(c) S.Natarajan
What Hindenburg type of short-sellers do? They often work in out of the square thinking. But the motive is plain and clear. Profit taking, of course huge profit taking at the cost of established companies with highly valued shares. They bet on the company’s shares to fall, based on many things including some problems with the management, corporate governance, tax avoidance issues, or product problems etc. The latest trend is to investigate the company like a spy and publish reports against the company thereby create a negative sentiment and take advantage by short-selling to make huge profit.
The Adani episode is an eye-opener for other corporates. If Indian Companies retrospect and understand and practice good corporate governance then it becomes self defence against those episodes.
The world of activist short-sellers to which Hindenburg Research belongs is a murky one.
Operators from this world typically, Identify a company whose stock they judge as grossly overpriced,
investigate where they think there are problem areas and write a report or article on the reasons for overvaluation,
Mobilise investors to invest in their fund, for short selling the stock
Then Borrow shares of the company from brokers, sell at going overvalued price and then publish the report on a website.
When successful, stirring the market, the report creates nervousness among shareholders of the company, causing a panic sale by them and leads to a sharp decline in the price of the stock as we evidenced in Adani stock falling by 50% in matter of days. At this point, the short-seller buys as many shares as he had borrowed from brokers and sold and returns them to the brokers. In the process, the short- seller makes a handsome profit.
Legal and Illegal reporting
As the motive is profit making, the above process might have landed many activist short-sellers in to murky waters between legal and illegal. When they started to publish their reports or articles anonymously or with pseudonyms the line between legal and illegal becomes as thin as hen’s feather. Therefore, only few serious institutional investors invest in their ventures. There are, accusations and law suites against activist short-sellers. Now U.S. Justice Department is about to launch a wide-ranging investigation of “spoofing” and “scalping” by them. Spoofing refers to an illegal ploy to flood the market with fake orders to push a stock price up or down, and scalping refers to the short-seller cashing out his position without disclosing
It could be 30 activist short-seller firms and their three dozen associates are being investigated upon. Hindenburg Research and that firm’s only identified associate Nate Anderson are on the investigation list.
Previously one country companies were targeted
Though activist short-sellers had existed earlier, they acquired prominence relatively recently. In a research paper, Ian Appel and Vyacheslav Fos analyse 252 episodes of activist short-selling between 1996 and 2015. These episodes average 10 per year during 1996-2007 in their sample but jump to 45 per year during 2008-15.
In recent years, activist short-sellers have targeted Chinese firms disproportionately. Huang Zhou of Wenzhou-Kean University identifies 17 cases of Chinese firms, listed on the Hong Kong Stock Exchange, that were targeted largely by US-based activist short-seller firms between 2014 and 2019.
Though SEBI(Securities and Exchange Board of India) will look into allegations by Hindenburg report, especially new ones, and SEBI will find whether the allegations are true or false . But there are many lessons to be learnt by other firms in India.
Do Indian firms sail in safe waters?
Indian firms are not exposed greatly to international exposures before like this. It is not the actual accusations of Hindenburg, but the manner in which the Hindenburg-Adani episode has unfolded is very shocking and it is entirely new to India. But that easy process to get huge profit could entice other US-based activist short-seller firms to play the same game very quickly. The episode has demonstrated that allegations can spread like fire through investigating reports like this. The episode has also demonstrated to future activist short-sellers that media and politicians can be effective instruments of magnifying their messages.
When firms whose operations are located wholly or principally in India become targets of activist short-sellers from abroad, their options are limited even if such targeting is based on questionable allegations.This was the case also, when Chinese firms faced short-seller barrages, they could not stand against that. Only foreign Governments and other agencies can take criminal action against the offending short-seller firm under such circumstances. Indian firms may sue for defamation in the foreign courts but prospects of winning such a case are poor.
The short-selling firms need not make definitive claims in their reports when lacking corroborative evidence . Just, planting doubts in the minds of retail shareholders is all they need to do to achieve their goal.
The only available safeguard
First we look at the allegations against Adani to draw what not to be there in an Indian company.
The report, which Hindenburg said was based on interviews with former executives and research from thousands of documents, raised concerns about high debt and the activities of top executives and concluded that seven of Adani’s companies were overvalued. Th report says Adani Conglomerate was “engaged in a brazen stock manipulation and accounting fraud scheme over the course of decades.”
This against the top valued conglomerate in India raises concerns about overall Indian companies’ practices. We look at the share value of Adani Group – Why first of all there is controversy.
