Short Sellers: Quit Whining and Follow The Rules

by: Tom Brown

Doug Kass’s ode to the market-efficiency-enhancing benefits of short selling in the FT last week would be more convincing if the list of short-selling all-stars he includes had some actual investors on it. But it doesn’t. Jim Grant is a journalist, not a money manager. Nouriel Roubini is a finance professor. So’s Robert Shiller. Yes, Jim Chanos had a hand in bringing Enron to light, but given the work Fortune’s Bethany MacLean and others did on the company at the same time, Enron would have blown up on schedule even if he hadn’t shorted a single share. So on Kass’s evidence (and despite his assertion) the shorts haven’t done a whole lot to improve the market’s ability to find a clearing price.

I have no problem with shorting stocks; the fund I manage is short a number of them. But please, don’t tell me, as Kass says, shorts “provide an anchor of objectivity in an investment world populated by those more interested in rewards than in uncovering systemic risks.” Bull! Short sellers are no more objective or disinterested than longs are, and want to profit from their positions like everyone else. And, yes, they can be devious. By the nature of short-selling, as Marty Whitman points out, shorts are highly motivated to do whatever it takes, including lie and distort, to get their short positions to crack sooner rather than later. Public-spirited guardians of the truth these people are not. I don’t understand why they insist on preening.

And I don’t understand, either, their sanctimony every time the SEC announces it plans to simply enforce its rules regarding short sales. Those rules aren’t too restrictive, after all. You don’t even need to wait for an uptick anymore. All the agency wants now is for short sellers to actually deliver the securities they have sold. Simple, right? When I buy a stock, I deliver the cash I’ve committed on settlement day. Why shouldn’t short sellers be required to do the same thing?

Yet it’s all gotten people unhinged. To people like Doug Kass, the SEC’s move means the agency “seems to be implicitly blaming the shorts” for the walloping the financials have take over the past year and a half. Wrong. Given the magnitude of the credit crunch and banks’ attendant writedowns, it’s clear the stocks would have cratered whether anyone had shorted them ahead of time or not. For his part, Bob Lang says the SEC’s proposed restrictions “smack of regulation and government control” and “is a complete farce and runs in the face of pure capitalism.”  Jim Chanos complains about “overly burdensome and unnecessary regulatory provisions.”

Calm down, girls. Here’s a reminder: the trading of equities in the U.S. is governed by a set rules and regulations designed to ensure the markets here are fair, open, and transparent. You’re not allowed to trade on inside information, for instance.  You can’t trade for your own account ahead of your clients’. Depending on what type of investor you are, you might even face restrictions on what types of securities you can own, and in what size.

These rules are well-known. And, oddly, I never hear a peep of protest from the investors who are required to follow them. It seems to be only the short sellers who find rules a burden.

Here’s one more rule. If you short a stock, you have to deliver the shares at settlement. If you didn’t have to do that—if you could sell as much stock as you’d like without having to deliver anything—individual equities might become subject to manipulation, and market would lose some efficiency and rational-pricing pizzazz. And in fact, there’s evidence that just that sort of manipulation goes on. Take a look, for instance, at the “threshold securities” list the exchanges publish daily. It’s a list of stocks for which sellers failed to deliver 10,000 shares or more over the prior five trading days. Companies will get on that list and stay on for weeks. Zions Bancorp., to pick one name I know well, that escaped the bulk of the credit crunch, and whose fundamentals are improving steadily, has been on the list for nearly a month. That’s not the sign of random clerical oversight; more likely, it’s evidence speculators have targeted the stock and are attempting to manipulate its price via relentless selling.

Now the SEC proposes to more judiciously enforce Reg SHO—that is, insist that short sellers actually deliver shares at settlement--and the hyperbole machine goes into overdrive. You’d think from the howls that free enterprise as we know it is being threatened.

No, it’s not. The government just wants short sellers to play by the rules, the way everybody else has to. If shorts could just get over this crazy idea they have of themselves as noble, disinterested truth-seekers, they might realize that, and adapt. In the meantime, a lot of us would appreciate it if they could just tone down the whining.

Tom Brown is head of

Disclosure: See declared holdings for fund managed by author: Second Curve Capital