Avoiding a short and distort attack

Thu 24 November 2022

Alexandra Cain

Moderator for Listed@ASX

Listed@ASX Summer 2022/2023

In 2019, Rural Funds Group (ASX: RFF) was targeted by an overseas activist short seller Bonitas Research, which published a shocking report valuing the company at zero. Although RFM, the responsible entity of RFF, refuted the claims, the shares went into free fall. Although the share price and business has subsequently recovered, other listed businesses facing the same scenario have not been so fortunate, with some companies in this situation ultimately failing. It’s more than enough to keep directors and executives awake at night. So what should ASX companies do if they find themselves in a similar situation?

Alexandra Cain, moderator, Listed@ ASX: James, take us back to 2019 and tell us what happened when the research was published.

James Powell, Rural Funds Management’s general manager – investor relations, corporate affairs and sustainability: Let me set the scene. Rural Funds Management (RFM) is an external fund manager and is the manager of RFF. The manager was founded in 1997 and listed RFF on ASX in 2014 as an agricultural real estate investment trust. The business had grown its market cap ten-fold since listing to more than $750 million (at the time of the short report). The share price had also risen from a dollar at time of listing to about $2.35. There were 15,000 investors on the register, a mix of retail and institutional investors. Back in 2019 we usually traded about 300,000 units a day and in the brief window after the report was released and prior to going into trading halt we traded six million units.

The day the short report appeared, 6 August 2019, I was preparing for a webinar for one of our other investments.

I remember it quite vividly because my mobile phone rang and at the same time, my landline rang, back in the days when you had a landline.

I looked up at my computer and I saw emails flooding in all with the words ‘short report’ in the subject line. Emails about the short report came to me from all sorts of people, so the publication and the distribution of it appeared to be quite well orchestrated. That was about 10:38 am. As it turns out, a Tweet was put out by the short reporter, who said he thought we were a fraud. So it was really serious from the start.

My immediate response was to go into the managing director’s office. He was in a meeting, which he quickly wrapped up. Our immediate reaction was absolute shock and disbelief.

ASX was quickly on the phone because the unit price was in freefall and the exchange paused trading on our units. Then we had to go through the process of formally requesting a trading halt, which we did.

This gave us 48 hours to strategise how to respond to this situation and formulate that response.

The formal trading halt was in place before 11.00 am. But in less than 40 minutes of trading since the initial Tweet outlining the report, we’d lost over 40 per cent of our market capitalisation. So, hundreds of millions of dollars of investor value had been destroyed in an incredibly short period.

James Powell, Rural Fund Management's General Manager - Investor Relations, Corporate Affairs, and Sustainability

"I looked up at my computer and I saw emails flooding in all with the words ‘short report’ in the subject line.”

Implementing a trading halt is an efficient process that just requires a written request to ASX, which our Company Secretary handled. Everyone on the current leadership team, the Company Secretary, COO and CFO pulled together to coordinate our efforts to deal with this on multiple fronts. Within that 48-hour window, you’re just absolutely bombarded with inquiries from investors, other stakeholders, the media and consultancies offering their services.

At the same time, you’re trying to digest a 31-page report. The contents of it were really alarming and included multiple allegations about artificially inflating our financial performance and overstating net assets, so these are really unbelievably serious allegations to which you must respond.

We quickly devised two strategies. One was a short-term strategy and one was a medium-term strategy. The short-term strategy was to review the document and form a response to the nine key allegations within the document. We devised a two-page ASX announcement released the day after the short report refuting each of those allegations. We knew we needed to be clear and concise.

Then, we held an investor webinar. At that point we would usually have around 50 people on a results webinar. That day, there were close to a thousand people on the webinar, which was completely unfiltered. Anyone could ask us a question. Retail investors, institutional investors, media and brokers and research analyst were there.

We gave a brief presentation, which effectively reiterated our statement released the day prior. Then, we went into Q&A. Our managing director stood there and took questions unscripted.

That transparency was really important. We also met in person with the large institutional investors on the register.

Giving them the opportunity to see the whites of our eyes was important in maintaining trust with our investors.

During the trading halt, management decided not to engage with the author of the short report. Instead, RFM worked with law firm Clayton Utz to engage Ernst & Young to conduct an independent review of the allegations in the short report and our responses to them. Eventually, we also started proceedings in the Supreme Court of New South Wales against the short seller.

