DOJ Investigates Short-Sellers For Potential Trading Abuses Including ‘Spoofing’ And ‘Scalping’

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Topline

The U.S. Department of Justice is targeting dozens of prominent short-selling investment and research firms in a sweeping federal investigation that has gone on since last year, according to several reports, with prosecutors probing potentially illegal trading tactics.

The vast DOJ probe has reportedly targeted nearly 30 short-selling firms and three dozen related … [+] individuals.

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Key Facts

Federal prosecutors have seized hardware, trading records and private communications as part of a broad investigation into whether short-sellers used illegal trading tactics to drive down stock prices by sharing damaging research reports ahead of time, The Wall Street Journal reported on Wednesday.

The Justice Department has been collecting information on nearly 30 short-selling firms, as well as three dozen individuals associated with them, since late last year, Bloomberg similarly reported several weeks ago.

Several of the illegal trading tactics under investigation, sources told the WSJ, include “spoofing”—essentially flooding the market with fake orders to drive a stock price up or down—and “scalping,” where activist shareholders cash out positions without disclosing it.

Several prominent short-sellers have already been caught up in the probe, including Muddy Waters’ Carson Block, who reportedly received an FBI search warrant that extended to his phones last October.

Federal agents in early 2021 also showed up at the home of and seized computers belonging to Andrew Left, the founder of Citron Research, according to Bloomberg, which first reported the vast DOJ investigation earlier this month.

Prominent firms and short-sellers also mentioned in DOJ requests for information include Melvin Capital and founder Gabe Plotkin, researcher Nate Anderson and Hindenburg Research, as well as Sophos Capital Management and Jim Carruthers, among others.

Key Background:

Short-sellers have rarely been a popular group of investors on Wall Street. Especially during meme-stock mania of early 2021, the likes of Plotkin’s Melvin Capital were among those vilified by the army of retail traders and the Reddit “Wall Street Bets” crowd, who were driving up the price of stocks like GameStop and AMC Entertainment. The meme-stock crowd took pleasure in causing steep losses for short-sellers, forcing some to call it quits altogether (Andrew Left said after the GameStop craze that Citron would no longer publish short-selling research, for instance). On the flip side, however, short-sellers can still be important in uncovering corporate scandals (Enron or Wirecard AG, for example), not to mention several like Michael J. Burry, who helped warn of the impending financial crisis in 2008.

What To Watch For:

The DOJ is yet to accuse any individuals or firms of wrongdoing, and opening a probe doesn’t necessarily mean anyone will face charges.

Crucial Quote:

“It’s very tough to defend yourself when you haven’t been accused of anything,” Left told Bloomberg earlier this month. “I’m cooperating and I have full faith in the system and the First Amendment.”