AJR  Features
From AJR,   September 2010

Short on Ethics?   

Two Web sites that investigate business fraud are funded by short selling—placing market bets that the stock of companies they write about will go down. It’s an approach that makes journalism ethicists very uncomfortable.

By Cary Spivak
Contributing writer Cary Spivak (cspivak01@gmail.com) is an investigative reporter for the Milwaukee Journal Sentinel, focusing on business issues. He explored the question of when journalists should share information with law enforcement authorities in AJR's Spring 2012 issue.     

At first the idea didn't feel quite right to Christopher Carey.

On the plus side, the idea of creating a Web site dedicated to investigating business and securities fraud seemed to be the perfect escape route from the newspaper business for the St. Louis Post-Dispatch reporter. Teaming up with Mark Cuban, the controversial owner of the Dallas Mavericks and cofounder of HDNet, would give the new site instant recognition.

It all seemed perfect — except, that is, for Cuban's unconventional financing idea. The self-made billionaire proposed trading the stocks of companies that Carey investigated. Not only that, Cuban was going to short the stocks before the stories were posted, meaning he would effectively place market bets that the value of the stocks would plummet.

"As someone who had been a print journalist since 1983, that caused me a lot of trepidation," Carey says. "I did a lot of soul searching."

Carey set his concerns aside, quit the Post-Dispatch and, on August 6, 2006, posted his first investigative piece on Cuban's Sharesleuth (sharesleuth.com) — an examination of an ethanol company called Xethanol Corp.


The stock quickly fell 20 percent after Carey's story questioned whether Xethanol's technology could live up to its promise of making alternative fuel out of wood chips, corn stalks and paper sludge. The Sharesleuth site discloses that Cuban shorted 10,000 shares of the stock when it was trading at about $12.65 a share. Since the company, now known as Global Energy Holding Corp., was trading for pennies a share in July, Cuban had an unrealized gain, or paper profit, of about $120,000.

And so a new, controversial model for funding investigative journalism was born: Using short sellers, a group viewed with disdain by some as the market's bottom feeders, to finance investigations of publicly traded companies.

"Call it journalism. Call it investigative blogging. Call it what you will," Carey wrote in his July 2006 introduction to Sharesleuth headlined "Welcome to the Jungle." Carey, who is the site's editor and main reporter, disclosed in the story that Cuban would occasionally short the stocks of companies Carey investigated. Shorting stocks provides traders with the chance to score big profits if a price plummets, but leaves the door open for unlimited losses if the price skyrockets.

"It's a tough way to try and fund reporting," says William Lobdell, editor of iBusiness Reporting (ibizreporting.com), a second site funded by short trades. "You can expose a company that is doing wrong and still lose plenty of money because of stock market momentum, takeover rumors and many other factors."

It's also a controversial way to fund reporting. "It isn't journalism," says Edward Wasserman, Knight Professor of Journalism Ethics at Washington and Lee University in Lexington, Virginia. "Their claim to be taken seriously as journalists, if they're making that claim, is ridiculous."

Disclosing that a site is funded by short sales doesn't remove the ethical questions that surround it, says Bob Steele, director of the Janet Prindle Institute for Ethics at DePauw University in Greencastle, Indiana. "It merely provides a form of transparency that reveals there's something behind the curtain," Steele says. "It doesn't mean that it's OK."

Cuban is characteristically terse and blunt in brushing off critics. "I don't care what they think," Cuban said in an e-mail, his favored form of communication. "If they think it's important enough they are welcome to do the same work and beat us to the story."

Cuban paints Carey's work as basic old-time reporting — reading government documents and knocking on doors — something he argues others in the media are not doing. "It's amazing what you will find if you just show up at a factory to see if they have electricity," Cuban says. "Or go to an office address to see if there is anyone there. It's basic stuff but no one seems to do it but sharesleuth."

Four years into the job, Carey is at ease working for a short-seller boss. "Based on what we've done this far and what's happened in journalism, I really have no qualms about this arrangement," the 49-year-old Carey says. "It was foreign to everything that had been preached to us....But let's face it, newspapers were for-profit institutions, and a lot of that profit did not get poured back into journalism."

