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Thursday, 31 March 2011

End corporate right to defend against defamation? Essentially the same argument supporting short selling: transparency

What have corporate defamation and short selling got in common?
Related: Joint Committee on the Draft Defamation Bill propose radical limits on corporate defamation proceedings.
On the surface, not very much.  Despite misplaced fears of some in the investment community, short selling per se should not adversely affect a company's stock price, whereas inaccurate information from a credible source can hugely affect market value.

There's still a moral question over short selling.  Is it right that someone can profit from a failure? Especially when that failure may result in job losses and other social injustice.

More importantly, does allowing someone to profit from a failure motivate that person to do everything in their power to cause that failure? For example - spreading information (true or otherwise) that could be detrimental to the interests of the company.

Yet there is a highly convincing arguments in support of short selling - it's one of balance, and transparency.

All corporations have the ability - a duty, in fact, to their shareholders - to promote themselves, their products and services.  Only regulatory influence dictates when corporations must (in the interests of their shareholders) make negative statements to the markets; and (in the interests of consumers) refrain from inaccurate or misleading statements about their products.

There's often an ocean between an accurate representation of the facts and what a corporation can reasonably get away with without breaking any rules, and this is recognised as an important freedom in a competitive market.

Naturally, corporations opt to present themselves in the best light possible, and invest an awful lot of cash to acheive this.

Without short selling, existing investors have only one interest - in seeing the company profit.  They become promoters of the company, with a vested interest in seeing positive information flow, and negative information stalled.  Essentially the same interests as the company and its PR machine, with a few well-defined exceptions (shareholder revolts).

Short selling introduces a pool of  investors with an interest in the negative.  A set of people with an interest in seeing negative stories about the company emerge.  In theory this should bring natural balance to the market and act in the overall best interests of all shareholders, as it increases transparency.

Of course one would never advocate a system that promotes malicious activity in spreading falsehoods for financial profit, but the mere existence of the ability of a corporation to sue for libel may discourage those with legitimate grievances from raising these grievances in public.

This is especially true in the UK, where not only is defence of a libel action incredibly hard, as the onus is on the defendant to prove their statements are true (not on the claimant to prove false), but also the cost of defence is beyond the means of many citizens and it's not always possible to reclaim the full cost of defence even if the defendant is successful (source).

The net effect of libel laws, especially in the UK, is chilling.  That is, people are discouraged to make negative statements in public, even if they believe the statements to be true.

I'm sympathetic to libel in some very personal instances.  I can't imagine what it would be like to be maliciously accused in public of a heinous crime, but if I was I would want a way to clear my name.

But in the corporate world, as I've already discussed, businesses are expected to have a fearsome spin machine.  Big business especially has access to press contacts and advertising channels that the ordinary campaigning citizen, blogger or even city trader could dream of.

If someone publishes inaccurate information about a company, surely the company can just publish a rebuttal?  Instead of investing in libel lawyers, invest in advertising and press releases.  If the company can't mount a reasonable public defence then I really would start asking questions about the real value of the corporation.

I see strong parallels in the case for short selling and the case against corporate defamation. Short selling provides an incentive to get bad news out of the corporation and into the public domain.  It's good for overall transparency, and therefore in the interests of all shareholders.

Allowing corporate libel is a disincentive against publishing negative statements; it'd bad for corporate transparency. Removing the ability to sue would remove this disincentive and improve transparency.


UPDATE 19:05 31/3/11 Interesting twitter discussion with @PhotoInsomniac:
@JamesFirth Agree re: short-selling up to a point. But short-selling exposes you to infinite risk, so only the mighty can dabble...
[link to tweet]
After a few exchanges to reflect this I'm pretty sure this doesn't dent my analogy, the jist being that if we agree that incentives to root-out bad news are good in one context, why not remove the disincentives in another?

Note: Traders will know the "infinite risk" can be mitigated in most cases by placing a limit buy order to close the short when losses reach a certain level. (Please don't take this as investment advice!)


  1. I think speculation itself is something which is not good for any market. The assumption of an anything goes, free market including speculation is capitalism that eats itself, the environment and its society. Speculation does not put capital to good use it has no product or real value add and thus should be driven from the system.


  2. Fair enough Al, but without speculation you can't have a stock market at all? So how could anyone invest in ideas? I suspect without speculation, innovation would be severely hit.

    However seeing how established non-innovative businesses (servicing saturated markets) rely on stock market investment - speculation in this context seems bonkers, as the market capitalisation is far far bigger than the innovative portion of the business.

  3. Here you go James


    Something I read this very day that's relevant too this conversation



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