With increased short selling and the advance of activist short sellers in the Australian market, it is time for companies to put themselves in the best position to stand tall against potential attacks.
If the recent entry of activist short seller Glaucus into the Australian market has taught us anything, it’s that companies need to start thinking now how they can best defend themselves against a short attack. While every situation will be different, we have set out below a potential response strategy involving three key steps, being: (1) stop and assess; (2) defence; and (3) consider litigation.
What is short selling?
Short selling involves selling shares the activist does not own at the current market price. To do this the short seller needs to borrow the shares to “cover” the short. When the time comes to exit the position, the activist buys the shares, potentially at a lower price and returns them to the lender. A short seller makes money in a falling market. Not all short selling is a short attack. The vast majority of short selling is simply pre-empting expected movements in share price having regard to differing views on value or performance.
In Australia, “naked” short selling (when the seller does not borrow shares to cover the short sale) is prohibited.
Short sellers face significant risks. If the share price increases, short sellers are forced to buy their borrowed shares at a higher price than they sold them for, which can create potentially unlimited losses.
What is a “short attack”?
A short attack is a carefully planned and coordinated attack by an activist short seller that involves taking a large short position in a company then attempting to drive the share price down by the release of negative information. This information can be released in a variety of ways including via a discussion paper, in the media, via “independent” analysts’ reports or on message boards and blogs. Often, these tactics are employed in combination for maximum effect.
Preparing for a short attack
Companies can take certain steps to make themselves less of a target for short sellers.
- Do not issue aggressive guidance or encourage investors or analysts to overvalue your company.
- Adopt conservative accounting practices and be cautious in using non-standard accounting measures which are often “red flags” for short sellers.
- Issue bad news as early as possible – do not allow it to “fester”.
- Continually monitor investor and wider sentiment in the company.
- Keep an ear to the ground for disclosure criticism and respond to it - activist investors target companies who they believe make misstatements to the market.
- It is possible to monitor a build-up in short positions through information published by ASIC and ASX.
- Engage external advisers early to provide guidance if you believe your company is vulnerable to a short attack.
- Consider undertaking periodic “fire drills”.
Responding to a short attack
Exercise caution in deciding what response mechanisms to employ. You don’t want to react too hastily and end up on the wrong side of ASX or in litigation. Directors need to be aware of the risk of being seen as spending the company’s money to entrench their own position. You should always maintain a balanced and reasoned view. Keep in mind short attacks can take a while to resolve, but once over, your share price can recover.
Stop and assess
- Consider a trading halt. If you believe there is a false market in your shares as a result of misleading information in the market, you can consider requesting a trading halt. But be conscious of the practical effects of coming out of a halt with no announcement released.
- Appoint an investigative committee. To the extent you don’t know the nature and accuracy of the short attack, you may establish a committee of independent directors (and potentially external members) to review the nature of the attack and assess the general sentiment of investors. This can give confidence to the market that the short sellers’ issues are being taken seriously but be mindful of the implications of announcing to the market that a more formal investigation is being undertaken.
- Engage external advisers. If not already in place, engage legal advisers and Investor Relations firms with experience in responding to short attacks.
- Respond to the attack. Answer criticisms and any greater negativity quickly and comprehensively with public disclosure.
- Don’t rely solely on the broad argument that short sellers are sinister or just pushing a self-interested agenda – bear in mind that Australian regulators believe that there is a role for short selling to aid market efficiency, provided it is done legally.
- Respond publicly before the ASX has asked you to explain why your share price has fallen.
- A good communications plan is critical.
- Be careful liaising with the media - the best strategy may be to deprive the short seller of media oxygen.
- Communicate to every stakeholder. Hold a teleconference for investors and analysts and consider a detailed rebuttal on your company website. Letters or postcards to shareholders may also be appropriate but may need to be disclosed to the market.
- Do not get distracted from running the company –good performance, demonstrated by meeting or exceeding expectations in earnings and revenues, is the best response.
- Get on the front foot. Consider whether it is possible to bring forward initiatives such as announcing a dividend, share buy-back or other corporate transaction that might have a positive share price impact. But remember, any decision on such initiatives must be made in the best interests of the company as a whole.
- The potential causes of action against a short seller in a short attack include allegations of market manipulation (s1041A Corporations Act), false or misleading statements (s 1041E Corporations Act), inducing persons to deal in financial products (s 1041F Corporations Act) or misleading or deceptive conduct (s 1041H Corporations Act and section 18 Australian Consumer Law), among others.
- You should only commence legal action against the short seller if in the best interests of shareholders.
- Pros: litigation could put pressure on the short seller to ease their attack (however, they rely on the share price to drop to return a profit so won’t back down easily) and litigation could demonstrate to investors that there is no merit in the negative statements by the short seller.
- Cons: litigation will cost you money, may open you up to more scrutiny and may make investors believe you have something to hide, unless you are in a position to secure an injunction to prevent the short seller making further representations or, ideally, to require the short seller to issue a correction.
- Short sellers may remain short for a longer period of time to prevent being accused of market manipulation.