How short-seller Hindenburg Research turns a profit through exposes

Explained: What is Hindenburg Research, what is short-selling and how much profit did the US firm make on its 2023 Adani Group report

Hindenburg Research, a US-based investment research firm known for its investigative reports and short-selling strategies, released new allegations against the Securities and Exchange Board of India (Sebi) on Saturday. The firm alleged that Sebi failed to act on its 2023 report accusing the Adani Group of financial misconduct due to a conflict of interest involving Sebi’s Chairperson Madhabi Puri Buch.

 

According to Hindenburg Research, Buch and her husband held investments in offshore firms linked to the Adani conglomerate, potentially compromising the impartiality of Sebi’s actions. This came after Sebi accused Hindenburg of sharing its findings with a New York-based hedge fund manager, allowing them to trade and profit from the information. Hindenburg has also reportedly made more than $4 million from its short-selling position on Adani stocks.

 

 

To better understand this situation, here is a close look at Hindenburg Research, what is a short-seller and how do they make a profit, as well as a recap of its findings on Adani Group and allegations against Sebi.  Also read: Adani group stocks dip up to 17% on new allegations by Hindenburg Research

 

What is Hindenburg Research?

Hindenburg Research, founded by Nathan Anderson, is a firm that specialises in forensic financial research. The company focuses on uncovering accounting irregularities, unethical practices, and undisclosed financial issues within corporations.

 

What sets Hindenburg apart is its practice of short-selling, a strategy where the firm takes a position predicting the decline of a company’s stock price. Hindenburg’s reports often serve as the catalyst for these price drops, allowing the firm and its associated investors to profit from the decline.

 

The firm is named after the 1937 Hindenburg disaster, an avoidable airship explosion that serves as a metaphor for the financial disasters Hindenburg Research aims to expose. The firm has a history of impactful investigations, including a significant report on the electric vehicle company Nikola Corp, which led to criminal charges against its founder and a substantial financial settlement with the US government.

 

What is short-selling?

Short selling is a trading strategy where investors bet that the price of a stock will decrease. Unlike the traditional method of buying a stock with the hope that its price will rise (going long), short selling involves borrowing shares of a stock and selling them at the current market price, to buy them back later at a lower price. 

The difference between the selling price and the buying price is the profit for the short seller. 

In India, short selling is recognised as a legitimate trading strategy and is allowed for all categories of investors, including retail and institutional investors, under a framework by Sebi.

 

How does short selling work?

Short-selling can be broken down into four steps, which are:

1. Borrowing shares: The short seller borrows shares of a stock from a broker.
2. Selling shares: The borrowed shares are sold in the open market at the current price.
3. Buying back (covering): The short seller later buys back the same number of shares, ideally at a lower price.
4. Returning shares: The purchased shares are returned to the broker, and the short seller pockets the difference between the selling and buying prices.

 

Why do investors short sell?

Short sellers speculate on the decline of a stock’s price, aiming to profit from it. Investors may short sell to protect gains or minimise losses in a portfolio. For instance, if they own a stock that might drop, they can short sell it to offset potential losses.

 

What risks are involved in short-selling?

Unlike buying stocks (where the maximum loss is the amount invested), short selling carries unlimited risk. If the stock price rises instead of dropping, the short seller must buy it back at a higher price, potentially leading to significant losses.

 

Additionally, if a stock with high short interest suddenly rises in price, short sellers may rush to buy it back to limit their losses. This surge in demand can drive the stock price even higher, exacerbating losses.

 

Hindenburg’s allegations against Adani Group

In January 2023, Hindenburg Research published a report accusing the Adani Group of orchestrating the “largest con in corporate history.” The report alleged that the conglomerate, under the leadership of Gautam Adani, engaged in stock manipulation and financial misconduct that inflated the company’s valuation by over $100 billion since 2020. It also detailed how key figures within the Adani Group, including Gautam Adani’s brothers, were involved in activities that Hindenburg characterised as fraudulent.

 

Hindenburg’s report had a dramatic impact on the market, wiping out more than $100 billion of the Adani Group’s market value.

 

How much did Hindenburg make from the Adani report?

Hindenburg Research made over $4 million from its short-selling position on Adani stocks, according to Bloomberg, which reported earnings figures disclosed in a statement by the firm.

 

In June of this year, Sebi sent a show-cause notice to Hindenburg, stating that Kingdon Capital Management, a New-York based hedge fund, had access to the Adani Report two months before it was published. Sebi’s notice claimed that the fund had given Hindenburg 30 per cent of the profits it made from its Adani trades.  

 

Kingdon gave Hindenburg $4.1 million and is yet to pay an additional $1.4 million, according to Sebi. 

Hindenburg has denied Sebi’s allegations.

 

Sebi’s response and allegations of conflict of interest

Following the 2023 report, Sebi initiated investigations into the Adani Group’s activities. However, these probes have faced criticism for not progressing significantly.

 

Hindenburg’s latest report, released on August 10, 2024, suggests that Sebi’s inaction may be due to a conflict of interest at the highest level. The firm alleges Sebi Chairperson Madhabi Puri Buch and her husband, Dhaval Buch had investments in offshore funds connected to entities used by the Adani Group for market manipulation. These investments, dating back to 2015, raise questions about the impartiality of Sebi’s investigation into the Adani Group.

 

Sebi has responded to Hindenburg’s claims, labelling them as ‘inappropriate’. The regulator stated that Madhabi Puri Buch has made all required disclosures and has recused herself from matters where there is a potential conflict of interest. Despite this, the allegations have cast a shadow over Sebi’s ability to oversee the investigation objectively.

 

The Indian government has taken a stance to not interfere with Hindenburg report on Sebi.