At the start of the year, short-sellers were facing a reckoning.
In January, Reddit’s rowdy WallStreetBets forum became a household name for launching GameStop and a motley assemblage of other « meme stocks » to previously unfathomable heights and, in the process, thrusting phrases like « diamond hands, » « tendies, » and « to the moon » into the popular lexicon.
They also put a target on the back of a sworn enemy: Wall Street investors like Melvin Capital and Citron Research who bet against them.
Their goal was annihilation. In their mind, a cabal of short-selling hedge funds were conspiring to screw the average Joe traders, and the Reddit army wanted to short-squeeze them into oblivion.
Little of it made sense by any traditional measure, but the numbers were too massive to ignore. GameStop, a money-losing video-game retailer whose value dipped below $250 million last year, surged to a market valuation of more than $20 billion, surpassing the likes of Lyft and Domino’s Pizza. Nearly 900,000 individual accounts traded the stock at its January peak, compared with fewer than 10,000 at the beginning of the month, according to the postmortem from the Securities and Exchange Commission.
It might have all amounted to a harmless sideshow if it weren’t for the tangible and immense repercussions. Marquee funds lost heaps of money — in the case of Melvin Capital, it opened a crater in its balance sheet so deep that founder Gabe Plotkin accepted a $2.75 billion investment from the hedge-fund hall of famers Steve Cohen and Ken Griffin, the founders of Point72 and Citadel, respectively.
Other short-sellers ducked for cover. Carson Block’s Muddy Waters drastically dialed back positions. Citron’s Andrew Left, one of the most famous bomb throwers in the industry, shocked Wall Street by throwing in the towel on short selling after two decades.
« Short Sellers Face End of an Era as Rookies Rule Wall Street, » blared a headline in Bloomberg. « Wall Street’s Most Reviled Investors Worry About Their Fate, » read another from The New York Times.
But it turns out the demise of short-sellers has been greatly exaggerated. The real story of short-sellers in 2021 is a more complicated picture of diverging fortunes.
Yes, meme-stock mania cast an undeniable chill over the industry early on this year, especially for passive short selling in the mold of Melvin Capital, which typically involves shorting a broad group of stocks without necessarily revealing their positions. But many activist short-sellers, the investors who wage public campaigns to tank their targets’ stocks, are thriving.
Total activist short campaigns have declined this year, but shares of their targets are down an impressive 25% on average for the first three quarters of 2021, according to research from the data and analytics company Breakout Point.
« For their standards, that’s very, very good, » said the Breakout Point founder Ivan Ćosović, whose Düsseldorf, Germany-based firm tracks analytics on short selling as well as retail stock trading.
Recent victories include the German real-estate giant Adler Group’s 34% plunge in early October after a report from the noted short-seller Viceroy Research that called the company a « hotbed of fraud, deception and financial misrepresentation » — claims that the company has strongly denied.
Around the same time, the veteran short activist Kerrisdale Capital went head-to-head with recent meme-stock darling Camber Energy. The stock sank 70%.
So what is the legacy of the GameStop-Reddit imbroglio on short-sellers? The bottom line is that Wall Street’s chief skeptics aren’t dead yet, even if the retail army has forced some short-sellers to throw in the towel, change their strategies, or go into temporary hiding.
« It’s a great time to be an activist short-seller because there’s an infinite number of sketchy companies you can dig into and expose, » Kir Kahlon of Scorpion Capital said.
The short-selling pullback
Gabriel Grego, an Italian born former paratrooper for the Israel Defense Forces, is known for labor-intensive short reports that send him to far-flung nations to investigate potential targets firsthand. He focuses on hucksters, serious frauds, and verifiable wrongdoing — being overvalued or poorly run isn’t enough to catch his interest.
His reports span dozens of pages and marry clinical presentations of evidence alongside liberal use of exclamation points, question marks, and, in some cases, the « face with tears of joy » emoji to emphasize his more egregious findings. Grego and his firm, Quintessential Capital Management, received some validation in late October when the SEC announced a $39 million judgment against Akazoo, a music-
upstart accused of defrauding investors and conjuring up phony financials and even fake corporate offices.
Quintessential first unearthed signs of corporate chicanery in April 2020, and a month later the European company was delisted from Nasdaq.
But for most of 2021 that part of Grego’s business has been on ice thanks in part to COVID-19 travel restrictions as well as the aftermath of the meme-stock mania.
When the meme-stock wave sent dozens of stocks skyrocketing in January and torched short-sellers, his immediate reaction was relief: None of his holdings were blown up. Then came curiosity: What was happening, and how long would it last?
« My assumption was it was transitory, resulting from a confluence of factors, » Grego told Insider, citing the COVID-19 lockdowns, fewer entertainment options, easy and free trading software, and millions of people with cash to blow from increased savings and government stimulus checks.
« People were bored at home with a lot of money and the ability to trade for free, » Grego said.
Like many activist short-sellers, he decided to step back from short selling for a few months while temperatures cooled, focusing instead on his long investments — a decision made easier given the international travel restrictions.
