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March 23, 2021
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In the first episode of A&M Disputes and Investigations Asia 'The Lighthouse' podcast, Senior Directors Henry Chambers, Jacky Lo and Irene Siu discuss how activist short seller reports can impact companies, recent examples of these campaigns, and how a response can be provided in the event that a company is subject to such a report. Click on the links below to contact us and subscribe to 'The Lighthouse' newsletter.

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Welcome to the Lighthouse podcast series by Alvarez & Marsal Asia’s Disputes and Investigations team. In this series, we discuss some of the challenges we see our clients face, how they impact businesses, and what can be done to overcome them.

Henry: Hello, my name is Henry Chambers and I am a Senior Director with A&M here in Hong Kong. On today’s podcast, I am joined by Jacky Lo and Irene Siu. Jacky and Irene are Senior Directors in A&M’s DI practice bringing a combined experience of over 30 years. Today they are going to share their thoughts and experience on how activist short seller reports can impact companies, recent examples of such campaigns and how a response can be provided in the event that your company is the subject of such a report.

Henry: Today we are going to be looking at how a company can respond when faced with an activist short seller report - Jacky, can you tell us what exactly a short seller report is?

Jacky: A short seller is a research firm that could be financially backed by private equity firms or private investors. Once a short seller identifies a publicly-trading company as a target, the short seller builds a short position and makes a profit when its share price drops. The short seller will usually release its thesis to the market via a number of different ways including social media, mainstream media, investor forums or other means to accelerate the drop in share price. Assuming the thesis is seemingly credible, the share price could be impacted in a matter of hours or minutes after its release. There are two general categories of short seller reports:

  1. Valuation-based: The company’s current share price is over-valued and needs correction, usually around business prospect or industry structural flaws.
  2. Accounting-based: This is usually to do with management integrity issues or misrepresentation in financial statements.

Henry: Given the nature of these short seller reports, what kind of examples have we seen of these reports in Asia in recent years?

Irene: We have seen a number of short seller reports on companies listed on the Hong Kong Stock Exchange or on Asian companies listed on foreign exchanges, for example, the U.S. Stock Exchange. It is not surprising as Hong Kong is one of the largest stock exchanges in terms of market cap and the number of IPOs. These short seller reports usually point to inflation of sales or revenue, and questionable business models that may be opaque or complex. They may also refer to transactions with an over-reliance on intermediary counterparts and/or a significant number of related party transactions. Essentially, these reports are saying the company is not worth as much as it claims to be. Often, we would see an immediate impact on the company’s share price following the release of a short seller report. For example, there was a dairy company based in China whose share price plunged by over 80 percent in under two hours after the release of a short seller report, wiping over $4 billion USD in its market cap. Sometimes the company under attack may need to immediately suspend the trading of shares. Senior management may have to step down, for instance the CEO. Often, the company ends up being de-listed or wound-up.

Certain types of companies appear to be more prone to short seller reports:

  1. Companies that appear to be over-valued, or adopt non-traditional accounting standards/practices, with irregular or over-complicated accounting treatments.
  2. Businesses in new industries that are currently considered to be trendy, for instance BioTech, e-Commerce, and cryptocurrency – inevitably attract more attention from short sellers.
  3. Businesses that operate in regions with the general perception of having weaker internal control practices or corporate governance standards.
  4. Companies that are tightly controlled by a small group of people where power or authority rested with one or few senior management staff, often without checks or oversight by an independent board.

We also observed that some of the “problematic” companies or companies that are often targeted by short sellers tend to have the same directors or engage the same advisors.

Henry: How do short sellers identify potential target companies?

Jacky: Short sellers carry out certain quantitative analyses on the financial data reported by listed companies in order to identify market outliers that display certain red flags. Once an outlier company is identified, further analysis is carried out using information from the company such as investor conference presentations or transcripts in order to understand the company’s business model and whether there is a rational explanation to justify the anomalies. The short seller may then dive deeper using other independent sources of information such as government data, statutory filings, market statistics and may even conduct covert interviews or visits. They corroborate all these data with financial records to look for inconsistencies. These findings are then presented in a final short seller report to convince the public that the company is not worth its traded value.

Henry: How should a company respond to short seller reports?

Jacky: Companies should consider halting share trading in order to buy time and formulate a response plan. There is actually very little time to respond to allegations before investors lose confidence and possibly attracting the attention of regulators and other stakeholders. The key is that the company should not just be looking at a short-term response to restore share price, they should also be considering the longer-term implications. The company needs to provide a robust response that is led by those charged with governance within the company to ensure the clarifications and/or responses are convincing, objective and accurate, supported by sufficient evidence. Should the clarifications made by the company turn out to be misleading or untrue, it can be very costly to repair any damages caused as a result. It is critical to preserve documents and data at the onset, as soon as possible, so that this information can be analysed and a proper conclusion formed before making any public announcements. Regulators may also come knocking on the company’s door. The company therefore must be prepared in answering the enquires from the regulators, including the steps that have been taken in drawing the conclusion, and the data has been collected in support of the conclusion.

Irene: Yes, it is important for the company to document the steps it has taken since the release of the short seller report – what they have done, who they have spoken with, how and what data has been preserved, and how the investigation plan around the allegations raised by the short seller is arrived at. These are information that may be requested by the regulators. Data preservation is very important. By taking the steps in securing the necessary information, this helps to show stakeholders, investors and the public that the company has nothing to hide and is committed to finding out the facts around the allegations.

Henry: Do you have any final advice for companies?

Irene: The company must be prepared and act quickly, as there is only a very short time to respond before any potential damage is done. The company should have a plan of what needs to be done in the event that it is faced with a short seller attack. The company should quickly acknowledge that it is aware of the short seller report and the allegations raised, and show that they have acted quickly in formulating a plan to ascertain the facts around the matter, including steps to preserve the necessary information and data. This will greatly help to restore investor confidence in the company.

Jacky: Companies need to ensure the scope of the investigation is adequate and they have adequate capacity to address short seller reports – all evidence will be closely analysed by stakeholders, auditors and regulators. Companies need to be prepared to answer any questions raised by these parties.

Henry: Jacky, Irene, thank you very much for taking the time today to explore the issues surrounding short seller reports and thank you all for listening to the first podcast of the Lighthouse, A&M Disputes and Investigations Asia’s podcast on real challenges we see our clients face. For more information from A&M, and to stay up to date with all our insights and advice, subscribe to our Lighthouse newsletter at I’m Henry Chambers, and until next time, take care.