21.08.2023 09:10
Short selling tricks: potential squeeze and further attacks by Hindenburg Research on FRHC shares
The attack on Freedom Holding Corp. (FRHC) shares, which has been going on for the past several days, can lead to a short squeeze for Hindenburg Research and those who followed the company’s advice and opened short positions, according to analysts from Kursiv Research.
A short squeeze is a situation on the stock market when stock prices grow rapidly due to a significant amount of short sellers rushing to cover their positions by buying the stock, driving its price even higher. Such demand and a price surge might be a result of positive news about a company, strong fundamentals, company management statements, or a limited supply of available shares for short sellers to cover their positions. Short squeezes can result in significant volatility, which might be good for those sellers who have long positions in the shares. In turn, those who failed to spread panic and make the price plunge may face a situation leading to a self-reinforcing cycle of buying and rising prices. Currently, it’s very hard to evaluate potential losses for short sellers. However, once they close their position, it will be crystal clear. According to experts, the total amount of short positions on FRHC shares set over the past several days can be about $100 million.
Earlier this week, on August 15, FRHC shares were attacked by Hindenburg Research, the well-known «bears» of the American stock market. It was the first time that the securities of a company with Kazakhstani roots faced a massive attack by short sellers from all over the world.
Even though the full analysis of the report isn’t completed, the preliminary conclusion by the lawyers is the following: the Hindenburg report, which is acknowledged to be a «short seller report,» was written to damage Freedom’s reputation and is not a credible report.
First of all, a central allegation in the Hindenburg report is that Freedom has openly flouted sanctions, Anti-Money Laundering (AML) and Know Your Customer (KYC) rules. As the American lawyers told Kursiv Research, this allegation is reckless and false. The support provided in the report for this assertion largely consists of statements from certain unnamed former employees that are not credible. It also cites statements from Freedom that have been taken out of context. In addition, the assertions about sanctions compliance are based on a lack of understanding of how the sanctions regimes work.
For example, the report states that Freedom has «openly admitted» to «sanctions evasion.» This is based on a statement that was taken out of context. In particular, the report cites Freedom’s Form 10-K filing with the U.S. Securities and Exchange Commission (SEC). This document plays a crucial role because all the information in Form 10-K is prepared in conjunction with third-party lawyers, approved by executive management and verified by independent auditors. The company provides all necessary information, while the party lawyers and auditors check whether the information presented meets reality. In the case of FRCH, the company hired Morgan Lewis, a legal firm that helped to fill the Form 10-K, while Deloitte, one of the Big 4, has audited the report filed with the SEC.
The report cites Freedom’s Form 10-K filing with the SEC to the effect that Freedom group companies had certain brokerage customers who are on US, EU or UK sanctions lists. However, the following text is included in the Form 10-K, immediately after the foregoing statement:
“These transactions did not involve any nexus with the United States, the European Union or the United Kingdom, as applicable. As of March 31, 2023, our customer liabilities relating to these individuals and entities in aggregate were $17.8 million, representing approximately 0.92% of our total customer liabilities as of such date.”
This quoted language is critical context for the former statement, lawyers told Kursiv Research. Most importantly, because of the lack of nexus, the relevant transactions did not violate the relevant sanctions. It is not uncommon for a company with a large number of international subsidiaries for such subsidiaries to have a small amount of business with individuals or entities that are on a sanctions list, and this is generally accepted in the international capital markets as long as the overall amount is not material in the context of the company’s overall business (in Freedom’s case it is less than 1%) and if the transactions had no nexus to the sanctioning jurisdiction, such that the transactions did not violate the sanctions. The Hindenburg report holds this statement out as its primary evidence that Freedom has «brazenly evaded sanctions,» which is false and disingenuous. In any case, since March 31, 2023, Freedom is winding down all of the relevant transactions.
Secondly, the report alleges that Freedom essentially has no KYC and AML procedures. As support for this allegation, it quotes an unnamed «former executive» as describing Freedom’s overall KYC and AML checks as follows:
«There’s no KYC. Nothing.» Freedom is «violating almost every country’s anti-money [laundering] and anti-terrorist financing laws.»
Moreover, this person was suggesting that most of the group’s business is done in cash to avoid KYC/AML.
