Ruling on Citron research report is not a freedom issue, it is about investor protection
Where does freedom of speech end, and investor protection
kick in?
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Enoch Yiu
29 August 2016
Where does freedom of speech end, and investor protection kick in?
There’s been much debate on this issue since Friday, after Hong Kong’s Market Misconduct Tribunal found US short seller Andrew Left guilty of market misconduct, after he issued what it ruled was a “false and misleading” report in 2012, about Chinese developer China Evergrande Group.
The head of Citron Research pocketed a HK$1.7 million from short selling Evergrande shares, two months ahead of issuing his report on the mainland developer.
He may now be forced to repay the profit he made from the deal, as well as being slapped with a five-year ban on trading in Hong Kong stocks. The penalty will be determined by the tribunal at a later stage.
This is a landmark case. It the first time the Hong Kong tribunal, chaired by Justice Michael Hartmann, has made a ruling against a short seller report, and also marks the Securities and Futures Commission’s first such action against activist short-selling firms.
Several short selling analyst, including Citron Research, Glaucus, and Muddy Waters, have profited by selling borrowed shares and then buying them back at lower prices, pocketing the difference.
They find holes in the books of listed firms and then rely on securities traders and the media to spread the word of their reports on companies they have already targeted.
Short seller reports are controversial. Some view them as useful as they identify dodgy companies alleged to have been involved in accounting fraud.
But their critics also suggest that short selling and their sellers have just one goal in mind: making a profit.
Look back at their track record, and they have had their successes.
In January this year, Hong Kong Exchanges and Clearing delisted China Metal Recycling (Holdings).
The SFC in July 2013 applied to court to have the firm would up, after accusing it of overstating its finances when applying for a listing in 2009, and in its annual report for that year.
Before the SFC even took that action, however, six months before Californian-based short seller Glaucus had issued reports on China Metal Recycling, accusing it of falsifying its financial statement.
Short sellers’ reports can provide valuable information to Hong Kong investors, but their reports have to accurate.
In Justice Hartmann’s 113-page ruling on Left, he focused on whether the short seller or his team had tried, to the best of their efforts, to check the information was right.
After he received an unidentified, 68-page draft analysis on Evergrande the judgement suggested that Left had been interested in issuing a report on his serious allegations against the property giant, and that the company could face the risk of insolvency and various forms of accounting fraud.
Left read the information and issue the report which Justice Hartmann said made the allegations “recklessly or negligently with no understanding of the Hong Kong accounting standards that applied and without checking them with an accounting expert or seeking comment from Evergrande”.
The fact is, four years after the Citron report was issued, China Evergrande is not insolvent and is still very much in business. But it did recently fall under spotlight after spending billions in buying shares in its rival, China Vanke.
The ruling on Friday is a landmark in setting the standards for future research reports.
The authorities did not have a problem with the fact the report in this case was negative. But they did have serious issues with the author, and whether he tried his upmost, as all should, to ensure the information was right before publishing a document on which stocks will be traded.
This is not an issue about freedom of speech, but it certainly is one for investor protection.