I'm not rushing to judgement on Andrew Left

My heart sank this morning when I read this headline in the Wall Street Journal...

U.S. Accuses Prominent Short Seller Andrew Left of Fraud. Excerpt:

Federal prosecutors on Friday charged famed short seller Andrew Left with fraud, accusing him of routinely making exaggerated or misleading statements about stocks to quickly profit on price moves caused by his reports.

The charges mark a major turn of fortune for the bombastic investor, who called his firm Citron Research because it analyzes the "lemons" of the stock market. He scored a major hit a decade ago with well-timed bets against onetime highflier Valeant Pharmaceuticals International but hadn't matched that success more recently.

An indictment returned by a Los Angeles grand jury accused Left of essentially trading on his name and reputation, announcing his bets and naming price targets far from where a stock was trading. Left quickly closed his positions after his statements caused prices to move in the direction he wanted, the indictment says.

And here's an excerpt from the press release from the U.S. Securities and Exchange Commission ("SEC"), SEC Charges Andrew Left and Citron Capital for $20 Million Fraud Scheme:

The Securities and Exchange Commission today announced charges against activist short seller Andrew Left and his firm, Citron Capital LLC, for engaging in a $20 million multi-year scheme to defraud followers by publishing false and misleading statements regarding his supposed stock trading recommendations.

The SEC's complaint alleges that Left, who resides in Boca Raton, Fl., used his Citron Research website and related social media platforms on at least 26 occasions to publicly recommend taking long or short positions in 23 companies and held out the positions as consistent with his own and Citron Capital's positions.

The complaint alleges that following Left's recommendations, the price of the target stocks moved more than 12 percent on average. According to the SEC's complaint, once the recommendations were issued and the stocks moved, Left and Citron Capital quickly reversed their positions to capitalize on the stock price movements. As a consequence, Left bought back stock immediately after telling his readers to sell, and he sold stock immediately after telling his readers to buy.

(The full 58-page complaint is here.)

Longtime readers probably won't be surprised why I was so sad to see this...

Andrew and I have known each other for the better part of 20 years. While we've only met a handful of times, we've communicated by phone and e-mail dozens of times over the years, talking stocks – mostly short ideas because we were both activist short sellers.

(Though I don't short stocks anymore, I was well known for it from 2008 to 2017 when I ran hedge funds, most famously for exposing Lumber Liquidators on 60 Minutes in March 2015 – you can watch it here.)

Andrew is incredibly smart, has great instincts, and, like many activist short sellers, is a bit of a wild man – he trades like a maniac and is very excitable. But I've never had any reason to question his integrity.

I, of course, don't have all the facts about this case, but my initial reaction is one of skepticism for a number of reasons, starting with the fact that while the complaint is public, we haven't yet heard Andrew's full defense.

There aren't very many activist short sellers, so folks in the business all tend to know each other – the old-school guys like Andrew, Jim Chanos, the Feshbach brothers, Marc Cohodes, David Rocker, David Einhorn, and Bill Ackman (all of whom are retired or don't go after companies publicly like that anymore)... as well as the youngsters storming the ramparts regularly today like Nate Anderson, Gabriel Grego, Sahm Adrangi, and Ben Axler.

I know all of them and have written about many of them here in my daily e-mails, most recently Gabriel's campaign against Cassava Sciences (SAVA) and "why investors should celebrate short sellers" in my July 3 e-mail.

The accusation that short sellers are engaging in some sort of unseemly, un-American, unethical, and/or illegal behavior goes back to the dawn of short selling, which dates back centuries to the establishment of stock markets in the Dutch Republic in the 1600s.

The three Feshbach brothers were among a wave of activist short sellers who got started in the 1980s – and, sure enough, here's an Los Angeles Times article about them, highlighting that "some critics question their short-selling methods," that could have been written yesterday, but in fact was published 34 years ago: Short Road to Success: Investing: The Feshbach brothers of Palo Alto have made a fortune betting that stocks will go down. But some critics question their short-selling methods. Excerpt:

The Feshbach brothers – Kurt, 38, and twins Joe and Matt, 37 – have gotten rich and famous (on Wall Street, at least) by being atypical in both their professional and personal lives. They have also irritated a lot of people, usually executives whose stocks – and reputations, many contend – have been slashed by the claws of these stock market bears.

