August 6, 2009
Short selling and naked short selling are vicious methods used to kill companies that are weak or perceived to be weak. In the absence of short-sellers relentlessly pummeling these stocks down, many of these companies would be able to recapitalize or restructure and become profitable. In addition, by allowing naked short-sellers to ply their trade with impunity, several companies have been decimated. Last year there were many companies that were on the SHO list for more than 200 to 300 days. That kind of action will push companies quickly into bankruptcy.
Myth #1 Short selling provides price descovery. This is not true. Buyers and sellers who own or want to own the stocks provide price discovery. Short sellers exaggerate the prices up or down and increase the volatility. The greatest example is the fall of S and P 500 to 666 in March 2009. If you plot the monthly short interest of SPY with price, you will find that the main reason for SP 500 to fall to that low a value was the presence of short-sellers. For many beaten down stocks, simply plotting the short interest against the price for several months will tell the story of destruction.
Myth #2. Short sellers provide "liquidity". Liquidity is the common buzzword used to justify the manipulation of stocks by short selling.
However, it is clear that many individual traders and hedge funds make their living selling someone else's stock short. SEC may be considering the uptick rule to somewhat lessen the impact of short-selling on a company's stock. This would not be stringent enough to curb the deleterious effects of short-selling. If short selling is allowed, it should be controlled with limits, naked short-sellers should be prosecuted, and fundamental principles of property ownership should be followed.
If I buy a property, I am the owner of that property. Nobody should have the right to lend that property (stock) to someone else so it can be sold short. Thus, a basic rule that needs to be promulgated by the SEC is that no stock can be sold short without the permission of the individual owner of that stock. It should not be incumbent upon the owner to submit registration forms after the stocks are purchased to prevent their shares from being sold short.
In summary, short-selling exaggerates price movement in both directions to the benefit of the short sellers. Individual investors are cheated by this artifical price action. Companies that employ hundreds and thousands of people are destroyed by the downward spiraling of stock prices due to incessant short selling. The SEC must protect companies and investors by promulgating rules to curb this practice.