SEC Subpoenas More Than 50 Hedge Fund Advisors

The Securities and Exchange Commission’s actions in cases of illegal insider trading or stock manipulation are essential in improving market efficiency. The potential that informed parties such as corporate insiders, brokers, underwriters, large shareholders and market makers are likely to be manipulators, as it has often been the case - is quite real. The reality is, these groups are close to the information loop, therefore their tendency of exerting less than honest influences toward their own best interests obviously increases.

Illegal insider trading is apparently a growing concern at the Securities and Exchange Commission, prompting the SEC, according to a WSJ report - to sent subpoenas to more than 50 hedge-fund advisers:

The subpoenas are seeking communications data related to short-selling and options trading in Bear Stearns Cos or Lehman Brothers Inc. Some of the hedge-fund advisers have received subpoenas related to both probes, while others were contacted with respect to only one.

The near-collapse of Bear Stearns earlier this year, which saw the investment bank sell for a bargain-basement price of one billion dollars to JPMorgan Chase, pushed the SEC to start investigating whether a combination of false rumors and manipulative short-selling combined, drove down the shares of the 85-year-old investment giant.

Lehman Brother’s shares also have been under pressure for quite some time. “There are a lot of rumors in the marketplace that are totally unfounded. We are suspicious that the rumors are being promulgated by short sellers of our stock that have an economic self interest,” Kerrie Cohen, a spokeswoman for Lehman Brothers, told Reuters.

Among the firms that have received subpoenas are Citadel Investment Group LLC in Chicago and SAC Capital Advisors in Stamford, Conn:

The subpoenas relate to trading in securities of the brokers, as well as correspondence between the hedge funds and other parties. The subpoenas are part of a broad inquiry, and firms that have received subpoenas were told by the SEC that they aren’t necessarily the focus of specific allegations.

Monday, Wall Street law firm Wachtell, Lipton, Rosen & Katz published a memo calling the new examinations into compliance programs “an important first step.” But it said “the SEC needs to undertake additional bold measures to constrain abusive short-selling and rumor-mongering.”

Comments

[glassbox:]

I hope the SEC bans short selling or at least makes it a point to inform all stockholders what happens when they agree to lend their stocks to those who intend to borrow it.

2008 Jul 15 06:20 AM

[jjason:]

I agree that short selling should be made illegal.

2008 Jul 15 07:17 AM

[wearmanyhats:]

Hedgefund investors better know what the hedge fund may invest in before they committ the money to the fund. If they didn't read the prospectus, they have no business investing in it. If they don't like short selling, then don't be in that kind of fund. Let the market take care of itself. Sooner or later, this kind of risky investing will weed itself out.

2008 Jul 15 07:38 AM

[trader717:]

Short selling makes the market more efficient. Rumor mongering does not. Short selling is not the problem, isn't it the same as hedge funds bidding up the price of a terrible company? What happens then? Well all those average people who bought into the stock because it looks like it's good lose money when it tanks. Hedge funds trade, short selling is necessary to make their clients money in both bull and bear markets, as well as to hedge away risk. If someone does on average 60 hours of due diligence on a company, why shouldn't they be able to short one that they have found is clearly in trouble. Otherwise it would be a waste of their time and they would have to move onto another 60hrs, until they find a buy.

2008 Jul 15 09:47 AM

[trader717:]

Besides, don't people realize that the only hedge funds out there are not just stand alone firms, like Citadel, SAC, Och-Ziff, etc. All the banks have hedge funds, Goldman, Morgan Stanley, JPM, LEH, and of course Bear Sterns!! It would be interesting to see if any of Lehman's or Bear's internal hedge funds are/were long/short. I guarantee they were. All the firms do it, don't let BSC and LEH fool you because they happened to be the 2 banks with the most exposure to the sub-prime and general mortgage market, with high leverage, and are now paying or paid for it.

2008 Jul 15 09:54 AM

[glassbox:]

Whilst it is nice to think that short selling makes the market more efficient - the current disclosure rules around short selling does not. Do you know who are the shareholders of a company? Yes, the major ones - at the very least. Do you know who are the major short sellers of a company? No one knows. Do you know whose stock they are borrowing to short sell? No. Do you know who lent them those stocks? No. Do you kknow if your broker or custodian is lending out your shares? May be not or may be yes - but they probably never told me anything when I opened the account. Do you know how much you as a shareholder actually get from lending out that share? Maybe and its probably pathetic returns. And in a scenario like this, what is the mechanism that determines the price of lending a scrip? Who determines that price? There are a million such questions to be answered in the current system - none of which has been addressed. So how can you say that short selling creates a more efficient market?? With the current system, short selling is being done in a information asymmetric framework - which is why rumour mongering and fear stoking can be allowed to be carried to the maximum. If this does not get corrected, it will only kill free enterprise and healthy risk taking.

