December 15, 2021

DOJ Launches Investigation of Short Sellers

Not that I’m crying any crocodile tears for short sellers, but 2021 hasn’t been the greatest of years for them. The meme stock crowd handed short sellers their lunch last winter, and the gravity defying rise of the stock market for most of the year hasn’t made for many other big scores – well, aside from shorting SPACs, of course. Now, according to this Bloomberg report, the year may be getting even worse for short sellers.  That’s because the DOJ has launched a large-scale investigation into short selling by hedge funds and research firms:

The U.S. Justice Department has launched an expansive criminal investigation into short selling by hedge funds and research firms, scrutinizing their symbiotic relationships and hunting for signs that they improperly coordinated trades or broke other laws to profit, according to people familiar with the matter. The probe, run by the department’s fraud section with federal prosecutors in Los Angeles, is digging into how hedge funds tap into research and set up their bets, especially in the run-up to publication of reports that move stocks.

Authorities are prying into financial relationships between hedge funds and researchers, and hunting for signs that money managers sought to engineer startling stock drops or engaged in other abuses, such as insider trading, said two of the people, asking not to be named because the inquiries are confidential.

Underscoring the inquiry’s sweep, federal investigators are examining trading in at least several dozen stocks, including well-known short targets such as Luckin Coffee Inc., Banc of California Inc., Mallinckrodt Plc and GSX Techedu Inc. And they’re scrutinizing the involvement of about a dozen or more firms — though it’s not clear which ones, if any, may emerge as targets of the probe. Toronto-based Anson Funds and anonymous researcher Marcus Aurelius Value are among firms involved in the inquiry, the people said. Other prominent firms that circulated research on stocks under scrutiny include Carson Block’s Muddy Waters Capital and Andrew Left’s Citron Research.

As Liz blogged recently, short reports can do long-lasting damage to companies, although those reports also have helped uncover some pretty massive frauds. However, short selling remains one of the market’s murkiest corners, and some pretty shady conduct involving the authors of short reports has been brought to light. Now that the DOJ’s on the case, things could get very interesting.

John Jenkins