Thursday, June 28, 2012

Duties, morality and short selling


I am involved in a short that has mostly collapsed. Take it as read that the company and its accounts were almost entirely fraudulent.

The stock however squeezed a fair bit along the way. Had you "played" the stock you could have made considerable money. But you had to understand that when it spiked it was a short-squeeze and short-squeezes are made to be sold.

The short squeeze happened when an elderly man who was rich from a successful mid-sized business started buying the stock aggressively. He purchased over 10 percent of the company - and more than 20 percent of the float. His purchases were well in excess of 10 million dollars - and on market value now he would be down $8-9 million (having been up considerably along the way).

Given this was a fairly easily determined fraud there was a large short interest - and some of those shorts were so big in the stock they had to buy back as the stock went up (short positions alas get larger as they go against you). So the shorts lost some. Short squeezes do that.

The old man lost, and some short sellers lost. Almost all the longs lost too. The only winners were a few short sellers with positions small enough to sit out the squeeze (which fortunately in this case includes Bronte), a few "players", and of course the insiders. Fidelity was a big loser losing tens of millions of dollars.

The insiders were crooks who sold stock more or less continuously. The insiders carved out something like 40 million of neat profit. All fraudulently obtained. Victims included the old man and Fidelity.

I did a fair amount of research into this elderly man. He wasn't usually a big-swinging stock player - instead he was an investor who had been successful in his normal line of business (a form of retailing) and took his (excessive) confidence into the stock market. Much worse though - he was being privately advised by someone who had previously accepted a ban from the securities industry for selling pump-and-dump securities to his own clients. The old man was being advised by a crooked advisor.

However only recently - and after the old man had lost most of his life savings - did I work out the advisor was a crook. Telling the old man now will just deepen his sadness. On paper he has $1-2 million worth of the shares left - but they are not saleable. If he tried to sell them the stock price would collapse to below a penny. He could - if lucky - get out 50 thousand dollars on the way down.

I know what it is in my interest to do. That is follow the crooked advisor to his next victim and short that stock too.

But I don't know what it is my moral duty to do. Do I tell the old man he has been had (and risk retribution from the advisor)? Do I hope he can salvage the last 50 thousand dollars from what was his 10 million plus dollar life savings? I told the regulators but nothing much has been done. (They don't tend to follow leads like that from short sellers. They perceive we have an interest in telling stories.)

I have now more or less covered the stock. I do not have any particular interest in future moves in this security which already trades well below $1.

Should I ring the old man? Would you?



John

48 comments:

Anonymous said...

It's a hard one.

The old chap is someone who can ring the regulators and kick some fuss (depending on where and how even bring some prosecution). On the other hand, the sad human tendency is to blame someone else - and in this case, blaming short-sellers is an easy instinctive thing to do. So, to an extent I believe it depends on how well the guy knows you - and I assume not much, since otherwise you'd probably advise him earlier to quit the investment. If he does know you, and you did tell him to exit, it's even worse since there's few people who can admit a mistake like that (but maybe you know whether he's of that bent).

On the other hand, moraly I know what I'd do - tell him, and tell him to sue (company directors and the advisor). If for nothing else, because otherwise how would I be better than the pump& dump crowd who are in effect just short sellers too? If I know something is stolen, and I deal with it and quietly sell for profit, am I better than the thief?

Brendan said...

"Telling the old man now will just deepen his sadness."

Not just that. The benefit of telling him is that he may well see the likes of the crook coming next time. His family might as well.

If you just let it go, he might think he was just unlucky, and be ripe for the picking next time round.

Sion said...

Are you sure he invested his entire life savings in one stock?

Sid said...

If you felt a moral obligation to the chap could you have offered to buy back his stock at a reasonable price while covering your short?

Not sure if that's legal but sounds like a dodgy market anyway.

Richard Smith said...

You have a range of options.

Minimal:
A "ban from the securities industry for selling pump-and-dump securities" is presumably public domain. Blog the link to it. Your man will find his next victim anyway but the trail might help someone somewhere.

Lavish is one or more of:
1. Identify the stock, promoters, etc
2. If you think needling regulators is a good idea, republish your email to them, with the date sent.
3. Contact your old boy.

Minimal might do it, Lavish feels like too much and has its own ambiguities.

Anonymous said...

Ring him. It won't hurt you, the guy might have an idea what to do about it - people who buildt a real business are normally good at dealing with dupes.

BlackRaven said...

Yes, Yes.

Anonymous said...

Don't tell the old man. Gloating won't earn you a cent and will only amplify his misery. If he has lost his capital, his error can't be repeated.

