Sensational Research: Andrew Left found "reckless" for publishing false and misleading report

The Market Misconduct Tribunal has published its report on the SFC action against Andrew Left. We reported on the Tribunal's rejection of Mr Left's interlocutory discovery application earlier this year.

The Tribunal's ruling

Mr Left, head of Citron Research, a US-based publisher of research reports on listed companies, has been found to have engaged in market misconduct1 for publication of a research report on the Chinese property developer Evergrande Real Estate Group Limited (3333.HK) that the Market Misconduct Tribunal held to be materially false or misleading (and recklessly so) and likely to have affected the market for the security.

• It was undisputed that Mr Left had authorised the publication of the Citron Report on his firm's website and was therefore concerned in the dissemination.
• The Citron Report was likely to have impacted the trading in Evergrande shares.
  • Citron Research, whilst not well known in Hong Kong, had a reputation in the US for being an activist short selling firm known for unveiling fraudulent behaviour in corporations. It was therefore likely to be picked up by Bloomberg and, in particular, US investments banks who would further disseminate to analysts globally.
  • It contained extreme and multiple allegations concerning the solvency and probity of Evergrande. including that it engaged in "fraudulent accounting" to disguise its level of debt and the creation of "phantom accounting profits", all of which would raise immediate fundamental concerns for any investor.
  • It was also not lost on the Tribunal that Left himself had first shorted the stock and started covering his short position on the day the report was published; ie it was evidently his plan that the price would fall, so it lay ill in his mouth to say otherwise. It was no defence for Left to say he owed no duty to the public because he was not licensed or did not have a special relationship to the market or that his readers were free to check the content of the Citron Report themselves. The Tribunal concluded that section 277 of the Securities and Futures Ordinance (SFO) imposes a duty on any person involved in the disclosure of information that is likely (meaning "probable") to have an impact on the market.
• The Tribunal found that the Citron Report was false and misleading as to the material facts.
  • It is interesting to note that the falsity and misleading nature of Left's allegations was determined solely on the basis of what was publicly available information at the time. The Tribunal had earlier refused Left's application for discovery of Evergrande's internal records to prove his case. The Tribunal took the approach that, as Left had touted the conclusions in the Citron Report as being entirely based on publicly available information, then that would be the "field" upon which its truth and accuracy of the report would be judged - it was not open to him to "fish" into the company for supporting evidence ex post facto.
  • Whilst Left declined to give testimony and defend his conclusions, the SFC deployed expert witnesses, the Evergrande CFO and the Evergrande auditor, who gave compelling evidence that Left's allegations were wrong and displayed an ignorance of Hong Kong accounting standards and practices.
  • Further, there were no shades of grey in the Citron Report, which deliberately used blunt and sensational tabloid language, referring to "crisis red flags" being identified, "bribes" being paid, "off-balance sheet" activities and a "negative 36bn" equity.
• Mr Left was reckless (alternatively negligent) as to whether the information in the Citron Report was false or misleading as to the material facts.
  • Left consciously disregarded the risk that the Citron Report contained toxic allegations against Evergrande that were not vetted by appropriate experts and which would alarm the general public.
  • The genesis of Left's Citron Report was an anonymous 68 page draft report on Evergrande that he received through the post. What at first appeared like a whistle blower's report turned out, in the view of the Tribunal, to be more like a poison pen letter drafted by someone bearing a grudge.
  • Given Left's self-professed experience in publishing corporate commentary. The Tribunal held that he should have appreciated that anonymous reports of this kind required careful scrutiny. Left failed to take precautionary steps to secure expert advice on the applicable Hong Kong accounting standards, to which Evergrande would have been subject before publishing the Citron Report.

Left's penalty will be determined by the Tribunal at a later date. According to media sources, he is considering appealing the Tribunal's decision.

Predicting the past with the future

When Left published the Citron Report on 21 June 2012, Evergrande shares (which were trading steadily during the preceding three months) declined sharply within a day to a low of HK$3.60, representing a 19.6% drop from the previous day's close (the Hang Seng Index declined just 1.3% that day). Coinciding with the time when the Citron Report became known in Hong Kong (the morning of 21 June 2012 Hong Kong time). Left started to buy 4.1 million shares in Evergrande to cover his short position and made a net profit of HK$1.6m.

The Tribunal made it clear that it determined the question of whether the misinformation was likely to impact the market for shares (see second bullet point above) without reference to what did in fact happen (as is the test) but nevertheless acknowledged the "limited support for the Tribunal's findings ... in the fact that the likely impact was borne out by the actual impact".

Setting the boundaries

This is the first time the Tribunal has made a ruling against a short seller engaged in the publication of otherwise unregulated market commentary. While there is a wider debate about the ethics of short selling firms, it was Left's use of alarming language and failure to take available and precautionary steps before publishing the Citron Report (such as seeking expert advice or asking Evergrande for clarification) which appears to have attracted the eye of the SFC and ultimately resulted in the adverse decision from the Tribunal.

The most controversial aspect of the case is the approach taken by the Tribunal, in deciding whether or not the information published/disseminated was false or misleading, to consider only information that was publicly available at the time. In particular, "the determination ... does not require the effectively impossible exercise of working through Evergrande's archives to have sight of its (no doubt) vast repository of primary documents financial and commercial''. Had the company collapsed in the four years between the publication of the Citron Report and the Tribunal decision, one might question whether there would have been a different outcome. But Evergrande appears today to remain financially healthy, and the simple fact is that the bases upon which Left made his conclusions were essentially erroneous, which was due to his misunderstanding of financial reporting and accounting rules. Seen in that light, the decision may not be so controversial.

Takeaways

Professional analysts may now be thinking twice about the parameters of responsible authorship and how best to minimise the risk of breaching the SFO. There are a number of precautions one should take before publishing research which might include the following. NB If you are a licensed person, the SFC has more latitude when exercising its disciplinary powers to determine if your publication (albeit maybe not strictly a contravention of the SFO) affects your fitness and properness.

• Know the source of your information. If it is privately-sourced and potentially from an insider, seek legal advice first.
• Be sure your conclusions are supported by publicly available information. Even if it turns out to be wrong, to establish the section 277 contravention the SFC will also have to show that no reasonably prudent market commentator/analyst would have arrived at (and published) those conclusions.
• Opinions should be expressed as such, without the risk these will be understood as facts.
• Keep a proper "paper trail" of your research, source information and reasons for conclusions drawn.
• Beware of colourful language. The institutional investor may be able to read it with scepticism, but the general retail investor may not; and whilst institutional investors may doubt the conclusions, where those conclusions are portends of doom (as they were in this case) would even the most sophisticated investor totally discount the veracity of the report if there were even a small percentage chance they may be right? If the answer is no, it seems that will suffice to move the market. So you had better be right.

1The SFC issued its notice under section 277 of Part XIII of the SFO