• January 16, 2015

January 16, 2015?Reporting of so-called short trades, investments\r\nthat reward sellers when a share price falls, could be enhanced in the United\r\nStates without invading investor privacy, said finance professor Stephen E.\r\nChristophe, a consultant for Nathan Associates. The economy would benefit from\r\nsuch reporting, he said.

Christophe, who teaches at George Mason University in\r\nFairfax, Virginia, discussed short-selling in a talk today with Nathan analysts\r\nas part of the firm?s ?Economists Present? series. Short-sellers, when they\r\ncomplete a sale, deliver borrowed shares; the short-sellers gain if they repay the\r\nlender with lower-priced shares.

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Short-selling can lead to allegations that speculators are driving\r\ndown shares. In response to the financial crisis of 2008, regulators in the\r\nU.S. and elsewhere imposed various curbs on short-selling. The massive short\r\npositions of some hedge funds, along with the speed advantage held by high\r\nfrequency traders who employ short-selling strategies, also arouse public\r\nsuspicions that the playing field is uneven.

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How Stock Price Response to Short-Selling Varies

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Research summarized by Christophe and colleagues Michael G.\r\nFerri and Jim Hsieh in a working paper found that stock prices reacted\r\ndifferently in the five days after short trades depending on the type of\r\ninvestor?speculator or broker-dealer, for example?making the trade. Exchanges\r\nnow report the daily short volume for each stock without sorting by investor\r\nclass. If exchanges reported that volume by investor class and the average size\r\nof trades for each stock, the market would be more transparent for the average\r\ninvestor.

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?Having capital markets that are viewed as fair is desirable\r\nbecause it allows companies to raise capital at lower required rates of return,\r\nthereby leading to greater economic output and growth,? Christophe said in\r\nremarks prepared for his presentation. He noted that some European exchanges require\r\nindividuals to disclose their short positions after they exceed a certain level.\r\nImposing such a requirement on individuals ?might be viewed as overly\r\nburdensome for U.S. financial market participants.?

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How Purpose of Trade\r\nAffects Stock Price

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Stock price outcomes might vary by investor type because of\r\nthe purpose of the trade. Broker-dealers known as market makers may need to\r\nborrow shares to fill customer orders, and are likely to short more\r\naggressively when customer demand for a company?s shares is high. Stock returns\r\nturn positive after broker-dealers make large trades. In contrast, large-sized\r\nshort trades by speculators?those placing bets on a share-price decline?are\r\nusually followed by large negative returns. The NASDAQ data the researchers\r\nused had no information on high frequency traders.

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Christophe made it clear that the share declines following\r\nshort trades can be justified and, ?on balance,? short-sellers are good for\r\nfinancial markets.

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“Skillful\r\nInterpretation” versus “Front-Running”

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?Short sellers should be considered good if, based on\r\nskillful interpretation of publicly available information, short selling pushes\r\nan over-valued company?s stock price back to a fair level,? Christophe said.\r\n?No average investor? should want to overpay. The selling crosses the line into\r\nabuse when short-sellers engage in ?front-running??trading on inside\r\ninformation.

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Christophe, an authority on securities valuation, is a\r\nNathan academic affiliate and expert witness who aids Nathan?s work supporting\r\ncounsel in financial litigation. This includes cases where pension funds and\r\nother investors say they lost money because of corporate fraud, including\r\nmisleading statements?later shown to be untrue?about a company?s performance.\r\nCo-author Ferri also is a Nathan academic affiliate and expert witness.

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