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When a lengthy “short” report is published, a company’s stock price will almost often experience a near-term drop as momentum traders react to the allegations. Billions of dollars can hang in the balance as investors sift through a densely written report posted on a website. In some cases, the publication will set off an extended battle in the media between corporate executives, short-sellers, and large investors that can last for weeks or even months.
Equally important to the company’s ultimate fate is the drama playing out “behind the curtains.” Actors including internal auditors, the independent accounting firm, the audit committee, regulators, and large shareholders seek to assess the veracity of the charges and see if they missed something of significant magnitude. The results of this frenzy of activity will often determine if the attack ends up as a minor footnote or a company- and career-ending debacle.
The current conditions of the COVID-19 pandemic have created a perfect storm for companies that are subject to an attack by short-sellers. Market volatility is exceptionally high. Visibility on many companies’ financial outlook is poor. Communication between management and board members regarding sensitive issues is challenging. And auditors face difficulties in performing work on the ground when many offices and facilities are shuttered.
For these reasons, it is more important than ever that both companies and investors understand the dynamics when a short-seller drops an apparent “bombshell” report on the market, often at the most inconvenient time.
Assessing the Credibility
The first issue to consider is: what’s the story? Short-sellers may claim that a stock is doomed to fail because of some emerging competitive threat, changing consumer preferences, or dwindling reserves of cash. The accuracy of these predictions will become manifest in time but do not speak to the integrity of the financials.
Other reports assert that the reported financials are fundamentally inaccurate. Revenues have been fabricated, profits are inflated, and assets do not exist. The authors may even accuse senior management of outright fraud and posit that the equity has no value.
When short-sellers level these types of inflammatory charges against a company, a range of parties involved must assess their credibility. Who are the authors of the report, and what is their track record? What evidence do...