In his book, Too Big to Fail, Andrew Ross Sorkin explains how David Fuld, then CEO of now defunct Lehman Brothers, lobbied Chris Cox, then head of the Securities and Exchange Commission, to ban the short selling of stocks. Fuld complained that the short selling of Lehman stock was responsible for driving down its price, which made it impossible for Fuld to find an investor to purchase the investment bank or extend it capital required to survive, which further eroded the price of its stock.
Sorkin discuses the tenacity of David Einhorn, the president of Greenlight Capital, who was the largest short seller of Lehman stock. Einhorn believed that Lehman was falsifying the value of its assets, which meant it was grossly under capitalized and its stock price therefore artificially high. He kept selling the stock short and profited handsomely.
Regardless, Fuld won out in his pleadings with Cox, who temporarily suspended short selling in the stock market.
Now we find out that Lehman was indeed cooking the books and Einhorn's actions served to expose this discrepancy.
Markets are a means of revealing information - that information comes in the form of prices and profits. By short selling Lehman's stock, thus driving down its price, Einhorn exposed the information investors needed to make better decisions, and as I said earlier, he profited handsomely. That was a good thing. By thwarting short selling in an effort to protect Lehman, the information needed by investors to make sound decisions was no longer available.
Fortunately, the ban came too late to save Lehman, thus minimizing the loss to potential investors. Had the ban occurred sooner, more innocent people would have incurred great losses rather than Fuld and Lehman's stockholders, whose actions caused the demise if the investment bank and who deserved to pay the price for its demise. Short selling, which drove down the price of Lehman's stock, thus revealing pertinent information to potential investors, provided the requisite information needed by investors to keep them from being suckered into Lehman's ruse.
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