In Adani-Hindenburg saga, SEBI’s haste makes waste The regulator has called a wrap

on its probe into the post-Hindenburg market mayhem. In the process, is it taking the
easy way out and doing more harm than good?
T Surendar Mumbai

11 July, 2024

The Securities and Exchange Board of India is basking in the glory of a job done
well. And quickly. On 27 June, SEBI issued a show-cause notice to US-based
Hindenburg Research, its founder Nathan Anderson and four others, accusing them
of fraud. The regulator said that all of them were guilty of violating several of its
rules and, as a consequence, liable to give back the profits they made from their
questionable trades
Earlier, between January and March, it sent notices to seven Adani group companies,
asking them why they shouldn’t be held guilty for non-disclosure of related party
transactions and failing to adhere to listing agreements with stock exchanges.

SEBI has thus managed to initiate action against both Hindenburg and the Adani
group. All in a matter of a year since the Supreme Court directed it to investigate
and safeguard interests of investors, in the wake of the market mayhem triggered by
the 126-page Hindenburg report. Made public on 25 January 2023, this report blew
a $150 billion-sized hole in investor wealth with its allegations of corporate
malfeasance and stock manipulation by the Adani group.
The market regulator’s actions, on the face of it, seem even-handed and decisive.
Even the Supreme Court-appointed six-member expert committee, in January this
year, said it was satisfied with SEBI’s investigation, initiated at the court’s behest in
March 2023, and called on it to take the findings “to their logical conclusion in
accordance with the law”.
But, can the regulator really take credit for the way it has responded to one of India’s
biggest market shocks in recent memory?
SEBI had been investigating the Adani group since October 2020. Yet, when the
Hindenburg report raised multiple issues that it was already looking into, there was
no acknowledgement of its probe into the group. It took the Supreme Court’s
intervention for the probe to become public. Turns out, SEBI had nothing to show
for its over two-year-long investigation until that point.
Then, in just 9 months, SEBI was able to wind up its investigation into 22 charges
and send show-cause notices to the Adani group. That kind of haste is
uncharacteristic of the way it normally operates. Especially in cases that involve
large corporations, where SEBI takes its own sweet time to investigate and issue
notices—usually two years or more. In the case of an insider trading case against
Reliance Industries, for instance, it took over a decade-and-a-half for it to finally
close its investigation.
“It appears that SEBI used the Supreme Court’s cover to wind up its investigation
into the Adani companies and bring closure,” says a senior counsel with a Delhi-
based securities law firm, requesting anonymity. “With the court already having said
it is satisfied with the investigation, there aren’t going to be any further questions.”

In one fell swoop, SEBI may have found a way to pull up an errant short seller as
well as rap India’s most powerful conglomerate on the knuckles. In doing so, the
regulator cleared the Adani group of a host of corporate governance charges. “The
question that comes to mind is whether SEBI watered down its charges to make the
show-cause more palatable,” says the senior counsel quoted above.

As for its show-cause notices to Hindenburg and its associates, SEBI’s action comes
across as inconsistent. Only last month, it punished a TV anchor and an analyst for
actions similar to what Hindenburg is accused of. The TV anchor and the analyst
weren’t given an opportunity to explain themselves. In Hindenburg’s case, though
the firm has admitted to the offence that SEBI has accused it of, it has been served
with only a notice seeking an explanation. “Why is SEBI dithering when it could
have set an example with a decisive order?” asks the counsel quoted above.

It beggars belief that all SEBI could do when faced with a $150 billion loss to
investors in India’s most valuable business group, beset with serious underlying
issues, is seek explanations and hand out fines. Its actions in the Adani-Hindenburg
saga will not just impact its reliability as a regulator but have a rub-off on all
stakeholders in the market.

Out of its depth

When the Supreme Court directed SEBI to investigate the allegations levelled by the
Hindenburg report, it basically meant the regulator would have to look into the
related party transactions undertaken by the Adani group. This would involve
scrutinizing financial reports and catching accounting fraud, not an area of expertise
for SEBI. So far, most of its actions, as evidenced by the majority of its orders, are
directed against market manipulation and securities trading-related issues.

