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Melvin Capital Management LP is under investigation by the federal Department of Justice for possible abuses related to short selling. From Bloomberg:
The Justice Department is collecting a trove of information on dozens of investment firms and researchers engaged in short selling as part of a sweeping U.S. hunt for potential trading abuses, according to people with knowledge of the matter.
Prominent firms and their leaders mentioned in the Justice Department’s requests to some market participants include Melvin Capital Management and founder Gabe Plotkin; Orso Partners and Nate Koppikar; Sophos Capital Management and Jim Carruthers; as well as Kerrisdale Capital Management.
In all, the DOJ is investigating nearly 30 different firms. They’re looking for illegal moves by short sellers to damage stock prices.
Those could include insider trading or colluding with research firms, as was alleged by Institutional Investor:
Institutional Investor published a piece last year detailing the “balance sheet” relationship between hedge funds and short-selling firms that publish research reports. As part of this relationship, the former pays the latter to publish a report (authored by the fund itself) that is critical of the company’s business. The report’s publication is timed to coincide with a significant company-related market event, such as an options expiry or earnings report, to induce further volatility and maximize profits. Many short sellers act in concert and pile onto the short trade, magnifying its effect and crashing the company’s stock price. The research firm that published the original report gets a cut of the overall profits or a fee.
Where does this leave Melvin Capital?
The hedge fund lost 39% last year on disastrous bets in shares of GameStop Corp. and AMC Entertainment Holdings Inc. And they’ve racked up another 17% loss to start 2022, taking their fund down by about half in total.
When investors see you drop by half, they figure you can go down all the way. Add a DOJ probe, and Melvin looks like the most toxic hedge fund on the planet.
I would expect to see investors pull out. When that happens, Melvin will sell whatever it can in order to meet those calls for redemptions.
In today’s volatile market, it may be selling at fire sale prices. This could put the fund into a death spiral.
As an investor, this information also makes me highly skeptical of research reports. You never know what agenda is behind them.
I’m fascinated to see where this probe goes!
What do you think of this investigation and Melvin’s future? Leave a comment at the bottom of the page and let me know!
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