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Identifying Suspicious Short Selling, But Not Who’s Behind the Trades

A new study suggests that hedge funds may be trading on insider information about companies they are lending money to. But a lack of regulation of hedge funds and short selling makes it hard to know who is involved in the trades.

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Pedestrians walk by the New York Stock Exchange on Sept. 15, 2008, in New York City. (Spencer Platt/Getty Images)

Last weekend, The Wall Street Journal highlighted new academic research showing that investors may be trading on insider information after companies approach hedge funds for loans.

Researchers found that on average, in the five days before companies announce a loan from a hedge fund, the volume of short sales increases by 75 percent as compared with the 60 days before a deal is announced. There was no comparable uptick in betting against companies that borrowed money from commercial banks instead.

With short selling, hedge funds and other investors make money by wagering that a stock's price will fall. Borrowing from hedge funds rather than commercial banks can be seen as a sign of distress, as hedge funds tend to charge higher interest rates.

One of the researchers, Debarshi Nandy of the Schulich School of Business at York University in Toronto, told ProPublica that the findings pose an important question of whether hedge funds are using insider information inappropriately.

(Here's a PDF of a working draft of the paper; the final version is not yet published.)

When companies ask hedge funds to consider giving them a loan, they typically require that the funds sign nondisclosure agreements. That's because the borrowers divulge confidential financial information in the process of trying to get a loan -- information that can provide insight into a company's future performance. That, in turn, can be valuable to investors.

In looking at instances when companies made changes to existing loans, researchers found that the short sales on companies amending loans from hedge funds were profitable, whereas similar short sales on companies amending loans from banks resulted in losses.

But the researchers stop short of saying that hedge funds definitely make insider trades. It's all a little bit hazy because there is little disclosure required for hedge funds and short selling.

While the paper identifies "abnormal" shorting activity, the identity of the investors making the trades is a mystery. "If it is truly insider trading by the fund or a 'tip-ee' of the fund, it would really be good to get some further data on who is actually doing the trading," said Anita Krug, an expert in the laws governing hedge funds.

Investors are required to notify the Securities and Exchange Commission when taking large long positions, but there is no equivalent requirement for short bets. During the week that Lehman Brothers collapsed in the fall of 2008, the SEC issued a temporary order requiring investors to report large short positions, but it did not renew that requirement last summer when the order lapsed. The pending financial reform bill also would not require disclosure.

Short sellers say more regulations would discourage their trading, which they argue helps moderate market bubbles and contributes to market efficiency, says Mark Perlow, an attorney at K&L Gates who represents hedge funds.

Luckily, we have a new “president” that will “CHANGE” all that. Yeah, he’s got TurboTax Geithner working hard on fixing all those bad things, right?

So, the CROOKS/kings continue to rip off the “peasants”. I HOPE people figure it out and get rid of these PUPPETS, exposing the whole New World Order puppeteers and throw them in a place that they ought to be put in.

They are all insiders! If we the lowly investors, learned anything, it is that they brokerage houses move the market for their own gains! I’m not even a genius and I could even figure this out.

Now if we the little people pulled such a stunt we’d be thrown in jail.

You mean They didn’t know this?. Everybody who has more than avareage knowledge of the stock market know about this.

Getting around this may be impossible. 
Wall Street is made up of a web of alliances and/or freinds or ‘tip-ee’s.

Congress has no stomach to stop much more highly visible and poetentially disastorus schemes than this.  Hedge funds contribute a lot of campaign money.

In the end, they wil just be stealing money from each other because the average person does not want to have anything to do with Wall Street.

They just blew up another generation of investors.

Moive Gallery Inc. was a company mentioned in the research.  It is traded in the over-the-counter market as “pink” sheeted stock which means for all practical purposes it’s very risky (trash).

Any average person trading pink OTC stocks is swimming with the sharks.  This article just confirms it.

Did anyone ask if all those short sales were done with a locate, and a delivery within T+3? 

I doubt it.  Most of those short sales were probably “naked”, with no intention to deliver against the sales.  And the SEC continues to ignore this behaviour.

