By Aviraj Pandey
The Indian stock market was appalled when Hindenburg Research published a report titled “How the World’s 3rd Richest Man is pulling the Largest Con in Corporate History”, on 24th January 2023.
The report alleged that Adani group of companies have been intricately involved in stock manipulation and accounting fraud. This report was published right before Adani’s Further Public Offer (FPO) expansion plan of Rs 20,000 crore, which was scheduled for the coming week. This FPO would have been the largest ever investment raised by any listed entity in the history of Indian stock market. The FPO had to be called-off and Adani group published its response on the allegations made by Hindenburg Research, which pillared on nationalism and stated that this is an attack on the Indian economy.
This occurrence came as a nightmare for many Indian retail investors, as the Adani stocks plunged up to 70 per cent. The response also mentions Hindenburg’s short selling activities, which helped its investors to make profit, as the research organization held short positions. The Adani- Hindenburg fiasco brought the regulatory authorities on their toes. There were 3 PIL’s filed in the Hon’ble Supreme Court demanding investigation into the said incident. The RBI and SEBI, were independently monitoring and investigating the said allegations on Adani group.
The paper dissects the Adani-Hindenburg situation from the regulatory perspective of SEBI. Whether Hindenburg was correct in publishing such a report about a listed Indian entity? Does the report violate Indian securities law? The paper shall further examine the powers of security regulatory authorities to investigate on foreign forces. The paper shall further discuss on the remedies obtainable in the stock market when such incidences occur. Lastly, this paper shall briefly cover the corporate governance aspect and the power of the securities market regulators.
Introduction
The Indian stock exchange suffered a catastrophe when Hindenburg Research published a report titled “How the World’s 3rd Richest Man is Pulling the Largest Con in Corporate History1”, on 24th January 2023. Hindenburg in its report stated how Adani group of companies are involved in manipulation of stock prices of their listed entities. This plunged down the values of the stocks up to 70 per cent, and stock exchanges BSE and NSE had to put a lower circuit on these stocks to protect the wealth of investors2. The report published by Hindenburg alleged 88 questions on Adani groups3, below are the few issues highlighted against Adani group of companies-
(a) The Adani group is involved in $ 218 billion brazen stock manipulation and accounting fraud over the past decades.
(b) The promoter’s family members have control over offshore shell companies mainly based in the United Arab Emirates, Mauritius and Caribbean Islands, engaged in syphoning of investors’ money, money laundering and tax evasions.
(c) Adani group of companies is overburdened with debts and are pledging shares of their subsidiaries to avail these debts. The group has investments from large government organizations such as State Bank of India and LIC.
(d) Adani has been frequently changing its Chief Financial Officer and also the Auditors of the company are suspicious of being in nexus with Adani group.
(e) Adani group through its offshore shell entities is engaged in stock parking, violating the SEBI exchange rules of minimum threshold of 25 per cent to be held by the public.
Though Adani group was under no such obligation to respond to the allegations made in Hindenburg’s report, it furnished a reply addressing 65 out of 88 allegations4. The response primarily states that these allegations are baseless, and are made with the objective of earning profits through short selling. It is enthralling that Hindenburg itself disclosed in its report that it is holding short positions on Adani group.
Adani group responded to these allegations that it is a staged attack on the Indian economy. The response also highlighted that the Audit committee of the company comprises Independent Directors only, and the Auditors are recommended by the Audit committee5. This report was published right before Adani groups Further Public Offer (FPO) expansion plan of Rs 20,000 crore, which was scheduled for the coming week.
This FPO would have been the largest ever investment raised by any listed entity in the history of Indian stock market. The FPO had to be called-off due to the impact it created in the stock market and particularly on Adani’s listed entities6. However, Adani group had managed to secure funds for its FPO from global business leaders and leading corporate houses in India, the FPO for Rs 20,000 crore was fully subscribed.
Hindenburg and Short-selling
Hindenburg Research, is a US based forensic financial research organization. The research organization publishes its report on various corporate houses and conglomerates globally. The founder of the research organization, Nate Anderson is an experienced professional in the securities market, having expertise in equity, derivative and credit analysis. The research organization picks corporate houses globally, and highlights the issues concerning the fundamentals of these companies. They look for accounting misreporting, management crisis, suspicious related party transactions, dubious overseas expansion, favoured debts, regulatory compliances etc. The research focuses at a rudimentary level and later delves into complex business transactions.
