A US hedge fund’s report on the allegedly shady activities of a healthcare company under investigation by the US Securities and Exchange Commission (SEC) offers a timely reminder for the positive market force that activist short sellers provide.
Following the public spat between retail investors, politicians and short sellers regarding their role in the market amid the GameStop saga, Hindenburg Research has released its findings from a four-month investigation into apparent misconduct by Clover Health but is not taking a position in order to highlight the role activist short sellers play in uncovering fraud and malpractice.
Explaining its decision, Hindenburg states: “Short selling is always high risk, these are unprecedented times; many people are angry and right now we believe it is important to demonstrate the role short sellers play in a healthy, functioning market.”
Short selling reports are often dismissed by the subject of the investigation and its long investors by highlighting the financial incentive a hedge fund has to apply downward pressure on prices, which may lead it to exaggerate a company’s flaws.
“We are taking that off the table for this one report so the investing public can more clearly see the work for what it is; deep-dive investigative research,” the fund states.
The report, Clover Health: How the “King of SPACs” Lured Retail Investors Into a Broken Business Facing an Active, Undisclosed DOJ Investigation, claims that the “corporate world is rife with fraud, and investors have little protection”.
And in a vacuum of regulatory, moral and journalistic oversight, Hindenburg states, “short sellers, like us, have stepped further into the role”.
Among the fund's numerous claims, it suggests that Clover neglected to inform investors it is under investigation by the US Department of Justice (DoJ) and that high-profile venture capitalist and Clover promoter Chamath Palihapitiya did not perform adequate due diligence and misled investors regarding Clover’s “deceptive sales practices” to drive growth.
According to a Civil Investigative Demand, similar to a subpoena, uncovered by Hindenburg and not disclosed by Clover to investors, the DoJ is investigating at least 12 issues ranging from kickbacks to marketing practices to undisclosed third-party deals.
Elsewhere, Hindenburg argues that Clover claims that its best-in-class technology fuels its sales growth, but in fact sales are driven by a major undisclosed related party deal and misleading marketing targeting the elderly.
In 2016, Clover was fined for misleading marketing practices by the Centers for Medicare and Medicaid Services.
Man of the people?
In addition to the healthcare provider's alleged malfeasance, Hindenburg argues that Clover’s “Wall Street celebrity promoter”, Palihapitiya, misled investors about critical aspects of Clover’s business in the run-up to the company’s special purpose acquisition company (SPAC) initial public offering in January.
Palihapitiya went on a major promotional campaign for Clover in the months leading up to the company going public, presenting it as a panacea to complaints of price gouging and up-selling that are common in the established US healthcare sector.
“We think Chamath has done a masterful job marketing himself, capitalising on the recent chaos with GameStop and WallStreetBets to align himself with everyday investors – but his public persona strikes us as the sugar that helps the poison go down,” Hinderburg says.
Ordinarily, Hindenburg funds “bets against wrongdoing”, aligning its research with its capital, publishing the reasons why it is shorting a company, with proceeds funding future investigations and research.
Since Hindenburg released its report on 5 February, the number of shares on loan spiked, with utilisation remaining maxed-out ever since, according to Ortex Analytics. Cost-to-borrow has also strayed just above the threshold for a ‘hot stock’ of 500bps.
Clover’s (NASDAQ: CLOV) share price is at a year-to-date low of $11.5 as of 16 February, although it has been in decline since hitting an all-time high of $16.77 on 31 December.
“Short sellers have exposed almost every major market fraud in the past several decades, yet there have been recent questions about whether short-sellers and critical researchers play an important role in a healthy, functioning market. We hope our research serves as a timely reminder that they do.”
Despite the “epic upheaval” of recent weeks, many average investors have “realised their strength” in an environment long dominated by large institutions and corporate insiders, the report states.
Short selling has “existed for hundreds of years”, the fund concludes, and the practice has been instrumental in exposing “most major market frauds” in recent history, including Lehman Brothers, Wirecard — in which German financial regulators were “negligent” in reacting to accusations of illegal activities made by short sellers against the company — and US zero-emission vehicle company Nikola.
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