Stating she was “not picking sides on activist investors,” Securities and Exchange Commission (SEC) chair Mary Jo White made it clear in a 10 November interview on Bloomberg TV that requiring disclosures by short sellers “is an issue that has our intense attention.” She stated the SEC is “reviewing whether to make short sellers step out of the shadows, as negative comments by research firms increasingly batter share prices.” She added, “Short selling has a legitimate, positive purpose in the marketplace. . . . That’s very different, though, than if you manipulate by short selling.”
White’s comments, which were immediately tweeted, reposted, and blogged, highlight the increasing tension between corporations, activist investors—both short and long—and regulators.
Short selling, the act of borrowing an asset in order to sell it with the hope of buying it back after the price has fallen, has been a part of the free market since at least the 17th century. Financial historians claim the first short was on the very first stock, the Dutch East India Company, by a former director who was cast out of the company for financial improprieties.
Currently, the SEC requires institutional investors and hedge funds to report their long positions but has no such requirement for short positions. Since 2012, European regulators have required funds to disclose individual shorts of as little as 0.2 percent to their national regulator and shorts that total 0.5 percent of a company’s market value to the public.
Twitter and blog sites have given the current generation of short sellers and researchers tools to spread bearish investment advice instantaneously, and sometimes, anonymously. Although some accusations go largely unnoticed, posts and tweets from a nameless source can destroy billions of dollars of market value in a company. In her interview, White stated unequivocally that Twitter is an “information source” that must be “policed actively,” and during the first week of November, the SEC filed securities fraud charges against a Scottish trader whose false tweets caused sharp drops in the stock prices of two companies and triggered a trading halt in one of them. In its own work, K2 Intelligence has identified short sellers and, in some cases, shown a clear conflict of interest between the short and the entity providing the research.
Although some are unhappy about activist shorts, arguing they drive down a company’s stock price with false allegations and then cash out at the bottom, a practice sometimes referred to as “short and distort,” a number of recent studies argue the rise of activist shorts has had a positive effect on the markets. Activist shorts counterbalance the effects of corporate posturing, investor overconfidence, and even a possible bullish bias by Wall Street itself, argue some.
Short sellers have also played a key role in identifying corporate bad acts. Perhaps most famously, short seller Jim Chanos was among the first to suggest that Enron had no clothes, later commenting, “Short sellers are the professional skeptics who look past the hype to gauge the true value of a stock.” Stock exchanges themselves do almost no independent vetting of listed companies if they meet the financial requirements, and regulators rarely have the resources to look closely at the multitude of listed companies. A 2012 study concluded simply, “Stock prices are more accurate when short sellers are more active.”
While the tension is clear, the solution is not. In 7 October letter to the SEC, the New York Stock Exchange urged the Commission to require investors to make “periodic public disclosures of short sale activities” in order to “bring light to a less transparent and increasingly consequential corner of the securities market.” Opponents of this proposal argue that disclosure rules would hamper liquidity, increase short squeezes, and artificially widen the bid/ask spread.
Unless and until the SEC finds a way either to limit or control anonymous or semi-anonymous blogging, or to educate the public about the unreliability of such posting, the most pernicious aspects of stock manipulation will continue. Wide-scale spreading of false information will be difficult or impossible to stop, adding unnecessary volatility to the market and distracting management from the business of running their companies.