The Senate Judiciary Committee will on Tuesday hold a hearing into hedge funds and their use of independent analysts, an area under scrutiny following high-profile lawsuits by companies that have been targeted by hedge fund short sellers.
The issue is already under investigation by the Securities and Exchange Commission and the Department of Justice, and is sparking interest among politicians.
Overstock, the online discounter, and Biovail, the Canadian pharmaceutical company, separately have taken legal action against hedge funds that have sold shares they did not own in the expectation of buying them back at lower prices.
Overstock lodged its suit against Rocker Partners, a leading short-seller, in August last year. Biovail took action against SAC, a large, secretive hedge fund based in Greenwich, Connecticut.
Both cases claim the funds paid an independent researcher, Gradient Analytics, to issue negative reports on the companies. Rocker, SAC and Gradient have all denied the allegations against them.
The Senate hearing, led by Senator Arlen Specter, the committee chairman, is expected to focus on the relationship between hedge funds and independent analysts, and whether there is the potential for collusion and fraud.
The allegations about independent researchers have centred on short sellers. Companies targeted by short sellers often complain that their share prices are pushed down by aggressive shorting. The allegations about fraudulent reports by analysts lend a new dimension to the conflict.
Overstock, which is based in Utah, has taken its case against short-sellers to Jon Huntsman, the Governor of Utah.
Last month, Mr Huntsman signed a bill which would fine Utah brokers $10,000 or more a day for allowing too many unsettled trades in a company to accumulate. Such trades are an indication of “naked” short selling, a controversial practice which Overstock has alleged was occurring with its shares. Naked short selling, where the trader or fund sells shares it does not possess, is not in itself illegal.
Patrick Byrne, Overstock’s chief executive, has gained a measure of fame for his outbursts against short-sellers. In a rambling address in a conference call last year he railed against the “Sith Lords” shorting the stock, alleged a conspiracy against his company by various unnamed parties.
Biovail’s case against SAC alleges that SAC got Gradient to prepare a negative report on Biovail, and wait to release it until after SAC had built up a heavy short position on the company.