DISTORTING THE SHORT SELLERS

Short sellers aren’t loved, nor well understood, by the general public. They became the target of angry retail investors during the GameStop trading frenzy early last year, blamed for driving GameStop’s stock into the ground before a short squeeze — in which the pace of buying forces short sellers to buy stock to cover their positions — catapulted it to the sky. The fracas sparked investigations into GameStop short sellers’ trading, but they have gone far beyond the wild events of January 2021. An investigation of short sellers by the S.E.C. and the Department of Justice, first reported by Bloomberg, has ensnared at least 25 individuals and firms — most of them activist short sellers — who have received subpoenas and search warrants, an individual familiar with the investigation said.

Companies targeted by the activists have been pushing regulators to go after these short sellers for years. But some in the financial industry say the far-reaching inquiry is fueled by a mistaken belief that abuse by activist short sellers is widespread and distorting stock prices.

Those beliefs have also led critics of activist short sellers to propose S.E.C. rules that they say would stem such abuses. These include forcing the activists to hold their positions for at least 10 days or, failing that, to disclose when they cover their shorts. Some have petitioned the S.E.C. to change the rules so that rapidly closing a short position can be considered a form of market manipulation.

Supporters of short sellers say that the research behind these proposals is misleading and that activists, by uncovering fraud, do more good than harm. They argue that the proposed changes would hamstring, if not destroy, a business that provides a vital service in policing the markets.

The idea that short activists need to be reined in has largely been driven by Joshua Mitts. An associate professor at Columbia Law School who also has a consultancy business, he claimed in a 2018 research paper, “Short and Distort,” that activist stock sellers who wrote under pseudonyms were deceiving the market to make a quick buck, and that the stocks they shorted bounced back a few days later.

You can read all of my story–including the takedown of Mitts’ research–in my New York Times story here:

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