An investment review: Why Hindenburg research analysts failed to bring down shares of Freedom Finance broker

An investment review: Why Hindenburg research analysts failed to bring down shares of Freedom Finance broker

What exactly is questionable in the report and what should be borne in mind when making an investment decision

An investment review: Why Hindenburg research analysts failed to bring down shares of Freedom Finance broker
Photo: depositphotos.com

Last week, a report on the operation of the Freedom Finance broker was published by Hindenburg Research. It included a whole bunch of accusations: circumvention of sanctions, falsification of income and reporting, manipulation of the securities market, misuse of client funds, and more.

The report had a transparent purpose (which its authors do not hide) – to profit from a nearing the shares of the subject of the assessment. This is Hindenburg's standard practice.

Mind's reference: Hindenburg Research was founded in 2017 by Nathan Anderson. It was named after the Hindenburg airship that crashed in 1937, as a symbolic reference to an "avoidable human-caused disaster". The company's activities include analysing the transparency of various businesses and publishing open reports on its website. The reports usually deal with corporate fraud, malfeasance in office, and other abuses.

Adani GroupNikola Corp. (Nasdaq: NKLA), Clover Health (Nasdaq: CLOV), Block, Inc., Kandi, Lordstown Motors, etc. have already been the objects of "research". The reports are disseminated to Hindenburg's limited liability partners, who collectively hold a short position in the target company before the report is published. That is, shares of the target company are borrowed and sold, and after the report is published, they are bought back at a (expectedly) lower price. The margin becomes a profit.

If the target company does have a questionable market valuation, this tactic might be very profitable, as the market is forced to realize that the "fair" value of the shares is downward. In a sense, Hindenburg's analysts do a noble job of "opening the eyes" of other investors.

However, the quotes of Freedom Finance (NASDAQ: FRHC) showed the opposite dynamics. Having traded on August 14 (the day before the Hindenburg report) at $75.7 and edited to $69 before publication, the company's stock went up sharply on August 18, continuing to rise this week. At the time of publication, FRHC was trading above $92 per share, more than 20% higher than the price before the report. And this is despite the fact that news agencies and social media quickly picked up the hot news and disseminated it.


Why did the bear speculation fail despite such serious preparations? Did the Hindenburg report cover the situation around Freedom improperly and the shares are not worth a fall? Or do the holding's shareholders actually have such a serious influence on the market that they were able to support FRHC's course no matter what?

Mind has examined the case and outlined recommendations for investors on the first things to focus on when reading such reports.

How did we study the report?

With Hindenburg's direct interest in reducing Freedom's stock price in mind, we divided their arguments into three groups, based on the level of credibility and significance:

  1. Reasonable claims.
  2. Exaggerated claims.
  3. Subjective/value judgements.

We provide specific examples for each group and specify how, in our opinion, such information should be handled. There has always been and will be a lot of contradictory data in the financial markets, and only those investors who are able to distinguish valuable facts from "white noise" can succeed.

Reasonable claims

This category refers to aspects of Freedom Finance Group's operations that do or may pose risks to investors. Their impact may have consequences now or in the future

Claims against the Belizean company

Freedom Finance Europe Limited (Freedom EU), a company registered in Cyprus, is used to work with European retail clients. It has the appropriate licences and opens accounts for clients, buys securities and provides statements  – traditional brokerage services. Hindenburg's report, however, focuses on another legal entity – Freedom Securities Trading (FFIN Belize), a broker registered in Belize. This company is 100% owned personally by Timur Turlov, Freedom Holding's majority shareholder.

Belize is certainly not known as the most transparent jurisdiction. And Hindenburg directly accuses Freedom of meeting clients in respectable offices and then redirecting them to Belize, where AML and KYC requirements are much lower.

Mind's reference:

AML (Anti Money Laundering) is a set of measures and policies designed to prevent the financial system from being used for money laundering.

KYC (Know Your Client) is a procedure for identifying and verifying a customer by a company (typically a financial one) before starting to provide services to them.

Pages 7-8 of Freedom's annual report list the legal entities that make up the holding. Interestingly, there is no company from Belize on this list, although the word "Belize" appears 177 times in the report itself. As explained there, after consultations and verification of the data with the auditor, including FFIN Belize in the consolidated statements was incorrect.

Although this company is not the immediate part of the holding, it generates a significant portion of its financial flow. Freedom's annual report reads (p.89):

"Fee and commission income generated from FST Belize accounted for approximately 60% of our total fee and commission income for the year ended March 31, 2023."

Mr Turlov himself pointed out that the firm plans to further reduce the role of operations with FFIN Belize, and even abandon it in the future. The company admits the situation in its annual report:

"We rely on our relationship with FST Belize for a significant percentage of our revenue, which exposes us to a number of risks" (p. 27).

