Shares in Nu Skin Enterprises (NUS) rallied strongly after reporting an excellent quarter and upwardly revised record outlook for the upcoming year. Just 2 days later its shares tumbled after a well-known publicity seeking hedge fund operator attacked another firm in their sector which also uses a direct selling approach[1]. This hedge fund operator last year urged investor’s short Green Mountain (GMCR) in the low $20’s, helping knock its shares to the teens—GMCR now stands in the $40’s and his hedge fund is up just 6% this year after being down last year, which some are saying may have propelled his latest rampage, including petitioning the FTC and hiring, according to his own words “two of the top law firms in the country” to investigate the firm.  God only knows what he is really paying these law firms to do, and why he felt compelled to take such action if his analysis was correct.

One brokerage analyst dropped coverage of his short position, saying for the foreseeable future its shares will not follow fundamentals, while at the same time calling the hedge fund’s case as “light.” Again, he did not short NUS, but it did have a strong associative impact which purged its shares by almost 20% this month.  Nu Skin’s Board is extremely strong in direct selling as are its senior management and the firm has earned high cash returns on capital every year over at least the past decade. Its auditor has been PWC throughout and the firm has a high cash tax rate (33.3% last year). Although I am not immune to the risks of a large direct sales workforce working solely on commission, I believe it is fully captured by the higher cost of capital for this firm.

Hedge funds are becoming a frustrating part of this business as they often sway investors, including beseeching financial intermediaries and legislators, often with misleading information and then taking their trumped-up cases to institutional funds. This selling often begets more selling by day traders and high frequency trading houses. The shorted stock in the cited case traded over 110% of its outstanding shares in 3 days.

While not one to often promote added legislation, I believe congress and the SEC should take a closer look at the tactics used by hedge funds, especially how they influence the confidence and integrity of the financial markets.

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