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The events of the past four months, the Hindenburg report’s release and the allegations made therein, ostensibly aimed at profiting by short-selling, have created mayhem for retail investors in India. After the Supreme Court intervened, it appointed a six-member expert committee to conduct a probe and make suggestions on changes in the legal framework to protect investors. The committee comprised retired Supreme Court judge Justice A M Sapre, retired Bombay High Court judge Justice J P Devadhar, former State Bank of India Chairman O P Bhatt, former ICICI Bank chief K V Kamath, Infosys Co-founder Nandan Nilekani and securities and regulatory expert Somasekhar Sundaresan. The committee submitted in its report to the Supreme Court "at this stage, taking into account the explanations provided by Sebi, supported by empirical data, prima facie, it would not be possible for the committee to conclude that there has been a regulatory failure around the allegation of price manipulation".
The report submitted by the committee became available in the public domain (on a limited access basis) on May 20, 2023. While the committee has suggested a slew of changes to the securities market regime, one important aspect which is the most important for the public is how to protect Indian retail investors and safeguard them from motivated short-selling. What is of critical importance is creating suitable regulations and a safety valve that can utilise a mix of technology and related safeguard measures for the common retail investors.
The committee stated in its report that it took inputs from various governmental bodies, including the Enforcement Directorate (ED) and the Income Tax Department. The ED found intelligence about potentially violative and concerted selling by the short-sellers just ahead of the publication of the Hindenburg report, and this may lead to credible charges of concerted destabilisation of the Indian markets, and Sebi ought to be probing such actions under securities laws.
These are fairly serious findings relating to short-selling and profiteering. In brief
- It has been found that some entities took short positions prior to the Hindenburg report and profited after the price crashed upon the publication of the report on January 24, 2023.
- Suspicious trading has been observed on the part of six entities, of which four are FPIs, one body corporate, and one individual.
- The trading pattern by FPIs is suspicious due to the build-up of short positions before the Hindenburg report.
- Detailed investigation being carried out by Sebi on short sellers.
After its report on the Adani Group, Hindenburg had also incidentally released another bombshell report on the American payment and mobile banking services provider, Block Inc. Block is a Silicon Valley darling, founded by entrepreneur and co-founder of Twitter Jack Dorsey, and has a secondary listing in Australia. Its shares then slumped 14.8 per cent in the following session. Hindenburg’s next victim was Carl Icahn’s investment firm, which also resulted in the company’s $6.3-billion wipeout.
The problem of such targeted short selling aimed at quick profiting is something relatively new in India. This obviously has serious repercussions for the small investors, which tend to destabilise the markets, shaking their confidence, and need to be taken care of seriously.
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What is "short selling"? Short selling is a trading strategy in which an investor bets that a stock’s price will decline. Having invested with a serious stake in making gains out of it, he actively works towards achieving his goal.
Short selling has been in vogue globally since stock markets began in the Dutch Republic in the 1600s. Shorting of the Dutch East India Company, among other stocks, led to a temporary ban on short-sellers. In the 18th century, Great Britain banned naked short selling, in which shares being shorted are never borrowed by the short-seller. In France, Napoleon Bonaparte outlawed short selling amid the French Revolution.
World over, many countries have different stances against short selling. For instance, South Korea had outright banned the activity in the aftermath of the 2020 Covid pandemic, however lifting it a year later (https://bit.ly/42WeCVA). In the US, short selling was first banned during the War of 1812, restricted during the Great Depression, and was subject to more scrutiny and regulations following the market crashes in 1987, 2001 and 2008.
What is the position in India? According to Sebi norms, short selling may be defined as selling a stock which the seller does not own at the time of trade. Naked short selling is not permitted in the Indian securities market and all investors would be required to mandatorily honour their obligation of delivering the securities at the time of settlement. Considering the global trends, there is, however, a dire need to protect the interests of small investors and maintain their confidence in the functioning of stock markets.
Now when the issue has reached the Supreme Court, although there are other issues involved relating to Hindenburg and Adani, and the apex court had granted time to Sebi to complete its investigation by August 14, 2023, without commenting on the other aspects it can be expected that some policy may be evolved in this regard, which will be timely and useful for safeguarding the interest of small shareholders.
Dhanendra Kumar is a former executive director for India at World Bank and former chairman, Competition Commission of India. He is founder chairman of Competition Advisory Services LLP