Short sellers face the end of an era as newbies rule Wall Street

Photographer: Spencer Platt / Getty Images

The latest attack on Wall Street short sellers has a long tradition, dating back, well, at least to Napoleon. “Treacherous”, he called them for betting against government bonds.

They survived this and several other attacks in the centuries that followed. But GameStop’s uprising may mark the end of an era for the sold public – long-maligned people who try to eradicate corporate irregularities, take positions betting that a stock will fall and then undertake public campaigns.

The biggest victim came on Friday, when Andrew Left’s Citron Research said it would discontinue the short sales analysis after 20 years of providing the service. Others are already adopting less aggressive tactics or evolving into different shapes and formats. Melvin Capital was forced to retreat, abandoning its short position on GameStop, Carson Block and others cut bets, and some of the most powerful hedge funds are fueling double-digit losses and exploring your next steps.

Few in Main Street or corporate America, which sees short sellers as obnoxious vultures with dubious practices, are shedding many tears, of course. However, some investors, who say that the sales sold serve to police the markets, may be. Repeatedly short sellers, who practice the risky art of selling borrowed stocks to buy them back at lower prices, have been seen as a critical antidote to sniffing out fraudulent companies, those with questionable accounting and business plans, or just to maintain evaluations under verification. Enron is the most notable example.

“I’m still in business, so today I think it’s good enough,” said Fahmi Quadir, a short seller best known for her successful bet against Valeant Pharmaceuticals and founder of the New York hedge fund Safkhet Capital. The most fundamental problem, she said, is that fewer and fewer companies are spending substantial money on research firms or, in her case, “identifying companies that are predatory or fraudulent”.

Even before the attack on Reddit’s wallstreetbets forum, where a crowd of 6 million people joined forces to fire the actions most hated by hedge fund elites, short selling was difficult enough. The vast majority of short positions were already irrelevant, thanks to the popularity of index funds and the longest-running bull market in history.

Their numbers have been declining for some time. Of the thousands of hedge funds in the $ 3.6 trillion sector, only about 120 specialize primarily in equity betting. And they saw the combined assets split over more than half, for just $ 9.6 billion, in just the past two years, according to data compiled by Eurekahedge.

“It’s like watching the police raid a bank,” said Crispin Odey, one of the world’s most pessimistic hedge fund managers, about the trend. “There were fewer short positions in the market before the Reddit crowd started its attack than we have seen in 15 years.”

An art that fights

Short sellers are under pressure amid rising markets

Source: Eurekahedge

Some of the most feared short sellers are hiding. Block, whose forensic research notes have led to dramatic drops in a number of companies, “Massively” cut his short bets. A London-based $ 1.5 billion hedge fund and one of the best short selling records declined to be mentioned in this story for fear of being hunted down by retail investors. Another appointed an employee to scour the street betting page for signs of ongoing revolt while reevaluating his bets.

Read More: Reddit Crowd strikes Melvin Capital on industry alert

Short seller Gabriel Grego, founder of Quintessential Capital Management, said he was interrupting pessimistic bets in the United States. Although he thinks “short selling is alive and well,” he said it is time for caution. The GameStop rebellion shows that retail investors are now aware of their power and that will not go away, he added.

Hated, but necessary

Shorts have faced such sieges repeatedly in their more than four centuries of existence. The first such transaction is said to have occurred in 1609, when Flemish trader Isaac Le Maire attempted to short sell the shares in the Dutch East India Company. A year later, the company persuaded the Dutch government to ban short selling, saying companies like Le Maire were harming innocent shareholders, including “widows and orphans”.

Napoleon banned the practice 200 years later, and during the 1929 Wall Street crash, short-sale seller Ben Smith hired bodyguards because of threats from angry investors. When the financial crisis intensified in 2008, US regulators restricted short selling of financial stocks. Many other countries followed. More recently, billionaire Elon Musk started criticizing short sales on social media, calling them blow.

But in the most favorable view, shorts are seen as the ultimate police officer on Wall Street, devoting countless hours of detective and forensic work, facing powerful companies and regulators and exposing themselves to potentially unlimited losses. Proponents say that in a world where the traditional stock research industry lacks the courage to put sales recommendations on struggling companies and as passive investment plays an even bigger role, Le Maire’s descendants are sorely needed.

Take, for example, the Enron accounting scandal. Jim Chanos, founder of the hedge fund Kynikos Associates, helped expose the fraud and mounted his decline from an average of $ 79.14 per share in 2000 until December 2001, when it dropped to 60 cents. And last year, German regulators praised short sellers after initially banning them for exposing Wirecard AG, which filed for insolvency after revealing that 1.9 billion euros ($ 2.3 billion) in money were missing.

Read More: Wirecard Adds to the winning list of short sellers in Europe

New Rulebook

Other observers are less sympathetic. Before the 2008 financial crisis, US regulators modified certain rules to facilitate overdraft operations, according to Brian Barish, chief investment officer at Cambiar Investors. Some hedge funds have used this as a tool to brutalize companies that were viable but needed capital. Insolvencies that were preventable followed and real people were injured, said Barish.

“I don’t think hedge fund books need help,” said Barish. “Let them taste their own medicine.”

For now, hedge funds that tactically make leveraged bets against companies for short-term profits face the greatest risk to their survival. They are expected to be selective, avoid congested negotiations, take out less loans and stay away from companies with a strong participation of retail investors. Most importantly, they can back off if necessary.

Peter Borish, chief strategist at Quad Group, predicts lower returns on these funds as they avoid shorting stocks at lower prices and making profits more quickly. “If you’re looking for a short seller to do home runs, you’re more likely to get singles and doubles,” he said of the new prospect.

Other funds may choose to use discrete over-the-counter put options to place short bets, as they do not need to be disclosed in regulatory records. The Melvin Capital shorts listed in their public archives helped make them a Reddit bro target.