The lawyers do not doubt that the statements from this unnamed individual are simply false and patently not credible. Freedom has extensive AML, anti-terrorism financing and economic sanctions compliance procedures, which include a robust KYC, AML and CTF and sanctions screening platform using various world-class third-party data providers (including Sum and Substance) in a system that is integrated with the company’s trading platform, including daily customer sanctions screening and review of individual financial transactions according to multiple risk parameters. These procedures are described in Freedom’s Form 10-K on page 24.
«Big 4» accounting firm Deloitte, the FRHC auditor, recently completed a full audit of the Freedom group and issued an unqualified audit opinion, which says that the auditor tested AML/KYC compliance procedures and verified that all the group subsidiaries and related parties, including FST Belize, indeed followed these procedures. As a result, the lawyers told Kursiv Research that the Freedom group has business practices and procedures that meet a high standard and fly in the face of the statements from the unnamed individuals quoted in the report. The Hindenburg report omits any reference to the Deloitte auditor report and instead bases its assertions on unsubstantiated statements from individuals lacking in credibility.
Thirdly, the report includes an assertion that Freedom’s CEO’s Belize entity (FST Belize) was set up to avoid Russian sanctions. It notes that the entity was set up 4 months after U.S. sanctions were imposed on Russia in 2014, thereby implying that its purpose was to avoid sanctions, without any evidence to support this assertion.
In fact, the report intentionally omits key information from Freedom’s Form 10-K which shows this assertion to be false. In particular, the report omits the key information that Freedom’s auditor, Deloitte, recently completed a full audit on the group and, after conducting the following procedures, issued an unqualified audit report. Deloitte’s audit opinion on page 89 of Freedom’s 10-K report includes key audit matters regarding related party transactions with FST Belize. To cover these key audit matters, Deloitte in particular performed AML-related audit procedures and conducted deep testing of the company’s balance sheet and revenue structure.
In its audit report (included in the Form 10-K) Deloitte says the following:
«With the assistance of our regulatory compliance specialists, we:
– Identified and evaluated whether there were indications that the procedures performed by FST Belize for new client onboarding and Anti-Money Laundering (AML) and sanction screening for both individual and legal entity customers would not be consistent with similar practices in other financial institutions.
– We tested the effectiveness of these new client onboarding, AML and sanction screening controls at FST Belize and the ongoing monitoring of these control activities at the Company.
– We selected a sample of individual and legal entities within the omnibus accounts and evaluated whether the individual or legal entity information obtained by FST Belize was consistent with external sources of information.»
The lawyers highlighted that Deloitte would not have issued an unqualified audit report after conducting such audit procedures if the relevant AML/KYC procedures at FST Belize were not consistent with international practice or were not effective.
Fourthly, the report notes that many former individual customers of sanctioned Russian banks transferred their business to Freedom companies after such banks became sanctioned. It cites this as evidence that Freedom violated sanctions. This conclusion demonstrates a lack of understanding regarding how the sanction regimes work.
As Freedom has disclosed transparently in its SEC filings, Freedom continues to have a significant number of Russian individuals among its customers. Those individuals are not sanctioned persons, and currently, there are no US, EU or UK sanctions that prohibit a brokerage company from offering services to Russian individuals generally, contrary to what is suggested in the Hindenburg report. In the cases when Freedom had direct contacts with a bank that became sanctioned, such as Alfa Bank and Tinkoff Bank, such contacts were made by a general license from OFAC designed to enable the winding down of the business of such banks. Any clients’ assets transfer was carried out exclusively during the period of validity of the OFAC General license and was provided only to non-sanctioned clients.
Well-known for its research activities in the financial market, Hindenburg Research has carried out a series of controversial attacks on companies. As part of their strategy, they open short positions in the stock markets and then publish reports aimed at discrediting and humiliating companies. These reports may include allegations of fraud, false financial reporting and other violations.
Over the past several years, Hindenburg Research’s actions have affected about 20 companies of various sizes and from different industries: automotive and pharmaceutical companies, as well as young startups and small businesses across the U.S., China, Canada, Australia and now from Kazakhstan. Usually, Hindenburg reports cause panic among investors, lead to a sharp drop in stock prices and even cause legal consequences, including lawsuits.
