‘Short-Sellers’ in Enron Finally Get Their Due


Enron Corp. may be the best friend that Wall Street’s “short-sellers” ever had.

Some of these professional bears bet against the energy company’s stock early last year, smelling a fraud. Yet any monetary gain they reaped could be of modest value compared with the long-term benefit to their image thanks to Enron’s demise.

That’s because the principal lessons Enron has taught investors are about the need to question glowing corporate forecasts of sales and earnings, to dig deeper into companies’ financial statements, and to think twice before affording sky-high price-to-earnings multiples to stocks of businesses heavy on hype and light on specifics.


Those are the hallmarks of professional short-sellers. Though often reviled for the end product of their work--the actual “shorting” of stocks, meaning borrowing and selling shares, hoping the price declines so the loaned shares can be replaced at lower cost in the future--short-sellers may be the last bastion of hard-nosed research left on Wall Street.

“It’s a lot of work to short a stock,” said Bill Fleckenstein, a veteran short-seller who heads Fleckenstein Capital in Issaquah, Wash. “You have to be right.”

They aren’t always right, of course. But Enron is a prime example of how short-sellers’ questioning of the conventional wisdom can prove to be spectacularly on target.

One of the few voices raised against Enron a year ago was that of James Chanos, a well-known research-intensive short-seller who heads Kynikos Associates in New York. Chanos publicly questioned other analysts’ assumptions about Enron’s true profitability and made the argument that the company was merely a disguised “hedge fund”--a high-risk trading operation that didn’t deserve the huge valuation investors had given it.

But Chanos got little publicity, and most institutional money managers were far more interested in hearing the upbeat pronouncements coming from then-Enron CEO Jeffrey K. Skilling and from the army of brokerage analysts covering the company.

Still, Chanos’ warnings belie the line heard most often on Wall Street today, as big investors and analysts try to explain why they didn’t see Enron’s collapse coming. The line is, “We were totally snookered--the company deceived the government, its auditors, and us.”


Baloney, says James Grant, editor of Grant’s Interest Rate Observer newsletter in New York and a longtime ally of the short-selling community. “I do not buy for one minute” the idea that anyone paying close attention to Enron’s finances wouldn’t have seen the same warning flags that Chanos did, Grant argues.

“And if it [Enron] was so opaque, why did people own it?” he asks.

Led by a handful of professional skeptics, more investors did short Enron stock as 2001 wore on. But those bets rose relatively slowly, and even by September--after Skilling had resigned and the share price was crumbling--a modest 13.8 million Enron shares (less than 2% of the total outstanding) had been shorted, according to New York Stock Exchange data.

In November, as bankruptcy neared, short-selling of Enron stock soared. But the big money would have been made by shorting the stock at $80 early in 2001, and holding that bet, rather than shorting it at $10 in November. (The profit on a short sale, after all, is the difference between the price at which borrowed stock is sold and the price at which shares are bought back to repay the loan. Enron shares were trading Friday at about 51 cents.)

Short-selling of stock in general was at record levels as of mid-December, the latest data available from the NYSE and Nasdaq. Yet professional short-sellers say those figures are misleading. Most shorting is connected with strategies other than betting on an overvalued stock’s collapse, they say.

Many short sales are made to hedge “long” bets--for example, an investor may short one stock in an industry to protect against a decline in a rival stock the investor owns, should the entire sector take a sudden hit.

The community of money managers who are actively researching stocks to short is tiny, Fleckenstein said. In all, he estimates there may be less than $1 billion committed to short-selling funds such as his own. The funds’ clients typically are institutional investors and wealthy individuals.

Short-sellers have never been a huge group on Wall Street, but they enjoyed a higher profile--and endured substantial public wrath--in the late-1980s, after the 1987 market crash.

Many of the famous short-sellers of that era, in particular the Feshbach brothers of Palo Alto, were accused of spreading lies about stocks to knock them down and thus profit from short sales.

Then came the great bull market of the 1990s. Shorting stocks, which, at a minimum, always smacks of being un-American, turned fatal for many practitioners.

The blue-chip Standard & Poor’s 500 index produced a total return of more than 20% for five straight years ending in 1999. Worse for many short-sellers, the S&P; was led by its technology stocks, a sector that some short-sellers believed had become overvalued by 1998.

As tech shares continued to climb, a bet against a stock because it was overvalued by traditional standards meant certain failure for many short-sellers, as the overvalued simply became more overvalued.

Some short-sellers learned the hard way just how risky the strategy can be. If you buy a stock outright, the most you can lose is your entire investment.

But a short-seller’s losses are potentially unlimited: If you short a stock at, say, $50, and the market price then rises instead of falls, your losses mount until you buy back the stock on the open market and repay the loaned shares (which usually are lent by brokerages).

Now, even in the wake of the deepest and longest bear market in a generation, most of the remaining short-sellers say that, so far, there is no rush of new money coming their way from investors.

David Tice, a Dallas money manager who heads the $200-million Prudent Bear mutual fund largely dedicated to short-selling, says the amount of money he has attracted after each major market sell-off of the last few years has declined sequentially. His fund was up 7.4% last year even as the broad market plunged.

Tice remains a raging bear. He sees “tons” of stocks to short, he said, given his outlook for the economy to remain troubled and his belief that many stocks are drastically overvalued relative to companies’ earnings potential in the next few years.

If any event draws more investors to consider trusting professional short-sellers with at least a portion of their portfolios, it ought to be Enron’s rise and thunderous fall.

For now, however, Fleckenstein considers the relative lack of interest in short-sellers to be a sure sign that the bear market isn’t over, because most people believe otherwise. “I find it comforting,” he said.


Tom Petruno can be reached at For recent columns on the Web go to: