Taking aim at short-sellers, but misfiring

Ken Lay

Enron founder Ken Lay (in red tie) being led from his fraud trial in 2006. Without short-sellers, the Enron ripoff might have continued for years. (PAT SULLIVAN / AP / May 1, 2006)

Northwest Biotherapeutics, a Bethesda, Md., firm with a purported cancer vaccine in development, has been in a long, bitter battle with short-sellers of its shares. It also has implied that Adam Feuerstein, a reporter for TheStreet.com, may be in cahoots with the shorts. 

Recently, Northwest has acquired some very high-profile support for this viewpoint. The mightiest shot came over the weekend from Steven Pearlstein, a Pulitzer Prize-winning business columnist for the Washington Post, who built Northwest's stock-trading travails into a broad case against short-selling in general and took a shot at Feuerstein as well. He drew much of his ammunition from a letter submitted to the Securities and Exchange Commission in July by Citizens for Responsibility and Ethics in Washington, a left-leaning good government group that urged the SEC to investigate Feuerstein. 

Like Pearlstein, the people at CREW seem to think there's something inherently nefarious about short-selling. This is a view shared by executives of companies that are short-sold and by not particularly well-informed members of the public.

But it's wrong. Short-selling is not illegal, not unethical and not bad for the markets. If you think the markets are rigged now, consider how they'd be if only traders with a relentless sunny view of a stock -- a view they were financially invested in promoting -- were permitted to participate. Every small investor, and not a few big ones, would become sheep for the shearing. That's how a world without short-selling would look.

A more important point is that in the process of attacking Northwest's short-sellers, both Pearlstein and CREW have accused Feuerstein -- CREW directly, and Pearlstein indirectly -- of being in the pocket of short-sellers. This is close to a smear. Neither offers any evidence whatsoever. 

Pearlstein says Feuerstein's "relentlessly negative" blog posts about Northwest "are filled with exaggeration, mischaracterization and half-truths." That's pretty close to what Northwest says about them; the company adds that they "seem designed to try to prevent investors from seeing the strength and progress in NW." Pearlstein also states that the posts "curiously have also coincided with the spikes in short trading." (Feuerstein's editor, Janet Guyon, says TheStreet has asked the Washington Post for a retraction of Pearlstein's piece. "We stand by our reporter, his work and his integrity," she says.)

Pearlstein asserts that reading Feuerstein's posts about Northwest would leave "mainline traditional journalists [like myself] appalled." 

I can't agree. Feuerstein's posts strike me as well-informed about an abstruse topic and aggressively skeptical, which is proper. I don't know Feuerstein and never heard his name before it was bandied by Pearlstein. He picks apart company claims and press releases relentlessly, but that's his job at TheStreet.com. It's not impossible that he's working for short-sellers, but his work does not appear to be at all inconsistent with sound journalism.

Yet CREW's executive director, Melanie Sloan, went so far as to tell me, "Adam Feuerstein is doing someone's bidding, is what I think. And I don't know if he's being paid for it. That's what I want [the SEC] to look into."

This is incredibly irresponsible for someone to imply, with no evidence. CREW and Pearlstein both should back off.

As for short-selling and Northwest, let's start with a quick definition. Conventionally, investors aim to buy a share when it's low, and sell when it's higher. Shorts reverse the chronology. They sell when a stock is high, in the hopes of buying when it's low. Before selling, they have to borrow the shares, with the expectation of buying them when the price has dropped and handing them back to the lenders.

Pearlstein blames short-selling for helping to turn the financial markets into "a giant casino which is easily rigged for the benefit of insiders." In his column, he said their "sleazy" tactics interfere with "allowing innovative companies to develop promising products that could save thousands of lives."

Pearlstein and CREW took similar approaches to Northwest -- they gave the benefit of the doubt to positive commentary about the company, whether it came from company executives or friendly websites, while treating Feuerstein's negative reports as suspect. But neither produced any reason to give credence to positive noises from Northwest's own press releases or biotech bloggers rather than to Feuerstein.

Pearlstein and CREW both come into this battle with notions about short-selling that require close examination. "Given the downside potential, which is manipulation, I don't actually find it all that socially or economically useful," Pearlstein told me. "I don't see why it's necessary for people to be able to bet against a company. If you don't like a company don't buy it, or if you own it, sell it."

As I wrote the last time there was a big to-do about shorts, traders betting on the negative are healthy "because unalloyed optimism is unhealthy for capitalism, as living on a diet exclusively of Twinkies would be for you or me. Almost every participant in the system wants to see markets rise, so the general impulse is to suppress bad news and play up, or even make up, good news." The SEC has no problem with short-selling in principle, unless it's abusive or manipulative -- just as it has no problem with buying long, if it's not abusive or manipulative. Without the work of famed short-seller Jim Chanos, investors might have been swallowing the lies of Enron's management for years longer than they did.

CREW's Sloan says that "short-sellers are now not merely making educated guesses, they're trying to manipulate the answers. And that's where I see the problem. Short-sellers who want to get an advantage are manipulating information in order to manipulate prices. It's going on way more than we all know." If that's the case, then what makes her think so?

Sloan is also concerned about Freedom of Information Act requests to government agencies: "A lot of people who are making FOIA requests are investment advisors and political intelligence firms. People who are all trying to get information ahead of everybody else about what's going on inside federal agencies."

Yes, that's life in Washington -- people manipulating information or trying to get information for their own profit. Why it should be nefarious for short-sellers to do that, as opposed to buy-side investors or corporate managements, Sloan doesn't say. Some 12,300 lobbyists were registered with Congress last year, spending $3.24 billion. Every dollar was devoted to manipulating information or obtaining it for someone's profit. It's a safe bet that almost none of the tab was paid by short-sellers. 

It's true, as Pearlstein writes, that biotech companies are vulnerable to short-sellers. They're small, risky firms and seldom have significant earnings. Their investors are doing what craps players call "betting on the come" -- on the chance of a big score against the odds. Northwest Bio is the definition of a speculative stock; the company has zero income over the last two years other than research grants, no product in the market, and $130 million in combined losses in 2012 and 2013 -- a pretty traditional venture-stage biotech.

As Pearlstein acknowledges in his column, "relatively few biotech companies ever succeed — share prices tend to be volatile, easily moved by rumors and news of regulatory action." To be precise, they're vulnerable to positive rumors as well as negative, to "pump-and-dump" bucket shop owners as well as short-sale manipulators. (Indeed, as the accompanying chart shows, Northwest shares have seen a lot more positive spikes in the last year than negative.) 

It's also the case that short-sellers are commonly blamed for problems at troubled companies that may have more fundamental causes. The easiest dodge for CEOs trying to explain why the market seems to be bidding down their shares in the face of their uplifting PR is to blame short-sellers. 

Pearlstein's argument that short-sellers are interfering with capital flowing to "innovative companies" deserves skepticism. Many of these companies have no business selling shares to the public. They did so because stock market money is easy money, and with full knowledge that it comes with the fickleness of public opinion. Many aren't as "innovative" as he assumes. He writes that in the battle between companies and short-sellers, "I'm siding with the companies." In the rough-and-tumble world of cheap, volatile biotechnology stocks, that may be the wrong choice.

Keep up to date with The Economy Hub by following @hiltzikm.

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