More thoughts on the Andrew Left situation

As you might expect, I still have my eye on the government's case against short seller Andrew Left...

In Friday's e-mail, I shared my initial thoughts on the federal indictment against Left, which it filed that morning (over the weekend, the story made the front page of the Wall Street Journal).

As I said, I was so sad to see this. I've known him for the better part of 20 years and previously never had any reason to question his integrity. So I didn't want to rush to judgements.

Of course, I was approaching the story with humility. As I also said on Friday:

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.

Today, I'll follow up with sharing insightful commentary from one of my favorite writers, Bloomberg columnist Matt Levine, as well as Australian hedge-fund manager John Hempton... and then adding additional thoughts of my own.

First, here's Levine in his column on Friday afternoon: Andrew Left Wasn't Short for Long. As he concludes:

In the government's telling, Left lied about a lot of stuff – his independence, his credentials, how he got paid, and most crucially whether he was still long or short the stocks he was writing about – that probably was material to his readers, and if he had been more honest about those things he might have moved the stocks less. He made money through dishonesty, the government alleges, and that's probably enough for their case.

But the government says less about the central things he said to the public: "This stock is good" and "that stock is bad." If he believed those things based on real research, and was mostly correct, then he would have a pretty good argument that it wasn't really fraud, even if he was dishonest about his own positions and cynical about his audience. If he was just making stuff up to manipulate stocks, on the other hand, there's not much defense.

And here's Hempton with a blog post on Saturday: Some thoughts on the Andrew Left indictment. Excerpt:

To win this case the DOJ needs to prove that Andrew Left said things that he did not believe or knew to be false in order to move the stock. (The more advanced lawyers will talk about Sullivan protections and the like – but the idea is I gather basically sound.) [Post publication editors note: a sophisticated reader has argued to me that if Left were reckless in his statements he is also likely in trouble. Given that he was right most the time and in the cases the DOJ actually raises it is going to be very hard to prove he was reckless.]

The DOJ has a hard case – because you can't necessarily tell what was in Andrew Left's head when he published his research reports...

Given that he was right it is going to be very hard to suggest that he lied.

But as Hempton continues, "there is a case here":

If the DOJ can prove that Left had been compensated by a third party to publish research and that compensation had been tied to the "success of a trade", then he lied in the Markopolous/GE report. And deliberate lies are not first amendment protected free speech. And if he made those lies to move the stock then he is guilty of stock manipulation.

I am watching. If I had to bet on this Andrew Left will win his case. But I do not have to bet on it so I will just watch on, fascinated.

After reading their thoughts, talking to some friends, and thinking about it more over the weekend, I'll add the following to what I wrote on Friday...

The many trades included in the indictment – and what Left wrote to others about them while he was making them – are, at best, unseemly... and this suit, even if he beats it, has hurt his reputation.

And reputation is a big deal...

For about 10 years of my 18-year career as a hedge-fund manager, I was extremely high profile – going on CNBC weekly and 60 Minutes twice, getting quoted in the print media, speaking at conferences, and sending e-mails a few times a week to 10,000-plus people commenting about stocks.

I could have easily traded around my public pronouncements, as Left did, and undoubtedly made many millions more dollars for myself and my investors.

Yet I did the exact opposite...

Given that there's a lot of gray area around what you can and can't do regarding trading around public statements about your positions, I simply didn't do it.

For example, in 2013 I shorted Lumber Liquidators because I believed its rapid margin expansion was unsustainable and the stock was overvalued. Then, as I did more work, I discovered that the company was trying to save a few bucks by sourcing dangerous formaldehyde-drenched flooring, so I added to my short position.

Later, I had the idea that 60 Minutes might be interested in a story about a major American retailer knowingly poisoning its customers – and, sure enough, they were. Months later, Anderson Cooper interviewed me... and then, many more months later in early February 2015, I saw 60 Minutes' usual teasers in that one of the stories in the upcoming show on Sunday evening, March 1 would be an exposé about a company doing bad things.

I of course knew the story was going to be about Lumber Liquidators... and I had good reason to believe that it would be very negative.

On the previous Tuesday, February 24, the stock closed at $68.78 per share. As rumors spread that the 60 Minutes story would be about Lumber Liquidators, the stock dropped 26% to $50.63 per share the next day and closed the week at $51.86 per share.

After the 60 Minutes story aired on Sunday night (it was devastating – you can watch it here), the stock crashed another 25% to $38.83 per share on Monday. And then over the next week, it kept falling another 28% – all the way down to $27.95 per share.

In total, in less than two weeks, Lumber Liquidators fell 59%.

Had I bought a bunch of short-term put options just beforehand, I could have made a fortune – almost risk free, because I had very good advance information about what was going to happen.

Gosh, was it tempting – millions of dollars in profits, just sitting there!

And here's the thing... it probably would have been legal.

I didn't have any inside information from Lumber Liquidators. I didn't know for sure what was in the 60 Minutes story – I just knew what I had said on camera months earlier. I had no idea that 60 Minutes had snuck hidden cameras into the Chinese factories, where they filmed managers confessing to producing illegal, formaldehyde-drenched flooring. And of course, investors making public procurements like I did are allowed to trade on and benefit from their own research.

But I didn't make a single trade – not only in the days, but the months – leading up to the airing of the 60 Minutes story. It didn't feel right... plus I suspected that Lumber Liquidators would sue me and all my trading records would become public, so I wanted to be squeaky clean.

I value my reputation and always try to keep in mind that, as Warren Buffett once said:

It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently.

At another point, as Buffett once wrote in a letter to Berkshire Hathaway (BRK-B) managers:

We can afford to lose money, even a lot of money. We cannot afford to lose reputation, even a shred of reputation. Let's be sure that everything we do in business can be reported on the front page of a national newspaper, in an article written by an unfriendly but intelligent reporter.

So, turning back to what I think of the Andrew Left situation today, after stewing on this all weekend...

I believe Left pushed far into the gray area of what's legal or not. That said, I think the government will likely have a hard time convicting him.

From what is public information so far, I haven't seen any evidence that he ever did a trade or said anything that was contrary to what he believed. When he publicly said he thought a stock was a buy, his private correspondence and trading were consistent with that. And when he said he was short the stock of a company because he thought it was a fraud (many of which, in fact, were), his private correspondence and trading were similarly consistent.

The fact that Left often did a ton of short-term trading around his positions and his disclosure was sometimes lacking isn't, in my opinion, likely going to be enough for the government to win this case. (Of course, as I noted on Friday and earlier today, some new piece of bombshell piece of information could emerge... So we'll have to wait and see.)

I'll wrap up today with a final thought...

If anything, this case could bring some clarity to a large gray area that has always existed.

There should be clear rules for investors who speak and write publicly about stocks in which they hold positions, long or short.

What needs to be disclosed? What if such investors talk to the media and have reason to believe that a story is coming out that could move the stock – can they trade on that? If they're scheduled to speak at a conference the next week or go on CNBC the next day and know what stock they're going to be pitching, can they buy the stock today? Are they forbidden to buy short-term options? How long do they have to wait after a public pronouncement before trading the stock again? Does it matter if it's an illiquid small-cap stock or a liquid large-cap one? Does it matter if the stock moves in their favor (or against their favor)? By how much?

These are the kinds of questions I grappled with on a regular basis for more than a decade back in my hedge-fund days... and it would be good to have more clarity.

Best regards,

Whitney

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