By William K. Black
June 27, 2017 Bloomington, MN
The president of the New York Stock Exchange (NYSE) launched a coordinated attack on “shorts” that mirrored his rival’s (Nasdaq) attack. The NYSE assault, however, used bizarre rhetoric.
“It feels kind of icky and un-American, betting against a company,” NYSE Group President Tom Farley told lawmakers in Washington Tuesday.
The heads of the NYSE and Nasdaq have appropriated the word “transparency” to support the effort to reduce the shorts’ effectiveness. When the NYSE purports to champion “transparency” – the key to reducing fraud by the CEOs of the companies whose stocks they exchange – it is time for investors to grab their wallets and hold them tight. The stock exchanges are very far from being champions of transparency when the question is what the CEOs of the listing companies should be required to disclose. Sure enough, it turns out that the stock exchanges’ proposed anti-short “reform” is actually a means to try to reduce the reliability of the public disclosures made by the CEOs of firms on those stock exchanges. A sophisticated stock fraudster wants the public to believe the firm is “transparent” because of its disclosures, but it is those very disclosures (when false) that turn that ‘transparency’ into an illusion designed to deceive the investor. When shorts improve the reliability of the disclosures that the CEOs of firms listed on the stock exchanges make, they protect investors from fraud. That makes honest “shorts” highly “American.”
When an investor “shorts” a financial instrument, he or she anticipates its current price is excessive. If the investor is right, he or she profits if the price falls quick enough and far enough. “Shorts,” therefore, can serve a valuable service. Their research and analysis may reveal that the company or the financial product is greatly overvalued. Honest, competent shorts make markets less inefficient and makes it much harder for CEOs to defraud or con future purchasers of the stock or financial instrument.
The fact that the shorts can be good for the world, the public, and investors does not mean that the shorts are saints or that all shorts are honest. They short stocks, derivatives, and bonds to make money. Shorts can be frauds, spreading false derogatory information about firms, CEOs, stocks, and financial instruments. Fraudulent shorts harm investors and market efficiency. The book, movie, and facts surrounding the “Big Short” shows why effective whistleblowers, regulators, and credit raters could have protected the public from the frauds far better than did the “shorts.” The “shorts” did not want the public to learn about the underlying frauds that inflated the value of mortgage products and the owners of such products until after the “shorts” were able to borrow the money to make large bets that the mortgage product and the firms that issued and held it were overvalued.
It is technically difficult, and expensive, to try to short many financial instruments over a long time. The sweet spot for shorts is to short the financial instrument shortly before it reaches its peak and falls sharply. The most common reason a financial instrument will surge rapidly in price and then fall precipitously is elite fraud. The movie portrayed the investors that made a fortune ‘shorting’ mortgage instruments as being greatly distressed because the mortgage instruments continued for months to have absurdly high values even though the information about the fraud epidemics available to the investors and credit rating agencies should have led efficient markets for mortgage instruments to fall quickly and severely. Only after the “shorts” made their bets did it became desirable from their perspective that the public learn that the mortgage products and firms that depended on their purported high values were in fact much less valuable once one realized the endemic frauds by mortgage lenders and those selling the mortgage product to the secondary and tertiary markets.
The “shorts” are not saints and it is a travesty that we celebrate the shorts in books and movies and ignore the whistleblowers and regulators who warned about the fraud epidemics and sought to prevent them – not profit from them. Honest “shorts,” however, are not “icky and un-American.” Honest shorts do the Nation, the public, and the world a service. They do honest firms a service by helping to drive frauds out of business, which allows honest firms to prosper. The shorts are neither saints nor sinners. It is revealing and revolting that the head of the NYSE attacks them as “icky and un-American” while ignoring rather than condemning the frauds led by the CEOs of the firms listed on his exchange that become wealthy by defrauding investors. It is telling that the CEOs of those listed firms fear the “shorts” far more than the NYSE. Worse, the head of the NYSE is making common cause with the fraudulent CEOs of listed companies who have enlisted the NYSE to try to squash the honest ‘shorts’ that the elite frauds fear will alert the public to their frauds.