The world of Web-based investigative business sites is a small one, but what the emerging genre lacks in numbers it makes up for with colorful characters — in particular, two felons convicted of well-publicized white collar crimes.

One of the sites, iBusiness Reporting, is owned by Barry Minkow's Fraud Discovery Institute, and it also uses short sales to finance its work. In the 1980s, Minkow went from being a teenaged entrepreneurial wunderkind to a convicted stock swindler when federal prosecutors proved that his ZZZZ Best carpet cleaning company was nothing more than a Ponzi scheme.

Since leaving prison in 1995 — he served more than seven years — Minkow has been a Southern California minister and a self-proclaimed fraud buster, often hiring accountants and investigators to help root out stock schemes.

Minkow's site goes a step further than Sharesleuth in using information to turn a stock profit. Minkow isn't the only one who shorts the stocks investigated by Lobdell, iBusiness Reporting editor and reporter. Lobdell says he has also shorted the stocks of companies he's investigated. Carey does not trade in the stocks of companies he probes.

"There's not much difference between working for the Fraud Discovery Institute that shorts stocks and shorting the stock personally," ex-Los Angeles Times reporter Lobdell says.

Says a flabbergasted Steele: "I'm astonished that he would not see it as a problem."

Hunter Adams, the brains behind The Street Sweeper (thestreetsweeper.org), helped launch the site last year, just eight years after federal prosecutors labeled him an associate of the Gambino crime family in New York. Adams, who was convicted for his role in a massive "pump and dump" scheme involving penny stocks, is still on federal probation for his crime.

Nobody connected with The Street Sweeper is shorting the stocks it investigates, though neither Adams nor Melissa Davis, the site's editor/reporter, rules it out. "We have left the door open for that possibility," Adams says. "I see nothing wrong with it, as long as it's legal and properly disclosed."

For now, however, the site is pursuing a different and unique Plan A for long-term financing: making the investigative work of Davis, 43, the basis for a reality TV show. "We would actually be going in and exposing these companies on television," says Davis, who worked for TheStreet.com for seven years before joining The Street Sweeper. "Some of them don't even have offices."

Adams says he has discussed the idea with several people "who've expressed interest in doing the show" but no deal has been struck.

Davis, whose outgoing personality seems suited for reality TV, prefers the idea of small-screen funding over short selling. She doesn't criticize the sites that are funded by the shorts and says she would be comfortable if The Street Sweeper went that route as well, though she would not trade personally. But for now, "I like the fact that people can't say we have bias."

Carey, Lobdell and Davis were respected journalists who captured some awards before they linked up with their current employers. The reporters say they have the freedom to choose which stories to pursue and to follow all of the traditional rules of journalism to ensure their work is well researched and accurate.

They may be OK with the short-selling model, but others, including fans of their work, are not. "At some level, I view the practice as distasteful," says Roddy Boyd, a former Fortune and New York Post reporter who launched his own investigative site, The Financial Investigator(thefinancialinvestigator.com), in June. Boyd, a onetime bond trader who is writing a book on the collapse of AIG, says he is paying for his site out of his own pocket.

"I would not want anyone to be able to say of my work, 'Whoa, it's tainted,' or that there are concerns," says Boyd, who praised the work of Carey and Davis.

Even Tracy Coenen, a Milwaukee-based forensic accountant who works with Minkow, is a tad queasy about the funding strategy. Coenen, owner of Sequence Inc.,says she does not trade in the companies investigated by iBusiness Reporting and wishes that Minkow and Lobdell didn't either.

"It tends to raise some questions about the independence of our work. It creates a reason for people to raise questions about us," Coenen says. "I prefer that very clear line in the sand." She adds, however, that she is comfortable that the work produced by Minkow's site is accurate. "He has a vested interest in publishing the truth," she says.

Medifast Inc., a health supplement company and target of Minkow first through his Fraud Discovery Institute and later through iBusiness Reporting, charges in a lawsuit filed this year that turning a profit is the key to Minkow's investigations.

Minkow, who has been operating the Fraud Discovery Institute since 2001, is much more public and aggressive than the other sites when going after a company. He's been known to go on YouTube and issue press releases attacking companies investigated by his team.

