30 June 2021

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Ian Zhou
Economic Policy Section

Activist short selling has affected many Australian companies and made media headlines in recent times. On 1 June 2021, the Australian Securities and Investments Commission (ASIC) issued an information sheet on activist short selling. This contributes to the current public debate on whether there is appropriate regulatory oversight of activist short selling.

What is activist short selling?

Short selling is an investment or trading strategy that allows investors to profit when financial assets such as company shares or currencies go down in price. When investors short sell shares (also known as taking a ‘short’ position), they borrow the shares and immediately sell them to buyers who are willing to pay the current market price.

The short sellers are obligated to return the borrowed shares, and in order to make a profit they hope that the share price will go down which provides an opportunity to buy the shares at a lower price than the original sales price.

‘Activist’ short sellers go further by taking a ‘short’ position and then releasing negative information about a company to deliberately drive down its share price—the term ‘activist’ having the more narrow meaning in this context of taking actions that are calculated to affect the share price.

Figure 1: a visual illustration of how short selling works

Source: Parliamentary Library

Who is affected by activist short selling?

Activist short sellers have targeted many companies listed on the Australian Securities Exchange by disseminating negative information about the companies. Examples of targeted companies include SEEK, Rural Funds Group, and Syros Resources. Targeted companies could potentially suffer reputational damage and lose consumer confidence.

Activist short selling is predominantly undertaken by hedge funds or agents acting on their behalf.

Is activist short selling legal in Australia?

Activist short selling is not prohibited in Australia, provided that the short sellers do not breach corporations law. For example, while short selling is allowed, it is illegal for short sellers to disseminate fraudulent information. Other types of behaviour that breach corporations law include insider trading, ‘naked’ short selling, and market manipulation.

Historically speaking, regulations on short selling tend to tighten in periods of market uncertainty. For example, after the 2008 Global Financial Crisis the Australian Government introduced the Corporations Amendment (Short Selling) Bill 2008 to restrict short selling.

Why is activist short selling not prohibited?

There are divided opinions about the impact of activist short selling on market efficiency and fairness. Activist short sellers believe that they are acting as the ‘white blood cells’ of financial markets by scrutinising overvalued shares and voicing legitimate concerns about the companies.

Professor Richard Holden of the University of New South Wales, among others, argues that activist short sellers can improve market efficiency, and more regulations may lead to a less efficient financial market. Similarly, Dr Antonis Kartapanis of the University of Texas believes allegations levelled by activist short sellers can be a strong predictor of corporate accounting fraud, and that therefore activist short sellers can play a positive role in the financial markets, while Dr Wuyang Zhao of the University of Texas found that activist short sellers tend to target companies with opaque operations or structure.

On the other hand, companies targeted by activist short sellers view them as market manipulators who profit from spreading panic. The companies argue that there is insufficient deterrence of ‘hit-and-run’ abusive short selling because it takes time for the companies to react to bad news. By then, the activist short sellers may have already profited from their trade and damaged the reputation of the companies. Therefore, targeted companies tend to advocate for tougher regulations on activist short selling.

ASIC Commissioner Cathie Armour said in a media release:

When activist short sellers provide accurate and meaningful new information, they can have a positive impact on price formation and market integrity as they may counterbalance excessive market optimism. However, activist short sellers can also unfairly distort the price of a target entity’s securities, which is harmful to the integrity of our markets.

Internationally, there is no settled approach to the issue, with regulators discussing the impact of activist short selling. For example, in December 2020 the Canadian Securities Administrators published a consultation paper to facilitate discussion about activist short selling.

In the United States, a group of academics have petitioned the Securities and Exchange Commission to enact more regulations on what they perceive as ‘short and distort’ selling.

ASIC information sheet on activist short selling

On 1 June 2021, ASIC published an information sheet (INFO 225) to recommend ‘better practices’ for activist short sellers to follow when they disseminate information to drive down stock price. Broadly speaking, ASIC places greater onus on activist short sellers to ensure that the information they disseminate is reliable and balanced, and that they give more time to companies to respond to the information.

ASIC has set out a number of enforcement actions it may take if activist short sellers do not follow the recommended practices. However, ASIC does not have regulatory oversight of activist short sellers located overseas.

ASIC has also recommended ‘better practices’ for companies to follow if they are targeted by activist short sellers.

Conclusion

Attitudes toward activist short selling vary widely, with some stakeholders favouring tougher regulations. ASIC has not announced that it will conduct a formal review of its policy on activist short selling. Therefore it remains to be seen whether ASIC’s information sheet is a stopgap measure that leads to greater regulatory oversight of activist short selling, and whether the information sheet alone will be effective in encouraging activist short sellers to follow the recommended ‘better practices’.

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