Fahmi Quadir fears for her safety, so whenever she travels, she shares her GPS coordinates with her lawyer and a colleague. Nate Koppikar was once tailed by a private investigator into the bathroom in his own office. And Gabe Plotkin recently hired security after threats to his family.
Digging up dirt on big companies, it turns out, doesn’t make you very popular.
Quadir, Koppikar and Plotkin are short sellers — investors who profit off the failures of companies by betting that their share prices will fall. For this, they are reviled by executives and shareholders alike. Short-selling itself is banned in some countries. Dealing with such hatred, Quadir said, is “a cost of doing business.”
It’s always been a tough job, and especially so in the past year as stocks marched higher. The recent frenzy over GameStop made it worse. Everyday investors, many of them seething against what they see as a rigged system created to enrich Wall Street, bid up GameStop’s stock in part to attack short sellers, dealing them a fresh reputational blow.
Some are rethinking their strategies. They are wondering whether the practice, portrayed in the 2015 Hollywood movie “The Big Short,” still has a profitable future.
Short sellers, including hedge funds such as Plotkin’s Melvin Capital, had wagered that GameStop shares would fall while its mall-heavy business shrank further. Instead, the shares skyrocketed when a group of mostly amateur investors, coordinating via social media and determined to outsmart big Wall Street funds, went on a buying binge.
Their actions shook Melvin, whose troubles spread to at least one other fund, Point72, which had an investment in Melvin. Point72′s billionaire founder, Steven A. Cohen, who owns the New York Mets, deactivated his Twitter account after he and other Jewish money managers were targeted on social media, with some receiving personal threats and anti-Semitic hate speech.
On Feb. 18, the short sellers will be under scrutiny at a hearing of the House Financial Services Committee, led by Rep. Maxine Waters, D-Calif. “We must deal with the hedge funds whose unethical conduct directly led to the recent market volatility and we must examine the market in general and how it has been manipulated by hedge funds and their financial partners to benefit themselves while others pay the price,” Waters said in a statement.
It’s unclear what regulators will do, if anything. During the financial crisis of 2008, the Securities and Exchange Commission temporarily barred short-selling on 1,000 financial stocks, saying that it was necessary to provide a boost to shares of banks, brokerage firms and insurers during the worst of the crisis. But studies showed that the ban did little to prop up those stocks, and the rule was scrapped.
Even before the GameStop frenzy, short selling was in a tough stretch.
Traditional short sellers see themselves as financial detectives, sniffing out corporate wrongdoing or inflated stock prices, while aiming to make a profit. Their strategy: borrow shares of the target company from a brokerage firm and immediately sell them, expecting that they will eventually fall — sometimes on account of their research, which they often share widely.
If the price falls, the short seller buys the now-cheaper shares back, returns them to the broker and pockets the difference. But the strategy can be risky. If shares climb — either because other investors make the opposite bet, as in GameStop’s case, or simply because the short seller got it wrong — short sellers lose.
In the past year, as the stock market soared more than 16%, hedge funds that were mainly shorting stocks lost nearly 47%, according to a Hedge Fund Research index that tracks industry performance.
“Short sellers have been beaten up and left for dead on the side of the road in this bull market,” said James S. Chanos, founder of the short-selling hedge fund Kynikos Associates, who is best known for predicting accounting fraud at Enron before it collapsed in 2001.
Chanos, who made some money shorting GameStop briefly last week, said short sellers once worried about lawsuits from the companies they targeted. But now they have to worry about attacks on social media and in some cases, personal security.
Quadir, whose Safkhet Capital manages about $50 million, said it was particularly challenging as a smaller hedge fund. “Try being a fund manager who goes after organized crime, international money laundering, the Russian mafia, all while managing pocket change,” she said.
The GameStop trading mania showed the power of a new force: an army of retail investors fueled by social media, spurred by easy access to free trading apps and bent on teaching hedge funds a lesson. Hedge funds “have left retail holding the bag for YEARS,” posted one user on Reddit, suggesting that GameStop stock was going to the moon with a series of rocket emoji. “I see dead hedge funds,” posted another.
So, short sellers now have to worry about their financial viability. After all, if millions of small investors band together to drive up share prices suddenly, it could raise the cost of shorting stocks to such high levels that short sellers find it untenable to stay in business. That nearly happened to Melvin Capital, which took emergency cash from other investors to right itself.
“You have this emboldened crowd that won, and I wouldn’t have thought they had the firepower to do that,” said Jason Sippel, who runs stock trading at JPMorgan Chase, which includes lending stocks and cash to short sellers. “That was kind of the shot heard around the world.”
The depiction of short sellers as evil by hobbyist stock traders has troubled professionals such as Koppikar, a portfolio manager at Orso Partners, a San Francisco fund. “I could probably have more economic success doing something else, but I think that what we do serves a social purpose,” he said.
Short sellers have weeded out corporate wrongdoing.
Two decades ago, Chanos began poring through regulatory filings and interviewing energy-market participants about the Houston energy trader Enron, which he suspected was using accounting gimmicks to lift revenues and hide losses. His hunch, and accompanying short position, proved prescient. Within a year of his investigation, Enron filed for bankruptcy.
Short sellers also sounded alarms about the impending housing crisis driven by subprime mortgages, shorting the mortgage insurer MBIA and the investment bank Lehman Bros., whose collapse helped set in motion a financial crisis in September 2008 and led to a devastating recession.
And in the mid-2010s, as the opioid crisis was raging, a short seller exposed Insys Therapeutics, which he believed was improperly influencing doctors to prescribe a powerful nasal spray containing fentanyl that played a role in the death of at least two patients. (Multiple former Insys executives have since been sentenced to prison on federal charges that the company bribed doctors to prescribe the spray.)
Short sellers often get into prolonged public battles. For years, many funds have been short on Tesla, the electric carmaker, saying that demand for the vehicles didn’t justify the stock’s price. But Tesla shares have skyrocketed recently, and Tesla’s chief executive, Elon Musk, has gleefully snubbed the shorts by selling red-satin bottoms festooned with the Tesla logo that he called “short shorts.”
Until last month, however, the attacks on short sellers were largely confined to the business and financial community. GameStop changed all that, as small investors found a way to employ a “short squeeze,” a classic Wall Street strategy to counter short-selling by driving up a stock’s price and forcing the short seller to put up more capital to cover losses.
Last week, Hindenburg Research, a firm that publishes reports on potential corporate malfeasance and usually takes a short position on those stocks, appended a defense of short-selling at the bottom of its latest note, on Clover Health. The firm said it didn’t take a short position in Clover, a health insurer, partly because “many people are angry and right now we believe it is important to demonstrate the role short sellers play in a healthy, functioning market.”
Marc Cohodes, a longtime short seller who now raises chickens on a farm in California and trades his own money, sought to distinguish between short sellers who focus on rooting out questionable business practices and illicit behavior, and other hedge funds that use short-selling purely as a betting strategy.
Cohodes, perhaps best known for exposing fraud at the subprime mortgage lender NovaStar Financial and at the Belgian software maker Lernout & Hauspie, said that many of his former colleagues now find themselves “in very crowded trades in a bull and speculative market and it’s destroyed what’s left of short sellers.”
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