Hindenburg Research exit shows it's no market for old shorts

By Chris Hughes

A little more than a year after legendary Enron short-seller Jim Chanos threw in the towel on activist short-selling, the equally famous Hindenburg Research is calling it a day.

Short selling, short-trade research and public activism are all key to the functioning of the stock market. And yet it’s fiendishly hard to combine the three strands into a business that endures.

The starting point is that the market has a structural deficit of skepticism. Even after regulatory reform, investment-bank research suffers potential conflicts of interest — hence all those disclaimers. True, investors still value the output. But that’s partly because they don’t really have to pay much for it. And big brokers aren’t in business to run dogged investigations into any red flags signaled by company accounts.

As for the independent research industry, it struggles to provide a corrective. Its economics are challenging, even for firms trying to spot “buys” rather than “sells.” Forensic deep dives into aggressive accounting require even more resources, including the reserves to fight likely legal battles. Investors value counter-consensus ideas; but too few are willing to pay what that really costs.

What about combining short research with trading for clients or on your own book? A successful short attack can generate huge profits superfast. But it’s not so simple. However you cut it, the business is risky and difficult, both personally and economically.

Founder Nate Anderson is winding up Hindenburg after a phenomenal run. Nowadays he’s best known for his 2023 attack on India’s Adani Group. The societal legacy will be the longer-term record. Hindenburg says its investigations have preceded fraud charges by the US Securities & Exchange Commission against 65 people, Department of Justice criminal indictments against 24, and others outside the US.

And yet...the business is closing. Anderson plans to share his methods online to encourage others. He’s also advertised the talents and personalities of his small team to recruiters (he calls them “assassins” with “little to no ego”). Some apparently plan to start their own research firms. For now, however, the market is facing a Hindenburg-sized gap.

Why call it a day? “There is not one specific thing – no particular threat, no health issue, and no big personal issue,” Anderson wrote on Hindenburg’s website. He says he’s gone from needing to “prove things to myself” to finding “some comfort with myself.” It doesn’t sound like it’s been better to travel than to arrive at that destination. “I needed to put myself through a bit of hell first.” That included missing “the people I care about.” Anderson cites a “desire for relief.”

Maybe there’s more to it. Or maybe Anderson’s made enough to retire and go clubbing. Then again, so have many who’ve been successful in finance, and it doesn’t stop them carrying on.

Combining research with trading in activist short selling clearly has the potential to be lucrative. The flip side is that a short trade is also risky on several levels. In 2011, Muddy Waters’ Carson Block said he’s had death threats. Since then, the forces against short sellers have grown.

The need to make an impact exposes you to claims of sensationalism. The already high risk of protracted legal battles is amplified by having skin in the game. You need correspondingly deep personal and financial resources to defend yourself; the short target invariably has more firepower. A takeover rumor used to be the main threat to a short. Since the GameStop Corp. drama, you risk an army of retail investors willfully squeezing your position. Regulators are taking increasing interest in the timing of trades by short activists and related parties either side the attack.

You need to be right, you need to be vindicated, and you need to prepared for intimidation to continue despite that. That’s a lot of hurdles.

Things would be easier if there was huge demand from investors to support short ideas. But this has declined with the relentless upward march of the stock market. At the end of 2023, Chanos decided to return capital to clients even while proclaiming the “Golden Age of Fraud.” Such investment strategies are quasi-insurance against market crises. As the Magnificent Seven tech stocks march on, investors have put less value on this — something they could well come to regret.

In the years prior to closing, Chanos’s declining assets under management made it harder to support the regulatory expenses of running client money. He has reinvented his business as a consultancy. But it’s easier to do that once your reputation is established, and those ideas will no longer gain such wide dissemination.

The paucity of sustainable short-focused businesses looks like a market failure. The bottom line is that investors won’t pay for an industry that fills gaps where regulators themselves should be more active. Each short business is a cog in the governance machine. Every time one calls it a day, the machine is more prone to malfunction.