"Short selling promotes market liquidity." "Short selling is un-American." "Public companies that choose to fight short sellers are always fraudulent enterprises." "Hedge fund short sellers are heroes; they uncovered Enron." "Hedge funds can only make money by engaging in elaborate market manipulations that buy off research analysts and spread untruths into the marketplace."
Do these representations sound familiar?
On June 28, during hearings entitled "Hedge Funds and Independent Analysts: How Independent are Their Relationships," the Senate Judiciary Committee tried to move beyond these, and other, broad generalizations that have been used by pundits, lobbyists, and regulators to shape the public debate over a practice sometimes called "short and distort." Whether the Committee was successful in putting a finer point on the issue remains to be seen. Certainly, the hearings were not without their own healthy share of drama, intrigue, and irony.
Playing to a standing-room-only audience and a nearly empty dais, Senator Orrin Hatch (R-Utah) and Senator Arlen Specter (R-Pa) asked academics, officials from the Department of Justice, and securities industry representatives whether there was evidence of criminal activity by certain hedge fund short sellers in America’s capital markets. Senator Charles Schumer (D-NY) also made a brief cameo appearance at the beginning of the hearings, but only to denounce them as outside the jurisdiction of the Judiciary Committee. Despite initial representations to the contrary, Senators Specter and Hatch played right into the hands of those who questioned why the hearings were not being held by the Senate Banking Committee. Instead of focusing on criminal law enforcement of the Nation’s securities laws (issues clearly within the Judiciary Committee’s purview), the hearings too often strayed to civil regulatory concerns (issues within the Banking Committee’s exclusive purview) or to gratuitous criticism of the SEC’s enforcement program by a fired SEC investigator who, with the help of the senators themselves, managed to muddy the names of several prominent Wall Street executives who have not been charged with a single violation or crime—all this broadcast live on C-SPAN and CNBC. If nothing else, these histrionics remind us all of the reason why SEC investigations are supposed to be conducted on a confidential, non-public basis.
Therein lies the rub. While the DOJ representative and other witnesses were busy smiling, saying "thank you Senator, quot; and otherwise being non-responsive to the questions posed, the Committee appeared to miss the ironic link between spreading rumors of an SEC investigation and illegal conduct in the capital markets. Some "event-driven" investors, it seems, favor the quiet build of a large short position, followed by making false/misleading reports of corporate misconduct to regulators, capped off by spreading rumors in the marketplace of an impeding SEC enforcement action or criminal indictment. This strategy, it has been suggested, manipulates the SEC’s investigative process, adversely affects share price, attempts to "convict" people in the Court of Public Opinion, and has a lasting impact on the reputations of both people and public companies. The SEC, for its own part, has been loath to adequately investigate allegations that its own processes have been manipulated. Sadly, that’s exactly what the Senate Judiciary Committee did on Wednesday when it rearranged its witness list to add public testimony by a fired SEC investigator about a non-public investigation, an investigation not even within the oversight responsibility of the Judiciary Committee.
If nothing else comes of these recent Senate hearings, perhaps legislators will pause to consider the similarities between the conduct they were ostensibly investigating and the conduct that they directly encouraged. We cannot expect the debate to advance on these rather serious allegations of market manipulation until legislators take seriously a fundamental concept of our justice system: innocent until proven guilty.
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