February 18, 2022

Regulation by Enforcement: Short Sellers & Scalping

In addition to the SEC, the DOJ may find itself under pressure to use novel academic arguments to support enforcement activities – even in criminal proceedings.  As I blogged last year, the DOJ has recently launched a major investigation into the business practices of short sellers. According to a recent NYT DealBook article, the legality of activist short sellers’ longstanding use of “short reports” has been called into question by Joshua Mitts, a professor at Columbia Law School:

Short sellers have long been told by their lawyers that as long as their reports contain no material inaccuracies and are not based on inside information, they have done nothing illegal. In the disclosure accompanying their reports, activist short sellers typically say they are short the stock but may cover at any time. And they add that they are not offering investment advice.

John Courtade, a former senior S.E.C. enforcement litigator who now represents short sellers, has designed some of these disclosures. “Scalping has to involve deception of some sort,” he said. “Just the fact that you’re going to close your position has never been held to be deception. If you look at the cases, they involve situations like not disclosing that you have a position at all.” But Mr. Mitts argues that whether the boilerplate disclosure is sufficient “has not been tested by the courts.”

The article says that the SEC is unlikely to move on a rulemaking petition submitted by Prof. Mitts, but that “it’s an open question as to whether the Justice Department will try to set a precedent by prosecuting short sellers for market manipulation under the scalping theory — or any other one not yet tested.”

I’m not a fan of SPACs or short sellers, but I am a fan of due process – and I think that there’s a legitimate risk that the SEC and the DOJ may cross the line in the upcoming months if they bring enforcement actions or criminal proceedings premised on conduct that has long been engaged in openly, with the advice of experienced counsel, and under the noses of regulators.

John Jenkins