Structured Product Derivatives (SPDs) used to Short-Sale securities- Whether within the ambit of Benami Transaction?

The recent short-sale of Adani companies shares by Hindenburg Research, which reportedly used Structured Product Derivatives (SPDs), which are similar to controversial Participatory Notes, must come under scrutiny for its legality and ethical implications. In this context, the use of SPDs for short-selling Adani companies shares by Hindenburg Research, as reported by the Hindu Business Line on February 9, 2023 raises questions about whether it is within the ambit of a benami transaction, as it involves the use of a name-lender (benamidar) to conceal the identity of the actual clients involved in the short-selling.

Such transactions are definitely questionable and appear to be per se illegal under Section 53 read with Section 3 of the Prohibition of Benami Property Transactions Act, 1988 (as amended in 2016) because the use of SPDs to short-sell securities of targeted companies by Hindenburg and its associates through a name-lender (benamidar) is an attempt to circumvent the provisions of SEBI regulations on short-selling, and to defeat the provisions of the Indian laws with regard to Short-selling and securities transactions by Foreign Entities.

Institutional investors that want to participate in the Indian securities market are required to register with SEBI and follow its regulations. Foreign Institutional Investors (FIIs) and Foreign Portfolio Investors (FPIs) that wish to participate in the Indian securities market need to be registered with SEBI and comply with SEBI’s Know Your Customer (KYC) and Anti-Money Laundering (AML) requirements. Unregistered foreign institutions use SPDs to enter the Indian market may be attempting to circumvent these regulations and engage in transactions that are neither transparent nor accountable to Indian Financial and Securities Laws and Regulators.

While short-selling in Indian securities market is regulated by SEBI, naked short-selling is not permitted, and institutional investors are required to disclose upfront whether the transaction is a short sale. The reporting of short-sell transactions is also mandated, with brokers required to collect details on scrip-wise short sell positions, collate the data, and upload it to stock exchanges for dissemination to the public.

In the case of Hindenburg’s short-sale of Adani companies shares, the use of SPDs appears to have been an attempt to hide the actual identity of the short-sellers, which is a clear violation of the principles of transparency and fairness in the securities market. Moreover, the timing of the short-sale, which was announced on January 24, a day before the monthly derivative market expiry, and a few sessions ahead of the proposed Follow-on Public Offer of Adani Enterprises Limited (AEL) as well as the Union Budget announced on February 1, raises further suspicions about the intention behind the short-selling.

The peculiar Timing of the controversial Hindenburg Report coupled with media amplification led to a “shock & awe” effect on investors and Hindenburg and its associates appear to have used it to their advantage to financially benefit from volatility in short-term market movements. The “shock & awe” strategy, in vogue, typically involves releasing information and making trades that can cause a sudden and sharp movement in the market, often resulting in significant gains for those who are able to time their actions correctly. Such actions create market instability and undermine investor confidence, leading to long-term negative consequences for the market as a whole.

In conclusion, though short-selling within the framework of law is a legitimate practice in the securities market, it must be conducted within the framework of the law and the principles of transparency and fairness. The use of SPDs to short-sell securities of targeted companies by Hindenburg and its associates through a name-lending benamidar raises equally serious concerns about the legality and ethics of such transactions, and it is important that SEBI and other Indian regulatory authorities duly investigate this matter thoroughly and take appropriate action if any wrongdoing is found. To ensure the integrity and stability of the Indian securities market, it is important to enforce regulations that require foreign institutional investors and foreign portfolio investors to register with SEBI and follow its rules without circumvention. It is also important to establish mechanisms that allow regulators to monitor and investigate suspicious transactions such as through SPDs in a timely and effective manner. By doing so, the Indian securities market can continue to grow and attract investment while maintaining its reputation as a safe and transparent market.

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