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July 17, 2024
SEBI seems to be playing the game of ‘Where’s Waldo?’ while searching for violation of Indian securities laws in the Hindenburg report. For the uninitiated, the reference is to a popular series of children’s puzzle books where the objective is to locate Waldo, a distinctively dressed character, hidden in large, detailed illustrations.
Today we are sharing the entirety of this notice, frankly because we think it is nonsense, concocted to serve a pre-ordained purpose: an attempt to silence and intimidate those who expose corruption and fraud perpetrated by the most powerful individuals in India.
…net of costs we may barely come out above breakeven on our Adani short.
Our work on Adani was never justifiable from a financial or personal safety perspective, but it is by far the work we are most proud of
Today we are sharing the entirety of this notice, frankly because we think it is nonsense, concocted to serve a pre-ordained purpose: an attempt to silence and intimidate those who expose corruption and fraud perpetrated by the most powerful individuals in India.
…net of costs we may barely come out above breakeven on our Adani short. Our work on Adani was never justifiable from a financial or personal safety perspective, but it is by far the work we are most proud of
To a layperson, the optics of this case would look like a foreign research firm potentially colluded with a short seller to deflate the stock prices of Indian-traded securities with a clear arrangement to take a quarter of the profits made. But turn on the legal lens and the case doesn’t seem as straightforward anymore.
Before examining the regulator’s case against Hindenburg Research (“Hindenburg”) and whether any effective action can be taken by it, here’s a quick recap of the story so far.
Does the SEBI Act3 explicitly provide extra-territorial jurisdiction to SEBI, say as in the case of our competition regulator? No. However, SEBI Act gives the regulator wide powers to protect the interests of investors in the Indian securities market. Additionally, the Supreme Court of India has recognized that if a person commits acts which affect the legitimate interest of investors in the Indian stock market, SEBI would be fully empowered to proceed against such persons.4
This should give SEBI sufficient jurisdiction to investigate Hindenburg’s actions.
There are two critical aspects of the RA Regulations at play here:
Facts. As per the RA Regulations, for any document to qualify as a ‘research report’, it needs to ‘provide a basis for an investment decision’. In this case, there were 2 reports involved:
Our View. Is it possible to say that neither the ‘private report’ to Kingdon (although in ‘draft’ form) nor the ‘final public report’ constitutes a ‘research report’, esp. when Kingdon initiated its short trades on the basis of the report? In our view, this may be difficult.
Yes, requiring every individual expressing an opinion on securities to register as an analyst, even without making recommendations, appears impractical and could stifle open discourse in the market. However, can a simple disclaimer take away the overall substance and messaging of the report? Would it then be possible for anyone to comment freely on the ‘desirability’ of a stock without obtaining any registration?
These are challenging questions to have brightline answers to. Given the overall sequence of events, SEBI may succeed in convincing a court of law (at least on a spirit basis) that Hindenburg indeed issued a ‘research report’.
However, should failure to tie-up with a registered entity be considered a major substantive non-compliance? Should not be. In our view, this should be viewed similar to any other non-registration lapse (e.g.: failing to obtain an ‘investment advisor’ registration) and therefore be considered as a procedural non-compliance.
Facts. SEBI has alleged that there were statements in Hindenburg’s report which built up a narrative to mislead investors, and this amongst other things violated the PFUTP Regulations and the SEBI Act.8 Broadly, the SCN alleges the following:
Our View. In our view, SEBI is fighting an uphill battle against Hindenburg. SEBI does not seem to have indicated that any of the facts presented by Hindenburg are incorrect or inaccurate. Instead, SEBI seems to have a problem with selective presentation of facts by Hindenburg and its approach of using hyperbole to state facts instead of presenting them as-is.
Did Hindenburg exaggerate and over-emphasise on bad facts selectively? Yes. However, would that be sufficient to trigger a PFUTP violation if the underlying facts are indeed true? May not be. SEBI at some stage will have to roll up its sleeves, sift through all the allegations made by Hindenburg, and establish that Hindenburg purposely presented incorrect/ fraudulent facts to mislead investors in order to profit from the resulting stock dive. Holding Hindenburg responsible under the PFUTP regulations for its seemingly ‘reckless’ choice of language may be difficult for SEBI if the facts presented by Hindenburg are true.
SEBI may also need to work overtime on the non-public information allegation, since both Hindenburg and Adani group seem to suggest that most parts of the report are nothing more than a mere aggregation of publicly available/ accessible information.
Finally, on SEBI’s concern on incorrect disclaimers, there appears to be some degree of inconsistency on Hindenburg’s part. The general disclaimer suggests that Hindenburg has a short position in all the stocks mentioned in the report, but the more specific one limits their short positions only to US-traded bonds and non-Indian derivatives. However, to term this inconsistency as ‘fraud’ may be stretching it a bit too far, and this once again may not be a clincher by itself for SEBI.
It’s neither Hindenburg nor Adani under the spotlight now. It’s India’s market regulator who had to join the party, albeit a bit too late, and unfashionably so.
The optics clearly go against Hindenburg, particularly the 25% profit share agreement. One cannot deny a slight degree of perception bias against short-sellers and their supporting research arms. But let’s play it the other way around – if Hindenburg had aggregated all publicly available information to bump-up the stock (instead of shorting it), would the regulatory perspective have been different? When the matter was being heard by the Supreme Court, SEBI itself had submitted that shortselling is a desirable and essential feature to provide liquidity and price correction in overvalued stocks. Optics aside, SEBI’s case is not about short-selling. It’s about information asymmetry (not UPSI admittedly), which allowed both the research firm and its client to make disproportionate gains. Unfortunately, what appears wrong may not always be illegal. Reminds us of a US billboard that once said, ‘just because you did it, doesn’t mean you’re guilty’.
To be clear, the regulator’s inability to pursue any action against Adani does not whitewash Hindenburg’s potential breaches and must be seen independent of SEBI’s action against Adani. On its part, SEBI will need to bolster the legal basis in bringing charges of ‘fraud’ against Hindenburg. Given the limited enforcement ability SEBI may have against a US-based researcher, the question is more of reputation and doing what’s right than of disgorging gains, which Hindenburg proudly claims it never made.
1 SEBI (Research Analyst) Regulations, 2014.
2 SEBI (Prohibition of Fraudulent and Unfair Trade Practices relating to Securities Market) Regulations, 2003.
3 Securities and Exchange Board of India Act, 1992.
4 SEBI vs Pan Asia Advisors Limited, (2015) 14 SCC 71.
5 See Reg. 16(2) r/w Reg. 16 (5) of the RA Regulations.
6 Section 12A (a), (b), (c) and (e) of the SEBI Act, 1992 r/w regulations 3 (a), (b), (c), (d) and 4 (1) of the PFUTP Regulations, and regulation 4(1), 4 (2) (k) and (r) r/w regulation 2(1)(c) of the PFUTP Regulations.
7 Reg. 16 (5) of the RA Regulations states: “Provisions of sub-regulations (2) to (4) shall apply mutatis mutandis to a research entity unless it has segregated its research activities from all other activities and maintained an arms-length relationship between such activities.”
8 Section 12A (a), (b), (c) and (e) of the SEBI Act, 1992 r/w regulations 3 (a), (b), (c), (d) and 4 (1) of the PFUTP Regulations, and regulation 4(1), 4 (2) (k) and (r) r/w regulation 2(1)(c) of the PFUTP Regulations.
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