- The Department of Justice is exploring if they can charge stock market short-sellers with the same law used to prosecute the mafia, according to a Reuters report.
- Several short-selling research firms have been on the DOJ's radar as they investigate illegal trading tactics.
- Subpoenas have been sent to dozens of firms, including Citron Research and Muddy Waters.
An ongoing investigation into the practices of several stock market short-sellers is heating up, and the Department of Justice is exploring if it can use a federal law that was originally enacted to prosecute the mafia, according to a Reuters report.
The Justice Department already sent subpoenas to dozens of short-selling firms last year, including high-profile activists Andrew Left of Citron Research and Carson Block of Muddy Waters.
While no final decision has been made by prosecutors, potential charges under the Racketeer Influenced and Corrupt Organizations Act, or RICO, remain an option "on the table," Reuters reported, citing two sources familiar with the situation.
This wouldn't be the first time RICO charges were leveled against Wall Street participants. In the 1980s, Michael Milken was charged with racketeering, though he reached a plea deal that did not include those charges. And in 2019, JPMorgan executives were charged with racketeering related to the price manipulation of precious metals.
The current investigation into short-sellers revolves around their trading practices, specifically whether manipulative tactics were employed around the same time a negative report was published.
According to prior reports, the DOJ seized hardware, trading records, and private messages from various short-sellers and is focused on the act of "spoofing" and "scalping," two practices that could lead to big gains for traders.
Spoofing is an illegal practice banned in 2010 in which a trader floods the market with fake orders to influence a stock price. Scalping is related to activist short-sellers selling out of their position for profits without disclosing it.
Short-sellers are an unloved group of market participants that get a lot of blowback from the companies they target and the investors of those companies. Some see their tactics as predatory, as they often have the power to move a stock that they might have a position in by releasing a critical report. Critics say these reports use misleading information that doesn't give a complete picture of the situation at hand.
But some short-sellers also have a proven track record of identifying and exposing fraudulent companies that sometimes go bankrupt. Such companies that were the target of short-seller research included Enron, Sino-Forest, and Wirecard AG, among others.
One person who is happy with the Justice Department's investigation is Tesla CEO Elon Musk.
"I am greatly encouraged by the Justice Department investigating short sellers. This is something the SEC should have done, but, curiously, did not," Musk said in an e-mail to CNBC. "They will short a company, conduct a negative publicity campaign to drive the stock price down temporarily and cash out, then do it all over again many times."
Musk's position against short-sellers is not surprising given that Tesla stock was a popular target among short-sellers for many years until it broke out to record highs in late 2019 as the EV maker turned a profit. While 25% of Tesla's shares were sold short in 2019, that figure now stands at just 2%, according to data from Koyfin.
So far, the investigation by the Justice Department has reached nearly 30 investment and research firms that engage in short-selling. No one has been accused of wrongdoing, and the investigation may not lead to charges being brought.