Short-sellers cry foul after ban
Beset by critics, bears insist they play essential role
By one description, they are the vultures of the financial world, swooping in to feast on carrion. Not a pretty sight. But without them, goes the argument, Wall Street would be littered with roadkill.
They are short-sellers - investors who bet on stocks falling instead of rising. They sniff out bad news about companies and profit when they're right. They help keep stock prices in check, proponents say. But they can also move markets, as critics said they did last week when shares of Goldman Sachs, Morgan Stanley, and other financial stocks were battered in a way that contributed to the crisis gripping Wall Street.
Some, in more nefarious circumstances, trade in rumors, trying to drive companies to the grave.
Now they are agitated and feeling like scapegoats. Federal regulators banned short-selling in 799 financial stocks last Friday for at least 10 trading days, in order to stop attacks on otherwise healthy stocks that were cre ating chaos in the market. The New York Stock Exchange has since added another 100 companies to the no-short list and expects the Securities and Exchange Commission to extend the ban to 30 days.
Indeed, in this extraordinary time of government intervention, these investors, sometimes called "bears" in Wall Street parlance, make themselves out to be the stalwarts of free and open markets.
"The bears and the curmudgeons and the ones who do sell short are the ones who try to keep stocks from elevating too highly," said David Tice, who manages his $1.1 billion Prudent Bear Fund from the Virgin Islands. "We have been the critics of the credit bubble and Fannie and Freddie and housing excess."
Short-selling is when an investor borrows a stock and sells it right away. The hope is the stock price will drop on bad news about the company, and the investor can buy it back at a lower price, pocketing the difference. It's been around for as long as stocks have been bought and sold, and today is a multibillion-dollar market. On any given day, short sales amount to 3 to 5 percent of the shares traded on the NYSE. On Sept. 15, the last report date, there were 17.7 billion shares held in short positions.
And short-selling is not limited to investors who prefer to remain in the shadows. Boston mutual fund giant Fidelity Investments, for example, has $130 million in a fund that can short up to 30 percent of its assets.
The ban has sparked both philosophical and practical objections. Tice, for example, said, "This is not a huge deal yet, but it is interfering in free markets." The regulators, he said are, in effect, "trying to enhance stock prices" by temporarily clamping down on mechanisms that can push prices down.
Most academics with expertise in the markets do not think the short-selling ban is wise, or will even work. James Angel, associate professor of finance at Georgetown University, said the goal of the ban will "probably not" be achieved when it is scheduled to end next Friday, and short-sellers can resume their bets against financial companies.
The argument for the ban, he said, was that, "People were in a panic. If you give people some time to think about it, they'll realize things are not as bad as they thought." But that doesn't mean investors will come back and move stocks up after this period of being frozen out, added Angel.
The irony is it's sophisticated financial companies, which are involved in short-selling themselves, looking for protection. When Morgan Stanley shares fell 24 percent one day last week, chief executive John Mack blamed short-sellers and sought assistance from regulators. But other companies that routinely battle shorts - alternative energy companies and biotechs, for instance - have enjoyed no such protection. Several contacted by the Globe declined to comment for fear of agitating short-sellers.
Short-sellers and market specialists say they play an essential function. For instance, prominent short-seller Jim Chanos of Kynikos Associates in New York, is credited with being among the first investors to ask skeptical questions of Enron Corp. If they weren't there asking the tough questions, spotting overstated earnings and accounting anomalies, short-sellers argue, ordinary investors would suffer even more if bad news about companies was suppressed longer.
Chanos and others in the business are most upset about a permanent SEC proposal to require largely unregulated hedge funds to disclose their short positions. Chanos has called the idea, "akin to the government suddenly requiring Coca-Cola to disclose their secret formula for free to all their competitors."
Tim A. Krochuk, managing director at GRT Capital Partners, a Boston firm that manages $600 million in hedge funds, said that with so many participants in the market shorting these days, the disclosure of those positions could pose a problem. For example, suppose a company refuses to see an investment firm's analysts because one of the firm's funds has shorted its stock, even though its other funds may be "long," or betting on the stock to rise?
Making the holdings public, Krochuk said, "is going to change the dynamics of the business quite a bit."
Worse, Krochuk said, most of the recent trouble could have been avoided if the SEC last year had not ended the rule that kept shorts from sending healthy stocks careening downward unnecessarily.
This is the so-called uptick rule, and Krochuk said it would have been better to restore it rather than institute the ban.
"The next time we have a bubble, will they prohibit buying?" Krochuk asked, only half joking. "It's the bubbles that create the busts. It would be better if we controlled the excess next time, and then we wouldn't have to deal with the hangover."
Beth Healy can be reached at bhealy@globe.com. Ross Kerber can be reached at kerber@globe.com 