Apparently, FRHC, an American company with Kazakh roots, was the first business to be able to withstand such a massive blow from the short sellers. The company’s shares have declined just a little bit and are traded at about $70.
Some of the companies that were attacked by Hindenburg Research
Company: Nikola Corporation (NKLA)
Industry: Automotive
Attack date: 09/10/2020
Hindenburg has accused Trevor Milton, the founder and CEO of the startup, which claims to have become one of the world’s leading manufacturers of commercial electric vehicles, of systematic distortion of information about the company.
Hindenburg cited data gathered from phone records, text messages, emails, and photographs, as well as a series of testimonies from people familiar with the situation that the company, which at the time was valued at $20 billion, was misreporting. Some market participants believed that Nikola’s claims to develop revolutionary battery solutions were empty words, which is why the company was looking for a technology partner among existing automakers.
Five days later, Reuters reported that the SEC launched an investigation into the results of the Hindenburg material. On September 20, 2020, Milton resigned. In December 2021, the SEC announced that Nikola had agreed to pay a $125 million fine to settle charges of misleading investors about its products, technological success, and the company’s commercial prospects.
On the day of the attack, Nikola shares dropped by 11%. A month later, their performance was also negative: -36%. Over the next three years, the company continued to decline in price and by August 2023 was worth about 20 times less than before the scandal.
Company: Clover Health Investments (CLOV)
Industry: Medicine
Attack date: 02/04/2021
The claims against Clover Health were based on a set of facts that Hindenburg uncovered through document analysis and interviews with a dozen former employees, competitors and industry experts. In the material, the company was accused of hiding the fact that the U.S. Department of Justice launched an investigation into violations in the development of the company’s core product – Clover Assistant software. Startup employees were suspected of kickbacks, non-transparent transactions involving undisclosed third parties, and marketing activities that misled elderly people.
The very next day after the publication, Clover Health received a notification from the SEC to open an investigation. The company immediately announced its intention to cooperate. In March 2022, the media reported that the company’s executives, led by Chamath Palihapitiya, once known as the «SPAC King,» were to face trial. Judging by the latest financial statements from Clover Health, the proceedings are ongoing.
On the day of the attack, the company’s shares dropped by 12%, and a month later the stock price declined even deeper by 40%. Currently, Clover Health shares are traded nine times cheaper than before Hindenburg’s report.
Company: Lordstown Motors Ltd. (RIDEQ)
Industry: Automotive
Attack date: 03/12/2021
The electric car manufacturer became a target of Hindenburg’s accusations in March 2021. Analysts from Hindenburg Research said that a large number of 100,000 pre-orders the automaker received were fictitious. In some cases, Lordstown even paid for the placement of orders.
In June 2021, the company launched its internal investigation. At the same time, the SEC also launched an investigation, which is still ongoing. In June 2023, the company officially announced that it would start restructuring. In fact, this was the launch of bankruptcy proceedings.
The company’s securities began to decline even before Hindenburg’s report was published. For instance, in February 2021, the Lordstown share price dropped by 40%. However, the report pushed the company’s business further downwards. A month after the release of the report, the company’s stock declined by 27%. By August 2023, the market cap of Lordstown plunged by 123 times compared to its value in February 2021.
Company: Adani Enterprises Limited (ADANIENT)
Industry: Diversified holding
Attack date: 01/24/2023
This time, Hindenburg chose to attack Adani Group, a large holding owned by Indian businessman Gautam Adani with interests in such spheres as coal and iron ore production, renewable energy and other industries, not a dubious startup. Hindenburg accused the group of manipulating securities and misuse of tax havens. Hindenburg’s analysts also pointed out the group’s large debt. Indian Citigroup refused to extend margin loans for the company.
The Adani Group described the investigation as disinformation and a set of baseless allegations. The company promised to take legal action. On the third day after the report, the group published an analysis of the Hindenburg allegations. However, the answers weren’t particularly convincing for investors, and the company’s securities continued to slide in price. The Central Bank of India even asked local banks to detail their exposure to the group’s companies. As of June 2023, the company insisted that it is not an object for any SEC investigation.
