The drastic new rules prohibiting short selling in financial firms have been ordered. The full text of the SEC statement is available here. In summary:

IT IS ORDERED that, pursuant to our Section 12(k)(2) powers, all persons are prohibited from short selling3 any publicly traded securities of any Included Financial Firm.  Similar to the Amended July Emergency Order, we are providing a limited exception for certain bona fide market makers. We believe this narrow exception is necessary because such market makers may need to facilitate customer orders in a fast moving market without possible delays associated with complying with the requirements of this Order….This Order shall be effective immediately and shall terminate at 11:59 p.m. EDT on October 2, 2008, unless further extended by the Commission.

This statement begs the question of how the inverse funds will handle the new rules.  There are two major competing ultra short financial ETF’s, the Proshares ultra short (SKF), and the Rydex 2x Inverse financials (RFN).  As of the time of this writing, neither of these firms has issued a statement on their website.  I called each of them this morning and they both stated that they are unaffected by the new rules.  They achieve their results not through actually shorting the markets, but from derivative swap contracts with counterparties.  Unfortunately, neither of them disclose who those counterparties are, and thus each of them do have counterparty risk of default.

On a side note, proshares and rydex list their holdings completely different.  It is crystal clear that proshares is using derivative swap contracts in their ultra short funds.  But from the Rydex holdings, it appears as though they are double short the indexes.  But despite how Rydex lists the holdings, they contend that they are actually using derivative swaps, and not actually shorting the indexes.