They may be the most influential writers you have never heard of. And their prose could be hitting you right in the pocketbook.
When the Department of Justice (DOJ) launched an investigation into a group of short sellers and questions of stock manipulation, their searches and subpoenas went behind traders and investors. They also swept up writers, too. More specifically, researchers whose reports are extremely influential in the short-selling community.
And recent reporting by Bloomberg News that the prosecutors sent new subpoenas to certain short sellers targeting the trading of blue-chip stocks such as Amazon.com and Microsoft hints at a broadening investigation.
The DOJ’s probe is focused on possible collusion between investment firms specializing in short selling and stock research firms that publish their reports on their own websites, promote them on social media, and on such popular investment advice sites as Seeking Alpha. Research firms often transparently invest in the stocks they follow.
Some of the most well-known researchers specializing in short selling are among the roughly 30 firms and individuals under investigation by the DOJ. They include Citron Research founder Andrew Left, Muddy Waters owner Carson Black, and Nate Anderson of Hindenberg Research.
Federal prosecutors are investigating whether short sellers conspired to manipulate the stock market by releasing damaging information about companies targeted for short sales and engaging in illegal trading tactics tied to those negative reports.
While that sounds like a plot line in a streaming TV drama, the stakes are very real. An estimated 145 million Americans have entrusted some or all of their savings to the market. If the allegations are true, the offending shorters have been polluting the stock market’s most precious resource — information — in order to manipulate its most valuable asset: Money.
Short selling is completely legal and plays an essential role in the market ecosystem by revealing fraud (for example, shorters blew the whistle on Enron) and keeping companies focused on their bottom line lest they draw the attention of short sellers.
Hedge funds and research firms that specialize in short selling often engage in “balance sheet” agreements. In such arrangements, the hedge funds pay the research firm to publish and promote a report critical of a company the fund has targeted for a short sale. If the hedge firm’s short sale strategy pays off, the research firm that published the original report receives a percentage of the profits or a flat fee.
While balance sheet agreements are not illegal, it would be unlawful for firms to collude to manipulate a stock’s price for their benefit.
California stock trader Amr Ibrahim “Anthony” Elgindy, whose nickname was “Mad Max of Wall Street,” was arrested on fraud charges for manipulating information about FBI investigations. The so-called “Emulex hoax” involved a fake press release from an employee at a wire service who had shorted Emulex stock and used phony information to manipulate the price.
Critics point to cases like Health Insurance Innovation, hammered by research reports from Capitol Forum and a short-selling activist under the pseudonym “Marcus Aurelius Value.” Reports were released appearing to conflate HII with one of its vendors that was under Federal Trade Commission investigation. At one point, HII became the biggest short in the market, with more than 100 percent of the shares shorted. But short sellers went silent when the FTC released information confirming HII was not a defendant. The stock quickly recovered.
Another company, Farmland Partners, is the poster child for those who suspect some short sellers of market manipulation. In 2018, a scathing report appeared contending that Farmland, a small Denver-based real estate trust, was in financial trouble. The report was released under a pseudonym on the Seeking Alpha investment advice website. Almost immediately, according to The Wall Street Journal, Farmland’s shares lost 39 percent of their value. Farmland sued the report’s author, Quinton Mathews, who later admitted that parts of the report were incorrect.
In a separate action, Farmland sued a Sabrepoint, a Dallas hedge fund, alleging the firm had worked with Mathews to drive down Farmland’s share price. Despite evidence of financial ties between Mathews and Sabrepoint and ongoing communication about Farmland between the parties, Sabrepoint denied instructing or paying Mathews to write and place his research. A federal judge dismissed the suit against Sabrepoint, but Farmland has appealed.
Now financial analysts are looking at the data to see if some research reporting has evolved into market manipulation.
In 2020, Columbia University securities law professor Joshua Mitts published an academic paper that analyzed 1,720 pseudonymous Seeking Alpha Posts that were critical of publicly traded companies. His research revealed these posts were preceded by suspicious trading through stock options. He calls this phenomenon “short and distort.”
Shorters predictably took issue with Mitts’ work, calling it sloppy in its failure to account for other reasons for the trading patterns identified in his paper. Nevertheless, the professor’s expertise has turned him into a resource for both companies targeted by shorters and for the DOJ.
While the DOJ has yet to allege wrongdoing by any short seller, the publicity surrounding its investigation and Mitts’ research has brought the spotlight onto an investment activity usually conducted away from the public gaze. No bad can come from that.
