Ignore Short Sellers at Your Peril

The Conference Board issued a report, Hedge Fund Activism, that recommends how managers should respond. Not all requests for change made by activist hedge funds, according to the report, reflect a hostile orientation or short-term investment goals. Directors should review these demands in light of the company's current situation, the activist's profile, and the long-term interest of all shareholders.

Much of what the Conference Board reports underscores the opinions of others, including  David Einhorn, a hedge fund manager and author of Fooling Some of the People All of the Time. Einhorn was also the short seller who reportedly helped Erin Callan loose her high-profile position as CFO at Lehman Brothers.

After Einhorn shorted the investment bank, he called Callan who was said to have fumbled some of her responses on Lehman's asset valuations. When Einhorn made her comments public, it raised an avalanche of questions about the company's liquidity. Within a matter of weeks, Lehman announced a worse-than-expected second-quarter loss, Callan resigned. This week Credit Suisse announced it had named Callan to run its global hedge fund business.

Marc Lemcke, a partner at CNC-Communications, a public relations firm that has worked with companies targeted by short sellers, tells the Financial Times that Callan did the right thing by "talking, putting arguments forward, defending the company. If a short-seller contacts you, then it is better to respond. It [offers] a better chance that you will convince them. If you let it go, he will start to convince others."

A short-seller borrows shares in a company, then sells them in the expectation that the share price will fall. If they are right and the stock falls, they buy the shares back at the lower price, pocketing the profit. Most, but not all, short-sellers are hedge funds who use the tactic as a hedging strategy. Increasingly, the FT story points out, short selling has become an investing strategy in its own right.