From several respects, the practice of “short selling” – selling shares and financial instruments the investor does not own in hopes of the price going down – can be both socially discomforting to the short seller as well as life-threatening, as a recent Donald MacKenzie article on the topic pointed out. But to fund managers such as Jim Chanos, there is a “psychic income” that can be derived from solving a fraudulent puzzle and warning other investors about impending peril.
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In 1998, Barron’s published an article describing “several terrified investors” who claimed to have been threatened with violence for their role in short selling shares in a US cable TV company. One year later, one such investor, Maier Lehmann, was found dead in Colt’s Neck, New Jersey. The multiple shots to the head were considered a professional hit, but the case remains unsolved, with various motives for the murder clouding the event.
He is not alone in accepting significant risk for exposing corporate fraud.
A British short seller identified as Fraser Perring told Bloomberg Markets that, while sitting in his car in 2016, parked outside his daughter’s school, two men suddenly got in and interrogated him, making it clear they knew a lot about his family.
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There are practical concerns as well.
One issue with short selling is understanding “the plumbing” behind borrowing stocks to sell that are not owned by the short seller. Often short sellers need to call around the “over the counter” market to locate institutions willing to lend them the stock so they can sell it, often done by charging interest. Finding the available stock can be a challenge, particularly if a corporation has been “put in play” by an activist investor.
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In the past, companies such as Enron were exposed by journalists such as then Fortune reporter Bethany McClean or the Wall Street Journal’s Jonathan Weil. Chanos also worked with Forbes reporter Dick Stern to help untangle the finances of Baldwin-United, his first short.
“Given the decline of print media, short sellers today would count themselves lucky to find a Stern or a McLean, a journalist backed by a high-profile publication and able to spend months probing the affairs of a corporation that will likely prove to be both opaque and litigious,” MacKenzie noted in the article “Hot to Solve the Puzzle.”
Today’s short sellers often write their reports, and there are a few independent journalists, such as Roddy Boyd of the Southern Investigative Reporting Foundation, who dedicate themselves to exposing corporate fraud.
The reports they write can have a meaningful impact.
In a National Bureau of Economic Research paper published in 2014, economists Alexander Ljungqvist and Wenlan Qian found that on the day of publication by a credible short seller, the target corporation’s shares fell by 8.2 percent on average. “If the accusations were flimsy, one would expect a rapid reversal of the price fall, but that wasn’t what happened,” the report noted, like three months after the release of a report, the shares in question were down, relative to the market overall, by an average of 21.9 percent. Looking entirely one year out, shares were down by 56.8%.
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When looking at how best to conduct research, Chanos notes that the “core of the onion” is in the accounting statements. Short sellers don’t consider official financial statements hard facts, but a representation that may be misleading. “They know only too well that there are many ways a corporation can tweak its accounting to present a flattering view of its finances,” MacKenzie wrote. “Short sellers must have a ‘nose’ for situations in which these tweaks add up to something worse than everyday embellishment.”
Sometimes that instinct can work against the short seller, as was the case with Herbalife. When activist William Ackman attempted to expose what he considered a fraudulent business activity involving the firm’s selling practices, he was “betting on zero” but ultimately abandoning his money-losing short thesis and exiting the activist space, with investors pulling out assets. The firm boasted assets of $18.3 billion in 2015 but at the end of March had $8.2 billion under management after several losing years.
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