Elliot says he wouldn’t have a problem if short selling levels were disclosed because by the time people get to know about them, they’ve already happened. “Short selling is a symptom of something being wrong, it is not a cause. Short sellers go where there are problems, but they don’t create the problems, they don’t make a company vulnerable. “With ABC Learning, people wanted to understand the margin loan, how much it was, and Eddy Groves refused to tell them. As a result people got fearful about it and assumed the worst, and in fact the worst turned out to be correct. Second, what caused it was not the fact that he had a margin loan against his stock; it was the fact that the company produced a six-month result that showed it had negative cash flow. That is what made the shares go down. Short sellers look for companies whose business models are unsound.”
Jonathan Little, chairman of BNY Mellon Asset Management (of The Mellon Group which owns 13 different funds manager brands, and also provides securities lending through its Bank of New York/Mellon custody arm) says he can understand both the pro- and anti-securities lending arguments. “A big case for the ‘against’ recently was Northern Rock – a bunch of shareholders basically had their stock confiscated by the Government, it’s worthless, and it was some hedge funds deliberately bottom-feeding and making a nuisance of themselves that helped create that situation,” Little says.
Indeed, between the end of June and end of July last year, the proportion of Northern Rock shares that had been shorted rose from 7 per cent to 15 per cent. By September, that short position had passed the 20 per cent mark (with a single hedge fund said to have been behind almost half that position), before the nationalisation announcement from the Bank of England. “One of Mellon’s managers, Newton, will obviously allow stock to be lent if clients direct them to, but they reserve the right to veto. For example if they are standing beside a board they rate highly, defending them against a hedge fund that is aggressively short-selling the company, they don’t want to facilitate that. It’s a part of their investment view, they’d just be acting against themselves to allow that stock to be lent in that instance,” Little says.
“Of course there are many instances where activist hedge funds have been a great positive influence on company performance, using a position to demand change to lazy management or to a strategy which has been underperforming. The thing about securities lending is that it’s much more flexible now than it was 10 years ago – an owner is able to call stock back very quickly these days.