The Dynamic & Often Controversial World of Short Sellers.

Short Selling

You’ve probably heard of Bill Ackman. The 49-year-old founder of Pershing Square Capital is worth a whopping $2.6 billion. He made his fortune investing in companies and buying up massive stakes. But his rise to hedge fund prominence has been anything but smooth. Ackman is an often polarizing and controversial figure in the industry. This has more to do with his short bets than his long ones.

For those of you who don’t professionally handle money, short selling is the opposite of buying a stock. When you buy a stake in a company, you become a part-owner and hope for the best. Short selling, however, entails borrowing a stock to sell it to someone right away, and then waiting for the price to drop so you can buy it up cheaper. The difference is, of course, your profit.

Essentially betting that a company fails or its stock starts to plummet is not for everyone, and it isn’t publicly popular either. But some argue that having short sellers in a market is healthy.

Prices tend to get out of whack with reality all too often, and short sellers tell the other side of a rosy story, bringing the market back to reality. Despite this, governments rush to block short sales when markets collapse. For example, the Chinese government pressured brokerages to ban short selling temporarily during the recent turmoil in Shanghai.

Ackman is a gifted short seller. He made a $1 billion bet that supplement marketer Herbalife is a Ponzi scheme that will collapse. He’s willing to bet the SEC and FTC will investigate the company soon and the stock price may go down to 0.

So far, however, things haven’t panned out as expected. The Justice Department and the FBI have ongoing investigations to see if Ackman’s company attempted to manipulate the price of Herbalife. The SEC and FTC are investigating other investments too.

Just a few days ago, a report by Citron Research pointed out that Valeant Pharmaceuticals, one of the companies Ackman has invested in, has been practicing sales tactics that could make it the “Enron of Big Pharma.”. That’s a pretty bold claim, and there is sure to be considerable investigation into the claims of the research team and the company before we know who’s right. But the damage is already done. Valeant’s stock fell by over 55% in a single day.

Short sellers have been increasingly focusing on regulatory malpractices and suspicious activity to figure out if a company is overvalued. It seems a lot easier to make a short bet if the company in question has been engaging in something illegal or unethical, rather than make a risky bet on pure fundamentals.

Sometimes the traders get lucky, as was the case with Volkswagen. A few hedge funds had made short bets on the German car manufacturer’s stock right before the emissions scandal hit and the stock plummeted.

It’s a world filled with regulations, legal disputes and considerable profit. Just another day on Wall Street.

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