A week after the attack, Adani Enterprises Limited, the holding structure of the group, lost 38% of its market cap. A month later, this figure reached 62%. However, the stock has been slowly regaining ground since April, even though it is still 40% cheaper than it was before the report was released.
A short squeeze is a situation on the stock market when stock prices grow rapidly due to a significant amount of short sellers rushing to cover their positions by buying the stock, driving its price even higher. Such demand and a price surge might be a result of positive news about a company, strong fundamentals, company management statements, or a limited supply of available shares for short sellers to cover their positions. Short squeezes can result in significant volatility, which might be good for those sellers who have long positions in the shares. In turn, those who failed to spread panic and make the price plunge may face a situation leading to a self-reinforcing cycle of buying and rising prices. Currently, it’s very hard to evaluate potential losses for short sellers. However, once they close their position, it will be crystal clear. According to experts, the total amount of short positions on FRHC shares set over the past several days can be about $100 million.
Earlier this week, on August 15, FRHC shares were attacked by Hindenburg Research, the well-known «bears» of the American stock market. It was the first time that the securities of a company with Kazakhstani roots faced a massive attack by short sellers from all over the world.
Why can this attack on shares be seen as an orchestrated attack?
Even though the full analysis of the report isn’t completed, the preliminary conclusion by the lawyers is the following: the Hindenburg report, which is acknowledged to be a «short seller report,» was written to damage Freedom’s reputation and is not a credible report.
First of all, a central allegation in the Hindenburg report is that Freedom has openly flouted sanctions, Anti-Money Laundering (AML) and Know Your Customer (KYC) rules. As the American lawyers told Kursiv Research, this allegation is reckless and false. The support provided in the report for this assertion largely consists of statements from certain unnamed former employees that are not credible. It also cites statements from Freedom that have been taken out of context. In addition, the assertions about sanctions compliance are based on a lack of understanding of how the sanctions regimes work.
For example, the report states that Freedom has «openly admitted» to «sanctions evasion.» This is based on a statement that was taken out of context. In particular, the report cites Freedom’s Form 10-K filing with the U.S. Securities and Exchange Commission (SEC). This document plays a crucial role because all the information in Form 10-K is prepared in conjunction with third-party lawyers, approved by executive management and verified by independent auditors. The company provides all necessary information, while the party lawyers and auditors check whether the information presented meets reality. In the case of FRCH, the company hired Morgan Lewis, a legal firm that helped to fill the Form 10-K, while Deloitte, one of the Big 4, has audited the report filed with the SEC.
The report cites Freedom’s Form 10-K filing with the SEC to the effect that Freedom group companies had certain brokerage customers who are on US, EU or UK sanctions lists. However, the following text is included in the Form 10-K, immediately after the foregoing statement:
“These transactions did not involve any nexus with the United States, the European Union or the United Kingdom, as applicable. As of March 31, 2023, our customer liabilities relating to these individuals and entities in aggregate were $17.8 million, representing approximately 0.92% of our total customer liabilities as of such date.”
This quoted language is critical context for the former statement, lawyers told Kursiv Research. Most importantly, because of the lack of nexus, the relevant transactions did not violate the relevant sanctions. It is not uncommon for a company with a large number of international subsidiaries for such subsidiaries to have a small amount of business with individuals or entities that are on a sanctions list, and this is generally accepted in the international capital markets as long as the overall amount is not material in the context of the company’s overall business (in Freedom’s case it is less than 1%) and if the transactions had no nexus to the sanctioning jurisdiction, such that the transactions did not violate the sanctions. The Hindenburg report holds this statement out as its primary evidence that Freedom has «brazenly evaded sanctions,» which is false and disingenuous. In any case, since March 31, 2023, Freedom is winding down all of the relevant transactions.
Secondly, the report alleges that Freedom essentially has no KYC and AML procedures. As support for this allegation, it quotes an unnamed «former executive» as describing Freedom’s overall KYC and AML checks as follows:
«There’s no KYC. Nothing.» Freedom is «violating almost every country’s anti-money [laundering] and anti-terrorist financing laws.»
Moreover, this person was suggesting that most of the group’s business is done in cash to avoid KYC/AML.
