– By Dr. Shakti Deb and Trisha Shreyashi
The Adani-Hindenburg episode may be hot news but acts of shorting have age-old histories across the globe. This fiasco catapulted the need to relook at the existing regulatory framework, the relevant causal factors, and the need for putting in place robust mechanisms to protect the investors must be looked into. It has projected the question of whether shorting is desirable for a healthy market or not, a question mulled over by the Supreme Court of India as well.
The pro-ban school argues that short-selling is fuelled by pessimism and draws profits only when the setbacks happen or the market crashes. This leads to massive disruption in stock prices which shakes investors’ confidence in the capital market and adds difficulties for firms in raising capital. Alternately, those against the ban argue that restriction over shorting carries the risk of inefficient market pricing of stocks and creates a cozy room for errant promoters to manipulate stock prices.
Short sellers are indeed fact-finding correspondents of capital markets who excavate worsening business entities, undue leverage managerial leverage, and corrupt management practices. They are beneficial intel, especially for an emerging economy where market controls like a hostile takeover, strong labor market, and investors’ activism are still on a developing curve.
However, there are instances of small short-sellers who attempt to distort the market based on rumors or ulterior personal interests. Shorting is not bothersome but the Adani crash resulted in losses of almost Rs 10 lakh cr. worth of investor money. Today’s India differs from the 1990s; the stock market is no longer just for the wealthy but a venue where a significant portion of the middle class also invests their life savings.
A 3-judge bench led by the Hon’ble Chief Justice of India at the apex court has heard the Public Interest Litigations in the instant matter. The Hon’ble SC has directed SEBI to probe into the matter on mainly three issues – (i) Violation of SCRA Rules, 1957 (ii) Failure to disclose related party transactions (iii) Manipulation of stock prices.
It also directed the constitution of an expert committee under Justice Abhay Sapre. The remit of the committee shall be essentially to provide an overall assessment of market factors, the extant regulatory mechanism, investigation of regulatory failure in the Adani-Hindenburg research matter and make suggestions to protect the interests of middle-class investors against sudden market volatility.
These pleas underscore the impact of the domino effect of Adani Group’s share price crash, resulting in devastating losses borne by retail investors and suicides in some cases in addition to adversely impacting the state-owned and private lenders. Thus, this case has propelled the question of whether modification of certain statutory laws is required and that a mechanism must be in place to ensure that the investors are protected.
Extant Framework: SEBI has plenary powers under Section 11 (1) of the Securities and Exchange Board of India Act, 1992, and Section 19 of the Depositories Act, 1996, to regulate the shorting of securities in the manner necessary and apposite to the investors’ protection and promotion of the development of, and to regulate the securities market. Presently, the SEBI has placed measures to secure the investor interests so that they have the knowledge of financial markets, investment methodology, and redressal of grievances. It has adopted a mandatory continuous disclosure-based regulatory framework for all issuers and intermediaries via screen-based trading, dematerialization, T+1 rolling settlement, etc.
Further, SEBI has prescribed the laws governing short-selling and securities borrowing and lending practices in line with the Securities Market Advisory Committee recommendation. The existing regulatory framework governing shorts has been prescribed by (i) a Broad framework for short selling and (ii) a Broad framework for securities lending and borrowing.
The framework for short selling allows trading of securities in the F & O segment to be eligible for shorting. This is driven by disclosing order placement intended as a short sale. The second framework obligates retail and institutional investors to disclose whether the transaction is a short sale at the time of placement of the order and demonstrate their ability to borrow to the satisfaction of the broker and data on a scrip-wise short position to the stock exchanges.
SEBI deems the market infrastructure institutions as the first-stage regulators. The stock exchanges are required to move extremely volatile scrips to additional surveillance measures (ASM), which signals the need for increased caution to be exercised by investors and due diligence by market participants who intend to deal with securities placed under ASM.
In the instant matter, NSE has placed Adani Enterprises under the ASM framework. However, this framework is triggered after price and volume volatility conditions are met, which might still be disconcerting for small and retail investors.
SEBI has implemented a one-stop solution for all investor issues, the SEBI Complaints Redress System (SCORES). It facilitates investor assistance, adjudication, prosecution, arbitration, progress on inquiry and action taken, directions, and compensation. It is mandatory for stock exchanges to establish investor services cells for the settlement of grievances, called the Investor Grievance Redressal Committee (IGRC). It acts as the nodal point to resolve the dispute by way of conciliation, failing which the dispute is referred to arbitration. Finally, all unresolved disputes reach the Office of Investor Assistance & Education. It is imperative to mention the exemplary penalty regime and powers the watchdog exercises.
However, this redressal mechanism works post-facto. The extant regime allows investors to seek gratification in penalties imposed upon the defaulter rather than obtaining a refund, especially in market manipulation matters. This leaves the middle class still reeling from the loss of their life savings.
Despite said regulatory framework, billions were already wiped off the stock market causing losses to investors due to substantial stock off-load in the stock market, before SEBI stepped in. It is necessary to determine whether the Hindenburg report was aimed at uncovering the wrongdoings of business organizations for the general benefit or for the personal benefit to attack a particular business organization with ulterior motives to derail their growth or to attach the corporate world of a country to derail the growth of the economy. The present episode of Adani-Hindenburg calls for a proactive regulatory response, not a reactive one.
Possible regulatory refit on short-selling: The market regulator may consider the imposition of an ad-hoc embargo on disclosure of research reports in the public domain and shorting until the report gets substantiated. Such proscription was imposed by the US market regulator Securities and Exchange Commission through an emergency order as a response to market developments which included likely superfluous or fake price movements driven by baseless rumours.
Additionally, there is also scope for improvement of the existing framework on shorts in terms of enhanced disclosure. This would act as a checkpoint for protection of retail investor interests and sustain market stability. Any companies listed in India and cross-listed in overseas jurisdictions and whose issued stocks or securities are subjected to such short positions shall carry the obligation to report the short positions concerning their issued stocks or securities on a monthly basis. This will facilitate the investors to be informed about such short positions and, accordingly, may react in terms of stock prices. The data on such short positions may easily be extracted from the stock exchange’s public information domain.
(Dr. Shakti Deb is the faculty member at Indian Institute of Management (IIM), Tiruchirappalli & Trisha Shreyashi is the advocate & honorary member at Harvard Business Review Advisory Council.)