While ASIC information sheet INFO255 is a welcome attempt to establish workable rules for 'activist short sellers', we query whether the guidance appropriately balances the interests of activists and their targets.
Activism has become a ubiquitous feature of the Australian public equities landscape. This includes so-called 'activist short campaigns', where the holder of a short position releases a 'short report' to support its view of overvalue, and trusts that the market will agree with its thesis (in which case the activist will profit on the subsequent share price fall). ASIC has rightly focused on the need to ensure that these reports are not misleading, incomplete or unsubstantiated.
ASIC has recently released the information sheet, Activist short selling campaigns in Australia (INFO255). The information sheet sets out what ASIC regards as 'better practices' for both activists and target companies in the course of an activist short campaign.
Where a short report contains materially false or misleading information, or amounts to outright market manipulation, ASIC has been ready to take enforcement action both in court and through administrative remedies. However, where the report merely contains inflammatory language or twists, omits or obscures facts without directly misstating them, the challenge of managing the material is more difficult.
The Rural Funds case demonstrates that our courts expect short sellers to exercise care in publishing their allegations and that they can, and will, be held to account where appropriate. In that case, the target brought action against a US short seller, seeking declarations of a breach of law arising from a selectively released short report. While the court had little trouble in concluding that the short report was misleading and that a breach of law had occurred, the shortcomings of the current regulatory regime were shown up by the fact that the activity complained of took place in August 2019, yet the court only handed down its findings in February 2020. The market disruption caused by the release of a misleading short report cannot be undone.
No doubt, the release of ASIC's information sheet was partly in response to this case and an attempt to provide guidance for short sellers on acceptable and unacceptable conduct. Unfortunately the guidance misses the opportunity to address some of these shortcomings and ultimately leaves responsibility for ensuring market efficiency with the target of the campaign.
Better practice for activist short sellers and authors of short reports
The information sheet sets out various recommendations for activist short sellers and authors of short reports. These include:
Short reports should be released outside of Australian trading hours and not immediately before the market opens
Target entities have complained that reports are often released during, or immediately before trading hours. By the time the target has had a chance to respond, the market may have moved. By requiring activists to release the reports outside of trading hours, the information sheet aims to give target entities time to prepare a more complete response (see below) so that the market can be fully informed before any trading takes place.
We think it unlikely that the more aggressive of activist short sellers will take up ASIC's invitation to forewarn its targets. In any event, the recommendation underestimates the complexity of the target's task in responding to what is more usually a complex and detailed thesis. A sensible response is unlikely to be written overnight.
The short report should first be fact-checked with the target entity before release
ASIC expects that doing so will help ensure that patent errors are rectified and any misleading information is addressed before reaching the public.
This is consistent with observations made by Justice Hammerschlag in the Rural Funds case, but those facts were quite different to the usual circumstances in the sense that he found that the short seller did not care whether what it was saying was false.
To us, ASIC's recommendation is problematic in that the insider trading and selective disclosure rules would generally preclude the target from engaging with the activist on an open access basis. Moreover, it appears contradictory to ASIC's (sensible) guidance that short sellers should not share their investment thesis selectively.
If disclosure rules are working effectively, activists should be entitled to rely on those disclosures as the basis for their theses.
Reports should be founded on verifiable facts
Reports should contain clear and objective statements that are based on reliable information. Any recommendation or opinion should be formed on a reasonable basis. Authors should not be selective with the facts that they choose to include.
This reflects existing market practice for the more sophisticated short sellers and is no different to the expectations that ASIC places on any issuer making a release to the market.
Reports should avoid using overly-emotive language
ASIC recognises that emotive, immoderate or vague language can distort facts and prompt panicked decision-making by investors. Only balanced, precise and unbiased statements should appear in the report.
Disclosure of conflicts
ASIC makes it clear that the author of a report should disclose if it has a short position from which it expects to profit if the share price drops. Again, this is common practice already, and any failure to do so would almost certainly breach the law.
Better practice for target entities
Significantly, the information sheet also requires targets of an activist short campaign to raise their game. Specifically, ASIC suggests:
Comprehensively responding to the claims
Target entities must prepare a detailed response to any short report released against them. Responses should address each assertion with 'sufficient detail' and be 'backed up by evidence' wherever possible. The information sheet makes it clear that, even where the target considers the report to be wholly without merit, 'broad statements dismissing an entire report as being false are unlikely to address investor concerns'.
Responding in a timely manner or seek a trading halt
Where a target has received prior notice of a short report, the target is expected to prepare a response quickly enough so that it can be released at 'around the same time' as the report. Targets are advised to request a trading halt in instances where they have not had sufficient time to prepare an adequate response.
What are our views?
INFO255 has been welcomed by some as a rebuke of 'short and distort' tactics, and as a potential indicator of more meaningful regulation to come. However, in at least two important respects — namely, pre-checking with targets and mandatory response requirements — the approach suggested by ASIC falls short of its objectives.
It remains to be seen whether INFO255 will be effective in encouraging less scrupulous players to operate within the boundaries of best practice. The fact remains that some of these operators are happy to operate at the margins of lawful conduct, in the knowledge that they are probably outside of ASIC's reach (often because they are based offshore). We are not convinced that ASIC's recommendations will change their practices.
Against this, we are concerned that the guidance imposes too heavy a burden on the target company in responding to an activist attack. Companies should be free to make their own assessment of the credibility of the short report and to factor that assessment into their market response. To impose a blanket approach on how targets should respond, could lead to a situation where companies find themselves in an endless round of trading halts, while they respond to claims with which they disagree, or which they consider are spurious or not worthy of comment. Ironically, under the new guidance, it is the target of the campaign who bears the compliance risk.
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