A less publicized and more sinister version of
short selling can take place on Wall Street. It's called "short and
distort". There is nothing inherently wrong with short selling, which is
permissible under the regulations of the Securities
& Exchange Commission (SEC). But the short-and-distort type of short
seller uses misinformation and a
bear market to manipulate stocks. Short and distort is as illegal as
the pump
and dump, but is mainly used in a
bear market.
It is important for
investors to be aware of the dangers and to know how to protect
themselves.
Short
selling is the practice of selling borrowed
stock in the hopes that the stock price will soon fall, allowing the
short seller to buy it back for a profit. The SEC has made it a legal
activity for several good reasons. First, it provides the markets with
more information. Shorters (traders who practice selling short for a
living) often complete extensive and legitimate due diligence to try and
discover facts and flaws that support their suspicion that the target
company is overvalued. Because most shorters are scrupulous and ethical,
their actions are conducive to the health of the market. Finally, short
selling also provides investors who own the stock (have "long"
positions) the ability to generate some extra income by lending their
shares to the shorts.
On the other hand, short and distort (S&D) traders manipulate stock
prices in a bear market by taking short positions and then using a smear
campaign to drive down the price of the targeted stock. This is the
inverse version of the "pump and dump" tactic, whereby crooks buy stock
(take a long position) and issue false information that causes the
target stocks price to increase.
Generally, it is easier to manipulate stocks to go down in a bear market
and up in a bull market. The pump and dump is better known than the S&D
because of the long bull market and the media. The stock market has been
in a general up-trend since the early 1980s, which provided ample fodder
for "pumpers". Movies like Wall Street and The
Boiler Room
helped educate investors about the risk of this type of stock
manipulation.
The S&D schysters try to profit by stimulating fear. They will use
online screen names that imply either that they are associated with the
SEC or the
National Association of Securities Dealers, or that they can
regularly spot worthless stocks. Their goal is to convince investors
that every proponent of the stock has ties to the company and that the
SEC is watching and will halt the stock. S&Ds also intimate that they
are looking out for investors' interests. Short and distort players
clutter message boards, so optimistic information cannot easily be
found. "Get out before it all comes crashing down" and "Investors who
wish to enter a class action lawsuit can contact…" are typical posts, as
are their projections of $0.00 and loss projections of 100%. If their
strategy is suspected by "longs", they attack the person that has caught
them. The market manipulator will do everything in his/her power to keep
buyers out of the stock and keep the price heading south.
The net effect is that the investors who initially bought stock at
higher prices sell at low prices because of their mistaken belief that
the stock is worthless, caused by an effective distortion campaign. At
the same time, the S&Ds cover at low prices and lock in their gains.
In light of Enron and current market conditions, investors are more
susceptible to this type of manipulation now than during the boom of the
'90s. In this current market, the first appearance of impropriety causes
investors to run for the hills. As a result, many innocent, legitimate
and growing companies are getting burned, and investors are getting
burned along with them.
A few tips to help prevent this in the future:
1) Do not believe everything you read - verify the facts.
2) Do your own due diligence and discuss it with your broker.
3) Hypothecate your stock - take it out of street name to prevent the
short sellers from borrowing and selling it.
The best way you can protect yourself is to do your own research. There
are many potentially great stocks out there, but Wall Street is ignoring
them. And even if the S&Ds attack your stock, you will be better able to
detect their distortions and be less likely to fall prey to their
distortions by selling the stock at a loss.
Another tool is to know the seven key characteristics of a good research
report. Here is a brief summary of how to spot them:
1. Is there a disclaimer?
The SEC requires that everyone providing investment information or
advice must fully disclose the nature of the relationship between the
information provider (i.e. research analyst) and the company that is the
subject of the report. If there is no disclaimer, investors should
disregard the report.
2. What is the nature of the relationship?
Investors can get some good information from pieces published by investor
relations firms, brokerage houses and independent research
companies. Using all of these sources will provide information and
perspectives that can help you make better investing decisions. However,
you need to evaluate their conclusions in light of the compensation (if
any) that the information provider received for the report.
Can a Wall Street analyst who is even partially compensated by trading
generated by the report be more objective than a fee-based research firm
that is paid a flat monthly rate with no "performance" bonus? The answer
to this question is left for each investor to decide, but both reports
are available to use for evaluating a potential investment. The nature
of the compensation will provide information to help you evaluate a
report's objectivity.
3. Is the author identified and is his/her contact information
provided?
Generally speaking, if the author's name and contact information is on
the report, it is a good sign because firstly it shows the author is
proud of the report and secondly it gives you a way to contact the
author for additional information. Research reports from legitimate
brokerage firms post the author's name and contact information near the
top of the front page. If the author's name is not given, investors
should be very skeptical of the report's contents.
4. What are the author's credentials?
Letters after a name do not necessarily mean that the author of the
report is a better analyst, but they do indicate that the analyst has
undertaken additional studies to expand his or her knowledge of finance
and investing.
5. How does the report read?
If the report contains a lot of grandiose words and exclamation points,
beware. I'm not saying that good analysts are boring, but good reports
don't read like the National Enquirer. We try to make it
interesting, but a reputable analyst would never use exaggerations like
"sure things" or "rockets", and they would never suggest that you
mortgage your home to buy a stock.
Objective research reports provide reasoned arguments to buy or sell a
stock. Key factors such as management expertise, competitive advantages
and cash flows are cited as evidence to support the recommendation.
6. Is there an earnings model and target price with reasonable
assumptions?
The bottom line for any recommendation is the earnings model and target
price. The assumptions upon which the earnings model is based should be
clearly stated so that the reader can evaluate the reasonableness of the
assumptions. The target price should be based upon valuation metrics,
such as P/E
or
P/B, that are also based upon reasonable assumptions. If a report
lacks these details, it is generally safe to assume that the report
lacks a sound basis, and investors should ignore the report.
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7. Is there ongoing research coverage?
A commitment to providing ongoing research coverage (at least one report
per quarter for a period of at least one year) indicates that there is a
solid belief in the fundamental strengths of a company. It takes a lot
of resources to provide this type of coverage, so a firm providing
ongoing coverage is a sign that the firm legitimately believes in the
long-term potential of a stock.
This contrasts one-time reports that are used to manipulate stocks. In
these cases, supposed research firms will suddenly issue "reports" on
stocks they have never reported on before. Generally, these reports can
be identified as an attempt at stock manipulation because they will not
contain the attributes of a legitimate research report (discussed
above).
To get more information on stock manipulation, you can visit the
following sites:
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