(Reuters] – A U.S. Department of Justice investigation into criminal charges against short-selling has begun. Short-selling is a dangerous practice for bearish investors.

According to three sources familiar with the matter, subpoenas have been issued by DoJ in order to examine short-selling by hedge fund managers and their relationship with research companies that publish negative reviews on specific companies.

The rise of short-selling in 2021 was due to a torrent of social media posts by retail investors criticizing the lack of regulation for short-sellers, and the havoc it can cause on company valuations. In a bid to show short-sellers the lesson, they also made use of social media to encourage other investors to purchase heavily traded stocks.

What is Short Selling?

Investors who short a stock place a wager that its stock price will drop. The borrow shares immediately to sell and wait for the stock’s price to fall before purchasing the shares at a reduced price. When they return their shares to the lender, they pocket any difference.

Who LENDS OUT SHARE SHARES? And Why Do They Do It?

Borrowed shares may be from stock brokers or customers who permit brokers to loan their shares. The short seller must pay the lender interest while the shares remain unreturned. Lenders will get more value if the stock price increases instead of decreasing.

What is SHORT-COVERING?

Investors who have borrowed shares from a lender must purchase the shares back to repay the lender. This is short-covering, the purchase of shares back to cover or close trades.

WHAT IS A SHORT QUEEZE?

An investor selling shares short should be able buy the shares back at a higher price in order to make profits. Sometimes, short sellers may have to purchase shares back at a higher cost to avoid losses. A short squeeze is when there’s a lot of short sellers trying to get out. This pushes stock prices higher.

Melvin Capital and other short-sellers had to hurry to buy GameStop’s (NYSE:) shares when it became clear that the market was soaring as more retail investors poured in. The “short squeeze”, as GameStop was called, may have contributed to the stock’s rise. [USN]

SHARE PRICE: SHORTING IMPACT?

How much trading volume is due to short-covering and long-buying? When investors purchase shares in hopes of increasing its value, it is difficult to determine how much. If trading volume is greater than the amount of shorted shares, short-covering will not explain the day’s price movement.

SHORT-SELLING RISES

As the stock market is not limited in its ability to rise, short sellers could suffer large losses. To cover their wager, they would need to pay the current market price. Stock availability is another risk to short-sellers. The short-seller must repay the exact number of shares they borrowed.

MIXED REPUTATION

Short-sellers can predict declines in prices by looking at financials and company operations. They are frequently criticized for publishing negative reports about stocks that they shorted.

Quinton Mathews published online research under the name Rota Fortunae. In June, he reached a settlement to pay Farmland Partners Inc (NYSE:) Partners Inc “a multiple of” his earnings from a wager against Farmland shares. He admitted to making mistakes in an article which helped to wipe out Farmland’s 2018 market value by $115 Million.

Jim Chanos at Kynikos Associates was a long-time short seller. However, he was convicted for selling now-defunct Enron Corp stock shares to Kynikos Associates before accounting errors started raising red flags on Wall Street late 2001.

SHORT-SELLING: WHAT DO WE KNOW?

The U.S. Securities and Exchange Commission receives quarterly reports from long-term investors, which include a snapshot of stock holdings. However, the regulatory requirements for short-sellers is much more stringent. The Securities and Exchange Commission’s staff reviewed this year’s meme stock frenzy and concluded that “improved reporting on short sales would enable regulators to better follow these dynamics.” SEC has a plan for disclosure reform.

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