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Posted 4/10/2006
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Beware companies that attack short-sellers
Short-sellers play an important role in financial markets by exposing problems. Recent lawsuits threaten to silence them, and that could cost you money.
By Bill Fleckenstein
As regular readers know, I have not been shy about speaking my mind in public. But I must admit, it's rather alarming to think that a company potentially short on scruples can sue short-sellers for exposing the rot which (allegedly) lies within (and receive favorable primetime coverage, to boot). Consider the case of pharmaceutical maker Biovail (BVF, news, msgs) vs. hedge fund SAC Capital, research firm Gradient Analytics and Bank of America (BAC, news, msgs).
Less than 60 minutes' worth of homework
"60 Minutes" was itself a "short sale" recently. In a segment on this controversy, the show painted short-sellers as some kind of black-hatted individuals -- with Biovail management as their purported prey. That portrayal did not sit well with columnist Joe Nocera of The New York Times, who on April 1 penned a rebuttal titled "Selling Short the Virtues of Short Sellers." (You can access the story here, but The Times will charge a fee for it.)
The Times story has three parts, with the first focusing on Biovail, the pharmaceutical maker. The more I have unearthed about it, the more I am convinced that it's a problem company, to be generous (though I have never held a position in the stock). I stand by my original claim: Companies that sue short-sellers tend to have something to hide. (See my March 13 column, "Confessions of a short-seller.")
Related news and commentary on MSN Money
The second part is a discussion on the potential misbehavior on the part of folks involved on the short side. We don't know if any has occurred. But if so, it's more a case of market manipulation (which is illegal, but appears to go virtually unprosecuted) than of any inherent dastardly short-selling tactics.
Equal-opportunity chicanery
Market manipulation is done by sleazeballs on both the short and long side. "Collusion/front-running" (the alleged wrongdoing of SAC and Gradient Analytics) happens all the time on the long side, in my opinion. Manipulation is manipulation, and I've complained about it ad nauseam. In my Nov. 7 column, Software shenanigans and Dell's dilemma, for instance, I said this about the upside romp in Mercury Interactive (MERQ, news, msgs): "In the last three days of October, lo and behold, Mercury rallied 8%, from about $32.50 to $35, i.e., higher than where it was when it gapped down on the (reduced revenue) preannouncement. Upon checking, I saw that as of the last reporting date, two firms owned a little more than 20% of the company. T. Rowe Price was the largest holder, with an 11% stake. I asked myself: Why did the share price spurt? Why did it spurt at month-end? Did it spurt because of the buyer's newfound faith in the fundamentals of Mercury? Or because of the buyer's need to have the share price go up?" People seem not to care about whatever tactics are used to boost a stock. Ironically, though, when shorts figure out that something phony or unsustainable has pushed a stock to where it doesn't belong, they sometimes get blamed when it subsequently goes down.
Blaming the mismanagement messengers
Let me repeat something I've said before: Short-sellers do not mismanage companies. They don't cause them to stuff the channel, build receivables or cook the books generically. Company managements do that. Short-sellers catch them.
While not always right in their investigations, shorts provide valuable research in many cases. I know that whenever I'm long a stock, I want to hear what the short story is.
Using legal muscle to muzzle shorts
Now for the third and scariest aspect of Joe Noceras story in The Times, which revolves around free speech. To wit, the specter of companies filing lawsuits to keep short-sellers from talking to the press. Hedge-fund manager Jim Chanos described what life would be like under the "Biovail standard": "Enron could have sued me for talking to (Fortune magazine reporter) Bethany McLean and (analyst) Mark Roberts for writing up my bear case on Enron. If stock prices go down, are we suspending the free speech provisions of the U.S. Constitution for market skeptics and short-sellers?" That's the chilling part of what Biovail is apparently attempting. As a measure of its "success," columnists Gretchen Morgenson of The New York Times and Herb Greenberg of MarketWatch.com, two friends who do great investigative work, tell me that they both have sources who are no longer willing to go on the record when discussing corporate chicanery.
What we don't want to see is the routine silencing of naysayers by managements with something to hide. This is intimidation masquerading as victimization.
(Editor's note: StockScouter, MSN Money's proprietary stock analysis system, was developed in partnership with Gradient Analytics.)
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily "Market Rap" column on his Fleckenstein Capital Web site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of CNBC or MSN Money. At the time of publication, Fleckenstein did not own or control shares of companies mentioned in this column.
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