And here's a New York Magazine article about Chanos from 2008, making him seem like a bad guy because he was profiting while everyone else was suffering: The Catastrophe Capitalist. Excerpt:

Your 401(k) has been plunging at the rate his fund is rising. Chanos is arguably the most successful hedge-fund manager on Wall Street right now.

As hedge-fund all-stars bleed red – SAC Capital's Steve Cohen is said to be off 18 percent this year, Citadel's Ken Griffin as much as 44 percent, and even David Einhorn, who presciently called Lehman's implosion, has seen his fund, Greenlight Capital, slide a reported 26 percent – Chanos's short positions have earned him a return of a reported 50 percent. He now manages some $7 billion. Trader Monthly estimated his paycheck in 2007 at over $300 million, and he's on track to earn a similar payout this December.

While many Wall Street refugees are liquidating their art collections and listing their trophy houses on the market, Chanos is buying. This summer, he closed on a new $20 million triplex on 75th Street, off Fifth Avenue.

For additional context, it's also important to understand that the case against Andrew is part of (and perhaps the culmination of) a multiyear government investigation of trading abuses by dozens of short sellers (Investopedia has more details here). As the WSJ article from earlier notes:

Left's indictment caps a three-year effort by the Los Angeles U.S. Attorney's Office and fraud-section prosecutors in Washington, D.C., to examine the tactics short sellers use to instigate and then profit from a stock's decline. Short sellers borrow shares from other investors and then sell them, in hopes that they can buy them back cheaper later and pocket the difference.

The Justice Department seized hardware, trading records and private communications as prosecutors looked for wide-ranging conspiracies and evidence of market manipulation, the [Wall Street] Journal reported two years ago.

From the beginning – and as I said on July 3 – I've thought that this overall campaign is "nothing but a misguided and counterproductive wild goose chase."

That said, I'm not surprised that the government ended up filing some cases, if only because, as Warren Buffett wisely noted in this 2013 interview, Buffett on JPMorgan: Jamie Dimon will survive fine:

"If a cop follows you for 500 miles, you're going to get a ticket." That's how Warren Buffett described the legal troubles facing JPMorgan Chase and its chairman-CEO, Jamie Dimon.

"You've had a lot of cops that have been following for a long time," the Berkshire Hathaway boss added in a CNBC interview Wednesday. "And they're going to write some tickets."

I'll also point out that Andrew is a wealthy man. I assume he could have settled with the SEC and paid back the $20 million in "ill-gotten profits" they claim he made, but instead he has apparently chosen to fight because he thinks he's innocent and can beat these charges.

Additionally, Andrew is a trader. It wouldn't surprise me if he makes 50 trades a day. He could easily make 10,000 in a year... and 100,000 in a decade. (I'm speculating here on the numbers, of course... and I have no idea how far back the SEC looked).

He's also a loudmouth. He's constantly speaking and writing publicly about stocks – on his website, sending out e-mails, being quoted in the media, on national TV, etc. He comments on dozens of stocks every year – and hundreds over a decade.

In light of such large numbers of trades and such voluminous commentary, it doesn't surprise me at all that a team of government investigators have come up with a handful of trades that look suspicious.

On page three of the SEC's complaint, it says:

In other words, Left bought back the stock almost immediately after telling his readers to sell, and Left sold stock almost immediately after telling his readers to buy.

At first glance, that sounds terrible, but upon further reflection, I have some questions...

Is it illegal for Andrew to trade around his own research and/or public statements? Not based on my understanding – unless there was evidence that he didn't believe what he was saying...

For example, let's say Andrew recommended a stock while simultaneously e-mailing a friend, "I think this stock is a dog and I need to get out of it, but I'd like to sell at as high a price as possible, so I'm going to issue a report saying it's a buy to see if I can pop the stock and then sell into it."

That would be fraud... but so far, I don't see that in the government's complaint.

The closest to that I see is this trade that the U.S. Attorney's Office for the Central District of California highlighted in its press release this morning:

For example, in November 2018, Left allegedly wrote a portfolio manager about Nvidia Corp., a publicly traded technology company based in Santa Clara, California. In the message, Left wrote, "Do you want to make some fast money[.] Put together a thesis why [NVDA] is oversold... We can destroy it... Just read the analyst notes from this past quarter and assemble the best of the ideas."

