More Indian firms on US short-sellers’ target? What they can do

American short-seller Hindenburg Research‘s second attack on the Adani Group in which it targeted Sebi chairperson Madhabi Puri Buch has failed to make much impact on the markets. Hindenburg has claimed that she and her husband had stakes in offshore entities linked to the Adani family. Unlike its first report against the Adani Group in January last year, this one has failed to have intended impact so far. Adani stocks did not suffer the kind of rout they did in the wake of last year’s report. Analysts have dismissed the report as “sensationalism” and say that it will not have much impact on stock prices.”It appears that this “revelation” is unlikely to impact the market meaningfully. The buy on-dips strategy which has been working well in this bull run is likely to work again,” said Dr. V K Vijayakumar of Geojit Financial Services.

However, Hindenburg has doubled down on its claims and responded to Sebi chief’s statement that accused the short-seller of attempting a “character assassination”.

Even though Indian markets as well as analysts have discounted the latest Hindenburg report and the short-seller has itself come under fire after Sebi’s show-cause notice to it in June, short-seller attacks constitute a high risk for Indian companies.

Short selling involves borrowing a stock to sell it in the expectation the price will fall, then repurchasing the shares and pocketing the difference. Thus, short-sellers make money from stocks of companies, which are facing problems, going down. But sometimes they try to put a company in trouble to profit from its resultant stock decline. Short-seller research reports are sometimes used to spread bad news about companies in order to benefit from shorting of its shares.

Indian companies in cross hairs of American short sellers

Indian companies with global operations must be prepared for more attacks like that of Hindenburg from American short sellers. In February this year, Indian-Canadian entrepreneur Prem Watsa’s Fairfax Financial Holdings, which is listed on the Toronto Stock Exchange but has considerable investments in India, faced a short-seller attack from US hedge fund Muddy Waters, which alleged financial wrongdoing and sent its shares tumbling by 12%. However, a research note from the National Bank of Canada downplayed the allegations.

Muddy Waters alleged that Fairfax Financial Holdings inflated the fair value of its assets which resulted in notional profits that boosted the company’s book value. The company owns several firms in India, either directly or through affiliates. They include Thomas Cook, Quess Corp, GoDigit Insurance, Bangalore International Airport Limited and CSB Bank. Watsa had termed the allegations of the short seller false and misleading.In an interview to ET’s Mohit Bhalla last month, William J. Stellmach, former head of the US Department of Justice’s Fraud Section who now works at New York-headquartered law firm Willkie Farr & Gallagher LLP, cautioned that Indian companies with global operations need to have crisis management plans in place given the rise in the number of short sellers. Stellmach is a partner at the firm’s Washington office and leads its global investigations practice, often advising and defending companies featured in short seller reports.He said it was extremely challenging to sue short sellers in the US and often counterproductive. “Short sellers have repeatedly defeated defamation suits in the USA, which set an extremely high bar. Another liability theory is to prove fraud by the short seller. But short sellers are generally very transparent in their disclaimers that they may have taken a trading position consistent with their short report, which means they fully disclose their conflict of interest,” he said.

Hindenburg has given a 416-word-long disclaimer at the end of its report on Sebi chairperson, saying that readers should assume that the activist-investor and its clients may have short positions in the companies mentioned in the report. Its says it intends to continue transacting in the securities covered in the post after the publication of the report.

“This report does not constitute a recommendation on securities. This report represents our opinion and investigative commentary and we encourage every reader to do their own due diligence. Use of Hindenburg Research’s research is at your own risk. In no event should Hindenburg Research or any affiliated party be liable for any direct or indirect trading losses caused by any information in this report,” the disclaimer says.

What should Indian companies do?

Stellmach has recommended Indian companies with global operations to have crisis management plans in place. His advice to Indian companies is to focus on managing the market fallout.

“The best plan of action is to prevent US regulators from getting involved. You need to have the right people to deploy if you are targeted. Your communication should be targeted to immediate stakeholders like lenders, auditors and business partners. Keep your responses tight and crisp, to no more than three pages. And act within seven to 10 days,” Stellmach advised.

Short-sellers under fire in the US

Last year, when several regional banks in the US such as Silicon Valley Bank (SVB), First Republic and Signature Bank struggled, the practice of short selling came under increased scrutiny. Short sellers had pocketed $1.2 billion in the first two days of May, analytics firm Ortex said.

Wachtell, Lipton, Rosen & Katz, a law firm that has represented large companies, such as Twitter, in mergers and against attacks from hedge funds, called on US securities regulators to restrict short sales of financial institutions. Wachtell said that the Securities and Exchange Commission (SEC) should regulate what it defined as “coordinated short attacks” by imposing a 15-trading day prohibition on short sales of financial institutions. This would allow time for regulators to act and for investors to digest information, the letter said, adding that attacks by short sellers are not related to fundamental performance and put the U.S. economy at “great risk.” In 2008, during the financial crisis, short selling was temporarily banned in the US, although a New York Federal Reserve review later showed the curb did not achieve the intended effect.

The practice of short selling has long been divisive, with critics accusing short sellers of trying to hurt companies, and short sellers arguing they help root out fraud and corporate misconduct. During the regional banks crisis in the US last year, while some market participants criticized the practice of short selling, others, like non-profit group Better Markets, said short sellers warned markets about the challenges regional banks were facing. “Short sellers act as a check to stock promotions and promotional management teams,” said Sahm Adrangi, who runs hedge fund Kerrisdale Capital, adding “It is a very worthy service we provide to keep financial markets running efficiently.”

Last year in October, the US SEC agreed to roll out new rules aimed at boosting transparency of short selling, the controversial practice of betting against stocks that drew new scrutiny amid the GameStop saga. The rules, first proposed in late 2021 and early 2022, require investors to report their short positions to the agency, and companies that lend out shares to report that activity to the Financial Industry Regulatory Authority (FINRA), a self-regulatory body that polices brokers.

In addition to GameStop, the rise of activist short-sellers who publish negative research on companies in the hopes of depressing the share price also drew regulatory scrutiny. Since at least 2021, the Justice Department and the SEC have been investigating potential manipulation by short sellers and hedge funds around the publication of negative research reports.
(With inputs from agencies)