The new ban by the Securities and Exchange Commission (SEC) on the naked short selling of 19 major financial firms sent banking stocks on a sharp rally after it was announced on July 15.

However, Sovereign Society Investment Director Eric Roseman says that by singling out 19 firms, the SEC has left hundreds more financial companies even more vulnerable. Washington Mutual (NYSE:WM), the largest US bank not included in the list, saw its share price plunge 35% last week.

Besides, poor financial supervision and weak government regulation created this mess in the banking sector, not short-selling hedge funds.

Bear markets tend to rear the government’s ugly head. In my book, the less government intervenes, the better. Markets should be allowed to function freely, as long as market participants use transparent reporting.

Sometimes, however, the government has to intervene when investors are unfairly punished or defrauded. This was the case earlier this decade during the Enron, WorldCom, Tyco, and the Spitzer mutual fund-timing scandals. Millions of investors were victimized, defrauded, and CEOs were subsequently sentenced or heavily fined.

But now the rules are about to change. It looks like short-sellers are the new target in the United States, the United Kingdom, and Australia.

In an effort to curb speculation in financial services stocks, the United States Securities and Exchange Commission (SEC) have introduced new short-selling rules for the next 30 days. These changes bar institutions, mainly hedge funds, from shorting financial stocks. The government has issued a list of 19 commercial and investment banks that cannot be shorted.

The SEC, announced these new rules last Tuesday after financial stocks plummeted for the second day. This announcement triggered a massive 17% rally for the bank index on Wednesday. The new short-sale rule was probably the biggest single factor contributing to the rally.

So will this new rule help financial stocks and their devastated shareholders? The answer is probably not.

Though the government has identified 19 financial institutions to be protected, this leaves a few hundred more that remain even more vulnerable as a result of this legislation.

Also, hedge funds and other speculators will find alternative targets. If a financial stock deserves to be priced lower, then it should trade at a discount to other more profitable companies. By isolating 19 companies, the SEC has invited vultures to the party as hundreds more are now fresh targets that are not protected by the 30-day rule.

Don’t blame the hedge funds for the woes afflicting the financials. The real blame falls on poor financial supervision, poor government regulation, and rogue CEOs that went absolutely wild issuing mortgages to sub-par applicants.

And don’t forget Wall Street. Investment banks, the largest of which are now protected by the Feds with the new short-selling rules, where the largest issuers and innovators of mortgage-backed securities tied to synthetic derivatives.

Source: What the SEC Really Accomplished with Their New ‘Short-Sell’ Rule