Short-sellers smell blood as Japan Inc wounded by accounting scandals

Until recently, corporate managers in Japan have enjoyed relatively limited scrutiny of their governance standards and accounting rigour, and a cosy tradition of cross-holdings between companies has relegated the status of minority shareholders and the importance of adequate disclosure.

But as the government of Prime Minister Shinzo Abe has tried to clean up corporate culture and activist investors have begun to kick the tyres of Japan Inc, short sellers are finding fertile ground for profit.

On Tuesday, prominent U.S.-based short-seller Citron Research launched an attack on Japanese robotics company Cyberdyne, claiming it was "the most ridiculously priced stock in the world" and had misled retail investors over its technology assets.

Cyberdyne, which closed down 7 percent on Tuesday, dismissed the report as an attempt to push its stock price down.

It is not known whether Citron holds a short position in Cyberdyne.

It is the second attack on a Japanese company in less than a month and the sixth since December 2015, when Well Investments Research challenged trading firm Marubeni, the first such campaign in Japan tracked by Activist Shorts Research.

According to Activist Shorts, the six Japan campaigns, half of them directed at Cyberdyne, have generated average losses of 23 percent, which means profit for short-sellers, who sell borrowed stocks and buy them back more cheaply.

It said that is among the top half of the 46 activist short-sellers to have launched campaigns in the past year and is more than double the year-to-date return of Asia's main benchmark.

The phenomenon of short-sell attacks took hold between 2009 and 2011, with investment and research firms such as Muddy Waters Research and Alfred Little attracting international attention for their campaigns against overseas-listed Chinese companies including Sino-Forest and Silvercorp.

Short-sellers and analysts said they expected more attacks on Japanese companies as regulators in China and Hong Kong fight back against short-sellers, and Abe's campaign flushes out deficiencies.

"As Japanese markets embrace the values of Abenomics, investors of all types, shareholders, short-sellers will insist that listed companies hold themselves to higher standards of transparency, accountability and corporate governance," said Soren Aandahl, director of research at Glaucus Research.

"That in turn makes short investment opinions more impactful," he added.

Glaucus itself sent shares in trading firm Itochu Corp tumbling 10 percent last month by claiming it had inflated profits through creative accounting, the biggest attack on a Japanese company by market value so far. Itochu denied the claims.

Aandahl declined to say if Glaucus was preparing more Japan campaigns but confirmed it was conducting research on other Japanese companies.

Revelations last year that Toshiba, the laptops-to-nuclear conglomerate, had overstated profits by $1.3 billion over several years sparked a public debate over Japan's inward-looking corporate culture, in which boards have typically held investors at arms' length.

The Toshiba investigation identified a corporate culture in which the management could not be challenged and didn't always heed its external auditors.

The scandal led the Japan Financial Services Agency to step up scrutiny of auditors, while the Japan Institute of Certified Public Accountants has conducted several quality-control inspections of its members.

In June 2015 the government also implemented a new corporate governance code in a bid to stimulate foreign investment.

"Right now, there's an interesting mix of factors at play in Japan. The Toshiba scandal could be seen as a blow to investor confidence, but that and Abe's moves also created the opportunity for short-sellers to spark a conversation on overvalued companies," said Claire Stovall, research analyst at Activist Shorts.

"In a country where Well Investments has described an acceptance of poor disclosure, partly built on corporate relationships and a laissez-faire trust in management, investors and regulators will likely be sensitive to negative research."

Analysts and short-sellers said they saw ripe shorting opportunities among Japan's commodities trading companies, which could be prone to aggressive accounting tactics following the global commodities slowdown.

GMT Research, which analyses company accounts for hedge funds, said earlier this year that the book values of Japanese trading companies were overstated by as much as two thirds in some cases.

"Companies reclassify their investments and affiliates all the time. In this case, it is probably the pervasiveness and the magnitude that warrant closer scrutiny on the practice," said trader and short-selling specialist Laurent Bernut.

Short-sellers burnished their credentials from 2010 onwards by exploiting concerns over poor corporate governance and accounting practices at more than 100 Chinese companies, in some cases exposing outright frauds at the likes of Sino-Forest and China Metals Recycling.

But a crackdown by authorities in Hong Kong, the main market for offshore Chinese stocks, has made such attacks riskier , while investors are increasingly pricing in doubts over Chinese companies, making such attacks less lucrative.

Citron Research's head Andrew Left is currently awaiting a Hong Kong tribunal ruling over allegations by the Securities and Futures Commission he manipulated the market when he targeted Chinese property developer Evergrande in 2012.