HONG KONG -- A legal battle in Hong Kong between a U.S. short seller and the local securities regulator is shaping up to be a fight over freedom of expression in financial reporting.
The lines were drawn in 2012 when the online investment newsletter Citron Research stated in a report that China Evergrande Group, a major Chinese property company, was near collapse and suspected of accounting fraud.
After publication of the report, shares in the company -- then known as Evergrande Real Estate Group -- plunged 20%, allowing Citron's founder Andrew Left, who had shorted the company's stock, to earn about 1.7 million Hong Kong dollars ($217,000).
The report and Left's ensuing earnings prompted Hong Kong's Market Misconduct Tribunal, which oversees financial markets, to slap a five-year trading ban on the founder in 2016 for profiting by allegedly spreading false information. The tribunal also ordered Left to forfeit his gains.
Left has appealed the decision, advocating freedom of expression in financial markets, and remains locked in a legal battle with the territory's Securities and Futures Commission.
"While there are some cases of companies suing short-sellers, this is the only instance in which a regulator has taken action against the activist short-seller in relation to his findings," said attorney Timothy Loh, who represented Left at a court hearing at the end of January. According to Loh, the report should be considered opinion based on Left's own research, not an intentional distortion of facts.
Stock prices are affected by a number of factors, including corporations' own disclosures. But Loh is arguing that these disclosures should be open to scrutiny by third parties, including outside analysts. "If the disclosure of a listed company is the only source, who can confirm the fact?" the attorney said. "Freedom of speech is very important for the Hong Kong market."
In 2018 alone, more than 200 companies were newly listed in Hong Kong, making it difficult for regulatory agencies to analyze and verify each corporate disclosure.
"Opinions are sometimes right, sometimes wrong. That's the market. Whether or not it has an influence on the market is simply dependent on the track record of the analyst," Loh said.
Many market players recall a case involving Moody's Investors Service, which in 2011 released a report titled "Red Flags for Emerging-Market Companies: A Focus on China." In it, Moody's listed 61 Chinese companies with poor credit ratings, warning about questionable corporate governance and opaque earnings structures.
Although the report was well-received, the Hong Kong securities regulator fined Moody's HK$11 million on the grounds that the report was inaccurate. Moody's appeal of the fine was rejected last year.
Since the report, however, many of the companies cited in it have either failed or seen their stock prices fall dramatically.
Short sellers and ratings agencies often clash with companies. Echoing a view held by many observers, a senior official at a Hong Kong securities company said: "Many times, Chinese companies fail to adequately disclose information, which causes investor distrust in their accounting."
Citron Research is not alone in exposing alleged corporate misdeeds. Muddy Waters Research reported on suspected accounting fraud between 2016 and 2017 at China Huishan Dairy Holdings, a dairy products company. In 2018, Bonitas Research pointed to suspected profit padding at Hengan International Group, a Chinese producer of personal hygiene goods.
Hong Kong has historically linked Chinese companies with investors around the world. As the feud between the short seller and the Hong Kong securities regulator plays out, debate continues over how long a leash research companies and other commentators should have in reporting on corporations, especially as regards financials.