Short Selling: Poop and Scoop!

The latest battle against short-sellers has been declared by Rui Feng, CEO of Silvercorp Metals Inc. The company operates silver mines in China. Sino-Forest’s woes (as happens in so many instances) opens the door to spread fear about any public company that has operations in China. Don’t get me wrong, I’m as dead set against fraudulent corporate behaviour as the next guy – despite that our value system and regulatory ‘regime’ actually encourage it.

When I posted Europe short-selling ban? Ban all of it everywhere! I received a flurry of comments in different discussion groups.

Arguments coming from fans of short selling were often hilarious, riddled with self-serving justifications: “Sure I’m getting rich by unethical means, but the end result is a better world for all!”

Here’s a sampling of the comments from others (for and against) that I thought were fun:

For:There are plenty of illegitimate trading activities on the long and short sides but the mere fact of shorting a company is in no way terrorism. There are many companies for which the so called spectre of short positions had bought their valuation back to accurate levels in a way that solely long and flat positions would not have done: there are also companies whose values have been artificially inflated to the detriment of investors by extraordinarily high demand on a relatively small free float of shares.”

For: The issue that Malvin doesn’t seem to grasp is that shorting can bring legitimate capital pressure to public companies. When does that occur? Short selling makes raising capital more difficult for companies that are either fraudulent, incompetent or simply wide of the mark. For example, a new firm may tout its unproven battery technology as the breakthrough that enables the mass-produced electric car. Since this is unlikely to have much merit (we’ve been waiting over 100 years) the short seller brings the pressure of technological reality to bear against the firm’s self-serving hype. Potential investors would do well to monitor short interest in the firm.” (interesting this fellow is unaware of mass produced hybrids using batteries, and the new all-electric Nissan Leaf.)

For: Borrowing does mean you have legal title to and economic ownership for the period of the borrow. If one banned shorting of physicals then the same practice would continue through CFD’s, TRS’s and sector based ETF’s with margins to the originators of these products meaning a less cost efficient product.(this fellow actually believed that when you borrow securities or rent a car….you own it during the contract period…aaauuuggghhh!)

And I like this following response which was directed at the author of the above comment (thankfully a fellow man of reason).

Against: You confuse actual legally actionable falsehood with the damage that can be done by the strategic use of completely non-legally actionable innuendo, and even by the knowledge that short sellers are gathering like vultures around a particular stock. Do you seriously think that all short borrowing does mean you have legal title to and economic ownership for the period of the borrow?

Most rationalizations in favour justify the practice by claiming it’s no different than an investor who is an owner of the stock deciding to sell it. I left this comment on a discussion to make my point:

“There’s no evidence anywhere that short sales have anything to do with ‘true worth.’ Any money manager knows that with enough funds he can make the stock price anything he wants. This is okay, but using ‘artificial’ funds is what really distorts prices in the extreme. Say you bought a horse with a loan and used it as collateral. I don’t own your horse, but I can legally borrow it from your lender and sell it to a third party for a good price. Now I start a rumor the horse is lame. The buyer in a panic is willing to sell it back to me at half the price. I made money and return your horse. Oh, but the lender finds out the “true value” of the horse is less than the loan value. He calls the loan – you lose the horse, or pay the loan if you can and are stuck with a horse everyone knows is lame (you put it down since it’s too expensive to feed and board it). You lose. If you think this is ethical stuff, God love you!”

Many folks have no idea that deliberately manipulating the stock price is illegal. They claim that “Pump and Dump” is just as evil – some defense eh? In fact, selling short is the exact inverse of pump and dump – so I’ll call it POOP (out the stock) and SCOOP (buy it back). As a reminder of how the former works, have fun with this video (from the Sopranos).

About Mal Spooner

Malvin Spooner is a veteran money manager, former CEO of award-winning investment fund management boutique he founded. He recently authored A Maverick Investor's Guidebook which blends his experience touring across the heartland in the United States with valuable investing tips and stories. He has been quoted and published for many years in business journals, newspapers and has been featured on many television programs over his career. An avid motorcycle enthusiast, and known across Canada as a part-time musician performing rock ‘n’ roll for charity, Mal is known for his candour and non-traditional (‘maverick’) thinking when discussing financial markets. His previous book published by Insomniac Press — Resources Rock: How to Invest in the Next Global Boom in Natural Resources which he authored with Pamela Clark — predicted the resources boom back in early 2004.
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