Throwing mud at and freezing the short sellers – any silver lining?

By Thio Shen Yi, SC

19 November 2012: Carson Block of Muddy Waters, a company well known for shorting shares, takes pot shots at Olam International Ltd. Olam is compared to Enron, and is assessed to have a high risk of failure, accounting gaffes and significant misconduct, therefore justifying a “strong sell” rating. Olam quickly refutes the claims, requests a trading suspension, accuses Muddy Waters of attempting to profit from its short positions, and on 21 November 2012, sues both Block and Muddy Waters in the Singapore Court. Muddy Waters then releases a 133 page report on Olam setting out the basis for its assertions. Shortly after, Olam announces a US$1.2 billion rights issue of bonds and attached warrants backed and underwritten by Temasek. This was seen as a counter-offensive to entice lenders to recall their stocks from short sellers in order to participate in the issue, or risk dilution. Later, the lawsuit was dropped, still at an early stage, and the excitement subsided.

Fast forward to February 2015. Iceberg Research takes aim at Noble Group Ltd, starting with a 17 page report alleging that Noble provided a misleading picture of its financial performance by recording inflated profits on long term commodity deals and overstating the value of its associated companies. Rebuttals and counter-rebuttals ensue. Noble dismiss Iceberg’s attacks as the work of a disgruntled former employee, one Arnaud Vagner, who was previously terminated for misconduct. In March, they go on to sue him, and a Seychelles company, Enlighten Ace Ltd, in Hong Kong, for conspiracy to injure. Muddy Waters (yes-them again) joins the criticism of Noble with a 14 page report. Michael Dee, a former senior managing director at Temasek Holdings (Singapore’s sovereign wealth fund), wades into the melee, saying that Iceberg was right all along, calling for the resignation of Noble’s chairman Richard Elman, and asking Noble to stop the “silly lawsuit” in Hong Kong. The saga continues.

More recently, on 21 August 2015, Silverlake Axis’ stock sank 27% after an anonymous 42 page report authored by “razor99” recommended shorting the stock. SGX’s Chief Regulatory Officer Tan Boon Gin urged firms to respond quickly and fully so that shareholders had a complete picture and could make informed decisions. But short selling in and of itself is not a bad thing – it “supports market liquidity and efficient price discovery”. More revelations appear likely.

Can a listed company sue when faced with an adverse analyst’s report?

Companies obviously would prefer it if no negative statements were made about them. If an adverse report is made about a company, or if there is a “sell’ recommendation, that is almost always, by definition, defamatory. But not every defamatory statement justifies a lawsuit. The truth is an absolute defence. So if an analyst, or a short seller, makes true statements, no matter how negative, then although they may face the prospect of a lawsuit, they will not be liable for defamation. However, most analytical reports contain more than statements of fact. They contain opinion, inferences, deductions and comment. Can the authors be sued if they are wrong? The law provides a further defence to defamation: that of fair comment. If the statement made is on a matter of public interest, based on true facts, and is a statement that a fair-minded person can honestly make on the true facts, then fair comment is established and there is no liability for defamation. It clearly is in the public interest that the market and investing community has access to reports on listed companies – good, bad or ugly – as long as these are honest reports.

What if the maker of the negative statement has a short position against the Company in question?

This is sometimes characterized as “trash and cash” trades. When the maker of the negative report or statement has a short position, it clearly stands to gain from the fall in the share price. This may allow the Company to allege that the maker of the statement acted maliciously, as proven malice will defeat the defence of fair comment. An ulterior motive is not in itself enough – the alleged defamer must not have honestly believed in the truth of the defamatory comment. So is the disclosure or non-disclosure of the alleged defamer’s short position relevant? Only where it can establish honesty, or lack thereof. In Muddy Water’s case, they did disclose their short position, and in Iceberg’s case, they denied having a short position.

Noble in fact did not sue for defamation in Hong Kong. They sued in conspiracy, which requires an overt act by two or more persons, with the intention of causing harm to another party. This is not always easy to prove – often, the true intention of the co-conspirators is to benefit conspirators themselves, not to harm a third party, notwithstanding the collateral damage to the subject company. It remains to be seen how the Hong Kong court will decide.

The Securities and Futures Act also prohibits a person from recklessly or knowingly making or disseminating materially false or misleading statements (s199) i.e. falsely talking up or talking down the market. It also proscribes the employment of manipulative and deceptive devices (s201).Again, before these sections are engaged, there must be an untrue and misleading statement made. This means that if an analyst’s opinion is capable of being fairly based on existing facts, then even if it is wrong, he would not be guilty under these statutes. The law generally requires some element of dishonesty to be proven before a company will have a remedy under these provisions.

The downside for Companies

To sue or not to sue?

That depends on whether one is able to recover meaningful damages. The alleged defamer may be in the foreign jurisdiction, or may not be identifiable, or may be a shell company without any assets. The lawsuit then results, at best, in a paper judgment. Of course, one can get an injunction from the Courts, but that again is only meaningful if it can actually be enforced, which is not always the case in other jurisdictions. The converse problem is if a Company faces an opponent ready, willing and able to fight. The allegations and comments made will get tested in a Court of law, but only after the Company’s accounts have been unsympathetically scrutinized, officers cross-examined, and its practices tested against prevailing norms. Skeletons, hitherto undisturbed, may tumble out of the closet. Defamation suits are capable, from time to time, of blowing up in the face of the Plaintiff.

So, who holds the advantage? Maligned company, or alleged defamer? Perhaps the market itself is the best judge of that.


TSMP law corporation