Private Investor: Short-selling small companies makes investors get mad

Bullying is wrong. It is banned at home and school, So why shouldn't small companies be protected on the stock market?

Bullying is wrong. It is banned at home and school, So why shouldn't small companies be protected on the stock market?

That was the tenor of the protests from a couple of guests at a party last weekend. Wow, were they angry! Two ladies, who had taken up investing to augment the household income and give them some amusement four or five years ago. But they were now finding the market a much rougher place.

A big kafuffle is going on following a mauling and several cases of recommended short selling of their stocks by some of the tipster websites. As it has been mainly in the Alternative Investment market (AIM) stocks, beloved of private investors, it has created more spleen than the mega raids launched by hedge funds.

What incensed these ladies was the way short sellers are pushing around small companies. They thought that some of this "shorting" (when the seller does not actually hold shares, but sells ahead of likely bad news with a view to purchasing back more cheaply) was not right. Especially not when doing this in combination of the power of websites. It had been going off in some of their companies, which were so small that there was unlikely to be enough trading for prices to recover easily.

The upshot is that investors like them are being put off, and raising capital to grow businesses is becoming impossible. "The market has changed dramatically in the last eight to 12 months, and not for the better," said one. The other added: "The shorters use Contracts for Difference (CFDs), spread-betting or covered warrants."

My ladies have consequently changed their investment style for small companies. From "buy to hold" they have switched to a more aggressive stance. It is a case of "if you can't beat them, join them". Shorting, arbitraging and short-term trading seem likely to be rife. Prospects for the market look restricted by the oil price increase, terrorist worries and rising interest rates. Hedge funds are growing and raising the speculative tone of the market.

Encouragement is also coming from stock lenders. Lacking corporate finance fees and share trading profits, insurance companies, pension funds and banks are filling the gaps in their income streams with fees from lending stock to speculators.

The giant fund manager Barclays Global Investors has built a cash management business out of the growing flow of cash collateral pledged by hedge fund stock borrowers.

But my friends have a point. Large companies can look after themselves. Bear raids can usually be countered with support from vested interests, such as brokers or shareholders. Recent cases include the hedge fund group Man, Abbey National, Cable & Wireless, Big Food Group, Lastminute.com, Carphone Warehouse and Regus.

But no one can be pleased when short speculators target small companies at early stages when they are still establishing themselves. Recent vulnerable hits have been on the biotech group Proteome Science, the pumps developer Pursuit Dynamics, HIT Entertainment, Transense Technologies and Pipewalk. It hardly helps AIM's international marketing campaign pitching it as the place for small companies.

Even market operators have been upset by shorting. May's enquiry into bear raids on Griffin Mining and others revealed the cause as short-sellers in Berlin. Around 150 companies were feared victims.

Back in London the Stock Exchange (LSE) seems to have made up its mind that shorting, and stock lending, are a good thing. The former controls overvaluations, and the latter helps liquidity and dealing prices.

That rationale is good as far as it goes. But it hardly holds up in cases that smack of the "hooligan behaviour" that angers investors. Shorting remains a contentious issue that bedevils private shareholders.

sally@sallywhite.fsbusiness.co.uk