to make it harder for traders to illegally drive down stocks of the two mortgage buyers and Wall Street firms and prevent another collapse like Bear Stearns Cos. The rule takes effect July 21 and expires at the end of July 29. It may be extended for a total of 30 calendar days.

The SEC also exempted some transactions by underwriters arranging sales of additional shares for the 19 companies that are covered, as well as brokers participating in syndicates to arrange offerings.

``We appreciate the SEC's prompt action,'' said Gary Katz, chief executive officer of the International Securities Exchange, which trades stocks and options. ``The SEC has taken a positive step to minimize impact on the options market and its use as an important risk management tool in times of market uncertainty and volatility.''

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The exemption is ``essential for separating legitimate market makers from those who may try to act illegally,'' said Ira Hammerman, senior managing director of the Securities Industry and Financial Markets Association, Wall Street's largest lobbying group.

Investors will be required to borrow shares that they plan to sell short when they bet a stock will decline in price. Prior to the order, investors were only required to locate shares that they had reason to believe were available for borrowing.

Market makers must quote bids to buy and offers to sell shares or options contacts on their assigned stocks. Securities exchanges sought exemption for the market makers, who rely on quickly shorting stocks to hedge their trades. They still must obtain the loan by the time the transaction is settled.

In a short sale, an investor borrows and then sells the shares in anticipation of a price decline. If the trade works as planned, the investor is able to buy back the stock at a lower cost and return the shares to the lender, pocketing the difference as profit.

Traders are sometimes unable to actually borrow the shares and complete a ``naked-short'' sale. If the loaned shares are never repaid, investors can sell more shares short than legally allowed and put pressure on a stocks' price.

To contact the reporter on this story: Edgar Ortega in New York at ebarrales@bloomberg.net.

Last Updated: July 18, 2008 16:28 EDT