Second, though, looking for the conflict of interest at the banks/prime brokers is a bit misplaced. The conflict here is basically between people who are long stock and people who want to short it. The longs want it to go up, the shorts want it to go down. To implement those desires, the longs own the stock, and the shorts borrow the stock to sell it short. From whom do they borrow it? Well, sure, their prime brokers, whatever – but the prime brokers are just middlemen. Where do they get it from? In the case of a new IPO, or at least in the case of Facebook, they kind of get it from their imagination, but in general they get it from someone who owns the stock, and even in the IPO that’s sort of the in-expectations case. Where else could they possibly get it?
Two things to keep your eye on are (1) the guy who owns the stock doesn’t have to lend out the stock – many big investors don’t, and (2) the guy who owns the stock and lends it out is facilitating downward pressure on the stock. Presumably the guy who owns the stock wants it to go up, so why is he helping it go down?