Recent market events around Gamestop stock have evoked critique of short sellers. Most prominently, some are confused how a company’s stock could be sold short in measure greater than 100%. This is mostly a mathematical quirk reflecting a stock with low float which has in turn been loaned out to be sold so as to presumably be purchased back at a lower price. This is best explained in detail – and is not the focus of this piece – by adequately-named (got their start promoting dotcom stocks like AOL) fool.com.
The entire situation – including Bloomberg’s Tracy Alloway correctly highlighting the scorn that short sellers have received – is best told by Matt Levine here. But short sellers, the majority of whom operate in compliance with the law, are worth defending. Short sellers can get ahead of regulators to suss out fraud. Indeed, we don’t need to look that far back for an example.
Observers of European equities markets will be no stranger to Wirecard, the former dauphin of the German payments/fintech sector, which at its peak was valued at $20 billion. When short sellers and reporters from the Financial Times brought forth allegations of fraud, the accusers were investigated by German financial regulators for financial manipulation. That’s right: the whistleblowers – including short sellers – were investigated by financial regulators instead of the company accused of illegal activity.
Short selling was temporarily prohibited in Wirecard securities by German financial authorities. As ongoing investigations are continuing to reveal, there were many ignored red flags, questionable compliance procedures on the part of the German regulator, and an inappropriate sympathy for the company and its CEO Markus Braun on the part of the head of the German SEC, Olaf Sholz.
Eventually, the problems came to light. An outside auditor could not locate $2 billion in cash that the firm had claimed on its balance sheet. Former CEO Markus Braun was arrested and charged with various financial crimes. Another top executive disappeared into Belarus with assistance from a former Austrian secret service member and has not been seen nor heard from since.
The German authorities didn’t limit themselves to financial executives, however. FT’s reporter Dan McCrum, who had initially broken the story on Wirecard, was rewarded for his fantastic journalism by becoming the subject of a new investigation.
Anyway, why did short sellers play an important role in bringing this fraud to light when its auditors and regulators had for years failed to do so? Short sellers have a profit motive to find and expose fraud. This profit motive cuts through political gladhanding, nationalist pride in an emerging tech company, or belief in a stock promoter who dressed just like Steve Jobs (or, more questionably, Elizabeth Holmes).
The warning signs ran into the dozens and had been called out for over a decade for WireCard. Perhaps there was sartorial foreshadowing at play though. American observers will recognize instantly the “look” of now shamed CEO Markus Braun. We know it as the Elizabeth Holmes look. Those familiar with Theranos will recall confident but fraudulent promotions by this now-indicted founder on account of her trademark wannabe Steve Jobs look. The image is infectious among fraudsters now – even the bitcoin scammers are stealing the look. Useful heuristic in tech: the hardcore Steve Jobs wannabe is like 80% likely a fraudster.
A ban on short selling was tried here and only helped extend fraud. American policymakers would be wise to take heed of this story because variants exist on this side of the Atlantic, complete with attempts at political interference to investigate the short sellers. The investigation into short sellers was short-lived as the allegations against the firm confirmed a fraud perpetrated by medical supply company MiMedx and its then-CEO.
The Wirecard prologue is still unfolding. For investors, the story is complete. Short sellers, if they could withstand the lawsuits and investigations, won in the end. Big time. But German development banks that had loaned money to Wirecard, many retail investors surely lost out (including a baffling number from Germany’s regulator BaFin), along with folks who generally regard the stock market as being well-regulated. These market participants, even if they managed to avoid Wirecard, will still be left to wonder about the independence and strength of regulatory institutions like BaFin. Had short sellers’ concerns been considered in good faith, confidence in the markets could have remained otherwise stable.
San Francisco Securities Outlook 