Going forward, SEBI would need to develop a high level of accounting expertise to
vet the books of companies. At present, companies are required to file their quarterly
returns to stock exchanges. Investors who want to raise questions on a company’s
accounts have to first file a complaint with a stock exchange, which will then forward
it to the regulator on a case-by-case basis.
That apart, to identify corporate accounting fraud, SEBI would also require forensic
auditing expertise. It currently relies on external forensic auditors who are paid by
the companies under investigation. “Forensic audit firms like Deloitte have ongoing
relationships with every large firm in India. It is unlikely that they will be very
critical if they are investigating the firm who is paying them,” says an institutional
investor, asking not to be named.
Recent history is replete with instances where SEBI has failed to spot related party
transactions and identify fraud. Even when cases have been brought to its notice, the
action has come too late.
One such pertains to another Hindenburg report that SEBI seems to have completely
overlooked. In 2019, Hindenburg put out a “sell” report on US-listed Eros Media
World, which happened to be the parent of India-listed Eros International.
Hindenburg disclosed that it had taken a short position on the stock after flagging
serious accounting irregularities in the India unit. The report led to Eros International
shares falling 10% on the day the report was released, and over 50% subsequently.

It was only last year that SEBI initiated action against Eros International in the form
of an interim order. It had found that the company had misrepresented its accounts
and siphoned funds. By the time SEBI acted, Eros International’s share price had
already fallen more than 50%. One of Eros International’s promoters and a board
member, who was in charge of day-to-day operations, had even relinquished his
position.

Another is Hyderabad-based Brightcom. A complaint to the NSE triggered an

investigation into the write-off of investments. Subsequently, SEBI found that
Brightcom’s promoter, Suresh Reddy, had misrepresented his stake in the company
and fudged reports submitted to stock exchanges. When these facts were highlighted
by the media, including The Morning Context, the Brightcom stock crashed from
over Rs 200 to Rs 18 in a matter of a few months.
Even in the case of Zee Entertainment, where the financial statements revealed
several related party transactions that involved moving large sums of money to
family-controlled companies, SEBI’s investigation began over 2 years after the
problems in Zee became public. The investigation is nowhere near complete and that
continues to weigh on the company’s investors.
These examples highlight the fact that though SEBI is expected to keep a tab on
accounting and ownership fraud, it has failed to act before the stocks crashed and
investors lost their money. In a recent public meeting, SEBI chairperson Madhabi
Puri Buch urged industry stakeholders to proactively report any malpractices within
their sectors. Effectively putting the onus on others to do its regulatory job. “SEBI’s
actions on misdemeanours of companies most often begins with some sort of a
complaint or news article and rarely by its own inference,” says a retired partner at
EY, requesting anonymity.
The bottom line is that though the Supreme Court has put the ball in SEBI’s court,
examining accounting flaws is not the market regulator’s strong suit.

Rocking the foundation

Consider this: after the Hindenburg report led to a steep fall in Adani group shares,
US-based institutional investor GGQ Partners acquired a big chunk of shares across
Adani companies and subsequently made a public announcement about its
acquisition. GOQ’s chairman and chief investment officer, Rajiv Jain, made a TV
appearance to explain the rationale behind the investment. From that point on , all
Adani shares began rising.
Can Jain be blamed by SEBI for talking up Adani shares after his investment?

Hindenburg has done exactly that, except in its case, it was a “sell” transaction
instead of a “buy”. Hindenburg’s associate, Mark Kingdon, took a short position in
one of the Adani group companies through a future contract and, subsequently,
Hindenburg posted its report on its website. SEBI says that the “sell” transaction
prior to publishing the report amounts to fraud as it was known that the Adani stock
would fall post publication. Isn’t it similar to announcing a long position after it has
been bought by a big institutional investor?
SEBI, on its part, says that Hindenburg’s wrongdoing lies in Kingdon squaring off
his short position after publication of the report and the speed with which it was done
amounts to market manipulation. But isn’t it obvious that if Jain built a long position
knowing full well that Adani shares will go up, Kingdon doing the opposite isn’t
wrong?

