Short and Distort: An Illegal Market Manipulation Tactic
Short-and-distort is an illegal market manipulation tactic where false information is spread to drive down the price of a stock. Unlike expressing negative opinions, short-and-distort involves spreading false claims for profit. To protect against such schemes, conduct thorough research on stocks and avoid overreacting to unverified information that may cause dramatic price moves.
Short selling is a legitimate strategy where investors speculate on a stock's decline. Expressing opinions about stocks is also a common practice. However, when opinions are replaced by false information to profit from a stock's decline, it becomes illegal market manipulation known as "short-and-distort," according to the U.S. Securities and Exchange Commission (SEC). Short-and-distort is the bearish counterpart to the pump-and-dump scheme, which involves promoting stock to sell it at a profit and often results in criminal charges. Both schemes can be utilized in both bull and bear markets.
Short Selling vs. Short-and-Distort
Short selling is a legal practice where investors sell a borrowed stock, anticipating a decline in share price to buy it back at a profit. It provides valuable information to the market, as short sellers conduct thorough research to identify overvalued stocks. While short sellers like Sino-Forest Corp., Valeant Pharmaceuticals International Inc., and Wirecard AG have exposed improprieties at certain companies, they must avoid spreading falsehoods.
In contrast, short-and-distort traders engage in market manipulation by spreading false claims to incite shareholders to sell, driving share prices down. They often utilize social media for anonymity and to quickly spread misleading information. While expressing opinions about stocks is protected speech, short-and-distort involves intentionally spreading false claims. Some short sellers have faced defamation cases, with outcomes varying based on the veracity of their claims.
Short sellers have also faced accusations of market manipulation through options trades and order spoofing. To prevent such abuses, restrictions on trading by short-selling activists have been proposed. Movies like "Wall Street" and "Boiler Room" have shed light on these manipulations and educated investors about the risks involved in market speculation.
Tips to Avoid Short-and-Distort Schemes
To avoid falling victim to a "short-and-distort" scheme, follow these tips:
- Conduct thorough research on stocks before making any purchases.
- Verify the facts and don't believe everything you read.
- Check for material information disclosed by publicly traded companies in their 8K filings on their investor relations website or the SEC's database.
- Avoid overreacting to significant share price movements based on unverified or incomplete information.
- Transfer stocks to direct ownership to prevent brokerage from lending shares to short-sellers. Note that this doesn't guarantee shares won't be available for borrowing elsewhere and may involve additional steps to sell directly held stock.
By conducting thorough research before and after investing in stocks, you can better protect yourself. With a solid understanding of the companies you invest in, you'll be more equipped to detect distortions and less likely to be swayed by spurious claims in the event of a short-and-distort attack.
Key Characteristics of a Good Research Report
Identify the main characteristics of a good research report:
- Full Disclosure: The SEC mandates that investment information providers disclose their relationship with the company being discussed in the report. Lack of disclosure should raise a red flag.
- Evaluating the Relationship: Utilize information from various sources, such as investor relations firms, brokerage houses, and independent research companies. Consider the compensation received by the information provider to assess their conclusions.
- Author Identification and Contact Information: Reports with author names and contact information demonstrate accountability and provide investors with a means to request additional information. Legitimate brokerage firm reports prominently display this information.
- Author's Credentials: While certifications don't guarantee superior analysis, they indicate the author's qualifications in finance and investing.
- Readability of the Report: Beware of reports that employ exaggerated language or grandiose claims. Good reports present reasoned arguments supported by verifiable facts about company operations, avoiding sensationalism.
Investors need to be cautious of unscrupulous tactics, such as "short-and-distort," which can harm their investments. However, they can rely on high-quality stock reports that distinguish themselves from manipulative claims made by stock manipulators. To safeguard their investments, investors should remain composed while analyzing stocks and avoid being swayed by online hype or sudden changes in share prices. By adopting a careful and objective approach to evaluate potential investments, investors can protect themselves from falling prey to short-and-distort schemes and make smarter stock choices.