The fortune of the richest man in the country with an estimated worth of US $ 150 Billion in 2022 was attacked on January 24, 2023 by an obscure US-based company, Hindenburg as the stock price of Adani Group crashed to less than 45% because of a report published by Hindenburg alleging that Adani Group has engaged in “brazen stock manipulation and accounting fraud scheme over the course of decades”.

What entangles this report further is that Hindenburg Research is not merely a research firm but it is a short-selling activist firm that generates public reports via its website that alleges corporate fraud and malfeasance and pockets the profits with an aim to gain a financial incentive with the stock price fall.

Short selling is basically betting on the falling of a company’s stock price. A short seller seeks out companies whose shares it believes are overvalued whether by market exuberance or by outright fraud and then sells the shares that he does not own but are borrowed (from a broker) and when the stock price falls, the seller buys those shares and books a profit.

While short selling is unethical but is not consequentially illegal.

In India, the Securities Exchange Board of India (SEBI) allows investors to sell something they don’t have only if they can buy it back the same day via intraday trading. Therefore, it is legally allowed to short-sell in India. While short-selling is not (yet) illegal, it can certainly be seen as immoral as firstly, it is a result of profiting from a failure of a company, secondly, the practice is damaging as it artificially lowers the stock prices of a company, thirdly, it’s a privileged investment tactic which is not available to everyday investors and lastly, the short sellers manipulate the market by conspiring. The critics of short selling are also convinced that short selling, directly or indirectly, poses potential risks and can easily destabilize the market.

In fact, even the International Organisation of Securities Commissions (IOSCO) has also reviewed short selling and securities lending practices across markets and has recommended transparency of short selling, rather than prohibiting it. However, there is a practice of short-selling known as “Naked Short Selling” wherein the shares sold by the investor do not deem to actually exist as the traders must borrow the stock before they sell it short. This practice has been declared illegal and is, therefore, banned in many jurisdictions including India.

However, after the market meltdown due to the crash in Adani Group stocks, due to the loss suffered by the Indian investors to the tune of ten lakh crore, SEBI is likely to probe short selling in the Indian stock markets as in the wake of the Adani-Hindenburg issue, the Apex Court has expressed its concerns about protecting the Indian investors and sought views of the Union Government and the SEBI to improve the regulatory mechanism. Not only this the CJI of India, Justice D.Y Chandrachud has also proposed the constitution of an expert committee to give suggestions on strengthening the regulatory framework. The same was done after two Public Interest Litigations (PILs) were filed seeking an investigation about the report published by Hidenburg which caused shockwaves in the entire stock market.

Short selling of companies like the Adani Group which controls the economy of an entire country leads to a huge amount of volatility (what we have been witnessing for the past two weeks) and Indian investors need protection against such volatility. This shall require a due assessment of the existing framework on short selling followed by the regulatory measures which have to be urgently imposed to strengthen the existing framework so as to ensure stable market operations.

While international securities markets have recognized that short selling can lead to the crashing of a market and may also lead to manipulative activities, most of the jurisdictions have also recognized short selling as a legitimate investment activity that has contributed significantly to market liquidity. Thus, the regulation on short selling must be imposed sparingly and with utmost care and caution, as the same, if misused in current market conditions, could translate into unprecedented financial turmoil much like what’s happening in the Indian Stock market at the moment.

By - Prapti Allagh