The lawyers do not doubt that the statements from this unnamed individual are simply false and patently not credible. Freedom has extensive AML, anti-terrorism financing and economic sanctions compliance procedures, which include a robust KYC, AML and CTF and sanctions screening platform using various world-class third-party data providers (including Sum and Substance) in a system that is integrated with the company’s trading platform, including daily customer sanctions screening and review of individual financial transactions according to multiple risk parameters. These procedures are described in Freedom’s Form 10-K on page 24.
«Big 4» accounting firm Deloitte, the FRHC auditor, recently completed a full audit of the Freedom group and issued an unqualified audit opinion, which says that the auditor tested AML/KYC compliance procedures and verified that all the group subsidiaries and related parties, including FST Belize, indeed followed these procedures. As a result, the lawyers told Kursiv Research that the Freedom group has business practices and procedures that meet a high standard and fly in the face of the statements from the unnamed individuals quoted in the report. The Hindenburg report omits any reference to the Deloitte auditor report and instead bases its assertions on unsubstantiated statements from individuals lacking in credibility.
Thirdly, the report includes an assertion that Freedom’s CEO’s Belize entity (FST Belize) was set up to avoid Russian sanctions. It notes that the entity was set up 4 months after U.S. sanctions were imposed on Russia in 2014, thereby implying that its purpose was to avoid sanctions, without any evidence to support this assertion.
In fact, the report intentionally omits key information from Freedom’s Form 10-K which shows this assertion to be false. In particular, the report omits the key information that Freedom’s auditor, Deloitte, recently completed a full audit on the group and, after conducting the following procedures, issued an unqualified audit report. Deloitte’s audit opinion on page 89 of Freedom’s 10-K report includes key audit matters regarding related party transactions with FST Belize. To cover these key audit matters, Deloitte in particular performed AML-related audit procedures and conducted deep testing of the company’s balance sheet and revenue structure.
In its audit report (included in the Form 10-K) Deloitte says the following:
«With the assistance of our regulatory compliance specialists, we:
– Identified and evaluated whether there were indications that the procedures performed by FST Belize for new client onboarding and Anti-Money Laundering (AML) and sanction screening for both individual and legal entity customers would not be consistent with similar practices in other financial institutions.
– We tested the effectiveness of these new client onboarding, AML and sanction screening controls at FST Belize and the ongoing monitoring of these control activities at the Company.
– We selected a sample of individual and legal entities within the omnibus accounts and evaluated whether the individual or legal entity information obtained by FST Belize was consistent with external sources of information.»
The lawyers highlighted that Deloitte would not have issued an unqualified audit report after conducting such audit procedures if the relevant AML/KYC procedures at FST Belize were not consistent with international practice or were not effective.
Fourthly, the report notes that many former individual customers of sanctioned Russian banks transferred their business to Freedom companies after such banks became sanctioned. It cites this as evidence that Freedom violated sanctions. This conclusion demonstrates a lack of understanding regarding how the sanction regimes work.
As Freedom has disclosed transparently in its SEC filings, Freedom continues to have a significant number of Russian individuals among its customers. Those individuals are not sanctioned persons, and currently, there are no US, EU or UK sanctions that prohibit a brokerage company from offering services to Russian individuals generally, contrary to what is suggested in the Hindenburg report. In the cases when Freedom had direct contacts with a bank that became sanctioned, such as Alfa Bank and Tinkoff Bank, such contacts were made by a general license from OFAC designed to enable the winding down of the business of such banks. Any clients’ assets transfer was carried out exclusively during the period of validity of the OFAC General license and was provided only to non-sanctioned clients.
Which other companies were targeted by Hindenburg?
Well-known for its research activities in the financial market, Hindenburg Research has carried out a series of controversial attacks on companies. As part of their strategy, they open short positions in the stock markets and then publish reports aimed at discrediting and humiliating companies. These reports may include allegations of fraud, false financial reporting and other violations.
Over the past several years, Hindenburg Research’s actions have affected about 20 companies of various sizes and from different industries: automotive and pharmaceutical companies, as well as young startups and small businesses across the U.S., China, Canada, Australia and now from Kazakhstan. Usually, Hindenburg reports cause panic among investors, lead to a sharp drop in stock prices and even cause legal consequences, including lawsuits.
Apparently, FRHC, an American company with Kazakh roots, was the first business to be able to withstand such a massive blow from the short sellers. The company’s shares have declined just a little bit and are traded at about $70.
