An emergency SEC rule that will go into effect on Monday prohibits naked short selling of 19 financial companies including Freddie Mac and Fannie Mae. The SEC expects the rule to curb illegal shorting practices that several financial firms claim are causing unnecessary panic and capital market dysfunction.

Short selling is the process of borrowing shares, selling the shares immediately, and then buying the shares back in the open market after the price has gone down (in order to return the shares to the lender). The borrower pays a fee to the lender and earns the difference between the sale price and the purchase price (minus transaction costs). Short selling is a prediction that a stock is overvalued and will decrease in value, and proponents argue that it is an important check on inflated stock prices.

Naked short selling occurs when short sellers and the entities loaning the shares (market makers and brokerages) do not identify whether shares are …