Ending Stock Market Manipulation

by Tom Donohue

"Naked short selling" and the impact of manipulative behavior on investors and markets have been big news recently. Unfortunately, there’s also been a lot of misinformation about what it really means for investors.

First, remember that legitimate short selling is a good thing. It is simply a bet against the future value of a stock, and it helps markets deflate "irrational exuberance."

But people who make bets sometimes try to cheat. "Pump and dump" is a well-known way for criminals to use rumors to illegally increase stock values. (It was even featured on the Sopranos.) The same thing in reverse is called "short and distort," where people spread false bad news about a company in order to make short positions pay off. This can have a terrible impact on good companies and their investors for long periods of time. Some bad guys even send false information to the SEC in an attempt to spawn investigations that will drive down a stock’s price for years.

The U.S. Chamber has long complained that the SEC has not done enough to stamp out short and distort schemes.

SEC Chairman Cox took a few small steps last week. He called for more investigations into rumor mongering on Wall Street. He also implemented temporary process limits that should reduce naked short selling in 19 high-profile financial stocks. Naked short selling is a technique used by short and distort manipulators that involves selling stock that may not even exist.

Neither of these actions were earth shattering, but at least the SEC acknowledged some problems. There have been companies parked for years on the "Threshold List" of those victimized by naked short selling. But much tougher and more extensive enforcement actions are needed. Enforcement officials need incentives to pursue these tough cases—as it’s often more tempting to focus on catching companies with meaningless accounting errors that are willing to pay big fines. Additional procedural safeguards must also be put in place to make fraudulent naked short selling and other manipulative techniques harder, while preserving legitimate investors’ ability to easily short stocks.

We applauded the SEC’s recent actions. However, crime doesn’t sleep and many companies and investors remain vulnerable to short and distort frauds. The SEC should extend and expand its new measures to protect additional companies. Then, it should work quickly to find permanent solutions to rid our markets of the scourge of short and distort.

Comments

[ChamberPost]

To Birdseye -

So you think that naked short selling – where sellers act illegally to sell something they don’t even have – is good for the market? Doesn’t inappropriate inflation of stock supply distort the supply and demand curve for the stock? Naked short selling impedes the proper functioning of markets, and regulators should do what they can to restrict it.

If you look at the Chamber’s multi-year advocacy on this issue, we have been saying for a very long time that this is a broad-based problem, certainly impacting more than 19 financial stocks. In fact, the hardest hit companies tend to be smaller, more entrepreneurial firms with more limited stock floats. We certainly haven’t said that 19 was the optimal number – and, as to the SEC’s motivations for their specific list, you should ask them.

Regarding the value of legitimate short-selling, I would point your attention to the following excerpt from the original post: "First, remember that legitimate short selling is a good thing. It is simply a bet against the future value of a stock, and it helps markets deflate 'irrational exuberance.'"

(David Chavern)

[Birdseye]

Mr. Donohue:

I am puzzled that the AMCC does not speak out loudly against such futile, if not unconstitutional, attempt to boost the stock prices of 19 financial institutions. Why not enforce the nacked short sale prohibition for ALL equities? Why are Wall Street houses excempt? The intent of the Treasury Dept under the guidance of Wall St. is quite clear: Boost the stock prices of the badly managed institutions in order to provide a higher base for further equity issuance. Hence the selectivity. As long as the government is a tool of Wall Street helping to distort the free markets, more dislocations will lead to more inefficiencies in the economy, as the constant meddling in the financial markets by the Federal Reserve in the past has shown.

Shortsellers in fact put a floor under the market, for they buy back when the rest of the public panics, and as such provide a buffer. Moreover, if shortsellers depress a price too much, smart investors will recognize value and the shortsellers will not succeed since they, by far, represent a tiny minority of the investing public.

It appears, that whenever markets adjust for good reason there are the Cassandra cries from Wall Street, but when markets embellish in Irrational Exuberance bubbles all is fine in Lake Wobegone. Perhaps a more balanced approach would let the free markets do its job, so that they can move back to equilibrium in due course, rather than creating one bubble after the other.