Short Sellers: Quit Whining and Follow The Rules

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 Bankstocks.com.

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

Comments

[fxtrader07:]

You are spot on, Tom. But don't expect anyone associated with hedge funds, naked short sellers and the cramer friends and media network to stop complaining about 'how bad shorts are being treated by the sec and the m,edia'. Even though the opposite is true. CNBC, Cramer and Co give the Ackmans Einhorns, Chanos, Tilsons etc etc. every time they want to talk and write stocks into the abyss. The SEC requires long positions in stoicks by funds to be reported - but incidentally, short positions need not. heck, if you own more than 10% of a stock you count as an insider and face severe reporting obligations and trading restrictions. But you could virtually be short 40 or 50% of a stock's float and need not even disclose it. And, no long holder, even a manipulator has ever destroyed the company he held . But naked shorts have killed many a fine company by artificially shutting the capital markets down for them. It's high time take on those crooks. just don't count on the SEC for it - it had all the time tio do so and never did anything about it. Even in crisis, all they do is to restrict naked shorting of select darling financial companies, which inciodentally, may be among the biggest naked shorters of other companies, actually. IT's a scam and it will go on as those whjo make fortunes on it have lots of influence at Capitol Hill, the SEC, the CFTC and the cramerized fincial entertainment media. It's just another obvious sign of decay and degeneration of the USA.

2008 Aug 27 04:21 AM

[glassbox:]

Great article Tom. and very well argued.

2008 Aug 27 10:25 AM

[venividivici:]

Good article Tom. Personally, I don't think that you should be allowed to short stocks at all. I think it is unhealthy. It's like allowing people to bet on a horse to lose a race rather than win it. It is a lot easier to manipulate a negative result than a positive one.

2008 Aug 27 11:04 AM

[User 251894:]

I wish I could short Second Curve Capital.

2008 Aug 27 11:24 AM

[glassbox:]

venividivici, its worse than betting on a horse to lose. Its like borrowing a gun and using it to shoot the owner, and returning it only when the owner's dead. It's object is destruction and thrives on atrophy - sometime humanity is trying so hard to go against.

2008 Aug 27 12:33 PM

[Cara Ellison:]

Just a technical observation: Chanos and Bethany McLean were working hand in hand to bring down Enron. He had *planned* to attack Enron stock during his annual Bears In Hibernation meeting, and had shorted billions of dollars of stock. He then told McLean that Enron's financial statements didn't make sense. Bethany, being a hungry young journalist, took his tip to heart and began to scrounge for proof of Chanos's comments.

It's not correct to divide them when analysing Enron.

2008 Aug 27 02:50 PM

[Value Dope:]

How can anyone defend Enron? The management team deserved what they got, yes Skilling is burning in hell where he belongs and Fastow is prob grabbing his ankles as he also deserves. They defrauded people of BILLIONS.

I do agree with Tom Brown, problem is there are too many wannabe shorts out there cause anyone can short anything and look like a genius in the current environment.

2008 Aug 28 10:04 PM

[User 256538:]

How can anyone even defend Naked Short selling ? Outside of the stock market, failing to deliver what you sold is fraud. If a district attorney decides to not go after a person who sold you a car, took your money then walked away is a partner in crime. The SEC is a partner in the crime of Naked Short selling by not enforcing the law's of the land.

2008 Sep 05 07:14 PM

[Cara Ellison:]

I defend Enron because it was a good company. There was no fraud at Enron; Enron was defrauded by LJM, a fact that nobody seems to grasp. And then the prosecution of the executives was just egregious. There were threats and coercion of both the defendants and anyone who might help the defendants.

I still heart Enron.

2008 Sep 08 12:05 AM

[Cara Ellison:]

I defend Enron because it was a good company. There was no fraud at Enron; Enron was defrauded by LJM, a fact that nobody seems to grasp. And then the prosecution of the executives was just egregious. There were threats and coercion of both the defendants and anyone who might help the defendants.

I still heart Enron.

2008 Sep 08 12:05 AM