Activist short selling campaigns in Australia under regulatory scrutiny

On 1 June 2021, ASIC published its new Information Sheet "Activist short selling campaigns in Australia" (INFO 255), in response to short selling financial products in Australia. INFO 255 specifically focuses on activist short selling, defined as the act of "taking a short position in a financial product and then publicly disseminating information (eg. one or more reports) directly or through an agent to negatively impact the price of the product", and recommends "better practices" amongst activist short sellers and authors of short reports, target entities, market participants and market operators.

ASIC's approach signals the importance it places on market integrity during short selling campaigns. For ASIC, its "immediate priorities with short selling campaigns are to protect investors, to protect the integrity of the market for the target entity's securities and to ensure the market is informed".

This article outlines key features of INFO 255, and then considers two recent cases on activist short selling. The first case is a private litigation brought by a target entity against an overseas activist short seller for declarations as to contraventions (Rural Funds Management Limited (as responsible entity for the Rural Funds Trust and RF Active) v Bonitas Research LLC [2020] NSWSC 61; Clayton Utz acted for the plaintiff), which foreshadows what an ASIC enforcement action might look like. The second case provides a timely reminder to companies of shareholder class action risk, where shareholders seek to investigate prospects of pursuing a class action by applying to inspect the books of the company where the company has become a target of an activist short selling campaign (Furniss v Blue Sky Alternative Investments Limited [2021] QSC 46).

Reports published by Activist Short Sellers

INFO 255 says that reports published by activist short sellers designed to cause the price of a target entity's securities to fall enabling them to realise a profit – for example in respect of the target entity's "finances, management, public disclosures or future prospects" – should be:

• based on reliable and verifiable information, avoid "emotive, intemperate or defamatory language", be "factual, relevant and expressed in a clear and objective manner" and clearly disclose any conflicts of interest;
• fact-checked with the target entity to avoid misinforming the market;
• released outside of Australian trading hours (but not immediately before market open); and
• prepared and released so that they are appropriately quarantined before their publication.

Target entities

In relation to target entities, INFO 255 says:

• if notified before the release of a short report:
  • they should prepare a response to be released to the market around the same time that the report is to be published and before trading recommences so that investors have all relevant information;
  • a trading halt should be sought if the entity disputes the claims and assertions in the report;
• if they do not receive prior notice of a short report and the report is likely to have a material effect on the entity's share price, they should immediately request a temporary trading halt to allow time to prepare a response so that investors have all relevant information; and
• they should ensure timely and transparent disclosure of information (not limited to its statutory reporting) about its business model, business activities, corporate governance and organisation, commercial strategies and financial position to minimise asymmetry of information available to investors.

Market participants

Market participants should monitor for suspicious short selling activity and report it to ASIC as soon as possible.

Market operators

Market operators should:

• institute an immediate trading halt if they become aware of a new short report that has had a material price impact on the target entity's securities;
• request that the target entity release a detailed and comprehensive response to the market as soon as possible; and
• continue monitoring for subsequent or follow up short reports and consider any possible breaches of the listing rules.

Enforcing "better practices" – sensible on paper but unclear in practice

INFO 255 states that in response to activist short selling, ASIC may:

• engage with activist short sellers to test the veracity of the claims made in their short reports, examine the process and timing of the release of such reports and whether conflicts of interest have been disclosed;
• examine the trading activity of short sellers, with a focus on "short and distort" campaigns and campaigns that exhibit signs of insider trading; and
• consider whether the conduct of short sellers (despite any disclaimer) amounts to the provision of financial product advice and whether they hold the necessary AFSL.

INFO 255 also provides a reminder of ASIC enforcement action for any breaches of the law, particularly market misconduct in contravention of Part 7.10 of the Corporations Act such as insider trading (section 1043A), market manipulation (section 1041A) and false or misleading statements (section 1041E). ASIC's willingness to undertake enforcement action to ensure the integrity of the Australian securities market is demonstrated, for example, by the insider trading and market manipulation cases in its recent enforcement update.