Medifast labeled Minkow's tactics a "get rich scheme" in a $270 million lawsuit the company filed this year in U.S. District Court in the southern district of California. "By taking a short position and then releasing the negative results of his investigation on the FDI website, posting video clips on YouTube...getting his associates such as Coenen and Lobdell (among others) to repeat his false allegations of fraud on their Web sites, Minkow, FDI, and their associates are able to reap huge profits when the target company's stock plummets as a direct result of their false and defamatory, and very public attacks," the suit alleges.

The suit is pending. Minkow and his team have repeatedly denied the allegations and defended their work in interviews and on their Web sites.

Several companies have complained about Minkow to the U.S. Securities and Exchange Commission, and the federal regulator is investigating him. Minkow says the SEC has subpoenaed some of his documents, including correspondence with reporters. He blames the investigation on companies trying to divert attention from themselves.

Though the legality of the sites has not been tested in court, several attorneys — including current and former federal prosecutors — say they do not appear to violate insider trading or other securities laws. The reporters for the sites are notinsiders and they use publicly available information filed by companies with the SEC as the basis of their stories.

Matthew B. Arnould analyzed the legality of Cuban's trading to support Sharesleuth for a 2009 article published in the Northwestern University Law Review. He's now an attorney at Ropes & Gray in Boston.

"Given the positive impact that Sharesleuth and its contemporaries appear to have on market efficiency and on the dissemination of compelling consumer information, perhaps this maverick has, indeed, achieved something nobler than simple rebellion," Arnould wrote, concluding that "[p]erhaps he has defined a new boundary for fiscally viable online publishing and a roadmap by which we may measure the future of business journalism."

For years, short sellers have tried to spread the bad word about companies in which they had positions. Funneling tips to reporters, posting negative information on any number of sites or just passing along rumors are among the techniques they have long used. Today, the shorts are escalating their online efforts.

"There are plenty of sites out there — just skim Seeking Alpha — where you have no idea whether the person writing the article, negative or positive, has skin in the game," says Michelle Leder, founder and editor of footnoted.com, a respected Web site that reviews and posts news, often negative, found in company filings with the SEC. "So the fact that some sites make a point of shorting the stock before posting something is a bit more honest. At least you know what you're getting in advance. That doesn't mean I totally agree with it, but at least you know what you're getting."

The difference is Seeking Alpha (seekingalpha.com), a collection of views and opinions of business and economics, and other sites do not promote themselves as investigative journalism venues. And neither should sites like Sharesleuth or iBusiness Reporting, says Wasserman, the Washington and Lee professor.

Wasserman isn't sure how to characterize the sites, though he is adamant that they are not journalism entities. "It's for private gain, not public illumination," he says. "It gauges success by the results it's able to gain on behalf of its client.... This is not about understanding. This is about exposing and profiting."

Yet Wasserman says the sites may be doing some good. "Everyone gains from chasing fraudsters out of the market," he says, adding that a journalist would go after fraud in all types of companies, not just publicly traded ones that have shares that could be shorted. "They're more like PI or PR people," he says, referring to investigators and spinmeisters, who both gather information to help a client prove a point. "This is not very different from attack ads in politics."

In a perfect world, says Boyd of The Financial Investigator, short sales would not be needed to fund the sites. "But this is not a perfect world," says Boyd, who teamed with Allan Sloan in July 2008 to write a highly critical story about Lehman Brothers. The story ran in Fortune and the Washington Post about two months before the collapse of the investment banking firm.

That's the type of reporting that too often is missing from the mainstream media today, Boyd says, adding the void is being filled by new online ventures. "There's a lot of talent that can tell you why Madoff happened or why Lehman happened," he says. "There's not a lot that can say what will happen."

Even a casual observer realizes that investigative journalism has taken a hit at newspapers across the country in recent years as financially struggling newsrooms slashed their staffs and imposed tough cost-cutting measures (see "Investigative Shortfall" ). "The global economic crisis has made it more challenging for newspapers to do the type of investigative reporting they once did," says DePauw's Steele.

