SEC and Short Sales

     Three hedge funds recently paid $2.4 million to settle charges of illegal short selling. (See SEC Press Release)  What they did should not be illegal.  The SEC has too many technical rules in to many contexts regulating short selling.  First let us be clear:  Selling short and then spreading false rumors to knock down a stock should be illegal and should be prosecuted.  However, selling short around market events or announcements should not.  The hedge funds sold short before "follow-on" offerings. 

     A follow-on offering is an offering that follows on the heels of a larger public offering of shares.  Sometimes the offering is a secondary offering, designed to put cash in the pockets of managers;  othertimes the offering reflects the additional cash needs of the issuer. 

     The SEC claims that short selling on the announcement of a follow-on offering but before the offering has been priced will adversely affect the price of the offering.  So what?  The announcement does have stock price consequences, the stock price usually will dip, short selling just takes advantage of the price dip. Short selling creates the new equilibrium price faster.  Those who believe the shorts to be wrong should buy and make money at the shorts expense.  If the short sellers are wrong, they lose money.  This should not be illegal.  Nor should the SEC prohibit short selling around any other structural market events that are publicly announced.  If the SEC can show that the short spread rumors to hurt the stock after they went short, that is another matter however.