How ASIC will enforce the "better practices" described in INFO 255 remains to be seen. Will ASIC deal with overseas activists whose reports may contain caveats that they are not intended for Australian investors but their online distribution and dissemination of their information on social media platforms provide ready access otherwise?

Rural Funds case – activist short seller misconduct

In February 2020, in the context of private commercial litigation, the New South Wales Supreme Court in the Rural Funds case determined an application by a target entity for declarations and orders as to contraventions against an overseas activist short seller.

In the Rural Funds case the plaintiff target entity, Rural Funds Management Limited (RFM), was the responsible entity of two stapled registered managed investment schemes, Rural Funds Trust and RF Active (together, RFF). RFM alleged that an activist short seller based in Texas, USA (Bonitas Research LCC) and Bonitas CEO and principal, Matthew Wiechert, contravened sections 1041E, 1041F and 1041H of the Corporations Act and section 12DA of the ASIC Act ^[1]

The conduct complained of was that Bonitas and Wiechert engaged in a campaign of disseminating information about RFM and RFF in August 2019 which was essentially dishonest and fraudulent. The disseminations included two Twitter posts (published on 6 and 8 August 2019), a report (First Report) and a summary report published on 6 August 2019, and a research report (Second Report) published on 8 August 2019. In response to this conduct:

• RFM requested a trading halt of RFF's units on 6 August 2019;
• RFM released a statement to the ASX on 7 August 2019 which "entirely" rejected the claims made by Bonitas and Wiechert and which stated that Ernst and Young had been retained to prepare an independent report investigating specific allegations in the First Report (EY Report);
• RFM issued a second statement on 8 August 2019 in response to the Second Report which reiterated that EY had been engaged to prepare an independent report;
• the EY Report was produced on 26 August 2019 and concluded that the claims in the First Report were unsubstantiated and that RFM's response to the market was corroborated; and
• the EY Report was released to the ASX on 27 August 2019.

Despite the steps taken by RFM, the activist campaign by Bonitas and Wiechert caused the price of RFF units to drop significantly and the Court readily inferred that Bonitas and Wiechert profited from the fall in the price of the RFF units which they caused. The Court held that Bonitas and Wiechert contravened sections 1041E, 1041F and 1041H of the Corporations Act and section 12DA of the ASIC Act. While the activist short seller chose not to defend the proceedings, the Court's decision ^[2] is significant as the first of its kind relating to "short and distort" practices and is a useful judicial determination of the kind of declarations that could be made as to contraventions by an activist short seller of the Corporations Act and the ASIC Act were ASIC to seek to enforce compliance with "better practices" under INFO 255.

The Court also held that, even though the activist short seller was based overseas, the Corporations Act and the ASIC Act applied to the conduct complained of, because statements directed from one place to another are taken to have been made in the place they were directed, and here the Court found that Australia was an intended destination for the statements and information disseminated by Bonitas and Wiechert and the statements and information were published in a manner that made them capable of being accessed in Australia and that they were in fact accessed in Australia.

There are obvious parallels between the "better practices" ASIC sets out in INFO 255 and the actions of the target in the Rural Funds case. In particular, RFM's response to the short reports is in line with ASIC's expectations under INFO 255 by:

• immediately requesting a trading halt;
• promptly responding to the short reports within a day of their publication; and
• providing a more comprehensive response by engaging EY to prepare an independent report.

The Rural Funds case shows that Courts in Australia are prepared to make declaratory and compensatory orders against activist short sellers where they engage in misconduct even if they are based overseas. It also provides context for regulatory action to enforce the "better practices" under INFO 255. The statement of ASIC's expectations in INFO 255 is a clear indication of the regulator seeking to set behavioural norms for activist short selling campaigns in Australia. Short sellers, based locally or abroad, ought to take heed.

Furniss case – shareholder's right to information and class action risk

INFO 255 provides a salutary reminder to target companies that relevant and accurate information is critically important to their investors. Target entities will know only too well the risks of civil penalty proceedings and potential shareholder class action risk. One way class action risk can emerge is when shareholders avail themselves of an application under section 247A of the Corporations Act to inspect the books of the company which has been the target of claims made in activist short reports.

