Short seller reports can have a huge impact on the stocks they target. Everyone from regulators to law firms and even Netflix are looking to the impact of shorting stocks – with one law firm arguing free speech is being put at risk
In the stock market, the traditional way to make money is to buy shares in a company and wait for the share price to rise. Another way is to short a company and wait for the share price to go down and buy back the cheaper shares. If the share price goes up, those shares must quickly be bought back in order to close losses, which is known as a ‘short squeeze’. Both ways are legal, but the perception of them and the analyst or investor recommending the buy or short squeeze is very different.
The unquestioned buy rating
We are used to seeing or reading analyst reports that recommend the purchase of a stock and give it a target price for 12 months. If the analyst works for a large research house, this broker will call its institutional clients and encourage them to buy the company. The strength of a large broker backing an idea can have a very significant impact on the share price. Naturally, companies that receive these buy recommendations are delighted. Future value is identified in the company and the share price usually rises.
Recommendations are often reported in the financial press. It is also common to see investment managers commenting in print or online media on the stocks they are betting on in their portfolios. In this age of the internet, if the manager or person recommending a company on social media is well known or has a good reputation as a manager, other people may be inclined to invest.
In these situations, no one questions the manager or analyst. Nor is the analyst questioned whether he or she decides to change the recommendation before it reaches its target price simply because the stock, for example, has performed much better in percentage terms than the benchmark. There is no question as to whether the research house has a management company that holds shares in the company before the report is published.
Analyzing the analysts
The reactions when a so-called ‘short seller’ research firm publishes a recommendation to short a company are very different. Short sellers specialize in reporting on companies where they believe there is some kind of fraud, whether financial, operational or related to corporate governance.
In January 2023, the listed companies of the Indian conglomerate Adani lost more than $100 bn in value following the publication of a report by Hinderburg Research. In Spain, a Gotham City Research report questioning the accounting, solvency and integrity of Grifols led to a sharp fall in its shares in 2024. The controversy increased when it became known that the analyst firm had closed a large part of its own short immediately after the initial share price fall, despite saying that the company was worth zero euros.
The Spanish National Securities Commission or Comisión Nacional del Mercado de Valores (CNMV) opened a case against Gotham and the controversy has reached the courts in both Spain and the US, with Gotham accused of market manipulation. All this is happening in a case where the analysis firm and the investor have declared their positions and when they were closed.
In July last year the SEC brought charges against Andrew Left, founder of Citron Research, claiming a multi-year fraud. The regulator accuses the fund of manipulating the share prices of companies through its publications on the internet: when stocks reacted to the postings, the SEC says the manager would close its positions by doing the opposite of what it recommended.
But there is controversy around the SEC’s actions – prompting law firm Dynamis to file a formal petition with the regulator, calling for rulemaking to clarify the legality of trading by investors who publicly comment on securities. The petition asks that the regulator set clear rules for investors to know when they can buy or sell after making public comments on a stock and that their free-speech rights be protected. They are also calling for disclaimers to be allowed in reports, informing investors that their position may change after the report is published in a bid to avoid legal action.
From fraud to Netflix
What is relevant in these cases? The days or minutes it takes to close a position? Or is it the number of shares you sell and buy back that is relevant? Is it wrong to post your opinion on social media? Is freedom of opinion at stake? Or is it wrong to require a target price to be met before closing a short position?
Proponents of this type of analysis argue that it has helped uncover fraud, such as at Wirecard, the German technology company whose share price soared for years despite allegations of fraud by some analysts and the Financial Times. The now defunct company was even the subject of a hit series on Netflix.
Far beyond the potential entertainment value, forcing a stock market position to be held for a minimum period of time simply does not make sense in frantic markets, with the risk of a ‘short squeeze’.
