Answer: Prison, Disbarment, and Disgorgement of Profits

The question:

What (if anything) is an appropriate regulatory response to the phenomenon of plaintiffs', their lawyers', or their confederates' selling short the stock of companies against whom they soon plan to file securities actions?

Check out this very timely discussion here.

Comments

[KipEsquire]

Yahya's piece is about as wrong as is humanly possible.

It is well-settled law that transacting in a security just to make a buck, rather than to manipulate the stock price, is never a Rule 10b-5 violation, even if in fact the stock price ends up being "manipulated" (i.e., affected). This includes short selling.

While we're on the subject, what about long selling? If it happens to be the case that a plaintiff owns the defendant's stock, must the plaintiff consider himself enjoined from selling it as a result of the litigation? That cannot possibly be the case. And there should be no distinction in this context between selling long and selling short.

Finally, since the plaintiff is (we are assuming) not an insider, fiduciary or agent of the defendant, there is no duty not to trade based on the possession of material non-public information. There is no misappropriation or "tipping" of any information, hence there should be no bar to trading.

[Dylan]

Kip, yours is the theoretically correct answer, and it would even BE correct in a world without securities actions that have little or no merit. But in the real world permitting short selling potentially opens yet another method to reward nuisance suits - they don't even have to get the management to cough up a small settlement if they scare the market enough with the initial (usually vague) accusation/pleading.

Some nontrivial percentage of suits in this area are clearly analogous to spreading false information to manipulate a stock. It's not the trading that's manipulative, but the underlying suit. Some regulation to limit abuses should be considered.

[Mahan Atma]

I think it highly ironic that Yahya identifies the source of the problem to be "excessive government regulation" and proceeds to recommend as a policy solution... increased government regulation.

And I also think he's wrong about this being a 10b-5 violation, for the same reason listed above (lack of fiduciary duty).