It seems to me that if the Government agencies wanted to uncover, prove and prosecute devious gamblers such as these hedge fund lenders who engage in short-selling it would be simple to do so. Just set a trap. And expose the catch.

I don’t think the SEC has an interest to fix the problem.

Not being astute on this subject it doesn’t take a lay person long to understand this is a serious problem that needs to be fixed.

Call your elected officials and complain!

Yeah, the idea of a “trap” would be good, but as you suggested,  I doubt the Feds really want to “catch” anybody. After all, George Soros, one of Obummer’s “advisors” makes BILLIONS on that sort of thing.

I keep trying to post that people need to contact their elected officials if they are upset over this.

Not saying anything to them doesn’t help at all.

I hope this time they’ll post this, or leave me alone.

Earl Allen Boek

July 9, 2010, 7:03 a.m.

That’s why I have nothing to do with the
stock markets, I’m not an insider, besides
I can have similar fun just dealing in
real estate short sales and distressed
properties.

http://distressedcommercialshortsales.blogspot.com/

This unethical behavior will not cease until we have 100% public funding for political campaigns.

The people who criticize Obama don’t stop to think that info re short sales was occurring under the Republicans. Grow up!

Patricia Gillenwater

July 9, 2010, 7:01 p.m.

I am not sure that calling or 100% public funding will fix this problem. Although I have made my calls as Judy suggested.

The problem is the lobbyists. If Wall Street and the Big Banks don’t want the issue to be “fixed” then it won’t be fixed.

Perhaps we will be surprised and the Justice Department has an investigation in the works. However I doubt it since like all the other Bureaucrat’s they have their thumb up their nose and will not be smart enough to go after an easy catch.

It is dangerous and sad to see people immediately link Wall Street to President Obama.

This type of trading has existed long before he came to office and was at its worst during the last administration (the time with the least amount of regulation)

Playing into populist sentiments misguides your anger & energy at the Obama administration when it should directed towards billionaire hedge fund managers who dance on others hard work & broken dreams.

Sylvia, It is our job to criticize a public official and his administration who does not fix a problem. It is irrelevant that the problem existed in an prior administration, it is still an issue to be solved.

To allow one group to create a package they know is suspect then to short sell based on the insider knowledge is criminal.

If the current administration does not take substantive action then they are complicit in the criminal activity.

Call your elected official and complain.  That a joke? Against lobbyists who are PAID to ‘call’ the elected official with money, luxury, and favors.  Do you understand? It is their job. Lawyers politicians lobbyists big bankers and violent thinkers all dictate what happens by acting as though they do not fear the people.  We are the hungry and poor America asked for.  Calling your official is like kindly asking the predator drone operator to wash his hands first. Living free can only happen when all humans are given equal rights. Globally. Did we make the world more peaceful by killing close to at absolute very least 100000 people directly in Iraq and Afghanistan?  Or better, more cultured?  We certainly brought something.  Did you know that at the beginning of the year the US special forces were involved in admittedly 62 countries? Guess what that number is now?  75 according to budget.  Our problem can only be engaged with methods far beyond a call. Martin Luther King Jr. was planning to bring 30000 homeless and dispossed people to Washington to LIVE!  That is a truly democratic act. To use our alleged freedom of motion to force consideration of those left behind by that ancient thirst for empire. Thank God most Americans don’t feel like they deserve the world. So let’s tip the polls.  Bring the foreclosed to the center to live. Grow a community garden. Liberate one neighborhood and the rest will fall but do not believe the insidiously state sponsored populist movement called the tea party. Make your own movement. The immigrant is not your enemy. I THOUGHT 1 in 20 people in The U.S. were of Irish descent. Can’t you smell a front? Don’t believe the lies of empire told to discontent citizens. We are free and constitutionally so. Take back society from those who begin, follow or perpetuate war, death and poverty.  The 1770’s was one hell of a decade. I’d sure like to yell at the tip of history something worth mention… perhaps something we could be proud of to tell our grandchildren. Peace is inherent in wisdom. Be wise and democracy will follow