(Bloomberg) — Trampled by markets and attacked by angry executives, short sellers now find themselves facing their biggest concern yet: the U.S. government.
Bloomberg’s most read articles
The new federal charges that one of the industry’s most prominent players, Andrew Left, committed securities fraud are sending shockwaves through the already shrinking sector of investors who specialize in betting against specific stocks. For a group that has long stirred controversy by taking on some of the biggest names in business, it’s a particularly sobering moment.
The U.S. government spent years investigating the industry’s practices, but as investigations by the Justice Department and the Securities and Exchange Commission have petered out in recent months, many have begun to think the probes have failed. Even Left, who stepped down after investigators seized his computers and phones, has gotten back into the game.
Everything changed on Friday.
Prosecutors have announced criminal charges against him, while the SEC has filed a civil suit — cases that could upend his company, Citron, and send him to prison for years.
According to the SEC, Left generated about $20 million in profits from illegal trades involving nearly two dozen companies. Prosecutors accused him of repeatedly misleading the public, disputing what they called “sensationalized” reports and describing times when he indicated he would continue betting much further down the road, even though he was already withdrawing his winnings.
At one point, Left bragged to colleagues that some of his public statements were urging retail investors to trade the way he wanted and that it was like taking “candy from a baby,” according to the SEC.
Other short sellers and their supporters were quick to argue Friday that the alleged misconduct was unique to Left and should not be taken as a general rebuke of bearish investing.
Still, some say it could make it harder for short sellers to find backers. Some predict they may have to spend more on legal advice and tone down their public statements.
“Faulty theory”
Left’s lawyer attacked the government’s case, saying it was based on a “flawed theory” that investors had a duty to specify their trading plans beyond disclosing their activity to the market. The lawyer warned that the charges would have a chilling effect on downside hunting, hurting public investors by leaving corporate wrongdoing unrevealed.
“The fact that Mr. Left trades the securities he researches and writes about is well known, and there is no rule or law requiring a publisher who discloses that he is trading to also publish his private trading intentions,” attorney James Spertus said in an emailed statement. “The allegations filed today should concern all investors because the publication of truthful information is essential to efficient markets.”
Short sellers have attracted a growing number of adversaries over the past decade. Executives at targeted companies have persuaded some shareholders that pessimistic investors are the real bad guys. Academics have echoed research showing that activists are overstepping the mark by adopting “smash and grab” tactics, driving stocks down and then undoing their bets before the public can determine who is right. Lawmakers have held hearings on Capitol Hill.
The Justice Department’s indictment and the SEC complaint now provide new food for thought for critics.
“For too long, short sellers have benefited from regulatory neglect because law enforcement feared they would discourage the occasional legitimate whistleblower,” said Paul Pelletier, a former federal prosecutor who represented a company targeted by a short seller.
The government’s case seeks to establish legal boundaries around what kind of speech constitutes market manipulation at a time when small investors and hedge fund managers openly debate their views on social media platforms and online chat rooms. The SEC noted that Left and Citron enjoy “considerable followings” online, with more than 100,000 followers on Twitter alone. The problem, authorities say, is that Left is using these platforms to deceive the public.
The Justice Department, for example, accused him of announcing “extreme price targets” for some stocks he was analyzing while concealing his intention to exit those positions well before the stocks reached those levels.
“To profit from the anticipated price movement triggered by Citron’s reports and tweets, Defendant Left covered all or substantially all of the positions he held in a targeted security, often within hours – and sometimes minutes – of the publication,” according to the indictment.
Left has been publishing reports and promoting bearish bets for more than 17 years. He made his name exposing accounting irregularities at Chinese companies that had rushed to U.S. markets. Prosecutors said he often provided commentary on business news networks including CNBC, Fox Business and Bloomberg Television.
He estimated he had published about 200 reports over the years. More than a dozen of the companies he targeted have been delisted or gone bankrupt. In a sign of the complicated relationship between short sellers and regulators, U.S. authorities have followed up on some of his research with civil or criminal charges against executives at the companies he targeted.
Examples include Valeant Pharmaceuticals, which has been accused by the left of being at the center of an illicit sales scheme. After announcing charges against two executives linked to the company in 2016, U.S. Attorney Preet Bharara pointed to the role played by investor websites and news agencies.
Derisory profits
But the short-selling market has only gotten worse in recent years. Some bears have had to fight the long-market bull run that began after the 2008 financial crisis. Then came the rise of meme-stock trading during the pandemic, with retail investors staging counterattacks against bets against GameStop and other struggling companies.
Profits from short selling can be small, even if a well-researched report moves the market. Nate Anderson’s analysis of Adani Group last year wiped as much as $153 billion off the stock’s value, yet Anderson said in a statement this month that he made just over $4 million on the trade.
And even then, those meager gains can be wiped out by short sellers who face the cost of lawsuits and, now, government investigations.
Jim Chanos, perhaps the best-known and longest-running short seller, turned his firm into a family office late last year after its assets fell to less than $200 million.
“Investors, primarily institutional investors, just gave up on the idea that there would be excess returns on the short side,” Chanos said of the decision to close. “People just didn’t want to invest.”
–With assistance from Stephanie Stoughton.
Bloomberg Businessweek’s Most Read Articles
©2024 Bloomberg LP