KEY POINTS:
US regulators are about to take their first legal action against a hedge fund which practises the controversial "naked short selling", which critics say distorts the stock market and drives down company share prices.
The New York-based Sandell Asset Management has been told by the Securities and Exchange Commission that it faces a civil lawsuit for trading in shares affected by the fallout from Hurricane Katrina last year.
A short-seller normally borrows shares and then sells them, betting they can be repurchased later at a lower price. A "naked short" is when the sale is made without borrowing the shares.
The practice has caused a furore in the US, thanks in part to a high-profile campaign by the online retail entrepreneur Patrick Byrne, who claims shares in his company, Overstock.com, were driven down by a conspiracy of naked short-sellers.
Congressmen investigating the hedge fund industry have zeroed in on short-selling, and naked shorts in particular, as they examine ways to prevent the offshore industry manipulating the US stock market.
The hedge fund industry has argued that short-selling improves market efficiency.
The SEC promised to overhaul rules around naked shorting. But it does not believe short-sellers can be forced to borrow stocks to cover their position. It is focusing on traders who repeatedly fail to deliver stock they have sold.
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