More evidence favoring short-selling

I have often criticized regulatory attacks on short-selling and cited evidence of short-sellers' positive effects on market efficiency, e.g., here. Here's some more: Karpoff & Lou, Do Short Sellers Detect Overpriced Firms? Evidence from SEC Enforcement Actions:

We examine short selling in the stocks of firms that subsequently are identified by the SEC as having misrepresented their financial statements, and report three findings. First, abnormal short interest increases steadily in the 19 months before the misrepresentation is publicly revealed. The amount of this increase and the level of short interest immediately before public revelation are positively related to the severity of the misrepresentation. Second, the speed with which misrepresentation is publicly revealed is positively related to the level of short interest. And third, there is no evidence that short interest facilitates a downward price spiral when bad news hits the market. To the contrary, short selling decreases the amount by which prices are inflated by these firms' misrepresentations, thus limiting uninformed investors' losses when they purchase shares during the misrepresentation period. Overall, this evidence indicates that short sellers anticipate the eventual discovery and severity of financial misconduct. Short selling also conveys external benefits to uninformed investors, by helping to detect financial misconduct and by keeping prices closer to fundamental values during periods in which firms provide incorrect financial information.

Comments

[Chaim Nutzman]

You might want to consider that the predictive quality of the short-selling in question is self-fulfilling in nature; i.e., that it is being done by those who are not just suspicious of fraud, but are actively involved in trying to unearth it, such as plaintiffs' class action lawyers and their friends and colleagues in the invesment community who are involved either as named plaintiffs or to-be-paid consultants.

[Michael Webster]

I agree with you about short selling. Do you know what abuse the SEC thought that they were addressing with the uptick rule regarding short selling?

Thanks