Apart from the research publication, the organization is actively involved in short selling, which is a trading method for earnings profits by selling off securities not owned by oneself. These securities are borrowed by the seller with prediction of fall in the value of that securities. After borrowing, the seller trades the securities at market price. Later, when the market price goes down of that particular security, the seller buys the dip. The seller purchases the exact number of securities borrowed at a lower market price and books the profit. These securities are now returned to its original shareholder. As, in the case the short-seller had borrowed the number of securities, and had not borrowed money equivalent to those shares, he is only liable to return those shares, irrespective of their market price. For instance, X borrows 1000 shares from Y, and sells it Z at the current market price Rs. 100 per share. Later when the price plunges to Rs 70, X will repurchase 1000 shares from the market at the dropped price. Further, X shall return the 1000 borrowed shares to Y.
It is substantial to understand the momentous short positions held in Adani’s listed entities by the research organization, at the time of publishing the said report through non-Indian reference securities and US traded bonds11 clears the ulterior intentions of the Hindenburg Research. These short positions were held before publishing the report, as their research was indicative of price fall, resulting in a number of shareholders might dump the stock in the market and Hindenburg booked profit by repurchasing those shares at lower price.
SEBI and its Dominions
SEBI Research Analyst Regulations, 2014
The Indian Securities market regulator Securities and Exchange Board of India (SEBI) provides in SEBI Research Analyst Regulations, 2014 the layout for research analysts and research organizations engaged in publishing reports on the Indian listed companies12. The regulation states that any research analyst or research organization planning to publish a report on any listed entity shall obtain prior permission from SEBI. The publisher is issued a certificate of registration with SEBI with regard to the research on the listed company. The R.A. Regulations further defines ‘Research Report’ under Regulation 2(w) read as- “any written or electronic communication that includes research analysis, a research recommendation, or an opinion concerning securities or public offer, providing a basis for investment decisions and does not include the following communications:
(i) comments on general trends in the securities market; (ii) discussions on the broad-based indices;
(iii) commentaries on economic, political or market conditions;
(iv) periodic reports or other communications prepared for unit holders of mutual fund or alternative
investment fund or clients of portfolio managers and investment advisers;
(v) internal communications that are not given to current or prospective clients;
(vi) communications that constitute offer documents or prospectus that are circulated as per regulations made by the Board;
(vii) statistical summaries of financial data of the companies;
(viii) technical analysis relating to the demand and supply in a sector or the index…”
The regulations also covers foreign research analysts and organizations under the said regulations, wherein it mandates any foreign research analyst and organizations willing to publish a research report on any listed Indian entity shall first tie-up with a research analyst in India registered with SEBI. The foreign research shall come into an agreement with the Indian research analyst, only then it can conduct research and publish reports about any listed in any stock exchange in India. This mandate plays a pivotal role, as it allows SEBI to supervise the stock exchange market and expands its jurisdiction over foreign research analysts and organizations13.
However, contrary to SEBI’s regulations, Hindenburg acted adversely by publishing the report- “How the World’s 3rd Richest Man is pulling the Largest Con in Corporate History”, without any agreement with any Indian research analyst registered under SEBI Research Analyst Regulations, 2014. As mentioned above about the short selling activities of Hindenburg, which also held short positions before publishing the report subsequently affected the investors sentiments concerning their investments in Adani group of companies leading to book profits for short sellers14. Since Hindenburg did not come into an agreement with any Indian research analyst it is salvaged from the jurisdiction of SEBI. Furthermore, Hindenburg may be granted immunity from the Union of India under Section 24B of SEBI Act 1992, wherein the government shall guarantee immunity from any prosecution in India if they agree to further disclose the details of the allegations mentioned in their report, along with substantiating evidence.