Some of the companies that were attacked by Hindenburg Research
Company: Nikola Corporation (NKLA)
Industry: Automotive
Attack date: 09/10/2020
Hindenburg has accused Trevor Milton, the founder and CEO of the startup, which claims to have become one of the world’s leading manufacturers of commercial electric vehicles, of systematic distortion of information about the company.
Hindenburg cited data gathered from phone records, text messages, emails, and photographs, as well as a series of testimonies from people familiar with the situation that the company, which at the time was valued at $20 billion, was misreporting. Some market participants believed that Nikola’s claims to develop revolutionary battery solutions were empty words, which is why the company was looking for a technology partner among existing automakers.
Five days later, Reuters reported that the SEC launched an investigation into the results of the Hindenburg material. On September 20, 2020, Milton resigned. In December 2021, the SEC announced that Nikola had agreed to pay a $125 million fine to settle charges of misleading investors about its products, technological success, and the company’s commercial prospects.
On the day of the attack, Nikola shares dropped by 11%. A month later, their performance was also negative: -36%. Over the next three years, the company continued to decline in price and by August 2023 was worth about 20 times less than before the scandal.
Company: Clover Health Investments (CLOV)
Industry: Medicine
Attack date: 02/04/2021
The claims against Clover Health were based on a set of facts that Hindenburg uncovered through document analysis and interviews with a dozen former employees, competitors and industry experts. In the material, the company was accused of hiding the fact that the U.S. Department of Justice launched an investigation into violations in the development of the company’s core product – Clover Assistant software. Startup employees were suspected of kickbacks, non-transparent transactions involving undisclosed third parties, and marketing activities that misled elderly people.
The very next day after the publication, Clover Health received a notification from the SEC to open an investigation. The company immediately announced its intention to cooperate. In March 2022, the media reported that the company’s executives, led by Chamath Palihapitiya, once known as the «SPAC King,» were to face trial. Judging by the latest financial statements from Clover Health, the proceedings are ongoing.
On the day of the attack, the company’s shares dropped by 12%, and a month later the stock price declined even deeper by 40%. Currently, Clover Health shares are traded nine times cheaper than before Hindenburg’s report.
Company: Lordstown Motors Ltd. (RIDEQ)
Industry: Automotive
Attack date: 03/12/2021
The electric car manufacturer became a target of Hindenburg’s accusations in March 2021. Analysts from Hindenburg Research said that a large number of 100,000 pre-orders the automaker received were fictitious. In some cases, Lordstown even paid for the placement of orders.
In June 2021, the company launched its internal investigation. At the same time, the SEC also launched an investigation, which is still ongoing. In June 2023, the company officially announced that it would start restructuring. In fact, this was the launch of bankruptcy proceedings.
The company’s securities began to decline even before Hindenburg’s report was published. For instance, in February 2021, the Lordstown share price dropped by 40%. However, the report pushed the company’s business further downwards. A month after the release of the report, the company’s stock declined by 27%. By August 2023, the market cap of Lordstown plunged by 123 times compared to its value in February 2021.
Company: Adani Enterprises Limited (ADANIENT)
Industry: Diversified holding
Attack date: 01/24/2023
This time, Hindenburg chose to attack Adani Group, a large holding owned by Indian businessman Gautam Adani with interests in such spheres as coal and iron ore production, renewable energy and other industries, not a dubious startup. Hindenburg accused the group of manipulating securities and misuse of tax havens. Hindenburg’s analysts also pointed out the group’s large debt. Indian Citigroup refused to extend margin loans for the company.
The Adani Group described the investigation as disinformation and a set of baseless allegations. The company promised to take legal action. On the third day after the report, the group published an analysis of the Hindenburg allegations. However, the answers weren’t particularly convincing for investors, and the company’s securities continued to slide in price. The Central Bank of India even asked local banks to detail their exposure to the group’s companies. As of June 2023, the company insisted that it is not an object for any SEC investigation.
A week after the attack, Adani Enterprises Limited, the holding structure of the group, lost 38% of its market cap. A month later, this figure reached 62%. However, the stock has been slowly regaining ground since April, even though it is still 40% cheaper than it was before the report was released.