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IPFS News Link • Stock Market

When Is Short Selling Fraudulent?

• by Robert P. Murphy

In this article I'll review that particular claim, as well as another seemingly dubious practice, so-called naked short selling. My conclusion is that shorting more than the total outstanding shares isn't perverse or fraudulent, whereas naked short selling—depending on the context—might be.

A Review of Short Selling

Before diving into the specific variants, let me first explain the basics of short selling and why it can be a healthy activity in a free market. (In this section I reproduce material I published in an earlier article.)

In general, those who speculate in the stock market provide a "social" service—if they profit—by steering asset prices to their correct levels, as I explain in this article. If investors believe a particular stock is underpriced, they can buy shares of it and then unload them once the stock has met or surpassed what they view as its "proper" level. In this way, the speculators push up the (initially) underpriced stocks, helping to correct the "error" in the original price structure. Notice that it doesn't matter whether the investors who notice the initial underpricing own any of the stock at the outset.

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