Research-based short selling a fine way to expose fraud
Short selling has proved to be very worthwhile in keeping corporate chieftains honest
Hong Kong’s listed companies have been on the receiving end of the most short-seller attacks this year, with many allegedly involving fraudulent activities.
Business, October 5
There has always been a whiff of the malodorous to short selling. How can it be right to sell something you do not own? Surely we ought to frown on people who scheme to profit from the misfortunes of others this way.
I like how it was put by a big 19th century Wall Street speculator, Daniel Drew, who had a habit in the presence of other investors of accidentally-on- purpose losing pieces of paper carrying messages, like “Buy Steel” when he intended to sell the stock. Drew said:
“Him what sells
What isn’t his’n
Must buy it back
Or go to pris’n.”
The rules on short selling are strict in Hong Kong. You have to borrow stock that you intend to short and the lenders charge a fee for such borrowings. Most big banks have lucrative stock borrowing programmes for this purpose.
The “fraudulent activities” in our case thus refer not to false promises of ability to settle a short transaction but to allegations that some people deliberately spread false rumours about a stock to drive the price down after they have shorted it.
Does it happen?
Yes, I’m sure it does, and the Securities and Futures Commission has acted against people they suspect of it. I think, however, our regulators would do well to adopt the light touch in such matters.
It is not easy to spread false rumours and have them believed. I think more speculators burn themselves than make money on such gambles. They also incur the risk of discovery. There are few stronger upward influences on a share price than the news that there is a big short in the market. How the shorts then squirm. The market disciplines itself.
But more to the point, short selling has proved to be very worthwhile in keeping corporate chieftains honest. Most notable for it in Hong Kong is Carson Block, operating under Muddy Waters.
His practice was (is) to research suspect mainland stocks closely and, if he discovers any with grossly overstated assets or earnings, to short the stock and then publish a research report of his findings.
If valid, down goes the share price, Muddy Waters makes money on closing out the short position, other investors profit from a falsehood exposed and mainland sharks are taught a sharp lesson. Everyone wins who should win, everyone loses who should lose.
But, of course, the research findings could be wrong. In fact, could be false outright. Should we then take action for fraud against the short sellers?
My answer is that, no, in the large majority of cases we should not. If false, it is not so much fraud as it is libel and a matter for civil action by the libelled. Let us not overburden our law enforcement agencies with criminal proceedings best left as matters of civil dispute.
I think it is particularly the best route to take because this kind of research-based short selling is one of the finest ways possible of exposing false accounting by mainland companies that know that official regulators are unlikely ever to catch them. We should encourage this, not discourage it.
And I do wonder at times about the SFC’s motives in its obvious dislike of research-based short selling. Accounting fraud by listed entities is our patch, they say. Others stay out. You hear? Stay out!
Others won’t, of course. You can’t keep a good investment opportunity down and, in my view, it is wonderful news that short-seller attacks are way up in our stock market.
There will be many more of them yet if stock exchange boss Charles Li Xiaojia gets his way in abolishing virtually all listing hurdles for new issues.