How Short Attacks Rob Investors

Danny is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Investopedia indicates that short selling is a technique used when an investor is sure a stock is going to decline and wants to profit from the decline.  A short attack is more neferious.

Any seasoned investor is likely familiar with a short attack: a report based on bits of truth, wrapped it in fear and innuendo, and bathed in unsubstantiated statements presented as facts. The attacker presents this dubious information to the investing public and the stock price withers, sometimes dramatically, with the attacker reaping  rewards at the expense of other shareholders.

A pain in the shorts

The market manipulation exemplified in a typical short attack has become all too commonplace. Penny Sleuth, a website dedicated to small cap stocks goes even further, calling it a short attack epidemic:

In 2011, manipulative short attacks have jumped the shark, making their way to major exchanges without anything standing in their way. Today, short attacks are one of the biggest threats to any small-cap investor’s portfolio.

Recently, even well-covered large caps are not immune to the short attack. Let’s look at two companies on the receiving end of these shorts to see how the average investor is swindled.

Short attention span

A recent company on the receiving end of such an attack is Intuitive Surgical (NASDAQ: ISRG).  A report titled “Has the Halo Been Broken on Intuitive Surgical?” was released by Citron Research. The report cited recent lawsuits, a high multiple, and lack of convincing scientific evidence as catalysts for a decrease in Intuitive Surgical’s stock price by half within 18 months. Intuitive Surgical fell more than 10% over two days. This move erased $2.3 billion in shareholder wealth.

After reviewing the evidence, analysts at Raymond James and TheStreet apparently disagree. Since the report, Raymond James reissued their Outperform rating with a $620 price target. TheStreet reissued their buy rating with a score of A-.

Citron Research is an online investment newsletter founded by Andrew Left. Citron’s website states, "Andrew Left has the longest published and most highly predictive track record of any market commentator or columnist on the specific topic of fraudulent and over-hyped stocks."

Others might disagree. The website details Left’s run-ins with both regulators and the legal system, including being barred from futures trading for three years, and court ordered fines for libel amounting to $2.5 million.

A detailed review of Citron’s report reveals discrepancies between claims and their underlying source documentation. They cite an article in the Seattle Times, quoting “some surgeons and hospital officials say it's being overused, employed for procedures where it offers no advantage. They did not cite this: Lenihan and many other surgeons say the surgical robot, the da Vinci, gives them powerful new abilities in the operating room, shortens recovery time for their patients, and decreases their risk of complications." Seems quite damning when taken out of context.

Elsewhere: "At Wentworth-Douglass, however, the robot has been used in several surgeries where injuries occurred. One patient …was so badly injured that she required four more procedures to repair the damage."

Several sentences further in the cited WSJ article:  "There's no evidence to suggest the injuries at Wentworth-Douglass were caused by technical malfunctions. Surgeons who use the da Vinci regularly say the robot is technologically sound and an asset in the hands of well-trained doctors."

Short distance

Another recent “research report” released by Copperfield Research focused on Ebix (NASDAQ: EBIX). This scathing report and its sequel characterized Ebix as a house of cards, misrepresenting their “organic growth” and citing multiple auditor resignations.  Over the five days following the release of the initial report, Ebix fell 28%, destroying $330 million in shareholder wealth.

Copperfield accuses Ebix of misrepresenting their organic growth with estimates of 11%, estimating it at only 4%. How do they arrive at this number? “Source: Estimates based on public disclosure. EBIX stopped disclosing acquired revenue in 4Q08.”

Which estimates to believe? How about an independent third party? 

Craig-Hallum Capital Group, an investment banking firm, took exception to Copperfield’s characterizations and released a rebuttal report, concluding: "We believe the data is being manipulated to tell the story the author has in mind."

The most concerning allegation is that of multiple auditor resignations, as this can be a red flag for cooking the books. If disagreements with management lead to auditor resignations, the auditor is required to disclose the reasons. No such disclosures have ever been made.  Ebix has had Cherry Bekaert & Holland as their auditor for the last four years, and have received clean audit opinions in each of those four years.

Copperfield has released other such reports. One focused on CorVel (NASDAQ: CRVL), a medical cost manager for worker’s compensation and auto claims. The report alleged numerous improprieties. Joseph Paduda, the principal of Health Strategy Associates, was quoted extensively as a source.  

He was so incensed by the content, he released a rebuttal, in which he states that while not a fan of CorVel, “Whoever wrote the hatchet job quoted me extensively. … It is quite clear that Copperfield knows next to nothing about CorVel’s workers comp business, or the work comp world in general, for that matter.” He goes on to detail a number of inaccuracies and inconsistencies in the report.  Some source!

Eat my shorts!

Researching these attacks provides important lessons. Not everyone who releases a report should be given equal weight or credibility and an incredible amount of shareholder wealth can be destroyed by fear and innuendo.  The prudent investor can benefit from considering the source of the information before making investment decisions.

David Gardner, the co-founder of The Motley Fool has stated "I would highly stress to all my fellow Fools that you inquire of anyone posting significant research with a bullish or bearish slant -- anywhere on the Internet, or TV, etc. -- 'WHAT'S HIS OR HER RECORD?' If you can't find a public record of your source's investment acumen, one that is cogent and winning, I would highly recommend you filter out that source's research."

Sage advice and one more step along the path to Foolish investing.

Danny owns shares of Ebix and Intuitive Surgical and has yet to short a stock. The Motley Fool owns shares of Ebix and Intuitive Surgical. Motley Fool newsletter services recommend Ebix and Intuitive Surgical. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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