SEBI backs short selling in its reply to Supreme Court

15 Feb 2023 , 08:27 AM

The market regulator SEBI has told the Supreme Court that it does not support outlawing short-selling or the sale of borrowed shares and that it is looking into claims made against the Adani Group by a tiny short-seller as well as changes in its stock price. 

The Securities and Exchange Board of India (SEBI) explained short-selling and what Hindenburg Research did in a written note submitted to a bench presided over by Chief Justice DY Chandrachud during the hearing of two PILs regarding the recent stock crash of the Adani Group. However, the 20-page document omitted mentioning the Adani Group once.

In the memo, it was said that the regulator was ‘already investigating both the claims contained in the Hindenburg report as well as the market action immediately prior to and post the publication of the report.’

The Adani Group allegedly pulled off ‘the greatest fraud in business history’ utilizing offshore tax havens and stock manipulation, according to a January 24 report by US-based short-seller Hindenburg.

The group has consistently refuted the charges, which have caused shares of its listed firms to tumble, resulting in a combined market value loss of more than USD 120 billion in just three weeks.

According to SEBI, short selling typically entails investors borrowing shares, selling them, and then planning to repurchase them at a lower price in the future before returning the shares to the lenders. They profit from the gap between the initial higher sale price and the latter lower purchasing price.

Some people view short selling as a good and necessary aspect of the securities market since it helps inflated stocks’ prices correct while also supplying liquidity.

Therefore, any restrictions on short selling, per se, ‘may distort efficient price discovery, provide promoters with unrestricted freedom to manipulate prices, and favor manipulators instead of rational investors,’ the article stated, adding that others view it as an undesirable activity that thrives on distressed selling and is susceptible to its own form of manipulation.

Short selling is acknowledged as a lawful investing activity by most nations’ securities market regulators, notably in all developed securities markets.

Therefore, SEBI remarked, ‘In all major jurisdictions, the authorities have authorized short sales to take place inside a regulated framework rather than outlawing them per se.’

In addition, the International Organization of Securities Commissions (IOSCO) examined the procedures of lending securities and shorting them on various markets and advised openness rather than outright banning short selling.

It described the structure for controlling short selling in Indian capital markets and stated, ‘India follows this policy of controlled short selling and has framed its system appropriately.’

According to the report to the court, SEBI did not outright forbid short selling even at tumultuous moments like the beginning of the Covid epidemic in March 2020, when Nifty plunged by about 26% over the course of 13 trading days.

There was no appreciable effect on the run on Adani Group shares at a systemic level that may call for a review, it added, adding that the markets ‘continued to function in a healthy way, rebounding significantly faster than other global markets.’

In the note, SEBI made indirect reference to the Gautam Adani group by noting that ‘the Group under discussion has multiple listed companies in India other than two recent acquisitions.’

The SEBI market framework, which is intended to prevent excessive volatility in stocks (both price increase and decline), was frequently triggered during the period when the share prices of the Group’s firms were rising significantly.

It added that the group has a number of bonds listed in the foreign market that were denominated in US dollars. According to Hindenburg’s report, its short positions in the Group are in foreign-traded derivatives and USD bonds on international markets.

The SEBI stated that it might not be suitable to provide specifics about the ongoing procedures at this time because the matter was still under investigation.

The SEBI has a robust set of frameworks and market systems to ensure seamless trading and settlement, including frameworks for volatility management and restrictions on short selling, including by foreign institutions, it said while listing out the legal and other frameworks that are available to deal with wrongdoings in the securities market.

In light of the facts surrounding the most recent incidents, the regulator stated that Hindenburg is a short seller research company, among other such companies in the US that conduct research on companies they think to have governance and/or financial concerns.

‘Short sellers then benefit by purchasing the shares or bonds at lower prices. Bond and share prices decline and their profits rise in direct proportion to how much the market trusts their forecasts and how often ‘stop loss limitations’ are triggered ‘It read.

On February 17, when it will consider forming a panel to investigate improving the regulatory environment, the top court is slated to hear the two PILs alleging exploitation of innocent investors and ‘artificial crashing’ of the Adani Group’s stock value.

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