Here is an interesting exercise for investors. Do a search on the phrase “company attacked by short-seller”. Such a search will yield a long list of entries. On Google, here is what appeared at the top of the list recently:
Short Seller Attacks Straight Path Communications And Shares Fall 12 Percent
Short selling shares an aggressive tool to influence companies
Short-seller Glaucus steps up attack on Quintis
Short Sellers’ Attacks on Listed Companies: Are They Immune to Risks?
Short sellers attack Japanese groups in Apple’s supply chain
Get the picture?
For newer or less sophisticated investors: first definition of terms. What is short selling? “Shorting” is the opposite of long investing. It is a bet that the price of a particular company will go down rather than up.
The mechanics of shorting alone point to the dubious nature of this financial practice. In order to short a stock, the short-seller must “borrow” shares from a legitimate long investor – almost always without either the knowledge or explicit permission of this long investor. The short-seller borrows the shares of the long investor in order to bet against that long investor.
By now, all serious investors will have seen numerous stories appearing in the media about “short-selling attacks”, with their frequency rapidly increasing. This leads to an obvious question: how and why did short-selling ever become a part of markets?
The “how” component traces back 400 years to Holland. A wealthy Dutchman named Isaac Le Maire is credited with originating this odious practice. At the time he engaged in his predatory behavior, there was only one stock – the Dutch East India Company.
There were no official markets for stock-trading at that time, let alone market regulators, so there was no one to stop Le Maire from engaging in his “trading”. Initially there was no problem…for about ten minutes. Then what happened?
An article titled The Spicy History of Short Selling Stocks is illuminating:
Isaac Le Maire started out on the inside. He was one of the directors of the Dutch East India Company, but there was some dispute over money that got ugly. The details are unclear, but the upshot was that Le Maire was cast out of the company and banned from the spice trade. Le Maire apparently wanted revenge. He hatched a plan to take down the Dutch East India Company. And even better, make money at the same time by placing a bet that the stock price would drop. The bet itself - the short - was fairly easy to do. Back in those days, you could bet that, say, the price of grain would drop. Le Maire did the same with shares of the Dutch East India Company - bet they would drop in value. Of course, there was no stock market back then. Financial transactions happened on this bridge in town. Apparently, trading was very physical. To negotiate a price one guy would put his hands out, palms up, shout out an offer, someone else would shout a counteroffer and slap his hands…
Then, as today, shorting was perfectly legal. Economists says it's even a healthy thing to have in a market, but what Le Maire did next would be considered unethical today, and it was 400 years ago. He lied. Le Maire started spreading rumors, things that would drive the stock price down. [emphasis mine]
That explains how we have short-selling: a very rich person with a grudge wanted revenge, and there was no one and nothing to prevent his clearly criminal conduct. This certainly begs answering the other half of the question: why do we have short-selling, when the very first example of shorting was clearly intentionally predatory and unethical conduct?
We can thank the bankers for this, along with our “market regulators”. The bankers came to these so-called regulators and told them that we needed short-selling in our markets. It would provide “better price discovery”, lied the bankers.
In all of the decades since, where short-selling has officially been entrenched in our markets as (supposedly) legitimate behavior, there has never been any valid evidence introduced that shorting produces better price discovery. However, the evidence that shorting is predatory and unethical conduct which should never be allowed in markets dates back 400 years, and the evidence gets louder each year.
Given the obvious predatory and unethical potential of short-selling (which has been in the public domain for four centuries), the only possible manner in which short-selling could ever be legitimately incorporated into markets is if it was accompanied by ultra-vigilant regulation – to prevent such predatory/unethical conduct. Instead, our pretend-regulators provide virtually no regulation of shorting at all.
Proving this assertion can be done with two words: naked shorting. Even our regulators acknowledge that naked shorting is totally illegal – yet they do practically nothing about it. At any given moment, $10’s of billions of naked shorting is present in North American markets with virtually zero enforcement against this illegal conduct.
For readers not familiar with this crime, naked shorting is a euphemism which equates to counterfeiting shares. As previously noted, to legally engage in a short trade the short-seller must “borrow” the shares of a long investor. With naked shorting, the short-seller makes no effort to borrow shares first. This makes the short-selling trade totally illegal and it makes the crime of short-selling identical to counterfeiting.
In the realm of criminal law, counterfeiting is regarded as one of the most-serious white-collar crimes. In the realm of public markets, our (so-called) regulators treat the counterfeiting of shares somewhat less seriously than jay-walking.
Pure criminality. No enforcement against naked shorting. When it comes to the sort of lying-and-manipulation in which Le Maire engaged 400 years ago, it is virtually the Wild West in our markets.
The onus is on the victim to prove that the short-seller has intentionally engaged in predatory/dishonest/unethical conduct. This is outrageous. As already explained; for 400 years we have known that short-selling could never be allowed in our markets unless strictly regulated.
This demands a reverse onus. In any legitimate market, a Short Seller who wanted to drive down the value of legitimate businesses (sometimes destroying those businesses) would have to prove the legitimacy of every negative assertion that was made to manipulate the price of that company lower.
If we can’t even trust our regulators to police naked shorting, we certainly cannot trust them to police the malicious manipulation of stocks via lying (i.e. “spreading rumors”). Short-selling must be banned – immediately and permanently.
We can reach an identical conclusion through parallel reasoning. While there has never been any evidence produced that shorting produces better price discovery in markets, there is an abundance of evidence that excessive shorting destroys markets. The most obvious evidence is the silver market.
(click to enlarge)
In proportionate terms, the short position in the silver market is gigantic compared to any other commodity market on the planet. It’s roughly 4000% larger than the short position in the oil market. What has been the effect of this gigantic short position?
It has destroyed the entire sector. It was this shorting which was largely responsible for dragging the price of silver to a 600-year low in real dollars. In turn, manipulating the price to this extreme level bankrupted 90% of the planet’s silver mines and silver mining companies.
The result of this extreme, ruthless, and permanent attack on the silver market by the Silver Shorts is that silver has been pushed into a permanent supply deficit. This is no price discovery in the silver market and there has been no price discovery for 30 years – if not longer.
Long investing builds markets. Shorting destroys markets (and companies). We have known this for 400 years. There was never a legitimate argument to allow short selling in our markets. The harms from short-selling are obvious, extreme, and multiplying by the day. It is time to ban short-selling – forever.