Investors likely remember last year’s historic short squeeze. Companies like AMC (NYSE:AMC) and GameStop (NYSE:GME) accelerated higher, driven by online investing communities like r/WallStreetBets. While retail investors gained from the pop in meme stocks, institutional investors lost billions of dollars. Now, the U.S. Department of Justice (DOJ) is investigating whether certain short sellers were using illegal tactics by sharing detrimental research reports ahead of time.
DOJ Targets Short Sellers in New Investigation
The DOJ announced that it has seized “hardware, trading records and private communications” in an attempt to investigate short sellers. In addition, regulators are also investigating whether short sellers engaged in spoofing and scalping. Spoofing involves placing a series of fake market orders in order to manipulate a stock price. The person engaging in spoofing has no intention of buying the actual stock. Scalping refers to when a short-seller liquidates their position without disclosing it.
Popular short seller Carson Block of Muddy Waters was served with a search warrant last October, according to people familiar with the situation. The FBI seized Block’s phone as part of the investigation. Furthermore, short seller Andrew Left of Citron Research had his computers seized by the FBI.
Left announced earlier this year that Citron Research would no longer publish short reports after 20 years. It’s certainly a possibility that the DOJ investigation swayed Left to make this decision. At the time of the announcement, Left was also facing blowback on social media for his position on GameStop.
Well, well, well, would you look at this. “Justice Department is Pursuing Wide-Ranging Investigation of Short-Sellers: Federal prosecutors are investigating whether short-sellers conspired to drive down stock prices….” — Wall Street Journal, February 16, 2022 pic.twitter.com/JGSIYGXdvS
— Adam Aron (@CEOAdam) February 16, 2022
AMC CEO Adam Aron seems to be supportive of this investigation, tweeting out: “Well, well, well, would you look at this,” with a link to a Wall Street Journal article concerning the investigation.
The Bottom Line
Investors are wondering how the investigation will play out, but it is clear that short selling is a double-sided blade. For example, Richard Grubman of the now-defunct hedge fund Highfields Capital was one of the first to question the validity of Enron’s financial statements. The fund eventually shorted Enron and received a generous payday when Enron filed for bankruptcy.
Last year, Wirecard filed for insolvency after engaging in fraud. Short seller Fraser Perring of Viceroy Research had accused Wirecard of fraud years before its collapse.
When done legally, short sellers can benefit investors by exposing fraudulent companies. Oftentimes, these short sellers publish research to the public detailing their claims, beating regulatory agencies to the pitch.
On the date of publication, Eddie Pan did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
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