The Big Short (Returns): Hindenburg vs. Adani

The primary (and intuitive) reason for investing in a company’s stock is the belief that its price will increase. However, there are people who trade on the opposite premise – that a company is terrible, will do something terrible, or something terrible will happen to it, causing its stock price to go down. Simplistically, these ‘short sellers’ sell shares at a higher price (say $100 per share), but they borrow these shares from another entity. When the price falls, they purchase the shares at a lower price (say $80 per share) and return them to the lender. They get to keep the difference of $20 per share. Short-sellers are careful investigators and they see something others can’t – as immortalized in The Big Short, they were the first to see the 2008 crisis coming.

But not all short-sellers wait around for the big reveal to happen on its own – when activist short-sellers discover something they think won’t become public on its own (or at least fast enough), they release the information, usually as a research report. Short-sellers’ reports usually allege that the company is defrauding investors, misleading them or the its stocks are overvalued. This usually causes the company’s stock price to decline and benefits the short-seller who probably built up positions already.

Are short sellers then beneficial or detrimental to the market? They are releasing non-public information they obtained through careful research, which is good for an efficient market. However, short-sellers are not necessarily releasing this information for altruistic purposes – they stand to make a profit when the share price tanks, which people consider unethical.

While there is no specific regulation prohibiting or regulating short-seller reports, the SEC has tried to balance the two by taking action past against short-sellers they alleged had included false and misleading information in violation of Section 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5 as well as Section 206 of the Investment Advisors Act of 1940.

While the SEC is rightfully willing to take action against false and misleading reports, short-seller reports have also served as a means for the SEC to identify issuers that are misleading investors and take action against them. Take for example, Hindenburg Research’s 2020 report on Nikola, an electric vehicle company. Nikola claimed that it had designed a semi-truck that was powered by hydrogen and released a video showing a fully functional truck. The Hindenburg report alleged that the truck didn’t work at all, and the video was shot with the truck rolling downhill, aided by gravity. As Nikola’s share price tanked, Nikola ran to the SEC to complain that the report contained inaccurate statements and also threatened to sue Hindenburg. Unfortunately for them, the SEC opened an investigation into and, in December 2021, Nikola agreed to pay $125 million to resolve fraud charges against it by the SEC.

Recently, another powerful securities regulator was forced to grapple with their own views on this issue. On January 24, 2023, Hindenburg released a report on the Adani group, an Indian conglomerate valued at $218 billion led by Gautam Adani, a man who briefly replaced Jeff Bezos as the world’s second richest man. The report was unprecedented in the Indian market. Most short-seller activists like Hindenburg are based in the US. Indian regulations make it difficult for foreign investors to buy shares without reporting their purchases, making short-selling rare and giving them no incentive to issue such reports. It is still unclear how Hindenburg itself shorted Adani’s securities, although their own disclosure claims that they did it using "short positions in Adani Group Companies through U.S.-traded bonds and non-Indian-traded derivatives, along with other non-Indian-traded reference securities”.

As share prices of listed entities within the conglomerate tanked (with one entity seeing a decrease of 79%) and the conglomerate lost over $100 billion in value, Adani fired off salvos at Hindenburg. While they had to call off their impending $2.5 billion share sale, Adani attempted to calm panic by paying off some of their credit facilities early and hiring Cravath to represent them in taking action against Hindenburg. An interesting part of their damage control was to characterize Hindenburg’s report as an “attack on India”, presumably in an attempt to deflect from the actual findings of the report.

All eyes were then on India’s securities regulator, the Securities and Exchange Board of India (“SEBI”). On one hand, Hindenburg’s report could be a violation of the Securities and Exchange Board of India (Research Analyst) Regulations of 2014 which requires entities issuing research reports to meet certain criteria, particularly if the entity is foreign to India. In addition, the fact that Hindenburg presumably issued the report in order to short Adani’s securities might also be a violation of the Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices relating to the Securities Market) Regulations of 2003 which prohibit, among other things, artificially depressing or causing fluctuations in share prices. On the other hand, Hindenburg’s allegations are explosive – they allege that Adani artificially inflated its share price by purchasing shares through shadow entities owned by the Adani family. Some of the other things the report points out are painfully obvious – the audit firm that works with Adani only has 4 partners and does not audit any other large listed entities. The audit partner signing this $200 billion enterprise’s report was as young as 24. SEBI, a regulator more paternalistic than the SEC, would have to do something.

To start, SEBI issued a generic statement on its commitment to ensuring market stability. It was only when a public interest litigation suit was filed before the Supreme Court of India, did SEBI file an affidavit with the court that it was investigating Hindenburg’s claims. In an interesting development, India’s Supreme Court has also formed its own independent panel to investigate the findings in the report. India’s central government indicated that it would like to nominate members to the panel, and the Supreme Court declined, possibly because of Adani’s group's close political ties with the current ruling party.

While it remains to be seen how the Supreme Court’s panel, the Supreme Court, and SEBI move ahead with this investigation, this marks a new period for the listed company space in India. As India’s closely controlled capital markets see an increasing foreign influx of cash, fresh challenges follow the money. Hindenburg’s report is only the beginning – issuers and regulators should expect that there will be more to follow from other short sellers. Regulators need to be prepared to deal with both ‘bad’ short-sellers and ‘bad’ issuers while acknowledging that the two may not be mutually exclusive. As markets like India open up and became increasingly sophisticated, they also need to realign their approach to investor protection. The next few years will be an interesting time for short -sellers, issuers and proponents of the efficient market theory.

Soumya is an LL.M. candidate at NYU Law. Prior to this, she was a capital markets lawyer in India for five years and worked with two of India’s leading law firms. At NYU, she is a Graduate Editor of the Journal of Law & Business and serves on the board of the Law & Business Association.