Those associated with the new investigative business sites sing the same refrain: They were created to fill the gap left as thousands of reporters were given pink slips. "It's just a market response to the lack of business reporting on fraud in the marketplace," Cuban says. "It used to be commonplace, now it's rare."

Whether it's journalism or not, Minkow — the ex-con turned minister — says fraudbusters like him are needed. "Brother, listen to me: CEOs and public companies do not fear [the traditional media's] investigative reporting," Minkow says. "It's not nearly as prevalent as it once was."

Perhaps, but these new sites are not focused on the nation's largest companies, preferring to delve into smaller ones. "It's hard to really argue the importance of their service to the greater investing public," Leder, who recently sold her footnoted.com site to Morningstar, wrote in an e-mail interview. "It would be a bigger service if they focused on companies that people actually owned instead of these two-bit (and in some cases) penny stocks."

It will take time, says Share-sleuth's Carey, but some of the sites will land the big fish eventually. "We want to work our way up the food chain," he says. "It's just a question of how and when. We'd love to find the next Enron."

Minkow and Adams believe their criminal pasts help the reporters who work for them track down fraud. "Without my background (including my convictions) in the securities industry, I would have never recognized the need for a service like TheStreetSweeper," Adams wrote in an e-mail interview.

"I wouldn't know how the game was played. I can see what these guys are up to while — and even before — they do it," he says. Adams came up with the idea for the Web site, though he says his estranged wife is financing the project.

Davis, who was hired by Adams when she answered an ad after being laid off by TheStreet.com, admits she was thrown when she looked into her boss' background. "My first thought was, "Oh, my gosh, who is this guy,' " she says. Today, she sees Adams as a valuable resource. "He really knows how the game works and how the manipulation works."

Lobdell, 49, had a similar experience. He met Minkow while he was still an L.A. Times reporter covering religion. Lobdell worked for the Times and its sister papers for 17 years. He says he intended to do a story about the ex-con-turned-minister. Instead, he says, he became intrigued by the fraud investigations that Minkow was overseeing, and he eventually joined Team Minkow.

Like Davis, Lobdell said in an e-mail interview, he appreciates the insights that his boss provides. "I've learned a lot from Barry, because he still has a criminal mind. I'll uncover some piece of damaging information, but can't figure out the motivation behind it. But Barry knows in a second," Lobdell says. "I have no concerns about Barry, but I follow President Reagan's advice: Trust but verify. Barry knows with me and everyone else that it's one strike and he's out."

His Fraud Discovery Institute — assisted by investigators and other experts he hires — has uncovered nearly $2 billion in fraud, Minkow says, referring to a 2009 computation by Coenen, the forensic accountant. He shows off letters from the FBI and NFL thanking him for assisting in fraud investigations. He notes that in a 2005 segment on CBS' "60 Minutes," U.S. Judge Dickran Tevrizian credited Minkow with uncovering several hundred million dollars' worth of fraud.

Quite a change from 1989, when Tevrizian sentenced Minkow, saying he was dangerous because he had "charisma, this gift of gab,this ability to communicate, but you have no conscience."

The personable Minkow still has the gift of gab, but he grows angry, often shouting, when his motives for launching iBusiness Reporting are questioned. "Everybody's in it for the money," he says. "You're paid. Everybody's got a profit motive. It's just that short sellers are the only ones blamed for it."

The future of iBusiness Reporting appears to be uncertain. It posted no new stories in June or July, and Minkow acknowledges he is rethinking the strategy of shorting stocks to finance investigations of public companies. He says he had more success in prompting action by authorities when he focused on privately held firms and may return to doing just that. "We are thinking through how we can have the most impact in the proactive fraud uncovering business," Minkow says.

The teaming of respected reporters with owners with questionable backgrounds is nothing new, Steele says, explaining that type of marriage puts pressure on the journalists. The ability of reporters to keep their owners in line may well determine what future these new business investigative sites might have, Steele says.

"Veteran, bright, skilled reporters may provide a leveling factor to the higher risk, entrepreneurial side," Steele says. "They can raise the yellow and red flag. I would hope the veteran journalists partnering with the non-journalist entrepreneurs may be able to provide that balancing."