Why has a bipartisan group of U.S. senators instructed the Securities and Exchange Commission to consider additional restrictions to curb “naked” short selling? Although there have been a lot of claims that abusive short selling contributed to our financial calamities, there’s been almost no supporting evidence.
A recent academic study looked a naked shorting and found that it isn’t widely used to manipulate markets. If anything, naked short selling may actually be making markets more efficient by creating additional liquidity.
So why are lawmakers focusing on this now? It’s certainly not an effort to “adequately protect shareholders’ rights,” as Senator Chuck Grassley claimed. Diversified shareholders benefit from market efficiency, and don’t have much of an interest in the performance of one stock or another. Non-diversified stock pickers also benefit from market’s efficiently pricing shares prior to their purchases.
What’s most likely really happening is a mix of symbolism and special-interest politics. Politicians love to make symbolic moves that impose no political costs but make it look like they are doing something for their constituents. Typically they exploit public ignorance so that people don’t notice they are addressing phony problems. They also love delegation to bureaucrats, which allows them to escape accountability for actual results.
Corporate executives tend to hate short-sellers, and want use their connections to politicians to inhibit short-selling. And this, really, is what’s going on here. While it’s not quite as blatant as the short-selling ban we saw last year, the crack down on naked shorting is really meant to increase the costs and risks of short-selling generally.
Both the strict pre-borrow requirement that some lawmakers are urging and the return of the uptick rule would increase the costs of short-selling. Short trades will take longer to put in place, and broker dealers will likely charge additional fees. Both create the risk of legal liability for violations, which will add to the costs of being in the short-selling business for even the most scrupulous short-sellers.
Far from being a pro-shareholder move, this is actually a case where lawmakers are urging the SEC to adopt a rule that would damage shareholders by making the markets less efficient and penalising the best corporate watchdogs around. Short-sellers called the destruction of Enron, Fannie Mae and Lehman Brothers before the broader markets or regulators caught on.
“This is part of a general government war on the shorts, which as I’ve argued…is also a war on market efficiency,” law professor Larry Ribstein writes at Ideoblog. “Neither business executives nor legislators really want the market to report accurately on how they’re doing — just favourably.”