Decoded: Hindenburg vs Adani saga raises more questions about short selling

The saga between Hindenburg Research and the Adani Group continues to be a complex web of accusations and investigations.

Remember the Hindenburg report from last year that accused the Adani Group of wrongdoings? It caused a big stir in the Indian stock market. Now, the short seller, Hindenburg Research, is back in the news, and things are getting heated.

 Let's delve deeper into the story, understanding "short selling" and the ongoing controversy.

What is Short Selling?

Imagine borrowing a car from a friend, immediately selling it to someone else, and then hope to purchase it back later at a lower price. You then return the car to your friend and pocket the difference. This is essentially how short selling works in the stock market.

 

• Investors borrow shares of a company they believe are overvalued.
• They sell these borrowed shares hoping the price will drop.
• Later, they buy back the same number of shares at a (hopefully) lower price to return them to the lender and profit from the difference.

Short Selling in the Hindenburg-Adani Saga:

Hindenburg is a short seller. They published a report in January 2023 accusing the Adani Group of financial irregularities, leading to a significant drop in the company's stock price. Hindenburg likely profited from this by buying back the borrowed shares at a lower price.

New Development: The Securities and Exchange Board of India (Sebi), India's market regulator, issued a "show-cause notice" to Hindenburg Research on June 27th, 2024. It is a formal document from a regulatory body like Sebi, outlining potential violations of regulations and asking the recipient to explain their actions. Essentially, Sebi asked Hindenburg to justify their research report and short-selling activity related to the Adani Group.

Hindenburg's response:

• Hindenburg claims the notice from Sebi is suspicious and suggests the regulator is biased towards Adani.
•  Hindenburg claims Sebi initially agreed with "several key findings" of their report but later halted the investigation.
• They believe Sebi is trying to help Adani instead of investigating the allegations properly.
• They also claim their short-selling activity followed Indian regulations.

What happened in 2023?

January 2023: Hindenburg publishes a scathing report accusing the Adani Group of stock manipulation, improper use of offshore tax havens, and inflated valuations. The report triggered a major sell-off, causing Adani Group's stock prices to plummet by over 70% in some cases, leading to a loss of over $150 billion in market value.

The Adani Group vehemently denies all allegations, calling them "baseless" and a "malicious attempt to undermine" the company. They claim Hindenburg's report is motivated by their short position against the Adani Group, where they stand to gain financially if the stock price falls.

Following the controversy, the Securities and Exchange Board of India (Sebi) launches an investigation into both Hindenburg and the Adani Group.

Public outcry and concerns about market manipulation led the Supreme Court to intervene. The Court directed Sebi to conduct a "thorough and fair" investigation into the allegations.

What happened now?
In June 2024, Hindenburg received a "show-cause notice" from Sebi. This notice outlines potential violations of regulations related to their research report and short-selling activity. Hindenburg expressed suspicion about the timing and motives behind the notice. 

Hindenburg's Defense:

Hindenburg maintained that their research report was based on extensive due diligence and publicly available information.

They argued their short-selling activity followed all legal and regulatory procedures in India.

Latest updates

Hindenburg has also alleged that  after its January report was release, Sebi  pressured stockbrokers (people who buy and sell stocks for others) to discourage short selling of Adani stocks. Short selling is a strategy where investors borrow shares, sell them, and then aim to buy them back later at a lower price to return them and make a profit.

It claimed that  Sebi allegedly pressured brokers to convince their clients to close their existing short positions on Adani stocks. This means these investors would have to buy back the borrowed shares, which would increase demand for Adani stocks.

Hindenburg also alleged that Sebi threatened brokers with lengthy and costly investigations if they didn't discourage short selling of Adani stocks.

By pressuring brokers to close short positions and discouraging new ones, Hindenburg argues that Sebi's actions artificially increased demand for Adani stocks. This might have helped prevent the stock price from falling further after the negative report (acting as a "floor").

Hindenburg claims that after the Supreme Court ordered Sebi to investigate the allegations in January 2024, the regulator initially seemed to agree with "several key findings" of their report. However, Hindenburg alleges that SEBI later claimed to be unable to investigate further. 
 

Hindenburg highlights a statement by the Adani Group's Chief Financial Officer, Jugeshinder Singh, from last month, where he dismissed some regulatory notices aimed at the group as "trivial." This statement, according to Hindenburg, suggests a level of confidence from the Adani Group in their dealings with Sebi.

To support this claim, Hindenburg points out that Gautam Adani, chairman of the Adani Group, met with Sebi Chairperson Madhabi Puri Buch twice in 2022. 

Hindenburg also released details about their short selling activity. 

In the 46-page notice, which Hindenburg attached with the post, Sebi said that the report released in January 2023  "contained certain misrepresentations/inaccurate statements" meant to "mislead readers".

"Today we are sharing the entirety of this notice, frankly because we think it is nonsense, concocted to serve a pre-ordained purpose: an attempt to silence and intimidate those who expose corruption and fraud perpetrated by the most powerful individuals in India," Hindenburg said.

"In our view, Sebi has neglected its responsibility, seemingly doing more to protect those perpetrating fraud than to protect the investors being victimised by it," it added.

In the post, Hindenburg Research also named the Kotak Mahindra Bank and said that it oversaw an "offshore fund structure" used by the short-seller's investor partner for shorting the Adani Group stocks.

"While Sebi seemingly tied itself in knots to claim jurisdiction over us, its notice conspicuously failed to name the party that has an actual tie to India: Kotak Bank, one of India’s largest banks...which created and oversaw the offshore fund structure used by our investor partner to bet against Adani," it said.

"Instead it simply named the K-India Opportunities fund and masked the 'Kotak' name with the acronym 'KMIL'," it added.

This is what Kotak Mahindra Bank has to say about Hindenburg's allegations:

“K- India Opportunities Fund Ltd. (KIOF) is a SEBI registered Foreign Portfolio Investor and is regulated by the Financial Services Commission of Mauritius. The Fund, was established in 2013 to enable foreign clients to invest in India. The Fund follows due KYC procedures while onboarding clients and all its investments are made in accordance with all applicable laws. We have cooperated with regulators in relation to our operations and continue to do so.

Kotak Mahindra International Limited (KMIL) and KIOF unequivocally state that Hindenburg has never been a client of the firm nor has it ever been an investor in the Fund. The Fund was never aware that Hindenburg was a partner of any of its investors. KMIL has also received a confirmation and declaration from the Fund’s investor that its investments were made as a principal and not on behalf of any other person," Spokesperson, Kotak Mahindra International Limited.

Hindenburg's financial Involvement:

• Hindenburg clarified they had only one investor partner for their short selling against Adani.
• Most of their profit ($4.1 million) came from this partnership, with a tiny amount ($31,000) from their own shorting of Adani bonds.
• They might barely break even after accounting for legal and research costs related to the Adani investigation.
• Despite the financial outcome, Hindenburg emphasized their pride in exposing potential wrongdoing at the Adani Group.

"We have made $4.1 million in gross revenue through gains related to Adani shorts from that investor relationship," it said. "We made just $31,000 through our own short of Adani US bonds held into the report."

"Net of legal and research expenses (including time, salaries/compensation, and costs for a two-year global investigation) we may come out ahead of break even on our Adani short," the blog post read.

What's next?

Hindenburg plans to file a Right to Information (RTI) application seeking details of Sebi's interactions with both Hindenburg and the Adani Group.
 

Sebi will likely review Hindenburg's response to the show-cause notice before taking further action.

Disclosure: Entities controlled by the Kotak family have a significant holding in Business Standard Pvt Ltd