Congressman Barney Frank, D-Mass., and other government officials are pushing to “restore confidence” in the stock market by making it harder for investors to profit from drops in stock prices. Companies dependent on a rising stock market are supporting this regulatory push.
At issue is the practice called “short selling,” a legal and common practice in which the seller profits when a stock declines in value. Say you borrow stock priced at $100; you immediately sell it, putting $100 in your pocket. Then the price drops to $90, you repurchase the stock, then return it to the lender. You walk away with the $10 difference between what you sold it for and the cost of buying it again.
Needless to say, investors looking for stocks to short have a stronger incentive than anyone to seek evidence a company is overvalued or is misrepresenting its strength.
Short sellers have many enemies, and they have been blamed for some of the 50 percent drop in the stock market over the past nine months. Retail brokerage Charles Schwab has lobbied hard to restrict short selling, arguing that the practice is often manipulative. “Our customers believe the market’s been rigged against them,” Schwab spokesman Jeff Brown tells this column.
Frank’s call last month for new restrictions on short selling was answered last week by Mary Schapiro, chairwoman of the Securities and Exchange Commission, who proposed “uptick rules” similar to those that were repealed by the SEC in 2007. There are a few different proposed uptick rules, but generally they prohibit short sales unless the stock is at least momentarily rising.
Regulation advocates say they are trying to curb “market manipulation.” This happens, they say, because selling a stock creates the perception that it’s overvalued, and other traders then unload it, driving down its value.
Charles R. Schwab, founder of the firm, advocated regulation in a recent Wall Street Journal op-ed, “for the sake of our children and grandchildren,” but there’s a less lofty interpretation of Schwab’s motives. Schwab gets more customers when the stock market is rising, and so anything that can drag the market down is harmful.
But stock prices are sometimes too high, allocating wealth to less efficient corners of the economy. If short sellers sometimes bring down stock prices, that’s a healthy corrective.
Consider Enron. Ken Lay blamed his company’s collapse on “short sellers organized and working together and conspiring together.” But Enron was overvalued, and it was the short sellers — not federal regulators or credit agencies — who rooted out the fraud in the company, saving the economy from wasting even more wealth on a house of cards.
Short seller Jim Chanos, who helped bring down Enron (and profited from its collapse), has hired lobbying firm Porterfield & Lowenthal to resist the regulations under the banner of the Coalition of Private Investment Companies.
Leading the pro-regulation lobbying team is Aflac. The Georgia-based company’s top D.C. lobbyist, Gina Joy Rigby, has organized a group of companies to back uptick rules both on Capitol Hill and at the SEC.
Aflac, according to at least one study, has been a victim of “naked short selling” — an illegal practice in which brokers offer stock for sale in order to depress prices, while they have no intention of ever delivering that stock to the “buyer” — but it is pushing to regulate even “covered short selling,” in which the short seller has borrowed or has located the shares he is selling.
Rigby has been a generous Republican donor in the past, having given more than $40,000 to Republican committees. She also cut a $500 check to Sen. Saxby Chambliss, R-Ga., just before Election Day last year, and Chambliss was an original co-sponsor of the Senate bill to reinstate the uptick rule.
There’s a money trail on the Democratic side, too. Charles Schwab’s lobbyist on short selling restrictions is Larry Romans, who, in the last three elections, has given more than $90,000 to Democratic candidates, including $6,200 to Frank.
Aflac’s political action committee seems to fund everyone — giving to more than 60 Senate candidates in 2007 and 2008, often contributing to both sides.
The political investments of Schwab, Aflac and crew could pay off in regulations that suppress short selling, and this could deliver the “investor confidence” they want. But that confidence might be unwarranted if the market has trouble identifying overvalued stocks.
