Myth #4: Short sellers are evil speculators
"I am soft, I am lovable. But what I really want to do is reach in, rip out their heart, and eat it before they die."
– Richard Fuld, fallen angel, on short sellers
People often forget that when Steve Jobs returned to the helm, the iconic logo once again made the cover of magazines in a casket. Amazon was not always the darling of Wall Street. What is now considered visionary management was, for a long time, branded as stubborn disrespect for shareholders.
When executives whine about vicious rumors spread by short sellers and their agents, they forget that Steve Jobs and Jeff Bezos had to stomach the same vitriol for years. They came up with the best antidote against short sellers. Make products that sell, manage your company properly, and short sellers will go away. Today, no short seller would ever take a stab at Apple. Note to all CEOs, the vaccine against short sellers is: put the interests of the company, its employees, its customers, the environment, its shareholders, and its management in that order and things will be fine.
If your approach is instead to hollow out resources from R&D, customer service, randomly "restructure" personnel, and flatten the organization chart, to engage in aggressive accounting practices, and vote for ridiculous stock option plans for the board, to gobble up sterile acquisitions and, above all, finance share buy-back plans, then, one day, there will be a pot of gold on the other side of the rainbow to be shared among short sellers.
In 2007, Mathew Rothman, global head of quantitative research, published a note about the demise of quants that went on to become the most circulated piece of research in the history of Lehman Brothers. As the battle between short sellers and Lehman escalated, he showed top management a white paper from Owen Lamont entitled Go Down Fighting: Short Sellers vs. Firms. Richard Fuld was not amused. He blamed short sellers for spreading vicious rumors that drove Lehman's share price down. A decade later, the dust settled. Every other article about the GFC and banker's hubris is illustrated with a picture of Richard Fuld's testimony before the House committee. Being the poster child of the GFC is a rough way to go down in history, even by cold calculating investment bankers' standards. My heart goes out to Mr Fuld…
Owen A. Lamont's Go Down Fighting paper can be accessed in full at Oxford Academic here: https://academic.oup.com/raps/article/2/1/1/1563177.
However, if all it took to bring down companies, markets, and currencies were bad breath, colorful language, and small positions relative to the overall float, then faith in capitalism should join the great white shark and polar bear in the list of endangered species. The national sport of short sellers is to unveil paradoxes in the fabric of the corporate space-time continuum. Ignorance and competence cannot exist in the same place at the same time. Basically, you cannot pretend to know what you are doing if you don't know what is going on. Strangely enough, this is a lie embattled CEOs would like us to believe. Whenever they are questioned about the illicit activities of their subordinates, their first line of defense is to feign indignation and throw them under the Bentley, pretending that they were unaware of the illicit actions perpetrated by a few isolated rogue individuals. That's commendable, except every single person on this planet knows that money does not grow on trees. Money leaves a trail. Bonuses are not charitable contributions.
Besides, company size is not a valid excuse either. For example, war is a dirty business. Generals are often far removed from the theater of operations. Yet, it does not mean their lowest-ranked soldiers can run around pillaging and looting with impunity. So, when CEOs claim they are not aware of fraud perpetrated by their underlings, either they are willfully blind and therefore complicit in the cover-up, or they really do not know what is going on and therefore incompetent. Either way, they are unfit for duty and undeserving of their compensation packages. That explains why, whenever short sellers uncover malfeasance, top management goes on the offensive and portrays short sellers as evil speculators who spread vicious unfounded rumors. Companies who have nothing to fear may not be happy, but they rarely waste time on legal action against short sellers.
Short sellers are the cicadas of the markets. No one has ever blamed cicadas for heralding the end of summer. When short sellers show up, this may herald the end of good times. They do not just talk trash. They put their money where their mouth is. If someone is willing to put capital at risk, the least long holders should do is revisit their bullish stance. Short sellers are often blamed for spreading vicious rumors and profiting from the decline. Companies will take analysts with Buy ratings for dinner and short sellers to court. Short sellers must therefore be careful about their facts and wording. Secondly, regulators do not take kindly to short sellers shorting across pension funds' large holdings. They are audited on a regular basis. Compliance is a survival mechanism. If your business model is to manipulate share price by spreading rumors and trade on it, then drop this book and go buy coffee mugs because "los federales" are about to establish a base camp in your meeting room.
"If we are victorious in one more battle with the Romans, we shall be utterly ruined."
– Plutarch on Pyrrhus
A word of caution for fellow short sellers. Short selling is an immature and fragile segment of the industry. On the one hand, short sellers want recognition for the value they bring to the markets. In the words of James Surowiecki, they balance out "Wall Street's inherent bullish bias," and play "a vital role in uncovering malfeasance." Short sellers also want to be treated fairly, just like any other market participant.
The preceding quotes are extracted from a 2015 New Yorker article by James Surowiecki, accessible here: https://www.newyorker.com/magazine/2015/03/23/in-praise-of-short-sellers.
Yet, on the other hand, short sellers come across as the enemy for a good reason. Airing commercials or sponsoring documentaries to expose companies as frauds and their management as crooks is a double-edged sword. Every successful campaign builds up resentment amidst corporations, regulators, and the public. Every short-term pyrrhic skirmish won makes the long-term victory ever more elusive. Many jurisdictions still ban short selling. Those that allow short selling have cumbersome administrative rules such as the uptick rule, an obligation to secure "borrow" before trading. The uptick rule stipulates that a short sale can only take place following an uptick in traded price.
Respect is never due but consistently earned. As long as short sellers fight dirty, they deserve to be treated with equal disdain. The most powerful incentive is probably the attitude of investors. Short sellers have such a sulfurous reputation that many investors will simply refuse to allocate to short sellers.
The premise of this book is that short selling does not have to be conflictual. Please be kind to top management. Do not remind them of their obsolescence. Time and markets are cruel enough already. The middle ground is simply to say you are shorting underperformers relative to the benchmark. Looking for relative shorts does not infuriate corporations, quite the opposite in fact. Every start up entrepreneur in Silicon Valley knows that markets have only two seasons, bull and bear. A bull market is series A and IPO season. A bear market is "go back working for the man" season. Executives in defensive sectors, such as food or utilities, do not expect their stocks to be assets of choice during bull markets. In fact, they would probably rescind their pension mandate to a manager who would gulp up their stock in a bull market, unless of course you are Warren Buffett and you talk to Coca-Cola.