But I do think you shouldact to shut down the the con artist.. Following him to his next con is akin to an undertaker following a drunk driver hoping he'll crash into someone. While it's ASIC's job, doesn't change what is the right thing for you to do.

Anonymous said...

The old man is/was rich and old so he most probably is wise. He probably took a calculated risk or may have had opposing positions.

Anonymous said...

John, long-time reader, first-time commentator.


Tell him. You say the old man is an experienced businessman. Although he'll be very hurt by what's happened, he will appreciate the opportunity to understand what's actually gone on.

On top of that, as an innocent victim of his crooked advisor, he can raise hell with the regulators in a way that 'evil' short sellers can't.

A couple of months ago, you posted a blog on the morality of short-selling. One of the conclusions was that it was in your interests for crooks to scam investors, despite the moral issues that this raised. Thisis your opportunity to put some karma in the 'good' column.

Rahul Deodhar said...

I would tell the old man if I knew him even remotely. It could backfire and old man may blame you as one of the short seller like Anon of 6.11 says.

But we have to call it someday else these idiots will make the waters murky.

You need not fight his fight but simply guide him to correct explanation of events.

Anonymous said...

Thoreau says if we are not *responsible* for something, there is no *obligation* upon us.

If I break your window, I *am* obliged to fix it. If someone else has broken your window, awful as that is, and much as it might be good that I choose to help or catch the culprit, I am not *obliged* to do so.

You are not responsible for this company, the fraud, this old man and his choices or the behaviour of the crooked advisor.

There is no *obligation* upon you to call him.

Friedman argues all contracts must be voluntary and well-informed, except in self-defence. You cannot coerce or trick people into their behaviour.

If a short-seller knew this advisor crooked and followed him to his next victim and went short to capitalize on that fact, the short-seller would be fully aware of a non-well-informed contract (between the advisor and his victim) and be *failing to disclose this fact to those with whom he goes short*.

Well-informed I would argue requires the disclosure of knowledge of any non-voluntary or non-well-informed contracts, e.g. people acting not merely from their choice or wish, but because they are forced or tricked.

So the short-seller is acting unethically; he is forcing a non-well-informed contract on another.

(Blank Xavier, posting as anon, because, as ever, the blogger log-in system is utterly shagged - and if I hadn't the presence of mind and long experience of this I would of course have lost this post. Go blogger!)

Revilo said...

John, no one ever made big money from investing in a hedge fund. People do make big money from running them, owning them, selling units to new investors; but only if they grow.

As a businessman you should be growing your business, so go ahead and generate some more publicity for Bronte. Publish everything you know.

(btw, I think I know the stock… it ends with a T and the investor must surely be taking legal action).

Raymond Lutz said...

Ask your son.

Oliver Townshend said...

If you have the time to deal with the consequences, tell him. Otherwise move on.

Anonymous said...

Not sure wether to tell the old man, but definitely make sure the crook is taken care of.

There's a difference between 'making money' and 'making the absolute most money at every possible opportunity'.

Anonymous said...

I would tell him anonymously so the man isn't swindled again by this advisor.

John Short said...

I don't feel sorry for Ned Sherwood. In China NOT everything is different. Unless you are talking about Waldo Mushman? I already know a billionaire Heckman who lost 500 million to China, 10 million is nothing.

Anonymous said...

You say the fraud was easy to see. But obviously the old man, Fidelity, and the regulator did not see it.

Perhaps you could write out a detailed explanation of the fraud so everyone can understand it. Perhaps have it published as an op-ed in the paper. And perhaps the old man will read the story.

It is the duty of regulators, not short-sellers, to protect old men and the rest of us from frauds. You could make clear in your writeup that the regulators failed here (again). Probably nothing will come of it, but the more times the public hears the same story of the uselessness of the regulators, the greater the chance that someday things will change.

The fact that the old man put so much money into a single speculative stock makes me wonder about his judgement. Fraud notwithstanding, he is not without responsibility for his loss.

Jonathan said...

Feels the right thing to do to contact him.

Anonymous said...

One thing I have learned about life is those who are extremely successful in their profession are so because they have a passion & natural knack for their business. As actions do indeed speak louder than words, your actions have shown that you are within this group. You recognized an opportunity and seized it. There is absolutely nothing wrong with that.

On the other end, overconfidence and ignorance tend to be the 2 main contributors to tragic occurences, but is it justified to lose one's life savings? That is a pretty hard lessoned learned, but if the person is willing to take that risk, so be it. However, being fraudelenty manipulated into making that decision is flat out wrong.

