Short-Sellers May Not Make Money When Markets Know Their Trades

(Bloomberg) -- When Dutch regulators accidentally revealed who was betting against local stocks last year, they didn’t just just expose George Soros and other short sellers’ secret trades. The stocks stopped underperforming, providing a case study for U.S. exchanges that argue shorts shouldn’t be allowed to operate in secret.

In the run-up to the leak by Dutch financial regulators in January 2017, the stocks being targeted by short sellers were lagging peers by an average of 4 basis points per day, according to a study by Rients Galema and Dirk Gerritsen of the Utrecht University School of Economics. But once news reports about the disclosure started circulating, the stocks showed an average positive return of more than 50 basis points, their research showed.

The larger the secret short position relative to what had been publicly disclosed, the greater the snap-back. Galema and Gerritsen say their research was originally sparked by a controversy in the U.S., where executives at Nasdaq Inc. and the New York Stock Exchange are pushing for rules that would require all short sellers to disclose their positions above a certain threshold.

"Disclosing short positions unveils the strategy of a hedge fund," so those positions might have been unwound as soon as they were revealed, Gerritsen said in a phone interview. "Also, short-sellers are afraid that CFOs of the shorted companies would not provide them with the proper information,” as they would for other investors, he said.

Un-American

While European rules require any holding exceeding 0.5 percent of a firm’s market capitalization to be published, the Dutch leak revealed shorts of as little as 0.2 percent, which must be disclosed to the regulator but aren’t made public. Soros, the billionaire investor, saw some of his short positions dating back to 2012 published on the AFM regulator’s website by mistake.

Nasdaq said last year that allowing secret short sales could be hazardous for publicly traded corporations, enabling investors to use strategies to drive down share prices on the sly. NYSE Group Inc. President Tom Farley even called the practice “kind of icky and un-American.”

That earned him the ire of short-sellers, who defended their research and place in the market, and said it would be unfair if disclosure ended up limiting their access to corporate management, as Galema and Gerritsen predict.

Making "previously confidential positions become publicly known is likely to result in an immediate drop in short selling activity and a simultaneous increase in stock prices," according to the Dutch academics, who published their paper in Finance Research Letters earlier this month.

--With assistance from Ellen Proper

To contact the reporters on this story: Ruben Munsterman in Amsterdam at rmunsterman1@bloomberg.net, Gavin Finch in London at gfinch@bloomberg.net.

To contact the editors responsible for this story: Dale Crofts at dcrofts@bloomberg.net, Ambereen Choudhury at achoudhury@bloomberg.net, Keith Campbell, Darshini Shah

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