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A short-selling scapegoat finally gets a break

By New York Times
Published December 19, 2006

"Short selling," thundered Rep. Adolph Sabath, D-Ill., "is the greatest evil that has been permitted or sanctioned by the government that I know of." It was, in short, the cause of the Great Depression.

He was speaking at a House hearing in 1932 on his bill to make short selling illegal.

Had such a ban been in place in 1929, he said, "I am satisfied that not one-half of the banks that were closed nor of the factories or other plants that were closed would have been closed, and there would not be 8-million or 9-million people out of employment, nor would there have been more than 20-million people who lost all they possessed, due to the manipulation on the stock exchanges."

Sabath's bill did not pass. But soon after the Securities and Exchange Commission was established in 1934, it sought to put limits on short sales. No longer could such sales be made any time a trader felt like doing so. Sales could be made, though, but only when the price was rising.

That rule, with minor adjustments, has survived, a monument to Depression-era distrust of what were called "bear raids."

This month, though, the SEC proposed dropping the rule.

Those most exercised over the evils of shorts - and their comments sound very much like some of the bombast of 1932 - say they have nothing against legitimate short selling. It is naked short selling they despise.

Naked short selling is selling stocks short without borrowing them. That leads to failures to deliver shares, although there is no agreement on just how bad a problem that is.

The SEC adopted a rule - called Regulation SHO, for short - in 2004. It led to the release of lists each day of stocks with a large number level of failures to deliver shares. This year, the commission proposed amendments that would toughen the rules, making it harder to execute naked short sales or to keep the positions open. Wall Street has protested that the changes could go too far, while some companies call them inadequate.

SEC chairman Christopher Cox has tried to keep everyone happy and to get unanimous votes on a commission that was badly divided before he arrived.

But that is not always possible, and the revised rules on failure to deliver, when the SEC produces them, will be a test of his ability to find compromises.

Normal short selling is about to become easier to do. But now, as in 1932, there are plenty of people who see the most aggressive short sellers as part of a Wall Street conspiracy to drive down prices.

[Last modified December 19, 2006, 00:45:18]