SEBI Prohibition of Unfair and Fraudulent (PFTUP) Regulations, 2003
The short selling trading technique is a legitimate and recognized trading practice globally15. However, in Indian context only regulated short selling trading is permissible. Hindenburg’s publishing the report was the prelude of a strategic short selling wherein they intended to plunge the Adani stocks price, as they were already holding short positions before the report was made public. Section 12A of the SEBI Act 1992 prohibits unfair, deceptive and manipulative devices for issuing, buying and selling of listed securities or securities which are proposed to be listed in any stock market in India, read as -“12A. No person shall directly or indirectly-
(a) use or employ, in connection with the issue, purchase or sale of any securities listed or proposed to be listed on a recognized stock exchange, any manipulative or deceptive device or contrivance in contravention of the provisions of this Act or the rules or the regulations made thereunder;
(b) employ any device, scheme or artifice to defraud in connection with issue or dealing in securities which are listed or proposed to be listed on a recognised stock exchange;
(c) engage in any act, practice, course of business which operates or would operate as fraud or deceit upon any person, in connection with the issue, dealing in securities which are listed or proposed to be listed on a recognised stock exchange, in contravention of the provisions of this Act or the rules or the regulations made thereunder;
(d) engage in insider trading;
(e) deal in securities while in possession of material or non-public information or communicate such material or non-public information to any other person, in a manner which is in contravention of the provisions of this Act or the rules or the regulations made thereunder;
(f) acquire control of any company or securities more than the percentage of equity share capital of a company whose securities are listed or proposed to be listed on a recognised stock exchange in contravention of the regulations made under this Act…”
This section is read with Regulation 4 of SEBI Prohibition of Unfair and Fraudulent (PFTUP) Regulations, 2003 stating- “dealing in securities shall be deemed to be manipulative, fraudulent, and unfair if it involves disseminating information or advice through any media, whether physical or digital which the disseminator know to be false or misleading recklessly or carelessly and which is designed to, or likely to influence the decision of the investor dealing in securities.”
These laws reflect the stringent nature of the securities law on unfair and manipulative stock trade in India. Since, the nation experienced the bitter taste of such stock market scams which shook the country’s economy and caused paramount loss of investors investments. Such activities have led to shattering the faith of retail investors in the stock market. Thus, these incidents steered in establishing securities laws in order to curb such fraudulent trading techniques.
The Hon’ble Supreme Court in N. Narayan v. SEBI17 highlighted the objective behind the above-mentioned sections is to curb out possibilities and malpractices of manipulative trading and misguiding the market. On the term market manipulation, the court said “unwarranted interference in the operation of ordinary market forces of supply and demand that undermines the integrity and efficiency of the market”. In furtherance with elaborating the term unfair, the Hon’ble Supreme Court in the case of SEBIv. Kanaiyalal Baldevbhai Patel, mentioned that the term ‘unfair’ is not explicitly defined in SEBI Prohibition of Unfair and Fraudulent
(PFTUP) Regulations, 2003. However, it can be interpreted that any trading technique compromising in ethical standards and acting against good faith can be classified as unfair. The short positions held by Hindenburg before publishing the report on Adani group, is indicative of their intended manipulative trading techniques as the market plunged after the publication of the report.
The report provoked the investors on the fundamentals of Adani’s listed entities and made the investors unsure about their investments. Hindenburg toyed with the investor’s confidence and good faith over Adani’s listed entities. This led to consummately gains for Hindenburg’s investors through its short selling trading technique. It can be concluded that the trading activities of Hindenburg violate the SEBI Prohibition of Unfair and Fraudulent (PFTUP) Regulations, 2003.
SEBI is assiduously examining the both sides of the Adani- Hindenburg fiasco. The investigation is thoroughly looking into the allegations made by Hindenburg on Adani group, as well on the other side SEBI is examining the market activity before and after publishing the report. The Hon’ble Supreme Court during the hearing of PIL in Vishal Tiwari v. Union of India19 indicated towards constitution of expert committee to look over Hindenburg’s allegation on Adani group of companies. The expert committee consisting of 5 members established by the Court are Justice JP Devdatt, OP Bhat, Nandan Nilakeni, Somasekharan Sundaresan and KV Kamath. The foremost purpose of the committee is to investigate the allegations made by Hindenburg on Adani group.
