Why Asensio never disclosed the long positions is a legitimate question--especially since securities laws require disclosure of all material facts to investors.

One obvious reason is the problem these positions pose for Asensio's M.O. His charges of "fraud" would be difficult to reconcile with a disclosure that he and/or his clients were holding long positions.   Especially when you consider how large some of these positions have been.  For the third quarter of 2000, client Blue Ridge Capital reported a long position of almost a million shares in Hemispherx, a stock Asensio was denouncing as a "fraud."  Add up other long positions that this hedge fund held in Asensio's so-called "frauds," and it turns out that Blue Ridge had dedicated 35 million dollars of its investors' money to long positions in these supposedly "fraudulent" companies.

Whether there are other reasons why Asensio has not disclosed client long positions in his reports is not possible to say. Clearly, long/short positions can be used for not-so-legitimate purposes. Whether Asensio and his clients have used long/short positions for such purposes is not something an ordinary investor can determine.

For those unfamiliar with this strategy, here is some Q and A.
 

A. In several ways. The most important is to help control the stock price.

If the price starts to rise, short-sellers with long positions can "dump" some of their long shares onto the market. The goal is to eliminate the highest bids for stock, thereby keeping a lid on the price.

A. A favored time is when the company puts out good news. The goal is to have the price fall despite positive news in hopes that less sophisticated investors will conclude it must be a loser. The more investors fall for this ruse and sell, the more the price can be depressed to benefit the short position.

Yes. The long shares offer protection against borrowing shortages. If a stock becomes hard to borrow, owners can short their own long shares. They can also use them to evade restrictions on short selling into downticks in violation of NASD short-sale regulations.

SEC regulations require institutions to report only their long positions. As a result, companies can be fooled into believing that funds that are more short than long are committed institutional investors.  Funds can use this status as seemingly loyal investors to seek information from management. The long position also gives them standing to pose as wronged investor.  Using it as a guise, they can file regulatory complaints and lawsuits whose real purpose is to depress the share price to benefit their short position.
 

A. Of course. No strategy is foolproof. And this one often requires good timing--having the foresight to cover the short position before a company's fortune makes it too attractive to fend off enthusiastic buying. But obviously, the strategy would not still be with us were it not working for those who use it.

A. Yes. It works best in thinly traded stocks. Targeted companies are often small firms in the R & D stage. Short-sellers who profess a particular concern about "scientific fraud" may be putting a clever spin on the real reason they target biomedical and technology stocks. Companies in these sectors often take a decade or more to generate revenues, for the simple reason that good science can take a long time. Their stocks are often thinly traded during these years.  This makes them vulnerable to those who play the long/short game.  A few institutional players acting in concert can literally take control of trading in these stocks.

Q. This sounds like market manipulation. Is it legal?

A. Not a question that a website like this one can answer.  Certainly it would help if the SEC would take a clear position on this practice--and require institutions to report both long and short positions in their quarterly filings.

Until the SEC clarifies the issue, the better question is probably "How easy is it to get away with?"

Unfortunately, the answer is obvious.

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Update, November 2003

Although Asensio's releases never acknowledge that he and his clients have simultaneous long/short positions, he does discuss the strategy briefly in his book, Sold Short.  Remarkably, he says nothing about how this strategy can be used for manipulative purposes.  But he does make a very revealing comment about the strategy, which he refers to as "boxing."

Boxing has its disadvantages, however. For one thing, it ties up capital while offering no possibility of any profit as long as you are boxed. For another, you never know when you are going to be bought in.  If you are boxed, and suddenly bought in, you'll wake up the next day with a long position in a stock you hate.

But if an investor has the long shares to cover his short, why would he be bought in (i.e. forced to cover, involuntarily, at the prevailing market price)?

The answer is simple.  Because his broker doesn't know about the long shares.  Those shares are held in a different account from the short position, in some cases at a different brokerage entirely.

Why would anyone go to the trouble of maintaining separate long and short accounts at different brokerages?   One compelling reason is to evade NASD rules that restrict the sale of long shares when the owner is more short than long.  These restrictions are designed to thwart "bear raids."  Obviously, those who participate in "bear raids" don't like to be thwarted.  Separate accounts are their solution to pesky rules.  If the broker doesn't know about the short shares, the long shares can be sold without restriction.

Those engaged in this practice naturally prefer to keep it quiet. But occasionally, someone slips up and inadvertently confirms what many have long suspected.

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Page Created 11/30/02  •  Updated 10/25/03  •  Updated 11/12/03