« You saw some reluctance in bringing out new public research, » Ćosović said. In the European Union, where regulations require greater transparency from short sellers, investors significantly pared back short exposure in the weeks surrounding GameStop’s late-January peak, according to Breakout Point data.
Through late November, the total number of activist short campaigns stood at 113, down 33% from the average of the preceding five years, according to data from Activist Insight Shorts.
But even with anti-short sentiment at a fever pitch, some of Wall Street’s skeptics carried on.
In early February, Nate Anderson of Hindenburg Research took the rare step of publishing a scathing report without taking a financial position in the stock, citing the « unprecedented times » and anger among the investing public.
The targeted stock, the health-insurance startup Clover Health, which has backing from the special-purpose acquisition company evangelist Chamath Palihapitiya, fell after the report published and is down 66% year to date — a sign that quality short research could still cut through the noise.
As more short reports dropped without getting scorched by retail traders, the waters began to feel safer.
Hindenburg, which gained notoriety last year for bursting the bubble on the electric-truck startup Nikola, continued undaunted, lobbing critical research at Lordstown Motors, the Chinese crypto firm Ebang, and the green-tech company PureCyle — all of which went into freefall.
Scorpion Capital in April targeted Quantumscape, the ballyhooed electric-battery company that counts Bill Gates and Volkswagen as backers, and it dropped as well. (The company has since pared its losses, climbing substantially in the past month).
Most activists Insider spoke with said the prospect of a run-in with rabid day traders now seems remote, especially compared with the bounty of overhyped companies gaining ground in this
Kahlon said people were initially wary after GameStop, but « I don’t really think anything has changed. I think GameStop was a perfect storm. »
« There’s a tremendous number of short opportunities out there, » he added.
Sahm Adrangi said Kerrisdale Capital, where he is founder and chief investment officer, took a several-month hiatus from publishing shorts after GameStop. But it’s back to business as usual, he said, and if anything the explosion of retail trading has presented more opportunities — because « you’ve got a lot more people who haven’t studied what they own. »
He’s not worried about the flip side of that coin — a mob of amateurs banding together to squeeze his positions.
« It’s very difficult to organize a Reddit mob and force a stock to go up, » Adrangi said. « It happens once in a blue moon. »
Not everyone agrees. Marc Cohodes, a vocal short-seller who’s been at it since the 1980s, said he has respect for the crowd of amateur traders on Reddit and other forums.
« If I’m watching a baseball game and I see a guy hit a 525-foot home run, I will never ever bet that that guy can’t do it again. You have to have respect for the markets when a stock goes from $20 to $450, » Cohodes said. « You have to have respect that if it happened once, it could happen again. »
The brunt of the pain hasn’t been shouldered by activist short-sellers like Anderson, Kahlon, and Adrangi, but rather by passive short-sellers.
Unlike dedicated activists — who typically target only a handful of companies per year given the resources, vetting, and focus required — many hedge funds run passive short books, holding a more diversified portfolio of dozens of short positions they expect to decline in value without necessarily believing they’re frauds or waging a public attack. Usually this runs in tandem with a portfolio of long bets.
In theory, a diversified approach reduces risk. But in this topsy-turvy market, where canine-inspired digital coins can rapidly amass billions in capital and small-cap stocks can achieve escape velocity seemingly on a whim, it increases the odds of a short-seller suffering a fatal blow. If a New Jersey delicatessen with less than $15,000 in revenues can trade at a $115 million valuation, not much is off the table.
When CNBC’s Scott Wapner in late October asked the Greenlight Capital founder David Einhorn about Tesla — a short bet that has bloodied the famed investor’s portfolio over the years as it marched to a $1.2 trillion
— Einhorn said he no longer discusses Greenlight’s individual short positions.
Einhorn explained that the downside risks have fundamentally changed in the past two years. Previously, a short bet that went sideways — whether because of an unforeseen acquisition or an earnings beat — might cost you 25% to 35% at the worst.
« What’s happened in the last couple of years is sometimes the stock can be up 200% in a day or 500% in a day. And that changes how you have to think about — well, what happens if you’re wrong about something? » Einhorn told CNBC. « So we’ve had to adjust the characteristics of our short portfolio and the way that we’ve structured it to take that into account. »
To his point, in early November shares of the car-rental company Avis Budget spiked as much as 200% after reporting earnings, clobbering some short-sellers in the process.
Bronte Capital, an Australian hedge fund with a diverse short portfolio, has also changed up its short-selling game amid the « over-the-top » retail-stock boom, according to the founder and CIO John Hempton.
« Rubbery companies recommended by disreputable people normally—eventually—decline in value, » Hempton wrote in the firm’s June investor letter. « Alas in late 2020 and early and mid 2021 garbage companies recommended by disreputable people go way, way up. And that makes it very hard for us to make money. »
« If you fight the bubble, your shorts will roll you over, you will lose frightening amounts of money and you will look stupid because you are stupid, » he wrote, adding that the rational response is to not participate in the mania.
Bronte is still shorting « the most nonsensical stocks we can find, » according to the letter, but it has made tactical adjustments to avoid decimation, including more aggressive hedging with derivatives and a more robust portfolio-review process to manage risk.
