Combating the Bear Raid: When Short-Sellers Attack

Makovsky

There is a highly-visible battle of epic proportions being waged between hedge fund titan Bill Ackman and Herbalife, the global nutrition company.

Mr. Ackman is believed to have $1 billion short position in Herbalife’s shares. In December 2012 he began his massive short campaign on the stock, which he has called a pyramid scheme. He has his own website for the campaign: FactsAboutHerbalife.com. Since the onset of his campaign, he has used multiple public platforms including the media and investor forums to criticize management and level various accusations; his latest being that management is “lawyering up” given the possibility of legal action against the company.

For its part, Herbalife has denied all the allegations and accused Mr. Ackman of market manipulation. In addition, Herbalife has confirmed investigations into its businesses by the Securities and Exchange Commission and the Federal Trade Commission. It is also believed that federal prosecutors are investigating potential market manipulation by Mr. Ackman.

Bear raids are nothing new and are believed have originated during the 1920s when the rules and regulations were not as stringent as they are today. Known “players” such as Jesse Livermore and Joseph Kennedy would collude and spread rumors to drive down stock prices.

In years gone by, short-sellers operated in the shadows. They typically targeted companies with valuations that were not in line with a company’s peers. They initiated their positions and then began their campaigns by spreading rumors throughout the trading community; some of which may have been picked up by the media. Of course, the Internet changed all that as message boards became fertile grounds for the proliferation of rumors by anonymous sources. In addition, short-sellers would hire less-than-scrupulous “research firms” to prepare and distribute research reports targeting companies of short campaigns.

While most campaigns will not reach the levels of the Ackman-Herbalife Affair, there are quite few lessons to be learned for companies that might find themselves in the crosshairs of short-sellers:

• Monitor everything – Sounds difficult and time consuming, but if you think your company is vulnerable, you need to stay abreast of what is being said and who is saying it. Popular message boards remain hotbeds for rumors and misinformation. Of course, the power of the blogosphere cannot be denied and a company’s reputation can come under attack in a matter of minutes. There are tools around to monitor what is being said. Unchecked rumor and speculation can become “institutionalized” and promulgated by the mainstream media.

• Keep your enemies closer – While many bears operate in the shadows, sooner or later, you will become aware of the negative interests. They’ll manifest themselves in public forums (investor meetings, conference calls, etc.) by making negative comments or posing questions skeptical in tone about the company’s products, technology or financial condition. Learn as much as you can about these people as they do tend to run in packs (your company’s outside legal counsel should be brought in to monitor the situation as well as uncover details about such investors).

• Fight fiction with facts – Rumors cannot be allowed to stand. As noted earlier, rumors have a way of becoming accepted as fact if left unchecked. You need to be vigilant and have the facts at the ready should you be confronted by rumors and be prepared to respond in the appropriate forums. In addition to regular updates via press releases and media interviews, host an analyst day and have all relevant personnel on hand to discuss various aspects of the company. This is particularly important for technology and biotechnology companies and those companies still in the research stage. The event should be webcast and the media invited to attend.

• Enlist allies – Be in a position to point the media to authorities and experts favorable to your cause. The obvious choices are the company’s covering sell-side analysts. However, there may be others such as academics who have published on your company’s science or technology who might be useful. Be advised that the media will seek commentary from the naysayers as well.

• Bolster credibility – Often you will see companies add industry heavyweights or prominent executives to their boards of directors. While some will view this as a sound practice, others may take the view that such moves are window-dressing in a vain attempt to mask a failing story.

• Call the regulators – If you suspect a bear raid, by all means contact the appropriate exchange. Have all the facts and evidence available. They will investigate the matter.

The key to successfully combating a bear raid is being vigilant and having a plan in place backed by the facts. Most of all your management needs to be ready to defend the company’s position in a forthright manner.

-Scott Tangney