September 10, 2008
Proponents of short-selling argue that they both add liquidity to the system and also add an element of balance to "exuberant or irrational" price inflation. However, what has proven more the case is that such short-selling exacerbates price declines and effectively erodes capital formation capabilities of the company targeted by short sellers.
Moves by the SEC to require the "finding" the shares and/or receiving actual delivery of the shares prior to shorting do not really solve the root of the problem. The root is that most securities are be held in street name (enabling rapid settlement of transactions) and most investors, having margin accounts with brokerage firms, are required to allow their shares to be borrowed by the firm for delivery to short-sellers.
Likewise, mutual funds and pensions (which actually hold shares on behalf of individual investors) likewise lend shares to short-sellers. In essence, holder of shares have their own shares used against them (for value destruction by short-sellers) — nothing short of a redistribution of wealth by the rules of the "professional" market players.
The SEC needs to focus on the issue of borrowing shares to begin with. An investor, who already must pay a brokerage firm for any money borrowed for margin, should not also be require to give over control of their long holdings as well. Furthermore, institutions should not be allowed to use the shares they hold with a fiduciary responsibility to the purpose of destroying price through excessive selling by shorts unless with explicit consent of the individuals for which they hold the shares.
This explicit consent must not be required to hold an account with a brokerage firm or institution nor should it be buried within the legal verbiage of the account agreements.
Only when shares must be explicitly borrowed from the actual shareholder (or ultimate beneficiary of a company´s shares) will short-selling be an "honest" tool of the marketplace.