Additionally, the committee shall suggest steps to strengthen the legal framework, avoid such kind of incidents in the mere future. The SEBI Chairman shall provide the necessary documents to the expert committee and assist in any other manner if required. The crux lies if the allegations made by Hindenburg are found to be manipulative then whether SEBI has extraterritorial jurisdiction powers to strike proceedings against the US based research organization. The Hon’ble Supreme Court in the case of Haridas Exports v. All India Float Glass Manufacturers Association held that MRTP commission shall have powers to pass orders on transactions executed outside the jurisdiction of India, extending the jurisdiction of the MRTP commission. Thus, SEBI shall also have extraterritorial jurisdiction, to prosecute Hindenburg, as the trade transactions were executed in US. Additionally, the Hon’ble Supreme Court in the case of Pan Asia Advisor v. SEBI22 held that SEBI has the power to prosecute individuals who are not corporally present within the territorial jurisdiction of India.
This enhances SEBI’s role in protecting the interest of Indian investors against individuals who execute activities hampering the interest of Indian investors. Furthermore, even if SEBI passes order against Hindenburg the question arises on the enforcement of that order overseas. Since India and US are members of International Organization of Securities Commission (IOSCO), which is an international regulatory body which brings security regulators to a mutual agreement in assistance and exchange of information from their concerned authorities, with the purpose of compliance of security statues of various jurisdictions. However, enforceability of SEBI orders shall face impediments from domestic laws in terms of acting independently.
The Way Forward
While SEBI and Expert committee setup by Hon’ble Supreme Court is investigating on the Hindenburg’s published report. The incidence has highlighted the lacunas in the regulatory framework of the securities law in India, and the nation witnessed how easily can the investors faith be sabotaged in the era of digitalization. Anytime there is a dissemination of misleading or inaccurate information its impact could be felt by an individual who may suffer a loss of reputation and go right up to destabilizing the economy of a nation and therefore impact of this was witnessed with Adani’s listed entities. The moment this sort of misinformation gets public its impact is in a matter of minutes and one’s ability to undo this in the manner of issuing a clarification or working to take some corrective action takes weeks in the meantime we know the market has suffered already.
The first challenge is to have a framework of instant response from the market regulators end. The moment such manipulative trading technique goes public the stock exchange shall control the trade regarding that particular stock. The SEBI shall be able to calculate the impact of such reports and put a stop-on on the trading of such targeted stocks for a limited period of days, which would protect the rights of the Indian investors and their wealth in stocks of these companies. However, implementation of any such framework shall be a tedious task, as many such dubious and manipulative tips keep circulating in the stock market.
Secondly the need a structure and a framework where different nations are able to participate to take corrective action and jurisdiction does not effectively become a challenge is realized to the market regulators and countries shall address this issue globally. In the US, the research analyst are aware of the rights of the investors where they can file a class action suit against such research analyst who are involved in abusive and manipulative short selling trading techniques.
SEBI’s primary role is to protect the investors rights and maintain the sanctity of good faith in the market. The current framework of SEBI is disclosure based, wherein listed stock companies publish about their business fundamentals and economic activities on their websites, and submit the same to SEBI which is available to the public. The investors on basis of these disclosures make their decisions on investing in these companies. However, the unregulated report of Hindenburg was not anticipated by SEBI and the report successfully managed to directly play with public’s sentiments concerning their investments in Adani’s listed entities, which lead to erosion of billions of dollars of wealth from the market capitalization of these targeted stocks.
Some market gurus also termed this incident as a corporate espionage, as the publisher of the report is actively involved in short selling and managed to earn profits from publishing of this report. The statutory authorities shall come up with robust laws addressing the issues of investors if they face any losses due to misinformation caused due to such third-party intervention, as their already exists laws to sue companies if they publish or disclose manipulative or lucrative data about the company such as projecting higher profits than the actual or misreporting of accounts. The legal framework should be developed in a manner which propagates quick disposal of such manipulative trading techniques at Securities Appellate Tribunal or National Company Law Tribunal. This shall foster confidence in the investors and redressal of their issues shall be prioritized when such dubious reports are published. The regulatory authorities also need to emphasis on awareness regarding such reports and publications among the investors. SEBI shall initiate drives in partnership with academic institutions addressing the issues and effects of abusive short selling, which shall lead to awareness among investors to not make investment decisions based on unverified reports, as the publisher of these reports may have ulterior motive which is to sabotage the market and earn profits
(The author is Consultant in Indirect Tax and Regulatory Advisory)
