After years of the sell side bearing the brunt of litigation by individual and institutional investors, short-sellers have recently been the target of a number of lawsuits by public companies including Overstock (OSTK) - Get Overstock.com, Inc. Report, Biovail (BVF) and Fairfax Financialundefined.
I have no idea as to the validity of the claims behind these three suits, but I do have a general view that the role of short-sellers on markets is a constructive one. As well, I have an interesting anecdote about when I was a target of a suit in the early 1990s, which makes me somewhat more sympathetic to the defendants and which could be instructive about the current ill feelings toward the short-selling community.
But some background first. I am a professional short seller, and I have generally found that those in the short-selling community to be more inventive, more detailed and more informed in their analysis of companies.
Importantly, I have found that serious fundamental short sellers, as contrasted with momentum-based short-sellers who dominate the short-selling landscape, are very good stock analysts. Indeed, the two leading practictioners, David Rocker of Rocker Partners and Jim Chanos of Kynikos, are the best securities analysts I have ever met. Their understanding of balance sheets and power of analytical dissection is far superior to any other analysts I have met in my 30 years on Wall Street.
Why is this so?
I don't know exactly why, but it could be in part that most analysts tend to be cheerleaders because it's in their best interest for stocks to go higher; short-sellers have to look at both sides (particularly the risk factors), so they tend to be more well-rounded in their approach to stock analysis.
Though at times vociferous, short sellers are dramatically outnumbered by long buyers, so in the aggregate, they are far less vocal compared to the legions of generally bullish talking heads in the media -- particularly among Wall Street sell-side analysts, who remain more cheerleaders than anything else.
As such, I believe this is one of the reasons that short-sellers are more likely to be the targets of lawsuits alleging nefarious conduct.
My own experience as the target of a suit by a company for my negative analysis came when I started to do some research on
. In 1991-92, Marvel was the Internet stock of its time, with comic book collecting all the rage. Marvel Entertainment (then controlled by conglomeratour Ron Perlman) was a hugely successful 1991 IPO. Coupled with Perlman's string of profitable takeover transactions, Marvel became the darling of the momentum crowd and enjoyed a several-billion-dollar enterprise value (market cap minus debt plus cash), despite its leveraged balance sheet, one-product profile and modest earnings.
During 1991 I began to canvass comic book stores to determine the value of Marvel's franchise position and growth prospects. At the time, comics were 100% of Marvel's product offerings, and as my research expanded, it increasingly became clear to me that the popularity of comic book collecting was ebbing -- traffic was falling at comic-book stories and some were even closing.
I could also tell Marvel had begun to lose its creativity, stuck in a creative rut of muscular male superheroes and buxom and sexy female superheroes.
Leading independent comic book publishers began taking market share from Marvel, and younger, hipper readers were increasingly turned off by Marvel's product line. I talked to comic book buyers, and they were telling me that they were more interested in the independent, edgier comic book offerings. Stated simply, Marvel was headed for a fall.
After completing my analysis of Marvel Entertainment's declining fortunes, I thought about sharing it with several of my friends in the media.
Then I got a different idea.
For 20 years I had admired
Alan Abelson. I had considered him a journalistic treasure, someone who was iconoclastic and willing to consistently write (in vivid prose) about contrary views against the market's prevailing (and bullish) bias.
So one day I headed down to Dow Jones headquarters and up the elevator to Mr. Abelson's office on the 16th floor.
There was one problem. I had never spoken to Abelson and didn't have an appointment. The receptionist said Abelson does not meet with "walk-ins." At that very second, Abelson appeared.
Seeing me in a wheelchair and obviously feeling bad for me, he led me to his office saying he had about a minute for me. I asked him about Marvel Entertainment, and he explained that he been doing some preliminary work on the company. I told him that I had spent weeks doing research on Marvel, and that I had written up a synopsis of my findings.
He then asked me to give him a copy of my findings and that he might "get back to me" at some time. That sometime was later that night, when he told me that, with the assistance of his editor, it would make a great cover story for
And that Saturday morning in February 1992, only three days after my initial meeting, my story on Marvel Entertainment ("Pow! Smash! Ker-plash! High-Flying Marvel Comics may Be Headed for a Fall!") appeared in
When markets reopened on Tuesday, Marvel's shares fell by almost 20%.This occurred despite First Boston (Marvel's investment banker on its IPO) reiterating a buy on the stock and raising estimates.
Not surprisingly, Marvel's management ridiculed my article, citing the company's strengths.Weeks later, Perlman's Marvel Entertainment filed suit against me and my employer, charging that our clients (at the time I had just started to run First Albany's institutional division) front-ran the article by shorting the shares (they did not, as no one knew about it), and that my analysis was ill-founded and inflammatory. On the contrary, it was well researched with copious notes and documentation.
Marvel Entertainment lost the suit.
Two years later Marvel Entertainment filed bankruptcy -- and two years after that, they filed bankruptcy again!
And I became known as a short-seller.
So what's to be learned here? It's lonely to hold a contrarian view against a company that's held in very high esteem, and it can be a lonely fight to hold to one's conviction when you don't follow the herd.
But it's that very herd mentality -- which often overvalues companies -- that can make short-selling such a lucrative line of work.
Editor's Note: TheStreet.com and James J. Cramer, its co-founder and major shareholder, were subpoenaed in February in connection with an SEC investigation into allegations by Overstock that a research firm, Gradient Analytics, engaged in a conspiracy with short sellers (including Rocker Partners, which owns a small stake in TheStreet.com, the publisher of this web site) to manipulate Overstock's share price. The SEC agreed that it would not, at that time, seek to enforce the portions of the subpoenas issued to the company and other media firms, including Dow Jones (DJ) , that concern communications between journalists and their sources.
At time of publication, Kass and/or his funds had no positions in stocks mentioned, although holdings can change at any time.
Doug Kass is general partner for two investment partnerships, Seabreeze Partners L.P. and Seabreeze Partners Short L.P. Until 1996, he was senior portfolio manager at Omega Advisors, a $4 billion investment partnership. Before that he was executive senior vice president and director of institutional equities of First Albany Corporation and JW Charles/CSG. He also was a General Partner of Glickenhaus & Co., and held various positions with Putnam Management and Kidder, Peabody. Kass received his bachelor's from Alfred University, and received a master's of business administration in finance from the University of Pennsylvania's Wharton School in 1972. He co-authored "Citibank: The Ralph Nader Report" with Nader and the Center for the Study of Responsive Law and currently serves as a guest host on CNBC's "Squawk Box." Kass appreciates your feedback;
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