This article investigates the evidence for market manipulation of ReneSola (NYSE:SOL) and JA Solar (NASDAQ:JASO) securities. Both are thinly-traded, small cap, Chinese solar companies that have been on the SEC's "watch list" for abusive naked short selling. Like most Chinese solar companies, these two stocks have tenuous balance sheets. But is it healthy short interest, or is it the abusive, manipulative variety?
Many have said that the practice of naked shorting was one of the contributing factors to the financial meltdown of 2007, and the Securities and Exchange Commission (SEC) began to crack down on naked shorting since then. As opposed to the normal variety, a naked short sells shares before ensuring that he has shares available to borrow. Thus, "phantom shares" are created. In the best case scenario, the short is able to buy shares and deliver on time - eliminating the phantom shares. However, sometimes naked shorts aren't able to cover, and a "Failure to Deliver" results.
From a market manipulator's perspective, the power of naked shorting lies in those phantom shares. The phantom shares can increase the supply of a stock and drive down prices - which might be very important if, say, a hedge fund owned put options that were about to expire.
I realize this might sound like crackpot speculation to some of my readers. If the SEC regulates the markets, how can market manipulation be prevalent? Unfortunately, it's not so rare. Jim Cramer openly discusses manipulation by hedge funds in this video (a very interesting watch!). Quote:
"… I would encourage anyone that's in the hedge fund industry to do it, because it's legal, a quick way to make money, and very satisfying."
"By the way, no one else in the world would ever admit that, but I don't care."
Cramer discusses market manipulation -
How Does the SEC Track Abusive Short Selling?
Brokers and dealers are now required to check that short sale orders are backed with borrowed securities, and it has been made "crystal clear that the SEC has no tolerance for abusive naked short selling." However, there are some indications that the practice continues. The SEC has estimated that 1% of all market transactions still result in failures to deliver. To keep tabs on which companies are likely being abused by naked short sellers, the National Securities Clearing Corporation maintains a list of "threshold securities." I view this as the SEC's naughty list, and others have described threshold security classification as a red flag. (To be fair, there are also legitimate causes of Failure to Delivers, such as technical issues, so classification as a threshold security doesn't necessarily stem from naked shorting.)
In mid-May, ReneSola very nearly qualified as a threshold security. For the qualification, two criteria need to be satisfied:
- Sellers failed to deliver at least 10,000 shares over five trading days, and
- The level of fails is a minimum 0.5% of the shares outstanding.
With 635k fails from May 19-23, ReneSola just missed the 0.5% threshold. Currently there are only 41 securities on the list, so qualification would have been a dubious distinction. JA Solar was off and on the list many times throughout May.
Time and Sales Data
Some believe that market manipulation can be spotted directly from time and sales data. This quote from Investopedia supports that belief:
"One way people can deflate the price of a security is by placing hundreds of small orders at a significantly lower price than the one at which it has been trading. This gives investors the impression that there is something wrong with the company, so they sell, pushing the prices even lower. Another example of manipulation would be to place simultaneous buy and sell orders through different brokers that cancel each other out but give the perception, because of the higher volume, that there is increased interest in the security."
When I looked at 30 trades from this morning's JA Solar feed, I saw that 22 of 30 trades were the minimum round-block size of 100! Minus one large transaction, the entire JASO feed was composed of 300-share or smaller trades. Since the level of high-frequency trading in this stock is incredibly high, it probably deserves extra scrutiny from the SEC.
Generally it's not worthwhile for retail investors to trade 100 shares at a time because commissions trim too much off the top (4% for ReneSola, 1% for JA Solar, assuming a $10 commission). The 100-block count for ReneSola was a bit lower at 14. The honor of fewest 100-block trades (over this brief period) in the solar industry belongs to SunPower (NASDAQ:SPWR) at just 10/30. That seems appropriate because I believe that SunPower is the strongest company in the industry.
June 1st, 2014 Time and Sales Feed for JA Solar
Time - Price - Quantity
Should longs fear manipulation?
The short answer is that longs who own shares need not fear market manipulation. If your investment thesis is sound and the company posts positive results, manipulation will not be able to hold a stock down forever. In fact, a long with conviction can add to his position at the artificially low share prices that short selling creates, becoming the short seller's worst nightmare.
On the other hand, if you are long JA Solar calls or ReneSola calls then you should be wary. Since options expire, it's possible that abusive short selling could hold the stock price down for an extended period and your calls will expire worthless. These stocks are traded too thinly and manipulated too heavily to be mixed with the inherent risk of naked options trading.
Disclosure: The author is long SOL, SPWR. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.