Hedge fund loans and short sales studied

NEW YORK  — Managers of U.S. hedge funds may be making
illegal trades before the funds’ loans to companies are announced publicly, research
indicates.

Researchers
found some companies that borrowed from hedge funds instead of banks saw sharp
spikes in the volume of short sales, or bets against the company’s shares, in
the five days before a loan from the hedge fund was announced publicly, The
Wall Street Journal reported Saturday. That suggests illegal trading by hedge
fund managers or others with knowledge of the loans, the newspaper said.

“Hedge
fund lenders, like banks, are ‘quasi-insiders’ and thus privy to private information
about the performance of borrowing firms,” the researchers said in a study
to be published in the Journal of Financial Economics. The study tracks trading
of 105 U.S. companies that borrowed from hedge funds from January 2005-July
2007.

The average
company receiving a new loan from hedge funds had a 74.8 percent increase in
the volume of short sales in the five days preceding announcement of the new
loan, compared with short-selling volume 60 days before the deal, the study
said.

The researchers
noted 255 similar companies that got loans from banks saw little change in
short sales in the five days before announcement of new loans.

The Journal
said investigation is needed to determine whether a spike in short selling just
before a loan is announced means hedge fund lenders are trading against their
borrowers or leaking information.

“Our study
raises important questions about regulating hedge funds when they make
loans,” said study co-author Debarshi Nandy of York University’s Schulich
School of Business in Toronto.

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