Kym Frasher, Partner, Clayton Utz

“You go to the place where the company is domiciled and you find assets.”

Kym Fraser, partner, Clayton Utz: The legal strategy was assisted by the very strong refutation by the managing director and James and the executive team of the allegations. So, it was clear this was wrongful conduct.

It wasn’t a great legal leap to make out a case that says if someone’s putting out false and misleading information to a market that has an effect on the share price, it deceives people and should be condemned. And that was really the legal strategy and the result of the legal proceedings.

You have somebody who deliberately based themselves outside of this jurisdiction to make this attack because they think they’ll be beyond the jurisdiction of the courts. Clearly, Justice Hammerschlag effectively said, “That’s not the case. This is a matter of Australian law. We can regulate our own affairs here.”

But then, it’s a question of enforcement in international law. You go to the place where the company is domiciled and you find assets. That’s really a secondary aspect to it.

Listed@ASX: What about the losses suffered by shareholders? What is the legal situation there?

Kym: Individual shareholders who sold on the back of this information would be entitled to seek damages against the wrongdoers on the same basis the information was misleading or deceptive conduct. If they could point to losses suffered, they would have an ability to seek recovery of that loss.

Matthew Weichert was behind Bonitas. He was included as a defendant in the proceedings being knowingly concerned in the conduct of Bonitas, and the court found equally that he was so liable. We understand he was in Texas.

While the perpetrators of these types of attacks may reside elsewhere, often they have assets in the jurisdiction or some existence in the jurisdiction you can trace. That’s part of the investigative process.

James: Rural Funds Management funded the legal costs associated with going to the Supreme Court. So, the fund that is listed and suffered the damage did not fund the legal action. It was Rural Funds Management’s decision to fund it to restore trust. We also made a statement that to the extent we could recover damages greater than the cost of the action, the balance would be paid to the Rural Funds Group. Our motivation was restoring reputation.

Our managing director very quickly came up with the strategy, which ultimately proved to be successful in so much as we were vindicated through the Ernst & Young investigation and then also through the court system.

The way we approached it was unique.

Other businesses that had gone through these types of “short and distort attacks” in the past had taken a different strategy.

It took approximately 12 months for the RFF unit price to recover from this attack and there were points in time where we were working up to 18 hours a day. But it galvanises your relationships not only within the business, because you’ve gone through a crisis together, but also with our institutional and larger investors, the majority of which are still on the register.

Listed@ASX: Todd, what are investors’ expectations of companies when something like this happens?

Todd Warren, portfolio manager, Tribeca Investment Partners: The advent of social media means share price movements tend to be exaggerated in both directions. We haven’t had one of our positions targeted by a short report.

But the immediate response would be to contact the company and seek to understand the contents of the short report before taking action. We certainly wouldn’t run for the hills immediately.

It’s important to understand the nature of your investor base. A higher concentration of retail investors leads to more of a knee-jerk response rather than a considered response. An institutional shareholder that has liquidity constraints doesn’t have the ability to run for the hills, so that can be another consideration from our side of the fence.

The company needs to have a very complete response as soon as humanly possible. We would try to engage with the short report writer, which can be easier said than done. In our experience, the authors of these short reports tend not to be known money-makers on the short side, ironically. They’re not known for their fact-finding missions or well-thought-out investment positions. So, broadly we are not that concerned by these reports, which can often provide an opportunity to buy. But these reports sometimes trigger questions you want answers to, so engagement by the company is key.

Todd Warren, Portfolio Manager, Tribeca Investment Partners

"If you appear to be hiding, rightly or wrongly, you are painting yourself into a corner.”

James: We certainly had a higher level of engagement over the following months with our investors as they were doing what was entirely reasonable, which is just seeking further clarification around points.

Listed@ASX: Todd, what’s your expectation of management and their communication and engagement with you? It sounds as though James ran the textbook response, holding a webinar and being completely transparent and open.

Todd: Absolutely. We’ve seen short reports on companies in our space where there’s been no such thing as a webinar or open conversations with management. If you appear to be hiding, rightly or wrongly, you are painting yourself into a corner.

So, companies need to stand up, answer every question, even the dumb ones, and look to be whiter than white.

Helen Karlis, Partner, Domestique Consulting

“Distinguish between short reports that genuinely enhance price accuracy and liquidity in financial markets and short and distort attacks that are akin to market manipulation.”

