Short sale activism – A new challenge for companies that are listed on the stock exchange in Sweden | White & Case LLP
As the year draws to a close, it is clear that 2022 will be the year when short-selling activism and short-seller reports took hold in Sweden. From having been almost unusual in a Swedish context, the use of short-seller reports has become a real headache for companies under attack. Amid recent developments, many companies want to know more about short-selling activism and how to respond to it, both proactively and after the fact.
Short-selling activism in a nutshell
Briefly, short selling is an investment strategy by which investors seek to identify (allegedly) overvalued companies in an attempt to profit from future declines in the companies’ stock prices. Once an overvalued stock has been identified, the short seller borrows securities in the company and sells them at the current market price. The plan is to buy back these securities at a lower price in the future, when the share price has fallen. The securities are then returned to the lender and the short seller takes out the price difference between the purchase price and the sale price as a profit. What distinguishes activist short sellers from traditional short sellers is primarily that they actively try to drive down the share price by convincing the market that the target company is overvalued. This is done by publishing a report, usually called a research report, which contains more or less substantiated arguments and circumstances in support of the short seller’s expressed opinion. The modus operandi also usually includes spreading the content of the report on various platforms, such as Twitter, and in the mainstream media to give it maximum spread and impact.
Although the concept of short-selling activism is relatively new in Sweden, it has been used successfully for many years in other markets such as the USA. Notable US shorting attacks include Luckin Coffee and DraftKings, but the activist shorting strategy has also proven successful in some EU markets; for example in Great Britain and Germany. The most infamous example is probably Wirecard, which later turned out to have serious accounting problems. Regulatory risks, accounting issues, confidential information, odd related party transactions and similar problems are examples of “findings” usually pointed out in the research reports published by activists. This type of problem has also been used by activist short sellers to justify short positions in Swedish listed companies in 2022, the most notable cases being Evolution Gaming, SBB, Sinch and Truecaller.
Latest example of short-selling activism in Sweden
In January 2022, The Analyst published a research report stating that online gaming company Evolution Gaming was overvalued as 62 percent of the company’s total revenue came from unregulated markets. The activist short seller expressed the view that Evolution Gaming’s unregulated revenue should be valued at a much lower multiple than the rest of the business due to the regulatory risks associated with such revenue. The research report caused Evolution Gaming’s share price to drop by 11 percent, temporarily wiping out more than €2 billion in value.
In February 2022, Viceroy Research published a short-seller report that concluded that the Nordic real estate company SBB was “uninvestable” due to inaccuracies in the company’s financial reports and secret information about relationships between SBB and board members and other related-party aspects. The publication of the research report caused large price fluctuations, which resulted in SBB’s share price initially falling 10 percent, then reversing around 15 percent and then falling again. Two days later, SBB published a response to Viceroy’s research report, stating that the report was incorrect and misleading.
In July 2022, NINGI Research published a report accusing Sinch of misrepresenting the company’s operations by, for example, misclassifying invoices that had not yet been billed as revenue and overstating the performance of the company’s operations in Australia and India. Sinch’s share price fell about 16 percent after the report was published. A week and a half later, Sinch published a written response to allegations that the short seller report was misleading.
In September 2022, Viceroy Research published a short-seller report stating that Truecaller was overvalued in the short to medium term due to regulatory risks, accounting issues and tax investigations. Truecaller’s share price fell about 20 percent during the day after the report was published. A week later, Truecaller published a response to Viceroy’s allegations, claiming they were inaccurate and false.
The examples mentioned above indicate that activist short sellers and the companies they target tend to take very different positions regarding the veracity of the various themes and issues discussed in the short seller report. Some individuals have even accused the activist card sellers of criminal behavior, but is there any legal merit to those types of accusations?
The regulations
Market manipulation is regulated in Articles 12 and 15 of the European Market Abuse Regulation (“MAR”). Article 15 states that market manipulation is prohibited, while Article 12 describes various types of behavior that constitute market manipulation. Section 12.1(c) establishes that dissemination of information through the media or otherwise that gives, or is likely to give, false or misleading signals about the price of a financial instrument constitutes market manipulation. The section also states that spreading rumors, where the person who spread them knew, or should have known, that the information was false or misleading, also constitutes market manipulation. The determination of whether the activist short seller report and related conduct constitute market manipulation under Article 12.1(c) must be made on a case-by-case basis. Furthermore, the use of short seller reports should also be considered from a
insider information perspective and the prohibition of insider trading according to Article 14 MAR. Research and estimates based on publicly available data should not, as such, be considered inside information, but confidential information that provides the views of a recognized market participant could potentially constitute inside information.
An account of the legality of activist short seller reports should also include a discussion of whether short seller reports constitute “investment recommendations” under the MAR. If a short seller’s report is considered an “investment recommendation”, certain requirements regarding, among other things, disclosure of conflicts of interest and objective presentation are triggered according to Article 20 MAR. In order to determine whether a short seller’s report constitutes an “investment recommendation” one must review and interpret the definition of “investment recommendation” in Article 3.1(35) MAR and the definition of “information recommending or suggesting an investment strategy” in Article 3.1(34) MAR – again must the determination is made on a case-by-case basis.
The assessment of whether a short-seller report should be seen as an “investment recommendation” and whether the publication of an activist short-seller report constitutes market manipulation is ultimately up to the Swedish authorities and courts to decide. Having said that, how have the Swedish authorities interpreted the legal framework?
Current attitude from the Swedish authorities
The Swedish authorities have so far not given any clear guidance on whether activist short seller reports should be seen as investment recommendations. The same applies if the modus operandi of the activist short sellers is market manipulation. In connection with the publication of the short-seller report that was addressed to SBB, Ilija Batljan, CEO of SBB, called on the Financial Supervisory Authority to investigate whether the activist short-sellers’ modus operandi constituted market manipulation. This request has so far not resulted in any public legal proceedings. The Ecocrime Agency (Ecocrime Agency) has, however, stated that they are interested in the phenomenon of short-selling activism and will follow developments closely. Nasdaq Stockholm, the prevailing stock exchange in Sweden, has also communicated that they are continuously following developments and will report any suspicious activities to the Financial Supervisory Authority for further investigation.
In essence, the above statement indicates that the legal implications of publishing a short seller report are currently unclear. Amidst this legal uncertainty, how can publicly traded companies proactively protect themselves against short seller activism and how should they act when attacked?
How to deal with short-selling activism
The first line of defense to avoid being targeted by activist short sellers is to have adequate procedures in place to proactively detect and correct any operational, financial, or disclosure-related issues that short sellers might otherwise be prone to exploit. It is also important to have a clear communication strategy that respects current rules and regulations regarding market communication. The communications policy should include the names of responsible spokesperson(s) within the company, procedures for internal lines of communication, and guidance on external communications. Having a clear communication strategy in place makes it easier for the company to quickly make accurate decisions about whether and how to respond to a potential short seller report.
If a company becomes the target of a short seller report, we recommend that the targeted company work with outside counsel. The short seller report will most likely raise sensitive communications considerations for the targeted company, and both the publication of a short seller report and the publication of a response to such a report may raise complex legal issues related to the company’s ongoing disclosure obligations. If in doubt, the prudent course of action would be to seek the support and advice of experienced legal counsel, financial advisors, PR firms and specialist data analysis.