If you believe, say, that Apple has been faking its revenue and profit numbers for the last 10 years, you can go ahead and short them on the expectation that they'll get caught, Tim Cook will go to jail and the stock will tank. In the meantime, the presence of your short will in some small way drive down the price of AAPL, or at least signal to the rest of the market that somebody believes things are not as rosy for the company as the current price indicates.

That's profiting from crime, in a way, but it's all you can do when it's not within your power to subpoena Apple internal memos or what have you.

As I read this article, this is more or less this is what JPM is being punished for doing, because in theory the small exotics group in the UK could have called the US headquarters and inspired them to contact the SEC, which didn't happen.

It's not a very good example, and hardly comparable to the JPM situation, since it was in JPM's power to raise the alarm (and keep raising it when no-one first paid attention).

Your crimes aren't magically washed away because the SEC wasn't doing their job well.

No, the Apple example is excellent. I forget what the name of the blog is but there's an investor who investigates firms for fraud, shorts their stock, then publishes his finding. It's not illegal in the slightest and is a public service.

Now, you seem to think that there should be communication between a trading desk and Madoff's custodian. Any compliance officer would disagree. There is simply too much risk of front running the client's account to allow this (especially when the account is as large as Madoff's).

> No, the Apple example is excellent. I forget what the name of the blog is but there's an investor who investigates firms for fraud, shorts their stock, then publishes his finding. It's not illegal in the slightest and is a public service.

Err... If you're thinking about the handful of self-proclaimed "activist investors" who frequently end up massively short after "investigating" the stocks they abandon, please spend some time reading http://www.deepcapture.com. You'll find their names in rather dubious company -- including Madoff, incidentally -- and associated with mountains of illegal activity.

I'm thinking of Guys like Chanos.

http://en.m.wikipedia.org/wiki/James_Chanos

Ya, check him out on deepcapture. His name shows up every so often, and not in very good light.

I've never really looked into shorting, so sorry that this inevitably sounds really dumb, but if a short is public and works as that kind of signal, can it be abused? Say, if a big investment bank shorts a stock, and then advise all their clients to do so, and in some way convince a significant number of others to short that stock. Does it eventually become a sort of self-fulfilling prophecy where the number of shorts can damage confidence so much that they either sell or sell+short themselves and the stock ends up spiralling? If enough people wanted to take down a stock, is there some kind of protection that stops them doing this?

I know generally you can just start selling low or whatever, but shorting would make you a huge profit if this worked while selling low potentially a loss?

There's some very entertaining stuff at http://www.deepcapture.com/.

A good place to start is http://www.deepcapture.com/the-story-of-deep-capture-by-mark... or http://www.deepcapture.com/category/1-the-players/

edit: changed starting suggestions because the website is confusingly laid out and some links don't seem to work.

Shorting is absolutely open to abuse, especially naked shorting (i.e. you sell the stock without buying it first). Google the CEO of Overstock.com. He had a lot to say about naked shorts being abused. Regular shorts aren't abused as much because the company's dividends have to be paid to the owner by the borrower (i.e. the short) this makes the varying cost of holding a short on a good company high. I also never understood why people lend their stock to shorts. You're just helping them put downward preassure on a position that you're long.

If they are short Madoff, it's in their interest for its value to go to zero - i.e. him getting shut down by law enforcement makes them a lot of money, so their incentives are very much aligned with those of the regulators. (If you're cynical, you might argue that in an ideal world they'd like the rest of the world to remain in the dark for long enough for them to build up a sizeable position first). Conversely, investors would benefit from it finding more investors before being shut down so they could cash out first.

Let's say I had a short equity position in some company. Now, some bad guy comes and murders the CEO of that company, tanking the equity. A crime was committed, and I profited. Did I profit from a crime? Did I do something wrong?

You did if you had prior evidence that the bad guy was going to murder the CEO.

Does not sound unfair to me, by not reporting it you have taken part in the conspiracy in my mind, that is if you actually believe it is a real conspiracy and not a bunch of talk.