S.E.C. Chairman Rebukes Staff for Subpoenas to Reporters

The New York Times reports that S.E.C. chairman Christopher Cox has rebuked his own staff for issuing subpoenas to two financial reporters:

"The issuance of a subpoena to a journalist which seeks to compel production of his or her notes and records of conversations with sources is highly unusual," Mr. Cox said in a statement today. "Until the appearance of media reports this weekend, neither the chairman of the S.E.C., the general counsel, the office of public affairs, nor any commissioner was apprised of or consulted in connection with a decision to take such an extraordinary step. The sensitive issues that such a subpoena raises are of sufficient importance that they should, and will be, considered and decided by the commission before this matter proceeds further.
"The subpoena was issued by a lawyer in the S.E.C.'s San Francisco office, which is investigating allegations of a conspiracy by a research firm and several hedge funds and traders to manipulate stock prices. Overstock.com, an Internet company, contends that its stock has been manipulated. In a lawsuit filed in Superior Court in California, it has accused the research firm, Gradient Analytics, and stock traders and hedge funds of working together to put out false information about Overstock just after the traders executed heavy bets that the stock would decline.

Short sellers make market bets that a particular stock will fall in value, and thus have a natural interest in circulating information that shows that the company is overvalued. A famous example is that of Jim Chanos of Kynikos Associates, who mentioned to Fortune reporter Bethany McLean that Enron might be overvalued. McLean and co-author Peter Elkind recount the conversation in their book, The Smartest Guys in the Room:

Chanos said, "Read the 10-K and see if you can figure out how they're making money."

Executives hate short sellers, but shorting a stock is not a crime. As McLean and Elkind point out, short sellers aren't operating with inside information; they're just doing their homework:

Chanos and the others who shorted Enron's stock didn't have any special information that wasn't available to the bulls.

After talking with Chanos in early 2001, McLean wrote a story with the headline, "Is Enron Overpriced?" which raised the question of how the company posted such impressive profits given its meager cash flow.
Short sellers perform an important function in our open securities markets: They bring to light information about troubled companies that bullish analysts and overburdened regulators might otherwise overlook.
For the S.E.C. to issue subpoenas to reporters who publish this information based on complaints from the offended companies, would be to play into the hands of executives who don't want unflattering information brought to light.