60 Minutes News Program Highlights Hedge Fund Lawsuit Filed By Biovail – What Is Selling Short and What Does it Mean?

March 27th 2006

Money

The CBS News show 60 Minutes had a segment on hedge funds and specifically a dispute and lawsuit filed by the Canadian Company Biovail against one of the world’s largest hedge funds, SAC. According to Lesley Stahl, hedge funds have little government oversight and operate in secrecy.

In this specific case the lawsuit alleges SAC influenced the analysis of Biovail stock. They allege SAC influenced the stock-analysis firm Camelback (The Arizona company has since changed their name to Gradient). Camelback gave the biotech firm an “F” rating, hinting at accounting irregularities among other things. This caused Biovail stock to plummet.

Usually when most people buy stock, they are hoping the price goes up. One of the strategies hedge funds use, called selling short, is contrary to this philosophy. Selling short involves the sale of a security that one may not own, but will buy in anticipation of making a profit by paying for it after its price has fallen.

A seller of securities could profit by selling stock or commodity future by selling short. A hedge fund or seller hopes to buy the stocks at a later time and of course at a lower price. For instance, I could offer to sell you stock at a later time. You hope the price goes up and I hope the price goes down.

Hedge funds take both long and short term positions, use arbitrage, buy and sell undervalued securities, trade options or bonds. They invest in almost any opportunity in any market. There are 14 basic investment strategies hedge funds use in an attempt to preserve capital and deliver positive returns. Selling short is just one of these strategies. The goal is to do this under all market conditions.

The hedge fund industry, on the whole, is valued at about $1 trillion. The industry is growing at about 20% per year with approximately 8350 active hedge funds. Various hedge funds use different strategies to achieve their return, and not all hedge funds hedge against market downturns. Of course hedge funds vary in risk and profitability.