The European Court of Justice [official website] on Wednesday dismissed a lawsuit contesting an EU regulation [text, PDF] that bans some short selling practices to increase financial market stability. The regulations were enacted to increase the transparency of short positions held by investors in certain EU securities, reduce settlement risks, ensure member states can intervene to reduce risks arising from short selling and credit default swaps, and ensure coordination between member states and the European Securities Markets Authority (ESMA) [official website] in exceptional situations. Following the court's ruling [AP report], British regulators will not be able to opt out of the short selling law, giving ESMA power in instances which it sees a threat to markets or the stability of the EU financial system. The court ruled [Reuters report] that the ESMA's power to adopt emergency measures in combating short selling is compatible with EU law. The controversial practice of short selling refers to the sale of borrowed shares in hopes that the price will fall so they can be bought back more cheaply to turn a profit.
Short selling has been the target of much criticism, particularly following the recent financial crisis. In September the ECJ advocate general Niilo Jaaskinen denounced [JURIST report] the decision by ESMA to ban short selling. Jaaskinen rejected the measure for lack of contribution to market harmonization and overreaching on the part of the EU. In 2009 the US Securities and Exchange Commission [official website] made permanent [JURIST report] a temporary ban on the so-called "naked" short selling of stocks. In a normal short sale, a trader borrows and sells a stock, promising to buy it back at a certain price in the future, but in a "naked" short sale, the trader doesn't actually borrow the stock before selling it. In its release announcing the retention of the rule, the SEC said that allowing the practice often left traders in a position where they could not deliver the stock, which would artificially drive down its value.