Under the current rules, naked short sales are not allowed in India (you cannot sell
any stock that you don’t own). Even institutional players cannot do intraday short
trades in a stock they own. That is, they cannot sell and buy shares in bulk in the
course of a day to capitalize on any sharp upward movement and bring down their
costs. For SEBI, this is akin to short selling.
Now, SEBI’s action on Hindenburg is likely to cast a further shadow on analysts
recommending a “sell” on any stock. In any case, even large broking houses rarely
put out “sell” reports on conglomerates as they fear retribution in the form of
companies denying them access to their management. Truth be told, such “sell”
recommendations are rare also because some of the larger brokerages fear loss of
business in their investment banking arms, Chinese walls notwithstanding. “Our
institutional clients want to know if we have access to the management. That won’t
come with a sell recommendation report,” says the head of broking at a foreign bank,
asking not to be named.
SEBI is said to be mulling more rules against short sellers in the light of the
Hindenburg episode. In what seems an unfair deal, it wants investors to disclose
short positions even if it is based on private reports like Hindenburg’s. If the investor
is a foreign portfolio investor, such an arrangement would have to be disclosed to
the SEBI-registered conduit it invests through.
In trying to make villains out of short sellers, SEBI may well be tinkering with the
most fundamental facet of any free market: price discovery. In a bull market, without
adequate sellers, stocks run the risk of rising fast, setting them up for steep falls when
sentiment changes. SEBI may argue that stock lending schemes are already in place
for short sellers, but they come with an added cost.
Short positions, almost always, are taken against companies that have something to
hide. “Institutional short selling is a guard against bad management. Countries like
India that have a high proportion of promoter-driven companies shouldn’t
discourage short sellers,” says the head of broking at a foreign bank quoted above.

Punishment or a way out?

There is also a feeling that the Supreme Court’s recognition of the power of SEBI to
investigate most aspects of corporate fraud could prove to be an advantage to
promoters. That’s because, unlike its US counterpart SEC, SEBI does not have the
powers to seize, arrest and jail. SEBI’s punishment is usually in the form of fines,
curbs on participating in the capital market and associating with listed entities. For
promoters who have already siphoned off money from their companies, this is a
small price to pay.
Coming back to Brightcom. In its final order in February, SEBI said: “The CMD
(Suresh Reddy) treated BGL as his private enterprise, disregarding the large number
of public shareholders and their interests. There were no checks and balances within
BGL of the manner in which financial transactions were recorded.”

SEBI fined Brightcom Rs 40 lakh and ruled that Reddy could not be a director in the
company anymore. He was barred from trading in the capital market for three years.
Ideally, SEBI’s strictures should have helped correct problems in the company.

But Brightcom didn’t seem to pay heed. When it published its much delayed
quarterly results for the quarter ended September 2023, the company revealed a
substantial income from its US operations. Its auditor appeared dissatisfied with the
company’s explanation on its source and qualified its report. Says an investor who
lost a big chunk of money in Brightcom: “The company appears to be continuing the
very crime SEBI caught it for—inflated income. This is one case that clearly
establishes that SEBI’s punishment has been quite ineffective.”
Likewise, in the case of Eros International, its promoters haven’t been able to recover
advances worth over Rs 250 crore made to certain companies. Some of these
companies couldn’t be traced, indicating the promoters may have given away the
funds to bogus entities. This should qualify as a criminal offence. But, since SEBI
had focused on the limited issue relating to non-receipt of money, it did not pursue
a criminal case against the promoters. Neither did it enlist the help of other law
enforcement agencies to trace the questionable companies to whom Eros
International gave money.
Its final orders on Eros International banned its promoters from running his company
for three years and also forbade them from holding a position in any listed company.
But, since the Lullas no longer hold controlling stakes in the company, which is
currently making losses, it is the investors who are at the receiving end. The
company is being run by a manager with the promoters in the shadows.

“If SEBI becomes the preferred recourse of smart promoters who would want to get
away with mere fines, investors will be at the receiving end,” says the law firm
partner.
So where does all this leave SEBI?
Despite all its shortcomings, SEBI’s importance cannot be overstated. India is all set
to be among the top three capital markets in the world after the US and China. The
NSE is already the biggest in the world for derivative trading. In that light, SEBI’s
actions need to stop oscillating between extremes and inspire confidence in
investors, especially when it comes to market-altering events like the Hindenburg
episode.