THE plethora of allegations of fraud, misrepresentation, corruption, bribery, and insider trading involving state-owned entities and companies operating in South Africa has done great reputational harm to those directly implicated, but the consequences may likely be systemic.
Fresh allegations of any impropriety enter an environment in which there is a high degree of inherent plausibility of such claims, as well as high levels of goodwill towards whistle-blowers. Viceroy’s report into Capitec arrives at the high point of governance and audit scepticism, and to a lesser extent scepticism about the robustness of the institutions set up to regulate, monitor and supervise markets, and the bank and non-bank financial services industries.
Some may balk at the idea of short sellers, particularly those that publish research on their positions, fashioning themselves as benevolent whistle-blowers, championing the interests of investors and the market as a whole. But it is worth re-emphasising that short selling is a legitimate business activity - it is not only legal but perhaps an integral balancing market force likely to keep companies honest and on their toes.
However, the fact that short sellers stand to profit from declining prices means there are adverse incentives to taking an activist approach in driving the price of their positions down.
Capitec and the South African Reserve Bank responded strongly and swiftly to Viceroy’s report - but whatever the veracity of certain details, or one's opinion, of Capitec’s business model, there is much about Viceroy’s modus operandi that triggers alarm bells of an attempt to provoke market panic, even if not an attempt to short and distort.
Why might Viceroy’s methods be particularly damaging? The following strategies in particular tend to result in sharp movements in markets which are sensitive to negative news:
Vague or undisclosed sources
Ideally, research should stick to referencing sources that are strictly in the public domain and capable of scrutiny by all who wish to do so. The report into Capitec’s operations leans in part on information supplied by former employees, whose level of insight into the business cannot be verified.
Media campaign and lobbying
It is certainly a compelling idea that the best short sellers and traders are likely to hold their positions close to their chest. In fact, institutional investors have short positions on their books unaccompanied by public reports on those positions.
Releasing the research into the market is legal and may in fact play a positive role in correcting information asymmetries. But the aggressive promotion of views through a series of presentations, sensationalist writing, and the failure to attach a target price suggesting the stock is worth near or at zero, are tactics more akin to agenda-driving than sober research, in my view.
Their communication style is distinctly different to that taken by fund manager Benguela which recently approached Capitec with questions and gave them a reasonable period to respond, unaccompanied by aggressive recommendations.
Aggressive recommendations beyond taking a position on the stock
Viceroy has called on regulators to place the bank under custodianship as well as for Jean Pierre Verster, chairperson of Capitec’s audit committee, to give recognition to its analysis that Capitec resembles African Bank before it crumbled.
Many short and distort strategists operate under a cloak of darkness, or pseudonyms. Though the people behind Viceroy are now known, the report is still not attributed to an analyst. The person working on a stock, the time covering that particular stock and sector, as well as their track record, are useful indicators of experience and credibility for consumers of research.
Of course, activist short sellers can drive a campaign and still be right, but I would be apprehensive of the view that it is done out of concern for investors. Campaign driving at its worst is designed to maliciously drive misinformation, and at its best to ensure quick and deep drops in prices so that the short seller can pick up stock at the cheapest price possible.
Despite the positive spin-offs with regard to information-sharing and possibly serving a watchdog function, it’s hard to derive some altruistic intention from it.
Sideways markets, or buffalo markets as described recently, are susceptible to uncertainty. One of those areas where credibility has been shot is the strength of corporate governance and the extent to which companies operating in South Africa do so in good faith.
The JSE’s booklet on ‘Insider Trading and Other Market Abuses’ highlights that awareness of market abuse regulations is high in South Africa. It also begins with a quote from Marxist Jean-Paul Sartre, but more on the ironies of that at some other time, perhaps. It does suggest that the commitment and incentive towards sound practices is the problem, and not awareness.
Response to short sellers may become more subdued in the future if investors become circumspect when perusing such negative reports, or if there is a serious response to talking about a new social compact and what that would mean in practice, beyond platitudes.
The focus in markets is typically on systemic risk of collapse, caused by financial interconnectedness and interdependency, but there is good reason to consider the consequences wrought by systemic reputational damage.
If the low trust rut corporate South Africa is experiencing deepens, it could be very difficult to escape because the enemy is hard to identify. Essentially, in low trust societies the incentives are such that doing the wrong thing yields more benefit than doing the right thing.
Whether this is true of South Africa may in time matter little compared to the perception.
* Gwen Ngwenya is an economist and chief operations officer at the South African Institute of Race Relations – a liberal think tank that promotes economic and political freedom. Views expressed are her own.
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