Listed@ASX: Helen, you have had a lot of experience with companies facing this situation. What’s best practice when it comes to engaging with stakeholders and also the media?

Helen Karlis, partner Domestique Consulting: The first thing we do in all cases is to review the target company’s disclosures and identify ways of enhancing transparency to comprehensively rebut the allegations in the short reports.

The next step is to distinguish between short reports that genuinely enhance price accuracy and liquidity in financial markets and short and distort attacks that are akin to market manipulation.

In July 2020 we were brought on to advise WiseTech, which at the time had been subjected to nine months of short attacks. We had a number of other clients in a similar situation and noticed similarities in the modus operandi so decided to undertake some research in conjunction with Sydney University to analyse short activist attacks on ASX-listed companies over the period 1 January 2015 to 31 August 2020.

The results of the research were extraordinary; there were clear instances of short and distort activity. With Wisetech for example, 12 short reports were issued, often days apart, during trading hours with one report, issued in the middle of their AGM.

The problem was everybody was looking at the attacks on an individual company basis and focusing only on the initiating report. Nobody was standing back and finding patterns in the tactics and share trading impacts of both the initiating and follow-up reports.

In the period from 1 January 2019 to 31 August 2020, there were 29 activist reports with approximately eight reports on each target company, accompanied by coordinated social media campaigns.

What was clear in all cases is that it is imperative to get on the front foot and ensure the market is fully informed. This means requesting a trading halt to provide the time needed to review the short report and prepare a detailed response that is lodged with ASX. Once the response is lodged with ASX you should proactively engage with investors and give them the opportunity to ask questions which you should answer as transparently and comprehensively as possible. At the end of the day, investors look for reassurance.

It is also important to look at your disclosures. For instance, you may have a complex corporate structure or business or you may have undertaken a significant number of acquisitions. There may be areas of opaqueness that require further explanation so investors can better understand the drivers of your financial performance.

Listed@ASX: Is there any way to engage with activist shareholders or hedge funds before it gets to the point where they are going to publish a short report?

Helen: Often the authors of the short activist reports do not reach out in advance preferring to have the element of surprise play out in the market. Another tactic is to leak extracts of their report to media. The target company will get a call from a journalist asking it to respond to allegations contained in a yet-to-be-released report. There have been instances where a couple of the report writers claimed they did contact the target companies and their emails went to spam and were missed, which is unfortunate.

It’s important therefore to be diligent about monitoring your investor relations emails and having processes in place for tracking social media posts, as often there will be tweets about upcoming short reports to be published.

Even being contacted by media about a leaked report helps put you on notice so that you can take steps to prepare and avoid being completely blindsided when the short report is released.

If you manage to get a trading halt before the short report is released and lodge a comprehensive response with ASX you can contain the typical sharp share price reaction that results when an explosive report is released during trading hours. You might still experience a share price drop once trading resumes but at least the market has your response and is better informed.

James: It’s important to remember there is a legitimate place for short selling within a market as part of appropriate price discovery. But what we’ve been discussing today is different. In our case, our view was that misinformation was being distributed to produce a profit. So engaging with those types of actors has limited value. The challenge from a regulatory perspective is some reports prepared on other businesses have been found to contain legitimate information. So that’s the challenge.

Listed@ASX: We’re coming to the end of our time together. Is there anything else you’d like to add to what we’ve talked about this morning?

James: I just want to reiterate that although the managing director and I were the public face, it was a company-wide effort. Everyone pitched in and it consumed our business for some time. When you have a management team that has worked together for so long and is so passionate about the business, it’s something we all took personally.

“It was a company-wide effort. Everyone pitched in and it consumed our business for some time.”

Todd: The point is we’re not attacking short selling per se, but more the disinformation circulation. Sometimes a short and distort report can come after a company has already started to stumble. This wasn’t the case with Rural Funds Group, however.

Kym: The response to an attack such as this requires strategic thinking to rehabilitate trust.

Helen: If you’re a complex business it’s really important to be able to explain what you do in plain English. So you need to communicate and be transparent because if you don’t and you leave a vacuum, then it’s easy to sow the seeds of doubt and you make yourself a target.

The role of the trading halt

Trading halts are implemented so ASX can ensure there is an orderly market in trading of any securities. They can only last two days. If the shares still don’t trade beyond this point, this is known as a suspension, which is a mechanism that can be implemented by ASX or the company. Beyond a certain point, suspensions have ramifications for raising capital without a prospectus.