The senior correspondent for Fox Business reported that Nasdaq, the New York Stock Exchange and Herbalife Ltd. were teaming up to “curb the power of short sellers” by forcing them to disclose large positions, something that is not currently required.
What gave his story juice was the presence of Herbalife. The company, as Gasparino reminded viewers, had fought an unusually high-profile battle several years ago with the activist investor Bill Ackman; it resulted in Herbalife promising (in a settlement with the government) to reform some deceptive business practices — and in Ackman licking his wounds from the beating he took on the stock, which is now near an all-time high.
(To refresh quickly: a short seller borrows stock, usually from a brokerage house, at a high price, and then buys the stock if and when the price drops. Thus, it is a way to make money on a falling stock rather than a rising one. If a short seller bets wrong, as Ackman did on Herbalife, he can get killed.)
To me, what made the story interesting was that once again, corporate America was trying to find a way to stick it to short sellers. The effort by the stock exchanges to discourage short selling will no doubt help them curry favor with their customers, i.e. the companies that list with them, which tend to take the self-interested view that short selling is the scourge of capitalism. And it may sound benign to the rest of us. But it’s not.
To hear Nasdaq tell it, all it is aiming to do is make the markets fairer and more transparent. After all, if an investor buys 5 percent of a company’s stock, the law says that he or she has to disclose the position. But a short seller can borrow as much of a company’s stock as he or she wants without either the company or its investors knowing.
Here’s how Nasdaq put it in July 2017:
[T]he asymmetry of information between investors with long and short positions deprives companies of insights into trading activity and limits their ability to engage with investors. It also deprives investors of information necessary to make meaningful investment decisions.
The exchange has bundled the proposal with several other ideas as part of a package to spur executives to press for long-term value creation instead of obsessing over quarterly earnings. Who could be against that?
I am. If such a measure were to pass, it could put a serious damper on an investor’s ability to bet against a company by shorting its stock. Why? Because, as I mentioned earlier, shorts borrow stock. If the price continues to rise, the short seller has to either pay margin calls or liquidate the position. If companies know who is shorting their stock, they can retaliate by muscling investment banks into ending the borrowing arrangement. Or they (or their proxies) can try to push the stock higher to inflict financial pain on the short seller. That’s called a short squeeze.
“When you buy a stock, you own it,” said Dan David, co-founder of the research firm Geoinvesting LLC. “When you borrow a stock, you’re always at the mercy of a counterparty.”
Or, as the retired short seller David Rocker put it to me in an email, “Why don’t they ask if they would paint a target in bright red on their foreheads?”
Although it is hard to get anything passed in Washington these days, I do fear that an anti-short-selling bill could get plenty of congressional support. Many people already consider short sellers to be the stock market’s black hats, and view the things they do as reprehensible. Shorts are often condemned for going on television or appearing at conferences to explain why they are negative on a company. Yet when a long investor touts a stock he owns, no one bats an eyelash. It is somehow viewed as un-American to root for a stock to go down.
What’s forgotten is the real value of short sellers: they are the market’s detectives. A short seller was the first to sniff out Enron. Short sellers tried to warn investors that Valeant was a house of cards. For decades, short sellers have done the hard digging required to expose frauds. The Securities and Exchange Commission often first learns about a fraud after it’s been exposed by a short-seller.
Next month, a documentary called “The China Hustle” will debut. It tells the story of how a handful of shorts, including the aforementioned Dan David and Carson Block, who runs the famed short-selling firm Muddy Waters LLC, exposed an enormous fraud. Dozens of Chinese companies, unable to list on an American exchange, did “reverse mergers” with U.S. shell companies and began selling their stock to Western investors.
Then they began reporting “quarterly earnings” that caused the stocks to rise. The shorts, suspecting that the earnings numbers were fraudulent, went to China, where they discovered that the amount of business being conducted was minimal — sometimes none at all. It's a striking example of the value shorts bring to the market.
One other thing: If the exchanges really wanted to promote long-termism, they would try to find ways to crack down on shareholder activists instead of focusing on short selling. Short sellers aren’t trying to get companies to change their business model for short-term gain. They are saying, “There’s something bad going on here, and we’ll profit when the rest of the world sees what we see.”
It’s the activists, the financial engineers, who are the real problem, buying up shares in a company and threatening a proxy fight or worse if management doesn’t find ways to quickly goose the stock. Short sellers, by contrast, have zero interest in companies with viable long-term strategies.
But it’s easier to attack short sellers, and always has been. And so it will continue to be until the next big fraud they expose.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Joe Nocera is a Bloomberg View columnist. He has written business columns for Esquire, GQ and the New York Times, and is the former editorial director of Fortune. He is the co-author of "Indentured: The Inside Story of the Rebellion Against the NCAA."
To contact the author of this story: Joe Nocera at jnocera3@bloomberg.net.
To contact the editor responsible for this story: Jonathan Landman at jlandman4@bloomberg.net.
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