May 10th, 2023 7:00am PDT
Federal prosecutors in Washington are currently investigating the actions of short sellers in relation to the recent instability observed in U.S. bank stocks. This instability was triggered by the collapse of three regional banks since March, according to a reliable source.
Short sellers are traders who profit from predicting stock price decreases. In recent days, they have come under increased scrutiny due to government struggles in stabilizing the banking sector and growing investor concerns about the viability of regional banks.
According to the source, the Justice Department is highly interested in investigating individuals who played a role in the banking crisis. They are specifically looking into possible manipulation within the securities market.
Reports emerged last week that various regulatory bodies were investigating potential market manipulation by short sellers. However, the recent disclosure of involvement from criminal prosecutors adds a higher level of consequence for individuals engaged in any illicit activities.
The chair of the U.S. Securities and Exchange Commission, Gary Gensler, along with regulators in California, have emphasized their commitment to closely monitoring any possible misconduct.
According to the source, it is uncertain whether prosecutors will ultimately file any charges since the threshold for initiating a formal investigation is quite high.
Following the closure of Silicon Valley Bank, the first bank to collapse on March 10, the KBW Regional Banking index (.KRX) has witnessed a considerable decrease of 24%.
Short sellers employ a strategy known as borrowing and selling perceived overvalued shares, with the intention of buying them back at a lower price in the future to profit from the price difference.
According to analytics firm Ortex, short sellers made around $1.2 billion in paper profits during the first two days of May. However, a slight rebound in bank stocks on Friday caused some of these negative bets to face pressure.
There is ongoing debate regarding the impact of short sellers on companies. Critics claim that they harm businesses, while proponents argue that short selling plays a vital role in monitoring public firms.
The American Bankers Association has recently reached out to the SEC, urging them to investigate substantial short selling of bank shares. They argue that these short sales do not accurately represent the financial condition of the banks in question. The association specifically pointed out cases where such short sales occurred shortly after positive earnings reports were released.
Furthermore, the association expressed its concern regarding the widespread discussions on social media about the health of different banks and the overall sector. The association noted that these discussions appeared to be unrelated to the actual financial realities.
For several years now, the Justice Department and the SEC have been investigating potential market manipulation by short sellers and hedge funds. These investigations specifically focus on instances where negative research reports are released.
It’s still uncertain whether this newfound interest in bank stocks is directly linked to the ongoing investigation mentioned earlier.