On December 10, 2021, Bloomberg reported that the United States Department of Justice had opened an extensive criminal probe into short selling by hedge funds and researchers. The DOJ fraud department, in cooperation with federal prosecutors in Los Angeles, are looking for evidence that some hedge funds coordinated bets on stock declines with research firms that publish negative reports on certain stocks, in order to depress the stock price and then cash in.
The DOJ sent subpoenas in early 2021 to dozens of companies, and then more subpoenas in October. The investigation involves multiple hedge funds and researchers, and dozens of stocks.
The news was significant enough for Bloomberg to post an enormous Breaking News banner on their Facebook page announcing the probe. It was, indeed, very big news.
For such a big story, however, there has been almost no reporting since December 11th.
The public has an expectation that “research” on companies will be independent. But researchers have been known to partner with hedge funds in order to share the profits that result from cooperative efforts — the hedge funds ask researchers for negative reports on target companies, then place bets that those stocks will decline, and then both the funds and researchers cash in when those stocks drop. Sometimes the reports are even inaccurate or misleading, but in all cases depress the value of the companies involved.
Twitter and Reddit users were thrilled at the announcement of the DOJ investigation. Small traders on social media site Reddit had complained loudly about the shorting of company stocks by hedge funds, calling on the US Congress to regulate what was clear manipulation by Wall Street insiders. New attention was brought to the practice in January 2021 when, in response to hedge funds depressing the value of GameStop and other stocks, small investors on Reddit launched clever counterattacks by buying up shares in the heavily shorted stocks. Their countermove drove GameStop up 700% in just one week, causing some hedge funds to lose massively. As reported by Laurence Fletcher for the Financial Times: “In the present environment of Reddit-led investing, it is very dangerous to short anything that has momentum,” noted Peter Sleep, senior investment manager at Seven Investment Management.
Now, a DOJ investigation is making shorting even more dangerous.
Along with the Reddit investors, numerous securities-law professors have urged the Securities and Exchange Commission to mandate certain public disclosures and other controls around the shorting of stocks that would prohibit market manipulation.
The DOJ is not commenting on the investigation.