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Tuesday, October 25, 2016, 23:36

Market gambit — will it be on the left or the right?

By Luo Weiteng
Market gambit — will it be on the left or the right?
Exchange Square in Hong Kong’s Central business district — the seat of the local stock exchange. The city’s securities watchdog has been tasked with redefining the line between freedom of speech and disinformation in the equity market in the wake of two high-profile rulings so far this year — one against short seller Andrew Left and the other against credit-rating agency Moody’s. (Lam Yik-Fei / Bloomberg)

Market manipulation in Asia’s key financial hub was dealt a crippling blow when Hong Kong’s securities watchdog handed down a landmark ruling in August in a rare move that would redefine the line between freedom of speech and disinformation.

Los Angeles-based short seller Andrew Left, owner and founder of Citron Research, was banned from trading securities in the SAR for a maximum period of five years, but he plans to appeal against the ruling.

The so-called “cold shoulder” ruling by Hong Kong’s Market Misconduct Tribunal (MMT) last Wednesday followed its verdict two months ago that Left was culpable of “disclosing false or misleading information inducing transactions” with the publication of a research report on Hong Kong-listed Chinese mainland property developer China Evergrande Group (known at the time as Evergrande Real Estate Group Ltd) in June 2012.

HK’s securities watchdog is tasked with redefining the line between freedom of speech & disinformation in the equity market

Left, who shot to fame with his successful bet on Valeant Pharmaceuticals, was ordered to disgorge his profit of HK$1.6 million from shorting Evergrande shares, and pay the Securities and Futures Commission’s (SFC) investigation and legal fees of up to HK$3.97 million with government expenses remaining undisclosed — a fine that would cost him at least HK$5.6 million in total.

“It’s the first time the tribunal has made such a ruling against a short seller engaged in the publication of otherwise unregulated market commentary,” said a report by global law firm Simmons & Simmons.

The decision is seen more of a “deterrence”, sending a strong signal that Hong Kong regulators would get tough with any form of market misconduct although some reckon that the punishment may have been too harsh given that Left was not licensed or regulated by the SFC, said Dominic Wu Sze-yin, chairman of Hong Kong-based Asia Financial Risk Think Tank.

“Left’s reporting, in the words of the tribunal, is a ‘racy tabloid format’ and ‘hard-hitting tabloid style’, using ‘direct, plain, tabloid’ language,” said David Webb, a shareholder activist and former member of the board that operates the Hong Kong Stock Exchange. “But, there’s room in this world for both the New York Post and the New York Times, the Sun and the Times of London.”

“Anyone reading Left’s report would, in our opinion, be clear that he was expressing his opinions and making allegations, not stating the outright facts.”

Webb’s remarks reflect growing concern that the high-profile ruling may curtail the services research firms could offer in Hong Kong, undermining freedom of expression in Asia’s financial hub.

Market gambit — will it be on the left or the right?
Over the past few years, there has been a big trend of short sellers preying on overseas-listed Chinese mainland firms, especially smaller ones with claims of falsified financial statements and other dubious practices, amid a string of scandals. (Parker Zheng / China Daily)

Such worries are nothing new after Moody’s was fined HK$11 million by the SFC in April this year — the first disciplinary action the financial regulator had taken against a credit-rating firm since it started regulating rating activities more than five years ago.

Moody’s was alleged to have failed to ensure the accuracy of its reports in July 2011 that identified possible corporate governance and accounting risks among 49 Hong Kong-listed mainland companies, leading to a slump of up to almost 17 percent in the share prices of more than half of the enterprises in a single trading day.

“The SFC’s action and the MMT’s finding (in the Citron case) have cast a dark cloud over freedom of speech in Hong Kong’s markets, wherever the commentator lives,” said Webb. “An unlicensed member of the public has the right to be wrong.”

However, Bloomberg Intelligence economist Fielding Chen believes that the line between freedom of speech and disinformation should never be blurred.

Over the past few years, there has been a big trend of short sellers preying on overseas-listed mainland firms, especially smaller ones with claims of falsified financial statements and other dubious practices, amid a string of scandals, including those involving Hong Kong-listed Tianhe Chemicals and sausage-casings maker Shenguan Holdings Group, that have fueled concerns over corruption and corporate malfeasance in the world’s second-largest economy.

Short sellers, who make a quick buck by identifying overseas-listed mainland firms as easy targets, typically set themselves up as whistleblowers and taught such companies a big lesson, Chen said.

But the sweetness they have tasted has also encouraged opportunism — some short sellers would presume there’s a problem in a certain mainland firm, then disclose groundless research reports and bad news over the targeted company in the hope that such information could be verified by media coverage afterwards, he noted.

In this way, short sellers profiteering from buying back securities that are sold short before price crashes are ironically turning from fighters against fraudulent financial reporting into forgers, Chen told China Daily. Such opportunism also pointed to the over-bearish outlook for the mainland’s economy at that time, which had somehow deviated from the country’s fundamentals, he added.

“What makes the Citron case not so controversial is the simple fact that China Evergrande Group appears to remain financially healthy today, indicating that the basis on which Left made his conclusions was essentially erroneous and was due to his misunderstanding of financial reporting and accounting rules,” said Simmons & Simmons.

Having seen its share price plummet 19.6 percent to a low of HK$3.6 and close 11.4 percent down on the day of the publication of the report — dwarfing the 1.3-percent drop of the benchmark Hang Seng Index on the same day — China Evergrande Group fought back quickly with investment banks such as JP Morgan, Citibank, Bank of America Merrill Lynch and Deutsche Bank, coming up with positive reports the following day — a significant step in stabilizing Evergrande’s stock price.

Like China Evergrande Group, large mainland enterprises may have more experience and resources to strike back at short sellers, while smaller firms, most of whose shareholders are retail investors, are still in a relative passive position to defend themselves, said Wu.

“Looking ahead, one thing for sure is that the conduct of credit rating and research firms remains a matter that regulators are closely monitoring and scrutinizing. Regulators in Hong Kong, joining the fray of their peers in the US and the rest of the world, would not hesitate to take disciplinary action against any form of market manipulation,” he said.

“And, it has nothing to do with whether the companies they intend to sell short are mainland firms or not. Professional analysts should always think twice about the parameters of responsible authorship.”

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