Analysis: As short sellers target Chinese companies in Hong Kong, hostility mounts
07/08/2017 01:00
* Short-sell campaigns against HK-listed companies at record
high
* Campaigns growing riskier amid Beijing's rising influence
in HK
* Activists say they are monitored, hacked, intimidated,
assaulted
* Hong Kong lawmakers call for further regulatory crackdown
By Michelle Price
HONG KONG, Aug 7 (Reuters) - Short sellers are increasingly
targeting Hong Kong-listed Chinese companies they allege have
committed accounting tricks, market manipulation and fraud. And
that's despite mounting hostility faced by investors who bet
against stocks.
This year, there have been nine campaigns by short sellers
against Hong Kong-listed companies as of mid-July, a record for
the period, according to data from Activist Insight. This time
last year there had been only two and in 2015 six.
Short sellers said increasing capital flows between mainland
China and Hong Kong, spurred by Beijing's recent moves to open
up its equity markets, were exacerbating corporate governance
problems in Hong Kong.
"We suspect the increased capital flows between the mainland
and Hong Kong have encouraged more stock manipulations and
frauds in Hong Kong," Carson Block, founder of Muddy Waters and
among the most prominent short activists, told Reuters in an
email.
But calling out these frauds is not for the faint-hearted.
Those betting against companies encounter a bitter response from
their targets, as well as from the shareholders in those
companies and from the Chinese authorities. The short sellers
say the backlash can come in the form of litigation, smear
campaigns, arrests, hacking of their information, surveillance,
physical assault and death threats - against them, their staff
and even their families.
Dan David, the 48-year old co-founder of U.S.-based short
activist GeoInvesting, says he has received emails detailing how
he might die, has been the target of multiple attempted hacks,
sued three times unsuccessfully, and confronted in his driveway
by an angry investor.
"People would rather make money on a fraud than lose money
on the truth," said David, who unveiled his most recent campaign
against food manufacturer China's Dali Foods Group 3799.HK in
June.
David claims the company has implausibly low expenses and
salary costs, while its tax filings display troubling
inconsistencies. The company has denied the allegations, which
it says are misleading and based on selective information.
SMALL PUBLIC FLOATS
The short sellers borrow stock in a company and then sell it
to take a short position - their hope being that they can buy
the stock back at a lower price and close out the position at a
profit.
(For FACTBOX showing companies targeted: urn:newsml:reuters.com:*:nL4N1KP2EN)
David and other short sellers focused on mainland Chinese
stocks listed in Hong Kong say that poor regulation, weak
enforcement and small public floats means there are more stocks
overvalued in the territory than in other major markets.
China's strict investment rules make it all but impossible
to take short positions in individual domestic-listed Chinese
stocks from overseas.
Some companies may have used accounting tricks to overstate
their profitability, or have over-promised - perhaps they have a
fad product whose popularity will fade quickly.
Critics say short sellers are cynical opportunists who
destroy shareholder value for their own gain. The shorts counter
by saying they are a force for good, going to great lengths to
expose fraud and persistent problems with listing and governance
standards in the city.
In June, Christopher Cheung, who represents financial
services and business interests in Hong Kong's legislative
chamber, called on Hong Kong's Securities and Futures Commission
to more tightly scrutinise short sellers, saying they had caused
"serious disturbance to market order" in Hong Kong and hurt
investors.
In a statement, an SFC spokesman said: "The SFC considers
that responsible research can all contribute to the overall
market quality and price discovery process and has no intention
to suppress legitimate commentaries on listed companies, whether
positive or negative."
Though less prominent than peers such as Block, David - who
is also chief investment officer of hedge fund FG Alpha - has
been seeking to expose dodgy dealings at Chinese companies
listed outside the mainland since 2010.
He typically sets to work screening for a range of tell-tale
signs, including auditors, brokers and investment banks that
have a track record of working for questionable companies.
Some firms, such as Asia-based Blazing Research, also
solicit tips and will pay "handsomely" for useful information,
it told Reuters in an email.
Many firms hire private investigators to review a company's
operations in China. They can spend months pulling business
registrations, poring over tax filings, counting truck traffic
or point of sale terminals (sometimes after installing cameras),
appraising land claims, and quizzing nearby residents. They are
often looking to see whether the reality on the ground matches
executives' statements.
RESEARCHER DETAINED
But such tactics can backfire. On one occasion, a member of
David's team was beaten-up by security guards who spotted him
counting trucks driving in and out of the company's factory.
Sometimes it is worse than that. AlfredLittle.com's researcher
Kun Huang, a Chinese-born Canadian, was convicted of criminal
behaviour and jailed in China for two years and then deported.
David and Block have also received anonymous threatening
emails. One received by Block in 2010 mentioned his wife Kathy,
asking: "Are you, Kathy and your dad ready for a bullet?"
Block moved to California the same year and now minimises his
time in Hong Kong, which he said is becoming a riskier
environment for short sellers because of Beijing's increasing
influence in the former British colony.
As Chinese companies grow savvier to short tactics, betting
against them has become riskier. They are faster to rebut
allegations and they also more often openly attack the short
sellers' credibility, making for more drawn-out, expensive
campaigns.
They will call on large shareholders or friendly funds and
brokers to help prop up the share price or to suck up the supply
of borrowable stock, making it more expensive to cover short
positions.
"Some Hong Kong stocks have a very limited public float,
making it easy for the controlling shareholder to prop up the
share price even though the company is indeed fraudulent," said
Blazing Research in an email.
It is unclear if Block made or lost money on his December
campaign against China Huishan Dairy 6863.HK after the company
quickly halted its stock and announced the chairman was
increasing his stake. The share price subsequently rose and
stabilised until plummeting 85 percent on March 24.
"Being right and making money are two different things. Most
of the time they do intersect for us, but not all of the time,"
said Block in June.
(Reporting by Michelle Price; additional reporting by Elzio
Barreto and Twinnie Siu in Hong Kong; Editing by Martin Howell)
((michelle.price@thomsonreuters.com; +85228472095; Twitter:
@michelleprice36;))
Keywords: CHINA SHORTSELLERS/