In 2021 alone the company stock price raised by a huge 407%. In 2022 another 225%. So there is always going to be one or the other short seller wanting to know why this happened. So Hindenburg investigated and says they found so many irregularities. Adani group answered to that and the Hindenburg studied the answers and said that only about 30 of those pages addressed issues raised in its report, and that Adani had not answered 62 of its 88 questions.
“India’s future is being held back by the Adani Group, which has draped itself in the Indian flag while systematically looting the nation,” the research group said. “We also believe that fraud is fraud, even when it’s perpetrated by one of the wealthiest individuals in the world.”
The implication is that the best defence of listed Indian firms against potential attacks by Hindenburg-like activist short-sellers is going to be what is anyway generally a good practice: superior standards of transparency and corporate governance. Indian Companies should not bow to the pressures of any political parties. The current political regime is known for its over use of IT, Enforcement, CBI, Vigilance Departments for its political reasons to suppress opposition. We dont know the negative side pressures on Indian Companies, but positive favouritism is a possibility if this kind of 400% plus and 225% plus jump in share prices of a particular company, happen in matter of 2 years. So the question of top level favouritism and influence is not ruled out yet. The ruling Government’s One man control structure and its onslaught on independent agencies’ independence has already raised eyebrows. That is one more reason for international communities reacting to report by beating down price of the stock. If the Indian Government should understand that compromising the authority of independent agencies for their political reasons has broader international repercussions about Indian Corporations and Indian economy.
What Indian Companies can do now? The fundamentals of liquidity, solvency, profitability and operating efficiency should always be under scrutiny by Governing boards, especially the independent directors . The jump in 2 years to 400% plus and 225% plus in share price, does the share price justify the real net worth or earning per share in just two years? Did Adani Enterprises and the board discussed about that and scrutinised that and after satisfied itself with the facts, then was there a good explanation made available to its shareholders? So think from the above angle any other boards of any other companies, anything not normal happening, the financial reports and board should have considered it in detail and pin pointed the reasons and likelihood of it happening in next year.This transparency really missing in many Indian companies. There needs to be lot of attitudinal changes to be adapted by many conpanies.
Many questions raised by the Hindenburg report had been around well before the latter came out. Why Indian regulator Sebi did not come out and give its verdict fast and reassure or warn public as the case may be. What actions SEBI did about share price hike to such an extent over the 2 year period even before the report came? If SEBI as regulator – itself is considering everything as routine, and also a spike in 400% and 225% in share prices as routine did not raise alarm to SEBI and it had never attempted to understand the reasons for its happening either by asking the company or by independently investigating, then there is systemic fault in Indian Regulator and its regulated. Or is there Political interference there in SEBI governance also? Or whether its independence itself is compromised to Political clout by SEBI in the case of a corporate who is closer to top power in India? Luckily, the collapse in Adani stocks has not spread to the stock market in general. But such a possibility in similar future episodes can be scarcely ruled out. As such, the regulator needs to totally change its character to that of preventer of these kind events by pro-acting rather than investigator after it happened as reacting. It should prove its independence by showing to the world that it cannot be touched by political power.
The questions come up from Opposition and other experts are many. Some of them are: How a share many pundits fix a fair share value of under 1,000 was allowed to go to near 4000 ? What is the influence of LIC and other National Banks purchase and hold of Adani shares during the 400% and 225% price rise during 2021 and 2022? Did the LIC and Banks purchase increased demand thereby hiked the price?
Alluding to Adani’s alleged links with the Centre, Opposition leader Rahul questioned how Adani net worth became $140 billion from $8 billion during Modi’s regime from 2014 to 2022.
Training his guns directly on the Prime Minister, Rahul levelled charges of crony capitalism and favouritism, saying
“PM Modi goes to Australia and by magic, SBI gives $1 billion loan to Adani. Then PM goes to Bangladesh and then the Bangladesh Power Development Board signs 25 years contract with Adani. Rahul says Modi used to travel in Adani’s aircraft and now Adani travels in Modiji’s aircraft.”
So any other corporate or firm or small company can prevent themselves to be caught by like Adani group share debacle? They have seen that political support will be exposed one day or the other – international community and local market can spot the wrong doings very easily. Masters of any company are shareholders and general public (in the sense they are the consumers whose purchases only makes a company profitable). Governments decide policies of nation and within those policies Company Board has its own policies formulated and employees execute the Company policies. In this chain decision making should be consultative, continuous feedback channel is enabled between these stake holders, and also full transparency and disclosures in dealings should be ensured. Then companies are on a safe turf.