In the United States, short selling – the practice of investors betting on a company’s stock price falling – is not, in and of itself, illegal. A legal short sale works like this: An investor borrows stocks – from a financial institution, for example – at the current market share price and then sells them immediately. If the share price drops, the investor buys back shares in the open market to return the borrowed shares to the lender and profit from the difference.

In theory, done legally, short selling can benefit the markets by holding companies accountable when they do not present their financial statements properly or when they fail to disclose certain other matters that could affect the price of shares.

“The problem is, that’s not what I’ve seen in the past 20 years in the area of ​​equity manipulation litigation,” said Wes Christian, partner at the Christian Smith & Jewell law firm. . “What I am seeing are top brokers, hedge funds and market makers rigging the system to basically guarantee that they will be able to make money out of their shorts.”

One of the most fraudulent schemes is to bare short selling. This is an illegal practice of selling stocks that a short seller has not borrowed, owned or considered, resulting in a “Fail to Deliver” (FTD) amounting to billions of dollars. dollars in FTD, as some research indicates.

“I believe [illegal short selling] is the biggest commercial fraud in US history. It makes Bernie Madoff’s shot look like a gnat on the backside of an elephant.

Wes Christian, Partner, Christian Smith & Jewell

By selling so-called “ghost” stocks, naked short selling gives criminally-minded investors the power to manipulate stock prices as they see fit.

“It’s like xeroxing your car’s title 100 times and selling that car to 100 people, but you only have one car,” Christian said. “That’s what Wall Street is doing.

With lax enforcement on the part of regulatory agencies, the big banks are incentivized to turn a blind eye to these illegal tactics and participate voluntarily by funding shorts because of the large trading fees they charge. Big banks make the most money in two ways: trading for own account (trading for their own account) and lending stocks to short sellers, Christian said.

The Depository Trust & Clearing Corporation (DTCC), a self-regulatory body, is not an indifferent party either. A classic example of the fox guarding the henhouse, DTCC describes itself as providing “settlement services” for the financial markets, but the number of FTDs is so systemic that DTCC has created what it calls its “warehouse of settlement”. ‘bonds’, where the FTDs basically go and die.

Put simply, naked short selling is a massive embezzlement scheme that has been ignored for years.

Criminal investigation in progress

The Fraud Section of the US Department of Justice recently launched a major criminal investigation into the dark world of short selling. According to a report by Bloomberg last month.

“It is high time that the Department of Justice now looked into this issue,” said Christian. “I think this is the biggest commercial fraud in US history. It makes Bernie Madoff’s shot look like a gnat on the backside of an elephant.

The investigation is said to focus on the kind of manipulative short-selling tactics that critics have suspected for years. An example of a manipulative short sale is publishing research under the guise of “independent” reports that are, in truth, intentionally misleading or inaccurate and heavily funded.

These so-called ‘short-and-warp’ campaigns manipulate stock prices to trick shareholders into panic-selling, allowing criminally-minded short sellers to cash in their trades and pocket the winnings before the stocks go. bounce back. The Justice Department’s investigation is also said to focus on possible insider trading, in which an infiltrator obtains sensitive information about the company and intentionally discloses it.

Basically, short selling raises questions that demand answers: What are the shorts that engage in deceptive and illegal tactics versus those that are not? And what clear evidence exists to prove the difference?

Among the companies under investigation are Anson Funds and anonymous researcher Marcus Aurelius Value, Bloomberg reported. Other short selling companies that have targeted companies in recent months include Muddy Waters and Citron Research.

Requests for comment from Anson Funds, Muddy Waters and Citron Research were not returned.

Defending oneself

The best proactive defense against abusive short-selling practices is for public companies to monitor the trading and daily volume of their securities for signs of manipulative trading patterns, said Barry Goldsmith, partner at the law firm. Gibson Dunn.

Some companies offer trade monitoring services. ShareIntel, for example, as noted on its website, proactively tracks equity flows and can help companies identify “suspicious, aberrant and / or unusual business activity.” ShareIntel also offers companies “the ability to historically aggregate data from the repository of reporting entities, brokers and shareholders.”

Keep an eye out for false market rumors and the spread of materially false information about the company, Goldsmith added. Watch social media channels, discussion forums and message boards, he said.

Once a business suspects it has been illegally targeted by short films, consider taking legal action. This is exactly what more and more listed companies are choosing: to revolt.

Cassava science is one example. In a regulatory filing in November, the clinical-stage biopharmaceutical company revealed that “certain government agencies” had asked it to provide them with “company information and documents” following allegations brought against it by Labaton Sucharow – a law firm recognized as representing anonymous clients who have a short position in cassava stocks.

Cassava CEO Rémi Barbier hit back in a 20-minute video message. “There is a huge motive for profit at work,” he said. “After the allegations were made public, that is to say after the damage was done – the law firm issued a press release admitting that its anonymous clients “hold short positions in cassava stocks”.

Barbier added, “We intend to vigorously defend ourselves and our stakeholders against false and misleading claims.

It is possible to emerge victorious from a lawsuit following a short seller attack. One high-profile example is Farmland Partners (FPI), an in-house real estate company that won its lawsuit against Quinton Mathews last year. Mathews, who went by the pseudonym “Rota Fortunae”, was the author of an attack published on the financial site Seeking Alpha in July 2018 as part of a scheme to bypass FPI.

Mathews was researching REIT on behalf of hedge fund Sabrepoint Capital, which held a position in REIT stocks. Mathews admitted that Sabrepoint paid him over $ 100,000 in 2018 alone for his work at FPI and other companies. He then publicly admitted that the article contained false statements that caused the REIT stock price to drop 39% on the day of publication. Pursuant to a settlement, Mathews agreed to pay REIT “a multiple of the profits” he made on the short positions.

“While the company waits for the relevant government agencies to take the necessary steps to significantly protect companies like REITs against these types of attacks,” FPI said it will continue to recoup the ill-gotten gains of Sabrepoint “and any other person who might have wrongly taken advantage of the artificial decline in the FPI share price caused by the false and deceptive attack on the company. “

Christian said that while the targeted companies can go to the relevant government agencies, “Honestly, they are overwhelmed. They don’t have the manpower for it. If going to a regulator is the route you choose, “Give regulators a very short window, and if they don’t work, then take action and try to be cured,” he said.