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New York—Short selling is difficult, expensive and unloved.  Now, some are accusing short selling of being rigged.   According to a recent article in Forbes, researchers at George Mason University have detected abnormally high short-selling in the three days prior to a research downgrade is made public.  However, the study appears to confirm what we already knew—employees at some investment banks were tipping hedge funds about pending downgrades.   

The research study was prompted by a Securities and Exchange Commission (SEC) case filed last year in New York federal court accusing 14 individuals, including employees of Bear Stearns, Morgan Stanley and UBS making $17 million in illicit profits selling research tips to hedge funds.

Stephen Christophe, Michael Ferri, and James Angel, three professors at George Mason which have done various studies of short selling activity, examined Nasdaq short-selling activity in the days leading up to stock downgrades for the period from 2000 to 2001, the end of the dot-com collapse. They focused on 670 stocks that traded at least 50 times daily at prices above $5, that didn't have any earnings announcements in the five days around a downgrade and other variables. They compared the short-selling activity to downgrades by analysts at 14 of Wall Street's biggest brokerages.

The study indicates that short-selling increased in the three-day window before a downgrade was published, at levels about four times the norm.  The academics conclude that the short selling isn't coincidental with the coming downgrade, but caused by it.

Forbes implies that the problem is still occurring:  

“Tipping is quite common according to the data, says Stephen Christophe, associate professor of finance at George Mason... ‘Our work calls into question the fairness of the special treatment accorded to certain groups of equity market participants,’ the report says.”

However, since the study focuses on the 2000-2001 period, it is unclear how it supports the assertion that ‘Tipping is quite common’.  Perhaps the study shows that employees at other investment banks besides the three implicated in the SEC case were tipping hedge funds.  It is unlikely that this activity, if it occurred, still persists, given the high level of internal and external scrutiny.

What the Forbes article does demonstrate is the recurring mistrust that surrounds hedge funds in general and short sellers in particular.