A bear raid is said to occur when an investor attempts to drive the price of a stock down in order to profit from a short position. Learn more about bear raids and how to spot them.
What Is a 'Bear Raid'?
A "bear raid" is a term used to describe a situation where an investor, group, or entity attempts to influence the price of a stock downward in order to either profit from a short position or acquire a new long position at a lower price.
While it is not against regulations to short a stock, and is permissible to issue fact-based research that suggests a company’s financials may be weaker than its stock price suggests, such actions can become illegal if it is determined that the investor has engaged in deliberate actions intended to manipulate the stock price in their favor.
In this instance, overt manipulation could include such actions as:
- Excessive short-selling
- Colluding with others to take short positions
- Trashing the company in the media
- Spreading rumors or false allegations regarding the company or its management
- Attempting to weaken the company’s ability to raise capital, establish partnerships, or otherwise negatively affect the company’s operations
Some high-profile investors and hedge funds commonly take large short positions and are often vocal about their stance. Regardless of whether their behavior crosses the legal line, it can be helpful for investors to understand bear raids so they can make better decisions regarding acquiring or disposing of affected stocks.
Tip: If an investor sees a bear raid unfolding, one thing to remember is that eventually short sellers must cover their positions by purchasing stock. That means that once a bear raid is unwound, the potential for a recovery in price will generally exist.
'Short & Distort' Definition
The phrase “short and distort” describes the specific actions of an investor who takes a short position in a stock and then engages in a smear campaign to disparage the company or create fear among its shareholders. The investor may attempt to distort the facts in order to ‘spook’ shareholders into panic selling to drive the price down. The investor then hopes to cover their short position at a much lower price, thereby profiting from the manipulation.
Short and distort is essentially the opposite of “pump and dump” – the technique of acquiring stock, singing its praises with inflated or overly optimistic statements, and then selling as others buy into the hype.
Both of these actions can constitute securities fraud.
What Types of Investors Conduct Bear Raids?
Aggressive investors, shareholder activists, or hedge funds that have substantial resources and who employ shorting as a regular part of their investment strategy are the likely actors to conduct bear raids. Raiders are also likely to have a presence in the media they can exploit to get their message out.
Legal Bear Raids
Bear raids are common practice for large investors and hedge funds whose stated investment objectives include profiting by short-selling stocks of companies perceived to be overvalued. Bear raids only become illegal when associated with manipulative practices, collusion, or intentional misrepresentation. Shorting stocks, even coupled with issuing negative comments on a company, can thus be perfectly legal if substantiated by facts.
2021 Meme Stock Frenzy
The meme stock frenzy of 2021 began with hedge funds initially taking sizable short positions in stocks like GameStop. While the funds were expecting to profit from a decline in GME stock, their actions were legal, as the company had experienced months of declining sales revenues and prospects for the future were dim. In addition, the hedge funds did not seek to inflame matters in the public arena, nor did they create any deceptions about GME.
It turned out that the SEC was more concerned about the activity of individual investors who were buying the stock, as they were openly conspiring with others on online chat boards to buy GME stock to ‘squeeze’ the hedge funds into covering their short positions at much higher prices. In the end, it was determined that no illegal behavior occurred on either side of the GME affair, though warnings by the SEC were issued.
Bear Raid Example
One of the most widely publicized bear raids of our time was conducted by Bill Ackman, the manager of Pershing Square Capital. Ackman began shorting Herbalife (HLF) stock in 2012, engaging in a public campaign claiming that HLF was a pyramid scheme and predicting that it would eventually be shut down.
Ackman was openly conducting a bear raid but what probably kept Ackman from being accused of illegal manipulation was that his claims were felt by many people to be true. Initially, Herbalife stock dropped 20%, but Ackman held on, waiting for the company to completely dissolve. While this ended up losing him money in the end, it may have also helped to avoid SEC scrutiny, since he did not seek to grab a quick profit from his negative comments.
A battle ensued between Ackman and Herbalife for years, eventually bringing in another investing legend, Carl Icahn, who took the opposite position to Ackman, seeing the stock as an attractive opportunity. Herbalife never cratered to zero, though it eventually did get into trouble with the SEC and settled on a $20 million fine for its business practices in China. Nonetheless, it survived and took off. Ackman ended up capitulating in 2018 with a billion-dollar loss for his failed bear raid effort.
Bear traps are situations where a stock temporarily declines, drawing in sellers and short-sellers, but manages to stabilize and resume its uptrend. Bear traps can be associated with bear raids such as those above or can be the result of situations where a stock breaks what is considered to be a technical support area in price, thereby inducing further selling. Either way, bearish players believe they have an opportunity to profit from a decline, only to be trapped in a stock that is rising, which pressures them into abandoning their positions at a loss.
Both the GME and HLF examples above ended in bear traps, where the bearish investors were initially correct but ended up losing money in the end. The reason they are considered to be traps is that bearish players who put on short positions must borrow the stock to initiate those positions and put up margin capital to ensure that they can repurchase the stock later to close out. As a stock rises, the margin required to maintain the short position in the stock also rises. This places short sellers in a trap that may require them to put in more capital to hold their position as the price keeps rising. Failing to do so will result in margin calls that can force them to close their positions at a loss.
This is also the essence of a “short squeeze” in which the short seller gets squeezed into covering their position due to margin pressures.
Bear raids are situations where short sellers attempt to profit from a decline in a stock’s price. They may be legal or illegal and they may be successful or unsuccessful for the short-sellers. Investors who understand what bear raids are attempting to do and who recognize when bear traps and short squeezes are likely to occur should be able to make more informed decisions about what to do when they find themselves confronted with any of these situations on stocks they own or are watching.
This article was written by
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.