Short Selling in a Financial Crisis: The Regulation of Short Sales in the United Kingdom and the United States

McGavin, Katherine | January 1, 2010

In a well-regulated market with minimal risk of abuse, the liquidity and information efficiency benefits of short selling far outweigh its potential harm. Contrary to the recent hostility short sellers face from market regulators and the popular press, short sellers in aggregate are neither market villains nor agents of destruction. While a small minority of short sellers have exploited lax regulation and inattentive enforcement of anti-abuse rules to manipulate stock prices and earn substantial fees, these rare episodes suggest that the world’s major capital markets need better enforcement of existing rules and not new rules per se. The failure of market regulators to prevent abuse and manipulation of stock prices by short sellers and curb naked short selling reflects a failure of enforcement, not bad underlying policy. This comment outlines past attempts to regulate short selling, explains the emergency regulations enacted in 2008 in response to the financial crisis, and offers a series of recommendations for policymakers as they contemplate a new era of short sale regulation designed to match the pace of modern capital markets and the character of modern investors.