Last week's historic market closedown has focused the attention of many nervous investors and the financial media on the topic of short selling. With last week's attacks, the debate rages over whether selling short is right or wrong in this uncertain economic and political climate. Emotions run high as rumors circulate that the alleged terrorists may even have profited from short sales of insurance companies before the attacks.    

Manuel Asensio is perhaps the most famous short-seller in the market, thanks to his adversarial style and very public profile. The author of Sold Short: Uncovering Deception in the Markets, Asensio has produced perhaps the best public record of stock calls in the business: on his website, www.asensio.com, Asensio & Co. has initiated "strong sell" coverage on 26 different companies since January of 1996, and the market has proven him correct on 24 of those calls (the 25th company is Network Solutions, and the 26th is VeriSign (Nasdaq: VRSN), which acquired Network Solutions in 2000; this is still an open position but so far very profitable.) Of the 26 stocks, 14 have declined in value by more than 90%, 8 of the 14 have been de-listed, and 3 of the 8 have gone bankrupt.

Practiced by Asensio, short selling isn't about betting that good companies will fail or about trying to profit from the misery of others. He argues passionately that short sellers play an important and necessary role in the market by correcting mis-allocations of capital that disrupt the economy. Selling short requires a belief that free markets will encourage enterprises that create value and discourage those that don't -- and the choice to concentrate on the second factor rather than the first. According to a company press release last week, Asensio argues that short sellers challenge "not the system, but those who abuse the system."

Back in May, Fool writers Zeke Ashton and Whitney Tilson talked at length with Mr. Asensio about how he targets companies ripe for shorting, why he specializes on the short side, and why he believes that he and other short sellers represent "the knuckles of the invisible hand" of an efficient market. Whether you short stocks or not, we think you'll find the following interview to be a fascinating glimpse inside the mind of a short-seller.

For more information on shorting, see our special, "Is Shorting Stocks Foolish?" 

TMF: Thanks for talking with us today. In looking at your website, where you publish your strong sell/short sell opinions, your track record is pretty much perfect. We counted 24 out of 25, or 95%, where things pretty much turned out as you described in your reports.

Manuel Asensio:  It depends on whether you consider Network Solutions and VeriSign to be one play or two plays [VeriSign acquired Network Solutions in 2000]. Because with our first call on Network Solutions, we didn't lose money, and now we've issued a strong sell on VeriSign, and we're still in the game there. So it depends on how you count it.

TMF: There are 10,000 or so publicly traded companies -- and you target publicly maybe three or four per year. How do you narrow down your selections?

Asensio: We have two very different universes that we look at. The first is the universe of companies that we publish, where our track record is nearly 100%. What draws us into the markets in those cases is that we have factual evidence, undeniable, with no uncertainty, that proves what the company is saying is not complete, not correct, or in fact, in many cases, diametrically opposed to the facts.

TMF: In other words, they are fraudulent.

Asensio: Let's not use the word "fraudulent," let's not use the word "false," because it doesn't matter. The only thing that is important is that we discover some companies that are disseminating information that is, to describe it in the most gentlemanly way possible, of questionable validity. Those questionable disclosures, which might include complete falsehoods or might simply be the failure to disclose negative material information that investors need to make a judgment about the stock. If the stock price is a result of the market believing what the company is saying, that we know to be incorrect, then we look at it. So we focus on questionable companies, but then we look for price action and volatility.

You then have to make a judgment -- this stock is trading at this much, based upon assumptions that we know to be incorrect. If those things come together, when we have factual, third party, unquestionable information that shows that the company is disseminating information that is both positive for the company and false, then those conditions make up the premise for our decision to initiate coverage with a strong sell report on our site and to short the company. Once we have initiated coverage, we also commit to the coverage and report on it continuously. 

TMF: Why do you take such a public, adversarial position relative to these companies? If you know that the stock price is based upon assumptions that aren't true, why not wait for the market to recognize that?

Asensio: Being public with our research speeds the process along. The fact that we are an advocate of our position and we strongly word our research, act quickly, and are accusatory in our language helps the stock correct itself, and helps the market correct itself. That is also what has created the controversy.  

TMF: So you make everybody put their cards on the table?

Asensio: If we relied upon giving that factual information -- which is hard to discover, sometimes hard to understand or to apply -- to a media outlet like The Wall Street Journal, which is institutional in nature and biased towards the status quo, that information would never be treated the way that we treat it when we issue our hostile adversarial short-selling research. People find it offensive, and of course most of those that are offended are involved in the battle and are also involved in the promotion of the company. This has led to some of these companies pursuing litigation at times, none of which has ever been successful. 

Our record, I feel, is a tribute to the efficient market, not a record in the face of an efficient market. In our thinking, the fact that we are rewarded and generated better profit in the bull market relative to other short sellers or even long players, comes from being very close to the knuckles of the invisible hand that sets prices. Society is willing to provide us with a profit in return for the benefit to society that we provide of eliminating obvious misallocations of capital, which is always damaging to capitalist society and free enterprise.

If the invisible hand is being hampered because there are no short sellers, no adversary to the promotion of the company, then you are going to get prices that are just too high. You have to put in valuable information in a manner that advocates the short side, and you will be paid to the degree of credibility you have and the correctness of your research and your information that you provide to the market that strives to be efficient. We are fundamentalists, and we are respecting of the efficient market and efficient capital asset pricing.

TMF: With all the companies out there, you can't read every 10-K and press release. How do you find the ones that are disseminating false information that you then decide to short?

Asensio: First of all, you have to concentrate on questionable companies and questionable management to begin with. The stock must also have a price and volume, and there has to be volatility, to make it worth our time to look at. For example, one company that we shorted, Zonagen (Nasdaq: ZONA), was a very questionable company that was picked up by some underwriters to do a secondary offering, and all of a sudden it was a respectable company.

TMF: But how did you know that Zonagen was questionable? How do you find the companies?

Asensio: We have a database of fraudulent stock promoters, and a database of companies that those promoters use to do Ref-Fs, Reg-Ds, 504s, private placements, and the like. 

TMF: So you follow the stock promoters and the underwriters?

Asensio: Exactly. We tend to be very active on the American Stock Exchange. The AMEX is a hotbed of fraudulent activity. 

TMF: To what do you attribute that?

Asensio: There is a widely held perception among investors that a listed company is more stable and better than a company that trades over-the-counter. This may come from the quality and size of the NYSE listing but the AMEX is very, very different, and worse so. Investors don't know this, and the AMEX insiders and penny-stock promoters use it to their advantage.

Hemispherx (AMEX: HEB) is certainly the most exposed stock fraud in America, and the AMEX refuses to de-list it. There were three high ranking officers in the American Stock Exchange involved in Hemispherx. One was a prominent specialist who has since been permanently barred -- another was on the board of governors, and the third was president. The American Stock Exchange has a deep institutional and fundamental problem with their listing requirements and with their business in general.

Next: Interview With a Short Seller, Part 2 »

Zeke Ashton (TMF Centaur) wouldn't be caught dead owning any of the stocks mentioned in this article, though he owns others you can see in his profile. He heartily recommends Manuel Asensio's book -- it's a fun read.

Guest writer Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a New York City-based money management firm. He owns no shares of companies mentioned in this interview. He writes Tuesday's Fool on the Hill column for The Motley Fool.

The opinions expressed by Mr. Asensio are his only and do not represent those of The Motley Fool, Inc.

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