Ethics & the Role of Short Selling

It's safe to say that short sellers aren't the most popular people on Wall Street. Many investors see short selling as "betting against the home team." Some hold short sales as a major cause of market downturns, such as the crash in 1987. There isn't a whole lot of evidence to support this, as other factors such as derivatives and program trading also played a massive role. 

On the other hand, it's tough to deny that short selling makes an important contribution to the market. It provides liquidity, drives down overpriced securities, and generally increases the efficiency of the markets. Short sellers are often the first line of defence against financial fraud. While the conflicts of interest from investment banking keeps some analysts from giving completely unbiased research, work from short sellers is often regarded as being some of the most detailed and highest quality research in the market. It has been said that short sellers actually prevent crashes because they provide a voice of reason during raging bull markets.

However, short selling also has a dark side, courtesy of a small number of traders who are not above using unethical tactics to make a profit. Sometimes referred to as the "short and distort," this technique takes place when traders manipulate stock prices in a bear market by taking short positions and then using a smear campaign to drive down the target stocks. This is the mirror version of the "pump and dump," where crooks buy stock (take a long position) and issue false information that causes the target stock's price to increase. Short selling abuse like this has grown with the advent of the Internet and the growing trend of small investors and online trading.