Short-sellers have been terrorising the Hong Kong capital market for years with private enterprises facing short sale attacks that caused their stock prices to plummet. Among them, Tech Pro (03823-HK) experienced a horrific 90% drop in its stock price after the release of a short selling report; and Fullshare (00607-HK) had to apply for a suspension after an attack from Glaucus which caused its price to drop 12%. As their name implies, short-sellers are in the business of digging up dirt on listed companies, and then profiting from their price drop caused by short selling reports, all of which are part of an elaborate trap set early ahead of time. Such activities have already aroused market criticism, and have caused individual investors severe damages. In face of such a situation, where can investors voice their complaints?

Being a mature financial market, Hong Kong has an abundance of corporate investors who are involved in long term investment and also other short term investment activities. In long term investment, various strategic measures are taken in order to hedge risk, such as options and futures trading, and sometimes, short selling might be used as a way to adverse risk. Therefore, Hong Kong  never prohibits the act of short selling, that is if investors can bind by the rules while maintaining a sufficient supply, then they can short sell a stock. Even when European markets were restricted from short selling listed companies during the 2008 Financial Crisis, the Hong Kong Exchanges and Clearing (00388-HK) still permitted investors to short sell, which was a testament of the faith regulatory authorities had in investors.

How do short-sellers work with corporate investors to profit?

 
Since the 2008 Financial Crisis, regulatory authorities have established a short position reporting regime to make information available to the public when a listed company is at a short position; however, the purpose is not to ban or limit the act of short selling, but to increase market transparency, and to provide market participants with a fair battlefield.  

However, short-sellers have taken advantage of the long-standing system of the Hong Kong market in recent years by publishing short selling reports to ‘complement’ its short selling activities  to make a profit. If research organisations were to find a ‘flaw’ in existing and open records and reported it,  that would have been an accepted practice. But is it ethical and a conflict of interest for a research organisation to be researching on a listed company and ‘plotting’ against it using the potentially negative news? Will that create an imbalance of information? And when short-sellers borrow shares, will the borrowers learn about their true intentions? If the borrowers were willing to lend their shares to short-sellers despite the truth, and even profit from the process, would this be appropriate? Considering the chaos the market will face and the losses investors will suffer, related organisations should think twice before they act.

Amongst the multiple attacks short-sellers launched against Hong Kong listed companies, the most notable example is that of China Metal (00773-HK before delisting). Trading of the company’s stocks was suspended after the release of a short selling report, and the Securities and Futures Commission later found that the company had committed false accounting fraud, which resulted in the delisting and liquidation of the company. Rotten apples exist in every capital market, if a research organisation could expose their flaws, that would benefit all investors; but unfortunately, many short selling reports contain ‘evidence’ that is unverifiable, causing investors to sell their shares due to panic and confusion, and the price only stabilised when the listed company made a clarification announcement. The losses investors suffered become the profits of short-sellers and their associates. At the same time, short-sellers are often not held responsible or accountable for their interferences of stock prices with their short selling reports, monetary losses of investors or the damage done to the reputation of listed companies. Since these short-sellers are not licensed, they are not regulated by any authority, and the disclaimer in their reports also acts as a jail free card.

Are short-sellers in violation of market misconduct?

According to the Securities and Futures Ordinance, market misconduct includes :
•        Insider trading
•        False trading
•        Price rigging
•        Disclosure of information about prohibited transactions
•        Disclosure of false or misleading information inducing transactions
•        Stock market manipulation
 

Since short-sellers are not licensed in Hong Kong, the credibility of their short selling reports are also in doubt. Furthermore, does anyone check the factual information in the report? And is there a conflict of interest since the report clearly stated the target company’s target price and valuation? Based on the six acts of market misconduct listed above, do short selling reports pose any violation of price rigging and disclosure of false or misleading information inducing transactions?

Does the disclaimer in the short selling report act as a jail free card?

The multiple attacks short-sellers launched against Hong Kong listed companies with questionable information had brought on the reputation of listed companies and also lawsuits. The best example is the case of Evergrande Group (03333-HK). When Citron Research published a short selling report in June 2012 claiming that the company was already at a point of becoming insolvent, Evergrande called the police, and the Securities and Futures Commission filed for a lawsuit against Citron. As a result, the Market Misconduct Tribunal found Andrew Left, the founder of Citron, guilty of market misconduct, the verdict required him to repay the HK$1.6 million profit he made from Evergrande, and banned him from participating  in market activities in HK for five years. Ruinian International (02010-HK), which was attacked by the short-seller Glaucus, filed a lawsuit in the US. Though the two parties reached a settlement at the end, it was the proof that the claims made by short-sellers lacked creditability, and their disclaimer does not always  offer them a jail free card.

Short selling makes up part of the Hong Kong capital market, and if investors stuck by the rules when short selling and only used it to hedge risk, there would be no complaints from market participants. However, how short-sellers utilise short selling reports to coordinate with their short selling activities to make a profit is against market ethics. Will the doings of short-sellers be in violation of the six market conducts? The Securities and Futures Commission and other regulatory authorities should work to have these short-sellers licenced so to increase market transparency and fairness.

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Media Contacts: Sunny Wan

                       +852 2153 7297 / sunnywan@finet.com.hk

                       Wells Pan

                       + 852 6925 6988