Here is how the short-selling game is played: stock prices are set by traders whose job is to match buyers with sellers. Short sellers willing to sell at any price are matched with the low-ball buy orders. When sell orders overwhelm buy orders, the price drops. The short sellers then buy the stocks back at the lower price and pocket the difference. Today, speculators have to drop the price only enough to trigger the automatic stop loss orders and margin calls of the big mutual funds and hedge funds. A cascade of sell orders follows, and the price plummets.
Where do the shorts get the shares they sell? As Jim Puplava explained on FinancialSense.com on Sept. 24, 2011, they “borrow” shares from the unwitting true shareholders. When a brokerage firm opens an account for a new customer, it is usually a “margin” account — one that allows the investor to buy stock on margin, or by borrowing against the investor’s stock. This is done although most investors never use the margin feature and are unaware they have it. The brokers do it because they can “rent” the stock in a margin account for a substantial fee — sometimes as much as 30 percent interest for a stock in short supply. The real shareholders get none of this profit. Worse, they can be seriously harmed by the practice. Their shares are being used to bet against their own interests.
There is another problem with short selling: the short seller is allowed to vote the shares at shareholder meetings. To avoid having to reveal what is going on, stock brokers send proxies to the “real” owners as well; but that means there are duplicate proxies floating around. Hedge funds may engage in short selling just to vote on particular issues in which they are interested, such as hostile corporate takeovers. Since many shareholders don’t send in their proxies, interested short sellers can swing the vote in a direction that hurts the interests of the real shareholders.
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