Is short selling a fair game?

RECENTLY in South Korea, retail investors banded together to lodge their protest against the short sellers of Samsung Electronics Co Ltd stock.

A bus wrapped in a banner calling for the abolishment of short selling in the centre of Seoul has become an icon of the movement to capture the attention of regulators.

This is just merely five months after the world’s longest short-selling ban (14-month ban) was lifted on May 4, 2021. Samsung’s share price has fallen year-to-date by around 13% but from the peak of 96,800 won (RM340.50), it has plunged close to 26% to 72,200 won (RM253.96).

What upset the retail investors is the constant shorting of the stock by local institutions and more so foreign funds in spite of a narrative on the global shortage of semiconductor

This is especially apparent where semiconductor giants’ share price such as AMD Inc, Nvidia Corp and Broadcom Inc in developed countries are outperformers of the respective index for 2021 but not South Korea.

In fact, retail investors are adamant the fault rest squarely on short sellers that it is fast becoming a political consideration with South Korean’s 2022 election only six months away.

Their stock market is not that different from Malaysia where it is dominated by local institutions and foreign investors with close to 80% of the overall market participation.

However, like everywhere else, there was a substantial retail investor influx in 2020 due to the pandemic. Since then, the hottest sector in 2020 were being shorted including healthcare and technology.

This went up another notch when a negative report on the semiconductor industry was released by Morgan Stanley in August titled “Winter Is Here”. It drove Samsung’s share price down another 13%.

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This then begs the question of the role of short sellers, given the disdain by retail investors all over the world. Do short sellers have merits to exist in the financial markets? I would like cite the examples of a few renown short-selling firms such as Muddy Waters Research and Hidenburg Research, which made spectacular bets against questionable companies.

Believe it or not, these shorts were not easy to pull off considering the companies that were targeted by them were among the flavour of the day for investors.

Luckin Coffee Inc, listed on Nasdaq, had a peak market capitalisation of US$12.7bil (RM53.14bil). It was once touted as “China’s Starbucks” with over 4,792 stores and kiosks. Prior to the accounting scandal, Luckin was reporting 500% annual revenue growth.

Muddy Waters, founded by Carson Block, published an 89-page report on how Luckin falsified its figures by inflating items sold in store. The share price plunged over 95% from US$32.49 (RM135.95) to US$1.39 (RM5.82) in the span of five months.

Although Luckin initially denied the allegations as unsubstantiated and malicious, it ultimately filed for Chapter 15 bankruptcy on Feb 5, 2021, with more than a quarter’s worth of business believed to be fake.

With the electric vehicle (EV) sector booming and special-purpose acquisition company (SPAC) space red hot in the past two years, it was a lethal combination that attracted many inexperienced investors.

The two notable companies which went from hero to zero were Nikola Corp and Lordstown Motors.

Nikola presented itself as the future of EV trucks which ran on hydrogen power. With zero revenue and no successful prototype, Nikola’s share price hit a peak market capitalisation of US$34bil (RM142bil), exceeding Ford Motor Co at one point.

General Motors (GM) even struck a partnership to take up 11% stake in the company at a value of US$2bil (RM8.4bil). Hidenburg, founded by Nathan Anderson, then released a report exposing Nikola as “an intricate fraud” by Trevor Milton, the founder of Nikola.

Financial Times subsequently confirmed the report’s claim where a showcase of a Nikola One EV truck rolling down a gradual slope had no onboard propulsion but used the force of gravity instead.

On July 29, 2021, the United Stated federal grand jury returned an indictment against Milton which included two counts of securities fraud and three counts of criminal fraud including “lying about nearly all aspects of the business”.

After Nikola, Lordstown was on the radar of Hidenburg. Lordstown was developing an all-wheel drive electric pickup truck. GM invested around US$75mil (RM313mil) in the company.

The company claimed it has received more than 100,000 pre-orders, painting a rosy picture of its future. I remembered watching CNBC when the CEO, Steve Burns, was grilled.

During the live interview, he actually said: “We’ve always been very clear, right? These are just what they’re intended to be. These are non-binding letters of intent. They’re called pre-orders out in the real world,. I don’t think anyone thought that we had actual orders, right?” At its peak, Lordstown’s market capitalisation was US$5.6bil (RM23.43bil). Even Greatech Technology Bhd, which was supplying to Lordstown, faced share price pressure when the news emerged.

On June 8, 2021, Lordstown said it did not have enough money to begin commercial production of its vehicle and was at a risk of bankruptcy. Lucky for the company, it managed to sell its manufacturing facility to Foxconn Technology Group, a contract manufacturer for Apple, for US$230mil (RM962mil) recently.

These are real life tales of exemplary short-selling manoeuvres which are for a worthy cause to expose frauds and scandals. Of course, not all short selling pans out well.

Remember GameStop? Retail investors caused a short squeeze and nearly imploded Melvin Capital with losses amounting to US$4.5bil (RM18.83bil). It was ran by star fund manager Gabriel Plotkin, who was the protege of Point 72’s Steve Cohen.

Even prominent billionaire activist investor Bill Ackman, who was engaged in the epic five years shorting of Herbalife Nutrition Ltd which he deemed as a pyramid scam, could not escape unscathed when the bet went against him.

In that legendary tussle, he eventually lost US$1bil (RM4.1bil) while Carl Icahn made the equivalent for buying in and causing the short squeeze.

Short selling is never easy because it requires great conviction backed by facts. By nature, it is an uphill battle due to potential legal threats of defamation and need for resources to withstand pressure by opposing forces to hide the truth.

Today, one of the most watched short position is Dr Michael Burry’s bet against Tesla Inc and Cathie Wood’s ARK Innovation ETF.

Ultimately, it is my belief that short sellers should exist in the financial markets to ensure an efficient and healthy market. That way, irregularities and pump-and-dump operations can be filtered out. Even if the authorities are slow to act, market forces may punish them.

On the local front, there is a need for more active short selling, especially towards those operator-linked companies which exist for the sole reason to trap retail investors. These operators are now moving from loss-making penny stocks to low-liquidity main market technology companies.

That said, I believe a fair game is necessary. If the regulators allow restrictive short selling (RSS) for approved entities (predominantly funds and banks) while only allowing intraday short selling (IDSS) for retail investors, that in my view is not fair.

Shorting is not a one-day process as it takes time. IDSS’ short timeframe favours nobody except brokerage houses who will profit from transaction fees.

In addition, while “China Wall” technically exist to separate different regulated activities within financial institutions, there are instances in our market where certain research reports are produced in order to facilitate trades or churn our volumes for the benefit of investment banks and brokerage houses.

The income generated, in turn, is used towards paying research employees indirectly. One can’t help but wonder about the independence or the lack of it thereof.

If this delicate balance can be managed well, short selling can be a force for good to protect retail investors rather than favour the institutions as it is now.

Hann is the author of “Once Upon A Time In Bursa”. He is a lawyer and former chief strategist of a Fortune 500 corporation.