The London Stock Exchange (LSE) has resisted Burford Capital's (Burford) attempt to obtain trading data, with the High Court ruling Burford's claims that US short-seller Muddy Waters Research (Muddy Waters) had manipulated the market to artificially lower Burford's share price were 'speculative'. A win for research based investment preventing inflated valuations or the affirmation of a fundamental menace to an orderly market?
Background
At the start of August 2019, specialist litigation funder Burford's share price was almost £14.00. However, Muddy Waters felt Burford had been overvalued and 'shorted' their stock; the process of borrowing a security which is believed to be overvalued, selling it at the 'inflated' price and then planning to buy it back at a later date when the price has fallen.
On 7 August, Muddy Waters tweeted a link to an opinion piece which explained why they had shorted Burford's stocks and stated:
"Thanks to a light disclosure regime, the esoteric nature of its business, and unethical behaviour by its largest shareholder, Invesco, [Burford] turned Enron-esque mark-to-model accounting into the biggest stock promotion on the AIM……[detailed investment data] proves [sic.] that BUR has been egregiously misrepresenting its ROIC and IRRs, as well as the state of its overall business".
On the same day, Burford's share price closed at £6.05; this was 56% lower that it had been at 1.30pm the previous day.
Burford's Spoofing claim
Although the judgement states that Muddy Waters' opinion piece and tweets were plainly designed to drive down Burford's share price, Burford's claim was not based on this conduct. They instead accused Muddy Waters of a market manipulation practice called spoofing or layering. A spoofer pretends to bid on a stock with the intention of cancelling before executing the trade; they will often provide the market with false information to distort prices and mislead innocent parties to trade at these manipulated prices.
However, both the London Stock Exchange and the Financial Conduct Authority considered the evidence Burford provided and independently found that it did not support the claim that Muddy Waters had engaged in spoofing or unlawfully manipulated the market in relation to Burford's shares.
Norwich Pharmacal Relief
Unconvinced by the LSE and FCA's conclusions, Burford sought further data to prove spoofing had taken place. They requested that the LSE provide them with the identity of each person who either bought or sold Burford's AIM-listed shares on 6 and 7 August 2019.
When the LSE refused, Burford applied to the court for Norwich Pharmacal relief to force the LSE to hand this data over. The Norwich Pharmacal principle is that were an innocent party becomes involved in the tortious acts of others so as to facilitate their wrong-doing, although the innocent party incurs no personal liability, she is required to assist the victim by giving full information and disclosing the identity of the wrongdoers.
Findings
In the first case of its kind against a UK stock market, Mr Justice Baker ruled that there was "no good arguable case that unlawful market manipulation occurred in respect of Burford's share price". He also stated that there were public policy considerations as granting the order could potentially harm public confidence in the FCA as regulator.
Burford had enlisted expert Professor Joshua Mitts of Columbia University to submit that there was strong evidence of spoofing or layering in the case. However, Mr Justice Baker found it "impossible to determine" whether there had been any manipulative practices based on the evidence.
Burford have released a statement that they are no longer in a position "to advance shareholder claims further" and do not intend to appeal.
The Ethics of Short-Selling
The case has brought short-selling and its ethicality into question.
The first point to note is that short-selling does not impact the operational performance of a company. It does not deprive them of any funds in the same way that a company does not become financially stronger when investors purchase their shares, driving the price up.
Short-selling actually contributes to a more efficient market, bringing overvalued stocks back into balance. Thorough research and analysis can also shine a light on previously unappreciated issues, forcing a company's management to address them.
Concerns arise when rumours without any basis in fact are circulated about a company's performance, causing a serious decline in share price for an issue that may never have existed.
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