Punishing Short-Sellers

If you’re a CEO and you’re upset that your stock is going down, never, ever,

blame short sellers for your woes. No one will sympathise, and the financial

press will have a field day tearing you apart. (See,

as a prime example, Overstock CEO Patrick Byrne.)

Generally, short-sellers are an important part of any efficient market, and

regulators should embrace them rather than punishing them. So what is the SEC

doing fining UK hedge fund GLG Partners $3.2 million over illegal

short-selling? (Reader Matthew Tubin sent me the link and

asked what the difference is between legal and illegal short-selling.)

The SEC has a huge set of rules regulating short-selling. It’s called Regulation

SHO, and you’re more than welcome to read all 30,000 words of it here.

Most short selling is allowed, but some short-selling is not allowed, and if

you’re an active trader in the markets it definitely behooves you to know the

difference. In the specific case of Rule

105, which GLG is accused of violating, you can’t short a stock into a public

offering, and then cover your short with shares you receive in that offering.

Can you short a stock into an offering, buy stock in the offering, and then

unwind both positions in the market at the market price? I have no idea: you’d

have to ask a lawyer about that one. But what does seem clear is that participants

in the market need to have a very detailed knowledge of the arcana of Regulation

SHO: I do believe GLG when it says that "it did not understand the rule".

In general, time and money spent worrying about compliance is wasted time and

money: it’s an inefficiency in the market. And rules against short selling in

general don’t seem to really help market efficiency and transparency very much

– if anything, quite the opposite. So while I have little sympathy for

GLG – they’re certainly big enough to know what they’re doing –

I also wonder whether this kind of fine serves any useful purpose.

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