Why no one blows the whistle until a short-seller turns up

Mint

4 days ago

The reaction to US-based short seller Viceroy Research's scathing report on the Vedanta Group was as predictable as it was performative. The company, not surprisingly, called the allegations 'baseless". There was also the familiar barrage of nationalist rhetoric summed up by former Rajya Sabha MP and BJP national executive member Swapan Dasgupta, who tweeted: 'Is there a concerted attempt by dodgy US financial entities.research organisations to undermine India's corporates/financial institutions?"
But strip away the outrage, and the uncomfortable question remains: why did it take a foreign short-seller to say what no one in India's financial ecosystem had the courage or incentive to? After all, as Vedanta's CEO Deshnee Naidoo admitted, the points raised in the report are not new and have been previously disclosed to shareholders.
Viceroy's dossier alleges opaque structures, questionable related-party transactions, and fragile debt positions across the sprawling Vedanta empire. You don't need to agree with every bit of the report. The key issue is that in a market ecosystem populated by regulators, exchanges, research analysts and institutional investors, why was such scrutiny absent until a short-seller showed up?
The discomfiting answer is the lack of incentives. Reviled they may be, but short sellers are among the few market participants who have a genuine incentive to unearth problems inside companies. Since they make money when stock prices of their target companies fall, they are financially motivated to find what others ignore. Their motives are certainly not altruistic, but they drive the kind of transparency and accountability that almost all other market players shy away from.
Take the recent Jane Street saga. The US-based high-frequency trader was eventually censured by Sebi for allegedly fraudulent and manipulative trades in index options. Sebi's action came as a surprise, but Jane Street's actions were known and discussed widely for months before the regulator's action. Shankar Sharma, Veteran investor and founder of GQuant Investech, posed the obvious question: Why did the exchange not act earlier? His answer: "Simple conflict of interest…How can they sanction JS when it drives FO volume massively, hence SE profits." That's because when you trade F&O contracts on the NSE, you are charged a small percentage of the trade value as transaction fees.
Sharma's critique strikes at the core of our market structure; when exchanges benefit from the very entities they are meant to police, enforcement becomes a question of convenience rather than principle.
That's why independent, profit-seeking actors like short-sellers are necessary, even if they operate in the shadows. It is no accident that some of the most explosive corporate scandals like Adani in India, Wirecard in Germany and Luckin Coffee in China, were flagged first by short-sellers. In each case, insiders maintained a studied silence till the proverbial fecal matter hit the overhead fan. In each case, external watchdogs were too slow or too compromised. The dirty work was done by someone with skin in the game and a profit motive.
Of course, short-sellers can be wrong. They exaggerate, cherry-pick and even manipulate. But their work, when rooted in data and grounded in fact, performs a critical function. They are often the only ones willing to publicly accuse a company of fraud — because they have the most to gain if they're right, and the most to lose if they're wrong.
Could the questions that Viceroy posed to Vedanta have been asked by its independent directors? Or its bankers? Or rating agencies? Or large institutional shareholders (foreign institutional investors (FIIs) and domestic institutional investors (DIIs) who together hold over 27% stake in Vedanta Ltd)? Possibly. But the brutal truth is that for none of them did the risk-reward trade-off make sense.
The vitriol aimed at Viceroy isn't anything new. Others who've dared to say the emperor is naked, have faced far worse.
In June 2012, Canada-based Veritas Investment Research called out Anil Ambani-group company Reliance Communications (RCom) for its accounting practices and corporate governance, leading to significant a drop in the company's stock price.
Here's how the telco responded to the charges: 'The Veritas report lacks any credibility and is malafide in intent and approach…The report is full of factual inaccuracies, and baseless allegations masquerading as research."
By 2016, RCom was desperately trying to sell assets in a bid to pay off its ₹45,000 crore of debt. In February 2019, it filed for bankruptcy.
In another 2011 report, Veritas called out Kingfisher Airlines for 'poor disclosures, capricious accounting policies and understated liabilities". The company dubbed the report 'mischievous and sensational".
In 2012, Kingfisher ceased operations and faced bankruptcy proceedings.
As for Veritas, it was forced to wind up its business in India in 2014 after Nitin Mangal, one of its analysts, was remanded in custody for his report raising accounting and governance issues at Indiabulls Financial Services, Indiabulls Real Estate and other group firms.
Markets need naysayers as much as they need Yes men and women, because uncomfortable truths often come from those with a vested interest in revealing them. Until domestic institutions are more willing, and incentivized, to speak up, we should be careful of shooting the messenger and look at the message instead.