2008 Jul 15 10:14 AM

[glassbox:]

Question, how does one short a bond? You cannot - cos no ones lends bonds to be shorted. So,they use a proxy - the CDS markets. Hence those who are long bonds only interestingly have had their capital 'preserved'. If a bond could be shorted, trust me that the value of that bond would have gone down much further. The shorts in the bond markets are playing in a different market from the bonds itself. For equities, sadly, shorts are shorting in the same market as the longs. Just think about it.

2008 Jul 15 10:18 AM

[Nick Gogerty:]

We need a few pricks out there to keep the bubbles from getting to big. Long live the short sellers.

2008 Jul 15 10:29 AM

[glassbox:]

i don't think the short sellers are so nice as to 'prick'. They are blasting.... Short sellers don't live long - cos they are essentially shooting themselves in the foot most of the time. And they live off others' misery, so the karma will get the better of them eventually anyway.

2008 Jul 15 10:35 AM

[trader717:]

What does knowing who the major shortsellers of a company exactly tell you? Does it really matter if you even know who the major holders are, besides maybe thinking what they will do in major voting situations, which is farfetched? People look to see who holds the stock because people follow smart money funds. Does it matter who they are borrowing the shares from? One person vs. another?

I don't understand how that affects due diligence that a smart hedge fund manager does on a company, and then profits from shorting it, which in the end makes the markets more efficient. It forces companies to compete and maximize shareholder return. If there weren't shortsellers, a company could simply run its business inefficient and ride the trend in its industry. Short selling helps to point out bad companies. Now I said before, rumor mongering does not. If a hedge fund shorts just to put out false information and profit from it, I am completely against that. It definitely happens, just like insider trading happens with employees.

Short sellers don't live long? Why is the market down 10+% and hedge funds only down .75%? Because they can short sell and hedge their bets, they are outperforming. Everyone gets pissed off when the markets drop like this yet this is something that is healthy for economy. Once in a while, you need a major shakedown and poor companies will be acquired or go out of business. If a company is truly great at what they do, short sellers will get squeezed and pay for it, the same way longs should pay for investing in a poor company.

2008 Jul 15 11:17 AM

[glassbox:]

trader717, I don't need short sellers to point out bad companies. The bad companies will not survive on its own, anyway - and that will be the punishment to its shareholders. its existing shareholders will sell the shares - what use do short sellers do to the overall scheme of things. Tell me how exactly do short sellers point out the bad companies? Are they that relevant in pointing out bad companies??

With the current non-disclosure, what is there to protect minorities from having a stock price manipulated so that a major shareholder can privatise a company without going thru the normal route.

You are obviously not a business builder when you say that you don't need to know who one is borrowing stocks from. Please read my post properly, I'm not talking about whether a person who is borrowing stock should know who he is borrowing from. Of course, the borrower should be indifferent as his only interest is to short the stock. Rather, as a person who follows the stock, I'd like to know who is lending - that tells you something about his position, doesn't it?

In any case, basic logic tells you that you cannot sell something you don't own, unless you borrow. So, if you borrow, then it is the cost of borrowing it and the system in which that price is determined. My case is that that system is currently extremely flawed and favouring the rumour mongerings and taking advantage of the long term investors. Rome was never built in a day but short sellers will want to destroy it in a day - if they are allowed. Think harder...what value do short sellers really add?

2008 Jul 15 11:46 AM

[RMG:]

I find fault with stock brokers. If you have a (non-IRA) brokerage account, and so long it is a margin account, the broker is free to lend your stock (to a short seller). The broker does not need to inform you ahead and you don't have any right to instruct the broker not to lend your stock (it is part of the agreement when you open a margin account). If SEC prohibits brokers from lending an account holder's stock if the latter does not want, the short selling will diminish and the price will not fall as much thereby benefiting the account holder.

2008 Jul 15 11:32 PM