A recently published study by researchers at the University of Chicago and the University of Toronto examined 216 corporate fraud cases between 1996 and 2004. Shorts uncovered 14.5% of those frauds, not far behind the 17% that were exposed by whistleblowers within companies. And what about the SEC? It uncovered just 6.6% of the frauds.
Looking back, it’s also now clear just how right the shorts were about the poor condition of U.S. banks and investment dealers before the 2008 financial crisis. A recent bankruptcy examiner’s report shows that officials at Lehman Brothers created an off-balance sheet mechanism to shift liabilities off the books, concealing weaknesses caused by Lehman’s own recklessness. As Michael Lewis correctly points out in his latest book, The Big Short, the problem is not that regulators allowed Lehman to fail, but that it was allowed to succeed.
In the months before Lehman collapsed in September, 2008, Fuld complained that the firm was being targeted by so-called naked shorting, in which traders put in sell orders for shares without even borrowing them first. A study by three University of Oklahoma researchers published in May, 2009, examined trading in several major U.S. financial stocksâ€”including Lehmanâ€”before and after the SEC imposed a ban on naked shorting of those issues in late July and early August in 2008. It found â€œno evidence that stock price declines were caused by naked shorting.â€
The trouble was that U.S. regulators took the complaints from Lehman and other companies far too seriously. In fact, that SEC order actually hurt investors. A study by Arturo Bris, a professor at IMD business school in Switzerland, concluded that the order dampened trading in the stocks, which widened the spread between market bid and ask pricesâ€”a spread that investors have to cover. Erik R. Sirri, who ran the SEC’s division of trading and markets during the crisis, recently conceded that the decision to restrict short selling was based on political considerations.