According to a report in the Wall Street Journal, the regulatory arm of the New York Stock Exchange (NYSE) is investigating the role of short sellers.  Basically, did they violate exchange rules and as a result, drive down the price of the Vonage IPO (which is down roughly 30% from its offering)?

Short selling is essentially a way to make money when a stock price falls.  In fact, this is a popular technique of hedge funds. 

Here's how short selling works:  Let's suppose you think Vonage is overvalued at $17 per share.  You borrow 100 shares from a broker and then sell the shares for $1,700, which is placed in an escrow account.  A week later, the stock is at $12 per share.  You buy back the 100 shares for $1,200 and make a tidy profit of $500.  You then return the 100 shares to the broker -- a process known as "covering your short position."

One issue:  Since Vonage is an IPO, where did these short sellers find shares to borrow?  Actually, this is not easy – since shares have yet to be delivered to the market (it actually takes three days for this to happen). But there is some wiggle room; that is, a short sale is allowed if there are "reasonable grounds" to think that the stock can be borrowed.

Well, if there are no reasonable grounds, then the short selling is a violation of exchange rules and is known as "naked" short selling.  And, that's what the NYSE is looking into.

But was short selling really a cause for the fall?  There are certainly other factors to consider:  the plunge in the Nasdaq; the confusion of the Vonage shareholder sales to 13.5% of its customer base; the recent announcements of price cutting for VOIP services from competitors; and even the negative media coverage.

Actually, take a look at the stock chart above.  Basically, the stock fell quickly and established a trading range of $12 to $13.  If the short sellers are so powerful – and the evil hedge funds are plotting against Vonage – wouldn't the stock fall even further?  Would the short sellers want to make even more money?