Later that morning, Left took financial positions in Nvidia, including short-dated call options that expired three days later. Short-dated options can offer quick profits if a stock suddenly moves in the narrow timeframe before expiration.

Left then promoted Nvidia as a favorable investment on Citron's Twitter account, stating, "Citron buys $NVDA. This is the first time in 2 years stock offers an appealing risk-reward to investors... We see $165 before we see $120." At the time, Nvidia's stock was trading at approximately $143.64. The tweet was reported on by major media outlets.

Despite his representation that he expected Nvidia's share price to rise to $165, less than two hours after announcing "Citron buys $NVDA," Left sold all his pre-tweet positions Nvidia was trading within a range of approximately $150 – $151, for a profit of at least than $960,000. Nvidia closed at a high of $154 on the day of Left's tweet and fell to $144 the next day.

My first comment is that anyone who bought NVDA at $143.64 (or $3.59 adjusted for subsequent stock splits totaling 40:1) and held to today has made more than 31 times their money. Those that followed the public advice and held on no doubt want to erect a statue in his name!

Ah, but he said, "We can destroy it." That not only sounds like market manipulation, but collusion to manipulate a stock, right?

Not so fast...

You need to understand how traders talk – especially excitable ones like Andrew. They're always talking about "destroying" this and "crushing" that...

Here's what I would guess really happened (keeping in mind that this is total speculation, but feels like a reasonable scenario)...

While the press release doesn't have the dates, on Thursday November 15, 2018, Nvidia's stock closed at $202.39 (pre splits) per share. The next day, the company must have announced bad news because the stock crashed 18.8% to close at $164.43 per share. On Monday, the stock continued to fall, closing at $144.70 per share.

Andrew no doubt looked at this... and I suspect with the stock down nearly 30% in two days – and believing it's a pretty good company – he thought that the selling was way overdone and therefore was an excellent trading opportunity.

Feeling so strongly about this, he went public with his views.

And if the stock rallied, he would make money – and "destroy" the short sellers. (To be clear, that's who I believe he's talking about destroying – not the stock, which he wanted to go up.)

So I would speculate that the next day, when the stock traded as low as $134.06 per share, Andrew put on his trade, told the world about it, and, sure enough, it popped and closed at $149.08 per share – up 11.2% from its intraday low. NVDA shares continued to go up and, two weeks later on December 3, hit $174.68.

Andrew said publicly at the time, according to the complaint, that he "expected Nvidia's share price to rise to $165" – and, just as he predicted, it did just a few days later... and then continued to rise... and eventually became one of the greatest stocks of all time.

It was a great call. Investors who followed it made either a little or a ton of money... and I don't see evidence that he was secretly shorting the stock or wanted it to go down.

So based on what I've seen, I fail to understand how Andrew did anything wrong, much less illegal here. Again, I obviously don't have all the information in this particular case – I'm relying on the public information and my insights about him and short sellers in general.

I also find it quite ironic that the regulators have made similar charges against Andrew for some of his short sales – many of which subsequently were exposed as frauds and went to zero – yet they have only filed a case against Andrew, not the CEOs of the fraudulent companies.

Ultimately, I believe in freedom of speech and freedom of trading. I think market participants should be free to speak and write about stocks they like or dislike – and everyone who listens to them should be aware that a person praising or criticizing any stock might have a position in it – and could exit all or part of their position at any time, even if it's only five minutes later.

The thing that should be banned (and prosecuted) is someone spreading information that they know to be false.

Meanwhile, as I've said time and time again over the years, activist short sellers in general are healthy for the markets. (If you missed it, I encourage you to read my July 3 e-mail on "why investors should celebrate short sellers.")

As we all know, people can be surprising... and sometimes our friends can let us down. I don't have the entire story with this case involving Andrew (and the feds likely have "cards" they haven't played yet), so I recognize that a bombshell piece of information could emerge in the future that could cause me to change my views...

But as I said earlier, I've known Andrew for the better part of 20 years and haven't had a reason to question his integrity before, so I'm not rushing to any judgements here.

Best regards,

Whitney

P.S. I welcome your feedback – send me an e-mail by clicking here.