The Burford Capital soap opera rumbles on, and for those who don’t hold shares, the temptation to ignore the story, or even worse, fall into the lazy belief that “there’s no smoke without fire” is tempting. However, the Burford story is much more interesting, and important, than that.
A brief recap. On 6 August, a US firm known as Muddy Waters tweeted that it would announce a new short position the next day. Rumours swirled the market and a number of companies saw their share price fall significantly. The next day, at 8.53, Muddy Waters announced that their target was Burford. Shares in Burford dropped from £13.81 on the close of August 5 to £6.05 on the close of 7 August.
Since then, Burford has provided several updates to the markets claiming that Muddy Waters research was flawed and inaccurate, which Muddy Waters appear to dispute. But in a sense, that is a sideshow, of interest only to Burford shareholders (I’m one).
What should be of universal interest is the announcement on 30 September that Burford has issued a Norwich Pharmacal Application (NPA) to the High Court against the London Stock Exchange. An NPA is a legal application for evidence: essentially, a person has been wronged but can only identify the wrongdoer with the help of evidence held by a third party, in this case, the LSE. I recommend everyone read the affidavit (link at end of article) lodged in support of the application.
Burford’s argument boils down to the following:
- there was a huge amount of “spoofing” of its shares on 6 and 7 August;
- there was lots of “layering” at the same time;
- there is evidence of multiple persons acting in concert;
- that the LSE is under a regulatory duty to keep details of “all orders advertised through their system”; and
- by disclosing that information the LSE may enable Burford to identify those responsible for spoofing and layering.
Spoofing and Layering
Spoofing is, in simple terms, placing orders to buy or sell shares, usually just outside the spread and then immediately withdrawing the orders, often to replace them at a slightly different price. This creates the impression of a wave of sellers or buyers attacking the bid or offer.
Layering is placing lots of orders on the books which are never intended to be executed, but which give the impression of a depth to the order book which isn’t accurate. Both create false impressions which create a feedback loop which can drive a share price down.
Spoofing and Layering are familiar to anyone who has worked in financial services over the last decade. They are two of the basic techniques of market manipulation that all compliance courses require all regulated persons to be able to identify and report.
They are not only illegal in themselves, but any regulated financial services business is legally obliged to take reasonable steps to detect and notify the FCA about any spoofing or layering they suspect may have been committed by their clients.
Burford employed an expert witness who claims to have identified significant and unusual spoofing and layering on 6 and 7 August. For example, in the six minutes before Muddy Waters tweeted the identity of its target, orders to sell over 400,000 shares – or around £5m worth of stock – were made and cancelled. Often cancellation took place within micro-seconds of the order being placed.
Debate About Regulators and Regulation
The whole report makes fascinating, if uncomfortable reading. According to the FT website, the LSE have argued that any investigation should be carried out by the FCA. This view was endorsed on Twitter by prominent shorter Matthew Earl of Shadowfall (twitter description: focused on unethical business conduct). Those who have followed the prominent shorters will recall that they generally regard regulators as useless and believe that any wrongdoing is better exposed by those with skin in the game. So the change of approach is noteworthy.
Burford themselves understand that this information will not be the end of the matter: it will probably only identify which brokers placed orders, and so a further court application will be needed requiring the brokers to identify the clients who were placing these orders.
This is, to me, a story of our times. The authorities, in this case, the EU and the FCA, bring in complex rules that create a huge compliance burden: in this case, on regulated firms to monitor for and ensure that market manipulation is reported to the authorities. A search on Google indicates that prosecutions for spoofing shares are pretty non-existent in the UK. And when one company claims to have been the victim of a spoofing attack, the FT reports that the LSE think that any investigation should be led by the FCA, who lack resources and have a track record of not bringing prosecutions (for whatever reason) in this area.
This is not all. The affidavit claims that Muddy Waters did not notify the LSE of their short position, in contravention of express regulation. Had they done so, it would have been apparent that, the day before they published a note claiming that Burford was “arguably insolvent”, they had been buying shares at £11-13 in order to start closing out their short. Paragraph 34 of the affidavit suggests this failure to disclose was made for the purpose of not alerting the market to the short. So the allegation is of deliberately breaking regulation in order to gain unfair advantage.
The LSE find themselves in an interesting position. Burford are claiming to have uncovered a nest of illegality, with notices not being filed, multiple parties acting illegally in concert, and multiple brokers either assisting or failing to either notice or report market manipulation. All of these are breaches of regulations brought in to show that the market is fair and transparent. Any one of these is a serious offence. Of course, Burford may be mistaken and everyone may have acted entirely properly. But on the face of it, there seems an awful lot of regulation not being complied with.
It seems quite possible that this is the tip of the iceberg. If there was layering and spoofing, then is it likely that it is the first time this has happened? Or is it happening systematically, and this is the first time that someone with the budget and tenacity to investigate has become involved? How many people and firms are involved? And the ultimate questions: is there systemic market manipulation across the LSE? And if there is, by whom and how will they be held to account? And is the regulation, imposed at great cost, simply ignored by a whole swathe of market participants?
Of course, the answer to all of these questions is that, without the evidence, we do not know. And clearly, there appears to be some interest in burying the evidence in an FCA investigation. So the Burford court case may be the best chance – the only chance – we get to discover the truth about the state of the LSE and AIM in 2019. Every private investor should lobby their MP, the LSE and the FCA to ensure that we get that truth. You can find some sample text here which could form the basis of letters to the powers that be. I recommend that you customise the text with your own views, so that addressees don’t all get copies of the same letter.
Paul de Gruchy