(Bloomberg) — Trampled by markets and attacked by angry executives, short sellers now find themselves confronting their biggest worry yet: the US government.
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Fresh accusations by federal authorities that one of the industry’s most prominent players, Andrew Left, committed securities fraud is sending shock waves across the already shrinking field of investors who specialize in betting against specific stocks. For a group that has long courted controversy by taking on some of the biggest names in business, it’s a particularly sobering moment.
The US government has spent years digging into the industry’s practices, but as inquiries by Justice Department and the Securities and Exchange Commission went quiet in recent months, many began assuming the probes had fizzled. Even Left, who pulled back after investigators seized his computers and phones, got back into the game.
That all changed Friday.
Prosecutors announced criminal charges against him, while the SEC brought a civil lawsuit — cases that could upend his firm, Citron, and send him to prison for years.
According to the SEC, Left generated about $20 million in profits from illegal trading involving almost two dozen companies. Prosecutors accused him of repeatedly misleading the public — taking issue with what they called his “sensationalized” reports and describing times when he indicated he would keep bets going much further, when he was already in the process of taking winnings off the table.
At one point, Left bragged to colleagues that some of his public statements caused retail investors to trade the way he wanted them to 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 shouldn’t be seen as a broad rebuke of bearish investing.
Still, some said, it may make it harder for short sellers to find financial backers. Some predicted they may have to spend more on legal advice and temper their public statements.
‘Defective Theory’
Left’s attorney attacked the government’s case, saying it all rested on a “defective theory” that the investor had a duty to specify his trading plans beyond disclosing that he was active in the market. The lawyer warned that the charges will have a chilling effect on bearish research, hurting public investors by leaving corporate malfeasance unexposed.
“The fact that the Mr. Left trades in the securities he researches and writes about is well known to everyone, and there is no rule or law requiring a publisher who discloses that he is trading to also publish his private trading intentions,” the attorney, James Spertus, said in an emailed statement. “The allegations filed today should concern all investors because the publication of truthful information is critical to efficient markets.”
Short sellers have attracted a growing number of antagonists over the past decade. Executives atop targeted companies have persuaded some shareholders that bearish investors were the real bad actors. Academics chimed in with research showing activists were crossing the line into “smash and grab” tactics, knocking down stocks down and then unwinding their bets before the public could figure out who’s right. Lawmakers held hearings on Capitol Hill.
The Justice Department’s indictment and the SEC’s complaint is now providing fresh fodder for critics.
“For far too long short sellers have benefited from regulatory neglect as enforcers have been fearful they might discourage the occasional legitimate whistleblower,” said Paul Pelletier, a former federal prosecutor who has represented a company targeted by a short seller.
The government’s cases seek to draw legal lines around what kind of speech amounts to market manipulation in an era in which small investors and hedge fund managers openly debate their views on social media platforms and online message boards. The SEC noted that Left and Citron command a “substantial following” online with more than 100,000 followers on Twitter alone. The problem, authorities said, was that Left used such platforms to deceive the public.
The Justice Department accused him, for example, of announcing “extreme target prices” for some stocks he was analyzing while concealing his intent to exit those positions long before the securities reached those levels.
“To profit from the intended 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 — after publication,” according to the indictment.
Left has been publishing reports and touting bearish bets for more than 17 years. He made a name for himself by pointing out accounting irregularities in Chinese companies that had flocked to US markets. Prosecutors said he would often provide commentary on business news channels including CNBC, Fox Business and Bloomberg Television.
He has previously estimated he had published around 200 reports over the years. Well over a dozen of the companies he targeted were later delisted or filed for bankruptcy. In a sign of the complicated relationship between shorts and regulators, US authorities followed up on some of his research by bringing civil or criminal charges against executives at companies he targeted.
Examples include Valeant Pharmaceuticals, which Left accused of being at the center of an illicit sales scheme. After then-US Attorney Preet Bharara announced charges in 2016 against two executives linked to the company, he referenced the role that investor websites and news organizations played.
Paltry Profits
Yet the business of short selling has only gotten tougher in recent years. Some bears struggled against the updraft of the long bull market that began after the 2008 financial crisis. Then came the advent of meme-stock trading during the pandemic, with retail investors organizing counter attacks on bets against GameStop and other struggling companies.
Short-selling profits can be tiny even if a well-researched report rocks the market. Nate Anderson’s look at Adani Group last year erased as much as $153 billion of market value, yet Anderson said in a statement this month that he reaped just over $4 million on the trade.
And even then, such paltry gains can then be wiped away as short sellers face the cost of lawsuits and, now, government probes.
Jim Chanos, perhaps the best-known and longest-running short seller, turned his firm into a family office late last year after assets dropped to less than $200 million.
“Investors — primarily institutional investors — have just given up on the fact that there’s going to be excess returns on the short side,” Chanos said about the decision to close down. “People just didn’t want to invest.”
–With assistance from Stephanie Stoughton.
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