Delaware's short-selling senator thinks the practice is fine so long as predators don't step in and create another Bear Stearns or Lehman Brothers-type crisis.
Sen. Ted Kaufman, a member of the Judiciary Committee and the man who took Vice President Joe Biden's seat in the upper chamber, told CNBC he hopes regulations expected to be announced today target those who sell stock short without actually possessing it and in the process create market havoc.
"We've known about predatory short-selling for hundreds of years. One of the things when you have a free market there are people who are going to come in and drive down price," Kaufman said. "I am totally OK with short-selling—I do it myself. But predatory short-selling has to stop."
Short sellers make money by betting that the price of a stock is going to fall.They borrow shares from a third party, sell them to another trader, then buy the shares back later, hopefully at a lower price, and return them to the original owner.
Some believe short sellers helped create the environment that led to the downfall of Wall Street titans Bear Stearns and Lehman Brothers. Short sellers helped convince the market that the two companies did not have sufficient capital to cover their losses on subprime mortgage securities, creating a run on the institutions.
The Securities and Exchange Commission is expected to announce new short-selling rules today that sources say will be aimed primarily at re-establishing a form of the uptick rule, a Depression-era regulation that only allowed short-selling at a price higher than the last previous sale.
The SEC is expected to establish a "circuit breaker" that would provide a version of the uptick rule. Kaufman said that is a good start but regulators must continue to be aggressive.
Wall Street insiders are the ones who can help stop predatory short selling before it causes market panic again, he said.
"There are plenty of people on Wall Street that I talk to every day, people in major financial institutions, that know what is going on but just will not say anything," he said. "It really would be very important for people on Wall Street who know what predatory short-selling is all about and know the impact to come forward and say what's going on. That's what it's going to take to get some real regulation."