Why is a liberal watchdog group barking at Bill Ackman and other short sellers?

Progressive nonprofit policy groups usually applaud when informed citizens accuse big companies of exploiting consumers and rally government action against the abusers.

Unless, it seems, those citizens happen to have put some money where their mouths are by betting against the shares of the companies they assail.

Citizens for Responsibility and Ethics in Washington is a mostly liberal-leaning group that typically works to expose corruption among government officials. Yet this month, CREW tried to kick up a fuss when it urged Congress and the Securities and Exchange Commission to investigate hedge fund managers who have enlisted government agencies and legislators to go after companies whose stock they’d sold short.

The main target of the group’s outrage is Bill Ackman of the $19 billion hedge-fund firm Pershing Square Capital, whose aggressive public crusade against Herbalife Ltd. (HLF) has raged since late 2012 and has involved the cajoling of members of Congress and the Federal Trade Commission.

Ackman’s central contention is that Herbalife, a multi-level marketer of nutritional supplements, is a fraud that makes most of its money not by selling products to consumers, but simply by recruiting new sales representatives using misleading promises.

The group has also called out Steve Eisman, the investor featured in Michael Lewis’s financial-crisis chronicle “The Big Short” for his prescient and fabulously profitable bets against trashy mortgage securities. CREW takes exception not with that correct position, but with Eisman’s later campaign to short several for-profit education companies.

Eisman, then of FrontPoint Partners, communicated with Department of Education officials to investigate alleged fraud in these companies’ student-recruitment and student-loan practices, and he testified for a Congressional committee on these issues.

As it turns out, of course, the Obama administration did find that some for-profit schools abused government-loan programs and it imposed tighter standards on them. The shares of leading for-profit education players Apollo Group Inc. (APOL) and ITT Educational Services Inc. (ESI) are down between 65% and 95%, respectively, in the past five years.

'Market manipulation'

Anne Weismann, interim executive director of CREW, says: “Our hook here is not short-selling per se, but using government processes for personal gain,” which she called “highly inappropriate.” She suggests that staking a financial bet against a stock and then assailing the company in public and in government offices falls “under the rubric of market manipulation.” (The legal definition of manipulation is murky and demanding, usually requiring coordination with other traders, intentional misstatements of fact or interference with the far operation of the market -- not simply self-interested public statements about a company.)

CREW was spurred to look into Ackman’s Herbalife position by a March 2014 New York Times article that detailed the extraordinary efforts Ackman employed to recruit members of Congress, the FTC and Hispanic-American advocacy groups to mobilize against Herbalife, which pulls members disproportionately from Latino communities.

Upon reading the piece, Weismann says, CREW “reached out to Herbalife and said, ‘What do you have on this?’” An Herbalife spokesman confirms that CREW contacted the company last March “after their investigations raised serious concerns about certain short sellers."

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A spokesman for Ackman’s Pershing Square declined to comment on the matter, which comes at a time when federal law enforcement officials are reported to be looking into whether people working with Ackman on his Herbalife efforts might have given false statements to investigators. Ackman told CNBC that neither he, nor anyone at his firm, has been interviewed or subpoenaed by federal authorities.

The campaign by CREW is a bit puzzling, having a seemingly tenuous connection to its usual activities. But, then again short sellers are commonly cast as market villains, even though research shows they frequently expose frauds or other improper corporate behavior. And their activities are – or should be – afforded the same treatment as any long investor who owns a stock and speaks publicly on a company’s behalf.

And it’s hardly true that shorts can somehow knock down share prices at will. They shoulder greater risks and costs to make their bets. And heavily shorted stocks routinely continue to soar after they’ve been targeted by the bears. Herbalife stock, indeed, went from $43 to $27, then up to $81 and now back to $41 since the day in December 2012 when Ackman delivered a three-hour public presentation of his bearish thesis.

A proxy fight playing out?

One amusing circumstance surrounding this situation is the fact that CREW has long received some financial support from the Open Society Foundations – the nonprofit enterprise founded by billionaire George Soros, whose investment firm happens to be a significant shareholder in Herbalife.

Indeed, Soros joined Carl Icahn and other prominent investors in taking bullish stakes in Herbalife in the months after Ackman’s public attack on the company. Just to add to the fun, Ackman in 2013 was reported to have complained to the SEC that Soros’s representatives improperly manipulated the stock by persuading other investors to buy in during private “idea dinners.”

According to public documents, Open Society has donated at least $800,000 since 2010 to CREW, whose annual operating budget runs near $3 million. An Open Society spokesman says its donations represent “general support funds. It is up to them to use as they see fit.”

A Soros spokesman says, “there has been no communication whatsoever between [Soros Fund Management] and [Open Society] on this matter.”

If CREW's actions were somehow a proxy skirmish in an ongoing battle of billionaire egos, it might be easier to explain. CREW’s interest is especially unexpected, given that liberal groups would likely not otherwise take the side of for-profit colleges or multi-level marketing companies that target minorities. While in the past, left-leaning groups have supported generous government guarantees for student loans, they are not natural allies of for-profit schools.

Weismann, indeed, says, “We’re not here to defend” those companies or Herbalife.

The companies, of course, are constantly pleading their case to friendly members of Congress and regulators, the way most corporate players do. Weismann says this is fine because they are expressly affected by industry policies, whereas the hedge fund managers have no particular expertise, and their “only interest is financial.”

In other words, even if short sellers are right and alert government officials to real corporate misbehavior, their work is suspect because they profited from it?

Correction: An earlier version of this article incorrectly referred to Citizens for Responsibility and Ethics in Washington as the Committee for Responsibility and Ethics in Washington.