Double standard

I don’t pretend to know one way or another whether the practice of naked short selling is ethical.  But it sure seems to this casual observer that the government’s new decree limiting the practice amounts to an egregious case of playing favorites.

First though, let’s back up a bit.  It seems this subject has even a lot of knowledgable people confused — from left-leaning economist Dean Baker to Wall Street Journal personal finance columnist Brett Arends.  They fail to make the distinction between regular short selling — borrowing and then selling a stock on a bet it will fall in price, then buying back the stock at a lower price and returning the borrowed shares — and naked short selling, in which you never actually borrow the shares to begin with.  There might be squawking about short selling in general, but it’s naked shorting that the SEC is cracking down on.

Of course as both Baker and Arends point out, there’s nothing wrong with regular short-selling; indeed it performs a valuable role.  But there’s not enough time in the day for me to figure out the ethics of naked shorts, and being a rather conservative type of investor, I have no practical need to do so.  Professor Michael Rozeff thinks that if companies don’t like naked short selling, “they can either devise a restriction on that stock or they can find an exchange that makes that a facet of listing.”  On the other hand, if a company has 60 million shares outstanding, and proxies representing 80 million shares show up at the annual shareholder meeting because of naked short selling, it sure seems like someone’s committing wrongdoing.

In any event, for the SEC to crack down on naked short selling in only one sector of the market — the one that happens to benefit most from the actions of the Plunge Protection Team in which the SEC chairman is a key figure — is an outrage.  The WSJ reports:

Critics of the SEC’s move Tuesday asked why certain financial firms were being protected — but not the broader market — especially when many of those firms are also active short sellers.

“For heaven’s sakes, they’re the very ones we believe have been doing this…to thousands of public companies,” said James “Wes” Christian, a lawyer with Texas law firm Christian, Smith & Jewell, who represents companies who have filed lawsuits relating to short selling.

So now we have one standard for the companies that grease the skids for naked short selling… and a different standard for everyone else (including junior gold miners — naked shorts is one of the reasons some experts cite for the fact juniors haven’t nearly kept pace with majors or bullion over the last year).

So what do you have to say?  Is naked short selling OK or is it an act of theft?  Let rip in the comments.

Update: Dan Amoss weighs in on the question in today’s 5 Min. Forecast.