Another prominent short-seller, who asked not to be named, said the long-running retail mania — but not the GameStop episode in particular — provoked a strategic shift. They narrowed and intensified the firm’s focus, with fewer positions and smaller stakes, unless the stock is under the radar. They also move more swiftly to reduce exposure when opportunities arise to bank profits.
« This is a market that’s very difficult to develop conviction in, » this short-seller said. « When you’re up against irrational behavior, you can’t just assume that’s going to come to an end any time soon. »
Others have simply called it quits. The veteran Wall Street short-seller Russell Clark closed his RC Global Fund in early November after losing 2.5% through October and seeing assets dwindle to $200 million from $1.7 billion in 2015, Bloomberg reported.
Short-sellers are widely hated — but usually right
Short selling has been around for centuries, and its practitioners have been the object of loathing for just about as long.
It’s not difficult to understand why, according to Frank Partnoy, a University of California Berkeley law and finance professor who’s studied the effects of activist investors.
He compares it to the craps table at a casino, a game in which most bettors are on the same team, boisterously winning together when the roll of the dice goes against the house.
« If you see someone betting on the ‘don’t pass’ line, they’re betting against the table, and we hate them instinctively, » Partnoy said.
Prior research from Partnoy and the University of Florida professor Peter Molk found stocks targeted by activist short-sellers suffer 7% declines on average relative to the market in the immediate aftermath of a campaign. Skeptics might conclude that this is simply the result of fearmongering by short-sellers.
But the professors’ latest study found the stock performance also worsened over time, with companies targeted by negative short reports seeing shares decline more than 20% on average relative to the market in the four years after a negative campaign. Operating performance deteriorated substantially as well, suggesting the short-sellers correctly identified firms with weak prospects.
Moreover, negative campaigns commonly result in class-action lawsuits and regulatory action, such as exchange delistings, according to the study.
« You can still hate them if you want, but there’s a reason the market is going down 7% relative to the market when they announce their intervention, » Partnoy said.
There are, of course, exceptions and bad actors that feed the public’s disdain. In an unusual case from 2018, a short activist from Dallas named Quinton Mathews was forced to retract an error-riddled report against Farmland Partners that sparked a 39% sell-off in the real-estate investment trust’s stock. He agreed this year to pay damages to the company to settle a lawsuit — a rare outcome.
Short-sellers have also been accused of « scalping » or « short and distort » schemes — attacking a viable company in bad faith and then promptly exiting the position to pocket a profit after the price lurches downward.
‘I gave these meme guys, these Reddit guys too much credit.’
A detente between the retail crowd and short-sellers isn’t likely any time soon.
Even if another squeeze on the scale of GameStop never materializes, the heightened influence of retail traders is likely to persist, creating some roller-coaster rides for investors trying to short popular stocks.
Look no further than the Quintessential founder Grego, who after a long hiatus launched his first short campaign of the year at the beginning of November.
The target: the Alzheimer’s drug developer Cassava Sciences, a retail favorite that at one point this summer was worth over $5 billion. But Grego says the biotech, which has received millions in grants from the National Institutes of Health, hired convicted criminals, cherry-picked patients and manipulated data for its studies, and forged scientific research, according to his 40-page report.
The company didn’t respond to Grego’s claims — but investors did. Cassava Sciences stock shot up over the next three days, at one point climbing as high as $100 a share, a 92% leap from the morning Grego revealed his short position.
« I thought it was a thing of the past, but of course I was wrong, » Grego told Insider.
The immediate aftermath, as with any new short report, was « complete madness, » monitoring the stock price and social media and fielding phone calls, Grego told Insider three days after issuing the report.
He’d prepared for this outcome.
« We knew this was a meme stock. We knew it had a large shareholder base, » he said. « We made sure we were protected from a risk-management perspective. »
He didn’t waste much time lamenting the setback. As he views it, Cassava’s future is binary: It has a successful Alzheimer’s drug — the holy grail of medicine, as he puts it — or it doesn’t and the company is essentially worthless. Either outcome would please Grego.
« If I’m wrong, it means the world has a new Alzheimer’s drug, » said Grego, whose grandmother died after battling the disease. « I think the chances are very small that it comes from this company. »
If he’s right? Score another victory for the short-sellers.
Still, he expressed some disappointment. He understood rallying against short-sellers who picked on a declining but legitimate business, such as GameStop. But his company’s track record rests in successfully rooting out frauds.
He’d hoped Cassava supporters would at least debate the merits and substance of the report, instead of the usual vitriol and ad hominem attacks hurled at short-sellers.
« I gave these meme guys, these Reddit guys too much credit, » Grego said.
This brawl between short-seller and meme stock, much like the industry at large, will continue to play out. Cassava last week disclosed in a securities filing that the company is under investigation by the government, and The Wall Street Journal reported the SEC and NIH are investigating whether the company manipulated its research. A company exec told The Journal it’s cooperating with the investigation and denied the accusations.
The stock sank and is down 47% from its November high.
This story has been updated from its original version.