Sept. 18 (Bloomberg) -- The U.K. markets regulator put a ban on short selling of financial shares for the rest of the year after HBOS Plc, the country's biggest mortgage lender, lost 37 percent of its market value over three days.

The Financial Services Authority will also require daily disclosure of existing short positions in financial companies of more than 0.25 percent, the London-based regulator said in a statement today. The rules will remain in effect until Jan. 16.

The measures were introduced after politicians and some investors blamed short-sellers for HBOS's plunge before it agreed to a 10.4 billion-pound ($18.9 billion) takeover by Lloyds TSB Group Plc. The U.S. Securities and Exchange Commission also moved to tighten rules on short-selling, saying that it may require hedge funds to disclose their positions.

``This is the most interventionist action in the U.K. economy that we've seen for quite some time,'' said Chris Brennan, a regulatory lawyer at London-based Barlow Lyde & Gilbert and a former FSA official. ``It's surreal.''

The emergency measures came with approval from the government.

``I have discussed this with the FSA and welcome their decisive action,'' said Chancellor of the Exchequer Alistair Darling. ``It is the right thing to do in the current market conditions and in the interests of financial stability.''

Lawmakers including U.S. Senate Banking Committee Chairman Christopher Dodd and executives such as Morgan Stanley Chief Executive Officer John Mack have said short sellers may be spreading false information and using abusive tactics to attack companies.

HBOS Rumors

The FSA investigated the cause of an earlier drop in HBOS's share price in March, when false rumors about the bank's ability to fund itself caused a 17 percent decline. The regulator didn't charge anyone, saying in August that it hadn't found any evidence of financial crime.

The Alternative Investment Management Association, which represents 1,280 hedge fund managers in 14 countries, said today that short-selling is a legitimate practice and shouldn't be confused with market abuse.

``There's a taint still out there that hedge funds have been guilty of some abusive practice and it's not at all substantiated,'' said AIMA Deputy Chief Executive Officer Andrew Baker in a telephone interview before the new rules were introduced. ``Everyone's been lumped in the same general category and the good apples want to see bad apples get out.''

SEC Disclosure

By placing a ban on shorting financial institutions, the FSA went further than the SEC did in the U.S. The SEC, as well as requiring disclosure, said it also plans to subpoena hedge funds' communication records in an effort to stem turmoil in stock markets.

``It's regulatory one-upmanship,'' said Darren Fox, a London lawyer at Simmons & Simmons, who advises hedge funds.

The FSA's rules are the third set in as many months from the regulator demanding more disclosure from hedge funds and investors who speculate on share prices dropping. Short sellers borrow shares and sell them on the hope that their price will go down. If it does, the speculators buy the shares back at the lower price, return them to their owners, and pocket the difference.

``This was the right thing for the FSA to do,'' said Mamoun Tazi, a London-based analyst at MF Global Securities Ltd., who has a ``neutral'' rating on HBOS and a ``buy'' recommendation on Lloyds. ``I'm generally in favor of short-selling as an investment strategy and don't think it's wrong. But the market has gone too far and something needed to happen.''

Amended Rules

Hedge funds criticized the FSA when it last passed emergency rules without consultation. The rules, which had to be amended four times in one week in June, required disclosure on positions of more than 0.25 percent of companies trying to sell shares in a rights offer.

``With the rights issues, the feeling was that the FSA was being a bit coy and that actually it was always about supporting the banks,'' said Fox. ``I think the FSA is now feeling bolder.''

The FSA will put out a list tomorrow morning with all the financial services companies covered by the new rules, said spokeswoman Kirsty Clay. The regulator will review the rules after 30 days, she said.

``While we still regard short-selling as a legitimate investment technique in normal market conditions, the current extreme circumstances have given rise to disorderly markets,'' said Hector Sants, the FSA's chief executive officer, in an e- mailed statement. ``We have taken this decisive action, after careful consideration, to protect the fundamental integrity and quality of markets and to guard against further instability.''

Under the new rules, no new short positions can be taken in U.K. listed financial services companies. While existing short positions don't have to be closed, they can't be increased, said Clay.

To contact the reporters on this story: Caroline Binham in London at cbinham@bloomberg.net.

Last Updated: September 18, 2008 15:28 EDT