Introduction

Listed companies in Hong Kong have recently become a favourite target for short sellers: just last month alone, four Hong Kong listed companies, including Credit China FinTech Holdings Limited (stock code: 08207.HK), China All Access (Holdings) Limited (stock code: 633.HK), China Huishan Dairy Holdings Limited (stock code: 6863.HK) (“Huishan”) and Sinosoft Technology Group Limited (stock code: 1297.HK) were analysed by short sellers and attacked by Triam Research, Muddy Waters Research (“Muddy Waters”) and Zhongkui Research respectively. However, at the same time, the stakes for publishing negative research reports on listed companies are high. A prime example is Mr Andrew Left (“Mr Left”) of Citron Research who has been banned for five years from trading securities in Hong Kong by the Market Misconduct Tribunal (“MMT”).  The MMT has ruled that Mr Left had committed market misconduct in relation to his publication of false or misleading information when criticising China Evergrande Group (“Evergrande”).

This month’s newsletter focuses on Muddy Waters’ attack on Huishan and the MMT’s finding against Mr Left to illustrate the risks that short sellers face in publishing negative research reports without sufficient evidence, and summarises the actions that listed companies may take in light of such attacks.

Muddy Water’s attack on Huishan

On 16 December 2016, Muddy Waters released a negative report about Huishan claiming that Huishan’s equity value was close to zero due to financial fraud. In response to the report, Huishan suspended trading during trading hours and released a clarification announcement on the same day refuting the allegations purported by Muddy Waters. In the clarification announcement, Huishan stated, among other things, that the accusations are groundless and contain various misrepresentations, malicious and false allegations and factual errors. However, Muddy Waters persisted in its attack on Huishan and unveiled a second negative report on 18 December 2016, speculating that Huishan’s reported revenue is also fraudulent. Huishan once again immediately took action by releasing two clarification announcements on the next day, 19 December 2016.

The clarification announcements issued by Huishan contains detailed information that rebutted Muddy Waters’ allegations. Most interestingly, Muddy Waters’ negative reports only took a slight effect on Huishan’s shares: Huishan’s shares declined by 4.3% at most after Muddy Water’s release of the first report, while the second report, instead of triggering a dip in stock prices, caused the stock prices to rebound instead. Huishan’s stock prices rose as much as 2.9% on 19 December 2016 when Huishan’s shares resumed trading. One reason for the rise in stock prices can be attributed to Huishan’s prompt issuance of the clarification announcements.

 The risks of publishing negative reports

The recent muted response to short sellers’ reports shows that investors have become circumspect when perusing such negative reports.  Moreover, short sellers who publish negative reports that are materially false or misleading could find themselves in breach of section 277 of Part XIII of the Securities and Futures Ordinance (Cap. 571) (“SFO”) for the disclosure of false or misleading information about securities or futures that is likely to induce investment decisions or have a material price effect. The information must be false or misleading in a material fact or through the omission of a material fact; and the person must know, or is reckless as to whether, the information is false or misleading in a material fact or through the omission of a material fact.

The recent MMT finding against Mr Left shows that the MMT holds negative research reports to a higher standard than positive research reports. For example, even though it could be argued that Mr Left was merely stating his opinion after analysing publicly available information about Evergrande, his opinion was considered “information” for the purposes of section 277. This means that any short-seller who is merely stating his/her “opinion” after analysing publicly available information could be found guilty of this section if the “opinion” turns out to be false or misleading. At one point, Mr Left requested Evergrande to disclose its undisclosed financial information, arguing that such information would reveal the true financial position of the company. The request was turned down by the MMT who ruled that Mr Left could only refer to the publicly available information to prove that his reports are not false or misleading.  Thus, negative research reports must be sufficiently justified and accurate, and short sellers must be vigilant with their research to avoid being found “negligent” or “reckless” in publishing their research reports.

Actions that listed companies may take
if attacked by short sellers

A listed company, when bombarded by short sellers’ negative allegations, should as soon as possible respond to and clarify the allegations and issue a trading halt if necessary pending the release of the response and clarification. A listed company should also consider if any information in the report would require disclosure under Part XIVA (disclosure of inside information) of the SFO, especially if the listed company has been relying on the “safe harbour” of confidentiality preservation under section 307D of the SFO to withhold disclosure.

It can be seen from Huishan’s example that a quick and informative response can result in a rise in share prices even after two attacks by Muddy Waters, as investors’ confidence in Huishan’s shares is restored following Huishan’s rebuttals. A delay can possibly lead to investigation and suspension of dealings in securities by the Securities and Futures Commission (“SFC”) under section 8 of the Securities and Futures (Stock Market Listing) Rules (Cap. 571V). One example is the failure of Superb Summit International Group (“Superb Summit”) in refuting the accusations brought about by Muddy Waters in November 2014. The result was that trading of Superb Summit’s shares was (and is still) halted indefinitely.

Conclusion

It has become increasingly difficult for short selling institutions to make gains through publishing negative reports. While the SFC expects a high standard of accuracy from such reports, listed companies are advised to adopt a proactive defence and ensure that clarification announcements are published as soon as possible in order to minimise the damage.

For enquiries, please contact our Litigation & Dispute Resolution Department:

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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.