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UK Regulators Still Hating On The Shorts

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You'd think that if we've learned anything from the past few waves of financial crisis, we'd have learned that shorts sellers play an important role in financial markets.
Shorts can check otherwise unbridled financial enthusiasm, improve price discovery and have often pointed out accounting chicanery at powerful public companies. Shareholders and management are incentivized to overlook or cover-up problems. They want stocks to go up. Regulators often lack institutional incentives to investigate wrong-doing.
But shorts, like John Paulson of Paulson & Company or Jim Chanos of Kynikos Associates, can make fortunes by uncovering hidden problems. In short (sorry), they are providing the market with a valuable service--let's call them positive externalities--all while pursuing profit.
Nonetheless, we haven't learned this lesson at all. Today the Financial Times reported that the UK securities regulator, the FSA, is going to impose new disclosure rules on short sellers who take positions on the shares of companies undertaking new share issuances.

What's prompted this new regulations is "extreme volatility" in the share prices of some of the UK's largest banks which are seeking to raise billions of new capital. If you haven't been keeping up with the situation across the Atlantic, just think about what's happened recently to shares of Lehman brothers
But is the extreme volatility the fault of short sellers or the fault of banks that have not only demonstrated they lack adequate risk controls and knowledge of their own balance sheets? This looks a little like shooting the messenger in the knee-caps. After all, those who shorted banks in recent months have been consistently shown to have made the right move.
So why all the regulatory scrutiny?
Shorts can often sound broken-hearted when discussing their relationship with regulators. They believe they are on the side of the regulators, and don't understand why the regulators don't view it that way. At the Wall Street Journal's dealmakers conference on Wednesday, Bill Ackman lamented that regulators don't seem interested in hearing from shorts at all. "Why don't they meet with someone like Jim Chanos once a month?" he asked.
But this sadness is rooted in a misunderstanding of regulators. Let's start with an explanation that shorts should understand. Regulators do not operate to improve the efficiency of markets. Rather, they operate according to the desires of constituencies that control their budgets. That is, regulators respond to special interest groups with influence among lawmakers. This means that they respond to large institutional shareholders and corporate management. Think of them like a board of directors captured by management. In fact, a lot of regulatory activity makes markets less efficient. For instance, much of the SEC's regulatory framework seems designed to give investors by more confidence when buying stock than is warranted.
What's more, regulatory agencies seek to accumulate power and preserve regulatory autonomy. Short sellers reveal the inadequacy of regulators by so often detecting problems earlier. What's more, short-sellers are actually in competition with regulators when it comes to uncovering fraud and abuse.
Every bear market ironically prompts vilification of the shorts. This is unlikely to change. Fortunately, every bull market compensates shorts for this vilification by providing profit opportunities to shorts.

FSA clamps down on short selling
[Financial Times]