On 19 March 2021, the Queensland Supreme Court determined a section 247A application by David Furniss, a shareholder of Blue Sky Alternative Investments Limited. The application was brought by Mr Furniss because of the following activist short seller behaviour and events:

• a short report published by Glaucus Research Group on 28 March 2018 which was critical of Blue Sky's financial management and the manner in which it valued its fee-earning assets under management;
• a public statement issued by Blue Sky on 3 April 2018 rejecting all criticism made in the Glaucus short report;
• Glaucus releasing a further report on 5 April 2018 which was also critical of Blue Sky;
• an announcement by Blue Sky on 16 April 2018 of a valuation review of every asset it managed; and
• the outcome of the valuation review, published in June 2018, showed that Blue Sky's fee-earning assets under management had decreased from $4.1 billion in March 2018 to $3.4 billion as at 31 May 2018.

On 20 May 2019, Blue Sky's share price had dropped from $11.43 per share (as at the time of the Glaucus short report) to $0.185 per share. Blue Sky was placed into receivership and administration. Mr Furniss' shares were rendered practically worthless.

The documents sought by Mr Furniss related to Blue Sky's investments, its financial performance, valuation of its assets and its insurance policies. The purpose of the application was to investigate:

• whether Blue Sky had information, prior to Mr Furniss acquiring his shares, which was not disclosed to the market but should have been, and if it had been disclosed he might not have acquired the shares;
• whether Blue Sky acquired information after he purchased his shares which (i) was not disclosed to the market but should have been or (ii) was disclosed to the market but not in a timely way, and if such information existed and had been disclosed on time, he might have sold his shares or some of them, before the Glaucus short reports were published or even shortly after the Glaucus reports were published;
• whether there was information which was disclosed but was misleading or deceptive or otherwise inaccurate;
• whether he had any potential claim against Blue Sky or its directors and other officers, or its auditor, for compensation for the loss in value of his Blue Sky shares; and
• whether Blue Sky held insurance policies that might respond to a claim against its directors and other officers (past and present).

The Court held that books could be sought under section 247A of the Corporations Act:

• for a purpose connected with the proper exercise of the rights of a shareholder as a shareholder and not as a litigant in proceedings against the company;
• to pursue "a reasonable suspicion of breach of duty";
• for the investigation of a potential representative claim or class action for losses sustained as a shareholder of Blue Sky; and
• to assist in considering whether it is commercially viable to prosecute a group proceeding, whether it is appropriate to settle the matter and if so for what quantum, and whether the extent of the indemnity potentially available may reasonably inform the nature and extent (and costs) of future group or representative proceedings.

If a shareholder of a company is entitled to the company's documents to investigate properly the prospects of establishing liability in respect of any wrongdoing by the company, its officers or auditors, it is also legitimate to examine not only the potential quantum of such a claim but its realistic prospects of recovery.

To the extent INFO 255 and the implementation of "better practices" may result in greater confidence by shareholders in the accuracy of activist short reports and increase shareholder and market expectations about the adequacy and accuracy of target companies' responses, it may encourage more section 247A applications. The Furniss case serves as a warning to target entities that where their responses to an activist short report are inadequate, shareholders will want to seek books and information about the entity to arm themselves with the necessary information to identify whether there are grounds for legal action against the company, its officers, directors or auditors and what the prospects are of recovering any damages.

The introduction of INFO 255 presents target entities with an opportunity to redouble their vigilance in:

• being agile and responsive in the face of activist short seller reports that contain inaccurate, incomplete or unsupported information; and
• complying with their continuous disclosure obligations.

^[1] Specifically: sections 1041D (dissemination of information about illegal transactions), 1041E (false or misleading statements), 1041F (inducing persons to deal in financial products by making statements known to the contravenor to be misleading, false or deceptive) and 1041H (misleading or deceptive conduct in relation to a financial product) of the Corporations Act and section 12DA (misleading or deceptive conduct in relation to financial services) of the ASIC Act. ^{Back to article}

^[2] The Court also ordered an award of damages against the defendants: Rural Funds Management Limited as Responsible Entity for the Rural Funds Trust and RF Active v Bonitas Research LLC [2020] NSWSC 335.^{Back to article}