Corporate Governance

The Ban on Short Selling and the Failure of Regulatory Intervention

By J. Robert Brown

When the market was plummeting and investment banking firms were dropping like stones, criticism began to mount about the role (or non-role) of the Commission.  The Agency gave the appearance it was standing on the sidelines while the financial markets burned.  Chairman Cox was challenged for attending a birthday party during the weekend of the Bear Stearns buyout while officials from Treasury and the Fed helped hammer out a deal. 

Determined not to appear inactive (or "peripheral"), the Commission stepped into the turmoil and banned short selling.  The Agency did so without any firm evidence (at least that it published) demonstrating that short selling was a significant cause of the turmoil.  Moreover, the Commission almost certainly did so in  violation of its own statutory authority.

The latest bit of information seems to confirm that the ban on short sales had little if any impact on the market.  According to a recent study:

• We find no strong evidence that the imposition of restrictions on short selling in the UK or elsewhere changed the behaviour of stock returns. Stocks subject to the restrictions behave very similarly both to how they behaved before the imposition of restrictions and to how stocks not subject to the restrictions behave.

In other words, the evidence suggests that the ban was a non-event, playing little role in the turmoil.  In many ways, the conclusion is good news.  Some suspected that by banning short sales and evicting those with pessimistic views about stock prices, the Commission was actually exacerbating the volatility of the market.

The ban on short sales probably pleased some issuers and reduced press criticism of the Commission, at least for awhile.  But the administrative authority was questionable and the intervention in the markets extreme.  For a proud agency, it was an unfortunate response.

Full post as published by The Race to the Bottom on January 14, 2009 (boomark / email).