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Tesla fight shows rise of short-sellers on Wall Street

Tesla, which can claim the chief executive with the most erratic Twitter strategy and may yet become the biggest public company taken private, is also due another laurel: the most shorted US stock of the past decade, in dollar terms.

According to data provider IHS Markit, $13bn worth of its shares have been loaned to investors for bets that their value will plummet. Indeed, Elon Musk’s detail-light scheme announced this week to take his electric car company private at a valuation of more than $80bn, including debt, appeared in part a response to those bets. “Being public means that there are large numbers of people who have the incentive to attack the company,” he said in a letter to employees.

The claim Tesla is the “most shorted stock in the history of the stock market” is more hyperbolic. Globally, that title goes to Alibaba, the Chinese e-commerce group with American Depositary receipts traded on the New York Stock Exchange. (It’s a figure boosted by arbitrage trades related to Altaba, the group that contains legacy assets of the Yahoo.)

Yet, with billions of dollars at stake, the Tesla spectacle highlights the scale of short selling in modern stock markets. The very public role of Tesla’s critics, on social media, investment blogs and in the media demonstrates how they have become part of the scenery of US markets, even as the demonisation of such critics has prompted calls for more regulatory disclosure.

“Short-sellers are not ever going to be loved by Wall Street in the US, but we’re pretty lucrative for banks, because of the borrow fees we pay. We’re largely tolerated,” said Carson Block of Muddy Waters Capital.

To sell short a stock an investor must first borrow it, generating income for the owner of the shares — often index or mutual funds which can use the money to reduce their fees — as well as the investment banks and brokers that facilitate the arrangement.

The stock is then sold “short” in the market. If it drops in price it can be repurchased at a profit. Shares must eventually be returned to the rightful owner, however, so if the price goes up losses are potentially limitless. In 2008, for instance, German carmaker Volkswagen briefly became the world’s most valuable company after disclosure of stakebuilding by Porsche squeezed hedge funds into a scramble for stock.

Mr Musk warned in May that a “short burn of the century” was imminent, in a statement which may present legal jeopardy for allegations of market manipulation, if his scheme proves not to have the promised “funding secured”.

Some US investors have little sympathy. “short-sellers are an easy scapegoat,” said Cliff Hodge, director of investments for Cornerstone Wealth. “When I hear a chief executive railing against short-sellers I don’t put much stock in it and if anything it suggests the CEO is not giving enough attention to addressing the underlying problem as they should be.”

Jamie Cox, managing partner at Harris Financial Group, said: “People rail against short-sellers all the time. To be honest, I think it is much ado about nothing. If you didn’t have short-sellers you wouldn’t have buyers at certain points.”

Indeed their presence helps to moderate market extremes. Sales of borrowed stock provides shares to buyers without forcing prices even higher. When a share price crashes, or a company under pressure is forced to raise equity, short-sellers become natural buyers in order to reap the profits of their bets.

Short-sellers are also a growing part of the US investment scene. Conferences dedicated to the sharing of short ideas have sprung up. At one organised by Whitney Tilson in New York this year Mark Spiegel, investor for Stanphyl Capital and frequent antagonist of Mr Musk on Twitter, laid out his case against the electric carmaker. Among three reasons for the stock price to go to zero was the claim that Mr Musk “has a long track record of making hugely misleading statements”.

Musk’s attacks on the shorts — a selection

© Reuters

“They’re jerks who want us to die . . . They’re constantly trying to make up false rumors and amplify any negative rumors. It’s a really big incentive to lie and attack my integrity. It’s really awful. It’s . . . hurtful.” Interview with Rolling Stone magazine, November 17, 2017

“These guys want us to die so bad they can taste it . . . Just wish they would stop sticking pins in voodoo dolls of me. That hurts, OK?” June 8, 2017

“Tragic. Will send Einhorn a box of short shorts to comfort him through this difficult time.” August 1, 2018, on news David Einhorn, president of Greenlight Capital and Tesla short-seller, would not be renewing the lease on his Tesla

“Stormy weather in Shortville.” April 3, 2017

“Short burn of the century comin soon. Flamethrowers should arrive just in time. Looks like sooner than expected. The sheer magnitude of short carnage will be unreal. If you’re short, I suggest tiptoeing quietly to the exit.” May 4, 2018

Twitter has also provided a forum for activist short-sellers, both identified and pseudonymous, to present their views, although Dan Yu, the face of Gotham City Reseach, argued that this is nothing new, and that short-selling is “an American tradition”, which has always been part of the furniture.

In the 1980s the Feshbach Brothers were known for their success as short-sellers, for instance, briefing journalists and talking up their positions in the press. Dan Loeb, the billionaire behind the hedge fund Third Point, has admitted to spending much of the 1990s posting on investment message boards as Mr Pink.

Short-sellers also fill a void, as investment banks and mutual fund managers often have little incentive to antagonise company executives or to puncture market enthusiasms. Mr Block contrasts the tolerance of this in the US to that of regulators in Europe, where he has targeted a small number of stocks such as Casino, a large French retailer: “They treat management as de facto stewards of capital. short-sellers must therefore be trying to destroy employment.”

There have been some calls in the US, however, to adopt the European system which requires disclosure of any short position of more than 0.5 per cent of a company’s stock. In 2017, for instance, the president of the New York Stock Exchange said betting against a company’s prospects felt “icky and unAmerican”.

Short-sellers tend to hate such rules, which require giving up their valuable intellectual capital. Significant ownership disclosure is required due to the influence that gives an investor over a company, but aggregate short interest information is sufficient to inform the market, they said.

Marc Cohodes, a former hedge fund manager and ongoing vocal short seller, branded the idea “crazy”.

To him, short-sellers already have the cards stacked against them. He said: “We’re detested, loathed, regulators are against you, rules are against you, companies against you, every force of nature against you, so only the strong survive.”

Additional reporting by Joe Rennison, Lindsay Fortado and Ben Foldy

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