Naked-Shorts Ban Gets Chilly Reception

By not reinstating the "uptick rule" -- which only allowed a short transaction to occur as a stock was moving upward -- critics say the SEC has effectively allowed speculative investors to hammer shares further and further into the ground. The agency did away with the regulation in July 2007.

"The SEC is really flapping its gums here -- it's really not doing anything different," says Robert Ellis, senior vice president of wealth management at Celent. "They missed another opportunity to bring back the uptick rule. I guess lobbyists and hedge funds don't want them to bring it back."

Nearly 30 billion shares were sold short in the market in late August, a sixfold increase over the last decade, according to ShortSqueeze.com. Ellis says that trend has effectively transferred wealth from retirement accounts, which are unable to short stocks, into hedge funds. He notes that brokerages can profit on both ends, because the collect fees on both the long and short positions, and don't necessarily have to tell clients that they are lending out the stock.

Still, just the promise of a more watchful regulatory eye and the threat of enforcement action may lead some traders to close out questionable short positions, says Ellis. A sharp decline in share price -- the proxy for market confidence -- can destroy a financial services company, which relies on that confidence to do business.

"The financial firms are unique in the sense that when they fail they not only bring down shareholders but the firms that deal with them," says Sreedhar Bharath, assistant professor of finance at the University of Michigan. "It's a domino effect for everybody."