As such, I would use that inate ability you have to methodically plan a legal means to figuring out how I could financially cripple that scumbag advisor & give some the proceeds back to that old man anonomously & possibly donate the remaining funds to a charity, given that your are in a very fortunate situation in terms of financial stability.

But a scumbag should be treated as such.

Dan said...

Tell him John. You don't have to get into details about the stock but you can tell him about the research on his advisor. Also, I second Raymond - what would your son say? I would be interested in hearing what your sons says if you're willing to share.

Kid Ing said...

F him.

Anonymous said...

You don't need to tell him personally, but I am sure you can find way's to make him find out and ensure his able assistant meets due retribution.

Maybe your friends in the media can assist.

I don't follow the line about 'deepening his sadness'; most competent businessmen wouldn't feel happiness or sadness about profit or loss... its more a case of 'improving his understanding'.

I feel he has a right to understand what flaws in his personality and those he surrounds himself with led him to this point.

The wider issue however is... how does this affect your business. Will these pangs of morality lead you to some Damascene moment whereby your stand up and renounce your beliefs?

The last paragraph is half in jest, although I am interested in whether this changes the view of your particular line of business. I sense that you have a great skill at finding these frauds, but if the regulators were even just sniffing their monring coffee a lot of your opportunities should dry up.

I wonder whether you are considering how to improve the regulatory game.

Sam said...

How is this situation different from any of your other short positions?

For a short to work, you need a buyer, for someone to buy crooked stocks, they're likely receiving crooked advice. So there's probably an old man and a crooked adviser at the other end of all your short positions.

jay said...

Anonymously post the company name, the advisor name and a link to any public information on his crooked advisor. Do it through an anonymizer site. If he's interested, he'll stumble on it via Google.

Anonymous said...

watch a re-run of the Godfather for lessons on when to speak, and when not to

philbrick said...

Tell him, even though he probably won't believe you.

I've been in similar situations before - the victim doesn't realise he's been taken until a couple of years later.

No regulator will act unless the fraud affects a lot of victims or there is a smoking gun.

Anonymous said...

Agree with Sam 8:47.

In your business you hope to win by having the advantage over the longs in terms of experience, skill, insight, or knowledge.

In this case a long got done over because he was out of his depth and got the decisions wrong.

The fact he took poor advice is irrelevant. Everyone is responsible for their own decisions in markets.

You won, he lost, that's the game we all play - no point getting a conscience now.

chris said...

Forget the bullshit, John. Just go with your gut. The fact that you are questioning this in a post means that you need to make the call to the old bloke.

What would you want done if you were him?

Just make the call. This is the stuff that makes YOU who you are. Fuck the possible backlash. That kind of gutless thinking is reserved for people with no backbone. You don't strike me as a man with no backbone. No commonsense, sure! But not someone without balls. :)

Note: we have some sun threatening to warm us on the Sunshine Coast this morning. But I'm stuck inside looking at a computer. Thus the pointed tone above!

Anonymous said...

It may be useful to ask the old guy some questions, like how he found the adviser, why he put so much $ on this position, whether the adviser works with others etc. Could add some data points for additional fraud research. Also, it's possible you gain an additional client, considering the guy sees you as honest and sympathetic.

Anonymous said...

I would have thought that as a fund manager your first and only duty is to your clients. As such preserving the ability to extract alpha is your primary purpose in your job.

Human nature drives people to feel obligated to help eachother, but at the end of the day alpha is a zero sum game, every time you make it you are taking it from someone else. This is your job as a hedge fund manager, to make others underperform the market by extracting excess value from it above the average. If you have found an ability to repeatedly extract alpha then basically it is a no-brainer, keep doing it, or get out of your job because your morals disagree with your entire purpose in life...

Anonymous said...

tell him. good karma is a powerful thing. open his eyes so it doesn't happen again and let him rage against the advisor.

@john short, heckmann lost his investors 500m in china water. he barely lost any, if any. speaking of frauds...

Anonymous said...

do an anonymous writeup on seekingalpha and mail/email it to him

Wayne Jones said...

Unfortunately I don't know you John, but my questions would be why do you want to ring this man?
Is it to make him feel better or make yourself feel better?
If you can do it in a sympathetic manner rather than him suspecting you may be gloating over your winnings then I would contact him. He must have a family that may be devastated over their changed circumstances at this stage of his life.
If you can't help him, you may at least allow the family to understand what happened.
However, the crooked financial advisor is another matter and you should do everything available to bring his actions to public and legal scrutiny.

Anonymous said...

Every investor has had a stock get crushed and go to zero or close to it. That's part of the game. For this man to ignore the most basic rule of diversification shows either out of control greed, ego or dementia. As such, he already had worse problems than a crooked adviser.

