CURBING THE BIG SHORT

SA’S authorities are proposing new rules to introduce greater transparency into the short-selling market. It’s a welcome move

It’s commendable that rather than cave in to the hysterical howls of besieged CEOS, the authorities seem to be leaning towards using a light touch in regulating short sellers like the often reviled Viceroy. Short sellers, for the uninitiated, are traders who bet on a share price falling. It’s the inverse of what many people consider conventional investment, where you take a “long” position on a share, expecting a price to rise.

Though short selling has been around for decades, it hasn’t made headlines in SA until recently. Until Steinhoff happened in December 2017, and a day later a little-known research outfit called Viceroy published a withering report on much of the fraud.

Viceroy followed it up too. In January, it published a report on banking group Capitec, and its stock price promptly plunged 25% within a week. Capitec growled with indignation, demanding all manner of investigations and, presumably, public hangings of anyone who dared suggest its business model was predatory.

Last week, Viceroy published a report into Nepi Rockcastle, a property company that grew out of the Resilient stable started by ex-banker Des de Beer.

“We believe Nepi’s investors are largely in the dark regarding the true nature and performance of the company’s operations,” said Viceroy. For example, Viceroy extracted company filings in Romania, concluding it was making losses of more than €40m there, rather than the €284m profit it reported to investors. And Nepi’s price tanked 14%.

Nepi’s CEO, Alex Morar, then held an hour-long conference call where he fumed that what Viceroy did was akin to “shouting ‘bomb’ after boarding a plane”.

“They accuse our management of lying. I accuse them of manipulating information for their own benefit,” he said. Morar urged the Financial Sector Conduct Authority (FSCA) to intervene because of the “material havoc they have caused in the market”.

Morar said he consulted lawyers about potentially suing Viceroy. “I find their approach intentionally destructive for their own gain and they’re hiding behind anonymity and a page-long disclaimer.”

He wasn’t alone. Lesetja Kganyago, the Reserve Bank governor, was then quoted by Bloomberg as describing Viceroy as a “hit squad”.

But fortunately the FSCA has no plans to do anything ridiculous such as “banning” short sellers. It released a discussion paper three weeks ago that concluded that a new “short-sale reporting and disclosure regime be adopted”. But this should be done in a way that recognises how short selling “contributes to efficient price discovery, increases market liquidity and facilitates hedging and risk management”.

The FSCA admits that short selling “can be used abusively to create misleading signals about the real supply, or the correct valuation of a security”.

This is true: “short-and-distort campaigns”, in which blatantly false information is released specifically to trigger a stock fall, should be eradicated.

But the entire practice of short selling shouldn’t be sacrificed along the way.

The FSCA is now proposing a system in which shortsale transactions “must be reported to the exchange” by the broker, and also that “short positions above an initial threshold must be reported to the FSCA”. The exchange, such as the JSE, would then “publicly disclose the total number of securities that have been short sold” on its website every day.

This, the regulator believes, will improve transparency, revealing who has a short position on a stock through an early-warning system. “This will allow the FSCA to monitor the situation, and can alert the FSCA to potentially abusive behaviour,” it says.

It’s similar (but not identical) to regulations used in countries such as the US, Australia, Canada, Singapore and Japan. Overall, it seems an eminently sensible approach, prioritising transparency and efficiency.

Of course, such a proposal would fall short of the more punitive measures that some CEOS would want.

But company executives have never been fans of short selling.

As Marc Cohodes, a legendary Us-based short seller who has rooted out fraudulent companies for the past 37 years, puts it: “Companies hate you, shareholders hate you … I constantly get death threats, threats against my son, threats against my family.”

As Cohodes sees it, the way that companies respond to short sellers is an indicator in itself of whether investors should be worried. “Any company with a management team that focuses on, mentions, is bothered by, or attempts to squeeze short sellers, is almost definitely a short,” he says.

‘They accuse our management of lying. I accuse them of manipulating information’