Short-sellers: enemies of the state or crusaders against evil corporations?

Short-sellers profit from market declines, something that has long ensured their unpopularity with politicians, regulators and chief executives. Napoleon saw the short-seller as “an enemy of the state”; in 1995, Malaysian policymakers proposed that short-sellers be punished by caning; politicians of all hues railed against them in 2008, blaming them for plummeting bank share prices. Accordingly, short-sellers tended to operate discreetly, betting against companies but rarely shouting from the rooftops about it.

A new breed of activist short-sellers, however, are less shy, using words like “evil”, “criminal” and “predator” to describe some of the companies they bet against.

Under attack at the moment is Asian commodity trading giant Noble Group, which has lost 30 per cent of its value since February, when a little-known outfit called Iceberg Research warned the firm was a "repeat of Enron". Earlier this month, shares tumbled further following a hard-hitting report from high-profile short-selling firm Muddy Waters.

“We are really short [on] Noble’s management”, the report said, before complaining of “substance-less accounting” and warning that Noble “seems to exist solely to borrow and burn cash”.

Bearish words from Muddy Waters have carried weight since 2011, when it described Chinese plantation firm Sino-Forest as a “multibillion-dollar Ponzi scheme”. An inquiry followed, with the company soon filing for bankruptcy.

Aggressive

Other short-sellers, ranging from high-profile hedge fund managers like

Bill Ackman

and

Whitney Tilson

to more secretive outfits like Gotham City Research, are taking a similarly aggressive approach. Billionaire investor Ackman has been involved in a war of words with nutritional firm

Herbalife

for over two years now, labelling the company as a “pyramid scheme”, a “modern-day version of a Ponzi scheme” and a “criminal enterprise”.

Tilson has described Lumber Liquidators as “evil”, accusing the US flooring company of knowingly ignoring health risks associated with its products.

As for Gotham, it takes a particularly no-holds-barred approach. Last year, it dismissed UK insurance outsourcer Quindell as a “country club based on quicksand”, warning that up to 80 per cent of its profits were “suspect”. Quindell became embroiled in a number of controversies in the following months, with shares suffering a peak-to-trough decline of 95 per cent.

Gotham enjoyed an even bigger success with Spanish wifi firm Gowex, which filed for bankruptcy days after the short-selling firm accused it of fraud.

Although short-sellers tend not to receive a favourable press, their defenders point to the valuable detective work they do, work that exposed questionable practices at huge companies like Enron, WorldCom and Lehman Brothers. Activist short-sellers, too, can point to many successes in recent years, especially in relation to China, thanks to the work of firms like Muddy Waters and GeoInvesting.

Secretive

However, many commentators are not keen on the secretive approach adopted by outfits such as Gotham. No address or phone number is provided on its website; nor is there any reference as to who is behind the company.

Other firms are similarly reticent.

The people behind Iceberg Research have chosen to remain anonymous. According to the firm’s Twitter feed, it has no short position in Noble Group stock. Noble alleges that a disgruntled ex-employee is behind the operation. Last autumn, shares in 21Vianet Group, a Nasdaq-listed Chinese company, almost halved after Trinity Research Group said it had “overwhelming evidence” that the company was guilty of fraud.

Billions of dollars were wiped off the market value of Tianhe Chemicals after Anonymous Analytics accused the firm of being "one of the largest stock market frauds ever conceived". About the same time, Emerson Analytics accused Hong Kong firm Shenguan Holdings of profit margins that were "too good to be true".

The authors of all three reports chose to remain anonymous, with no contact names or numbers provided.

Death threats

Short-sellers argue that anonymity is helpful when it comes to critiques of Chinese companies. In 2012,

Carson Block

of Muddy Waters said death threats forced him to leave Hong Kong. Another short-seller,

Jon Carnes

from the

Alfred Little

firm, has also reported being threatened. One of his researchers, Kun Huang, was jailed in China for two years before being deported, authorities saying he committed “the crime of impairing business credibility and product reputation”.

In the case of China, short-seller secrecy is understandable, to say the least. The fact that so many Chinese frauds have been exposed lends credence to the notion that accusations of market manipulation – “short and distort” – are usually fanciful. That doesn’t mean short-sellers are always right. Indeed, Anonymous Analytics recently came to the defence of Shenguan Holdings, saying Emerson Analytics’ charge of accounting irregularities was misplaced.

Motivations

Whatever about their accuracy, activist short-sellers insist they are motivated by more than just money. Both Ackman and Tilson have indicated shorting can be more bother than it is worth. Ackman, who describes his anti-Herbalife campaign as a “patriotic short”, said recently that the rewards “are probably not great enough to justify the time and the energy” of an activist campaign.

Like Ackman, Tilson prefers to go long rather than short. In a recent presentation, he listed 12 reasons not to short, saying it is a “brutally tough business”.

So why bother? Making money on the short side is five to 10 times more gratifying than making money on the long side, says Tilson. The game is "incredibly interesting and entertaining, thanks to the preposterous lies and incredible cast of promoters, charlatans and crooks you encounter". He adds: "The psychic rewards are enormous. It feels good to bet against these cretins." Vultures, paranoid fools and threats: When short-sellers and companies lock horns There have been some famous battles between companies and their short-sellers. Enron At a conference call in 2001, Enron chief executive Jeffrey Skilling was rattled by tough questioning from a short-seller regarding the firm's accounting practices. "Well, thank you very much, we appreciate that . . . asshole," he replied.

Skilling and Enron chairman Ken Lay were eventually found guilty on multiple counts of fraud, despite their defence that the firm's demise was a "conspiracy" caused by short- selling "vultures" attempting to "kill a company so that they will make money".

Overstock.com Patrick Byrne, chief executive of internet retailer Overstock.com, has been engaged in a war of words – a “jihad”, to use his own words – with short-sellers for some years now.

In 2005, Byrne held an extraordinary conference call in which he admitted to making up stories that he was a gay “cokehead”. He said he was hoping these stories might help uncover the “Sith lord” who had “orchestrated” a campaign against Overstock in collusion with “captured journalists”.

In a later interview with Bloomberg Television, Byrne said that “they are going to come after me” and that “you’ll probably read a headline that I was stopped with drugs or a dead body”.

Short-seller Mark Cuban called Byrne “a paranoid fool”.