Will Caskey said...

Telling the old man is a really great way to get yourself sued.

When you've lost eight figures and all that you're worth someone coming along after the fact either seems like gloating or another shark.

So if you want your name in the papers and your attorney to be the richer for it, go right ahead.

contrariansmind said...

Ask yourself what is truly the upside?
Looking for a good moral duty to perform today?
Call your mom,dad,brother or sister and let them know you love them...

SBTrades said...

Reading all this trash people have written above, I just have to say one thing.

You already know what you want to do, so just do it. Listening to everyone else's nonsensical opinions is hardly useful to you.

Anonymous said...

Feeling the need to ask the question means you know you should.

People making bad decisions are one thing, but he should know about his advisor having "a ban from the securities industry for selling pump-and-dump securities to his own clients."

Why help the scumbags thrive more than necessary?

Anonymous said...

What will you be proud of doing 20 years from now when Bronte is wrapped up and you spend your days on the beach?

TeleBob said...

Have you considered advising the old man to having the crooked adviser hit?

Taylor Conant said...

With 41 comments I'm not going to check to see if anyone has pointed out the obvious yet (the first three did not) but...

There is no such thing as a positive moral obligation.

Morals are things you do NOT do to others. Ie, Don't hit. Don't steal. Don't rape. Etc.

It is not a moral if it involves, "You must do X."

No one is anybody else's slave therefore no one has any obligation to do something to or for another. Our only obligations are to leave others to their own freedom.

Your question is more of an econo-cultural dilemma: are the costs of taking a certain course of action less than the perceived benefits? And further, is living in the kind of society where you tell a man when he's been stolen from, worth the potential risk of blowback from letting it be known?

Irene Burgess said...

John, accept it or not,but, you saved a lot of people when you told the story of Trio/Astarra. What you did then was not wrong, and many of us thank you unashamedly.
We lost a lot, but not all.
Help that man to at least save some of his money.

Anonymous said...

The answers to the question are seriously disturbing because they show the great depth of ignorance society has sunken.

Morally, there is an obligation to either publicly make known the fraud - if one KNOWS FOR CERTAIN fraud/lies have been committed.

If one is not certain, then they must decide if they know enough so as to not commit calumny. This can be done by sufficiently noting the limits of one's knowledge regarding what one believes the situation to be. Likewise when discussing the character of the individuals involved.

As for duty and all the other non-moral ethical questions, one is only bound by the laws of the land.

Personally, I'd make publicly clear my speculative thoughts and write a letter to the appropriate authorities. At that point one has met their obligations of action. Responding to inquiries etc. is fine and completely a personal choice.

As for contacting the large investor directly, doing so is of course an act of Charity. Just as if one is in an airplane going down in a plane which is one parachute short of the number of people on board. You are not responsible for the death of the other individual without a parachute if you take a parachute and jump; however in Christian teaching giving that parachute to the other person so they may have life would probably, as the saying goes, "cover a multitude of sins". This is obviously a much easier situation to face. And of course, one's relationship to the large investor could change the situation. However since the scenario given is one of a stranger, those aspects become moot.

Anonymous said...

What you should do depends what kind of person you want to be. Do you want to be someone who maximises their personal benefit at all costs? No, obviously not. Do you want to be someone who does no harm, but does not do the right things unless it's a benefit to you? No, obviously not. Do you want to be someone who does the right thing, if it won't hurt you? Yes, obviously. Do you want to be someone who does the right thing, even when this can hurt you? That's a question you have to answer.

If you want to be a generally decent guy, then treat other people as you would want to be treated. If you were the old man, how would you want 'John Hempton' to act?

If you want to be a truly virtuous person, then just ask yourself what action of yours is the most right and virtuous. I.e. what would be both moral, and most effectively serving the greater good. Clearly that is to expose the fraud, push the regulators to improve their conduct, educate the old man as to what happens, and inform the public as much as possible. Negative consequences are of no concern to the virtuous - if soldiers can charge into machine gun fire to preserve our liberties, then any of us can do any dangerous activity if it's the right thing to do.

Most of the commenters here disgust me with their craven self-interest, lack of balls, and general gutless yellowbelly philosophies. This kind of self-serving servile and cowardly behaviour is exactly why there are so many problems and injustices in the world. Do you want to join them or be something better?

Anonymous said...

What did you do in the end, John?

Anonymous said...

An interesting story John, but you know what, the old man is not as innocent or kindly as you think. I met the old man in 1975 and followed his "business" for a while. He got what he deserved.

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