"Due to our omnibus brokerage arrangement with FST Belize, penalties and other enforcement actions could be brought against us under relevant anti-money laundering and counter-terrorist financing laws due to breaches by FST Belize of those laws and regulation and similar laws despite the fact that we have no direct control over the activities or policies of FST Belize" (p. 34).

The implication is that Freedom Holding does not have full knowledge of the ultimate beneficial owners of FST Belize's clients, as it operates a pooled account. We consider this to be the biggest potential problem area  –  will it be possible to transfer clients to European or other jurisdictions, with the correct full KYC and AML procedures? Should the situation remain as it is, the likely problems in Belize could have an indirect impact on the entire holding.

Delay in reporting release

The company's annual report, to which we referred earlier, was published two months later than the deadline. Hindenburg wrote that this could lead to a potential delisting from the Nasdaq. Freedom itself reported that the delay in publishing the report was precisely due to the need to thoroughly check everything and get the approval of the auditor, one of the Big Four, Deloitte.

Having removed unnecessary emotions, we focus on the facts. Nasdaq's claims are set out in the following document. Among other things, it states that the company received a letter from the relevant exchange authorities regarding "being not in compliance with the Listing Rules as a result of its failure to have timely filed its Annual Report on Form 10-K."

"The Company has until 14 August 2023 to submit to Nasdaq a plan to regain compliance in accordance with the listing requirements. If the Company’s plan is accepted, Nasdaq may grant the Company up to 180 days, or until December 12, 2023, for the Company to regain compliance.”

Thus, there is a fact of non-compliance. The consequences, however, can be remedied, so we have to keep this topic in mind as a potential risk should the company fail to meet the deadline. Mr Turlov says that the quarterly accounts are due to become public in early September. This should be the focus of our attention  –  delisting is possible if the violations continue, and not as a result of the delays that existed at the time of Hindenburg's publication.

Exaggerated remarks

This group is the most challenging, as it may contain real facts. However, they are presented in such a way that their true meaning and impact are lost. Here, the reader must be careful and stop in time to draw a line between the data and its interpretation.

Freedom's affiliate in Belize commingles clients funds, exposing them to extreme risk

Here we are talking about FST Belize again. Hindenburg refers to paragraphs of Appendix 5 to the Brokerage Services Regulations. It states that "FFIN Belize can commingle client funds and essentially do whatever it wants with them for its “own interests”.

It further states that US companies are subject to SEC Rule 15c3-3, which governs the separation of client assets from firm assets, and is intended to allow clients to recover their assets if the firm becomes insolvent. We don't really understand why Hindenburg analysts refer to US law and then conclude that FST Belize does not comply with FINRA (also a US self-regulatory organisation).

As mentioned above, FFIN Belize is not a direct member of the holding, but is linked to it both in terms of ownership structure and business. In fact, it looks like this: FFIN Belize accepts money from clients and accumulates it on its accounts. Then this company itself serves as a client of the Freedom EU broker through "omnibus accounts".

Mind's reference: An omnibus account is an investment account in which a broker or agent pools resources from several individual investors and manages them together.

Therefore, as a client of a Cyprus company, FFIN Belize indeed carries out transactions on its own behalf. The company was registered in Belize, not in the US, so it adheres to local standards and regulations, which are obviously less strict than in the United States.

FST Belize clients should understand all the risks associated with the Belizean jurisdiction compared to the EU or the US. Simpler KYC procedures in exchange for less investment protection –  this is how this compromise appears. Mind has already reported on this in more detail in our crypto exchange ranking, where we showed how clients can choose between licensed exchanges in the US or EU and platforms from freer jurisdictions.

Too many fines

Hindenburg points out that the four Freedom entities in Kazakhstan have 244 violations, resulting in 121 penalties and fines totalling 160,082,585 tenge ($353,000). The emphasis is placed on the nature of the violations – "charges ranging from money laundering to terrorist financing".

This sounds impressive, but the sheer volume of fines (an average of about $1500 per violation) clearly indicates that there are no truly serious abuses. Those  who have experience of working in regulated financial markets know how easy it is to get fined for certain violations there.

Substantial risks associated with investing in a single issuer

Hindenburg writes: "SEC filings show that freedom invested 35% of its gross principal trading balance, amounting to $835 million, in the debt of one Kazakh issuer."

Looks alarming, at first glance. If the reader goes further than the headline, however, he or she will see that it is the securities of the Kazakhstan Sustainable Development Fund. That is, these are investments in government securities, the overall risk of which is traditionally the lowest (adjusted for jurisdiction, of course). Page 125 of the annual report details this issue. It also mentions the holding of $1bn of government bonds of Kazakhstan's Ministry of Finance. The fund's credit rating from S&P Global is BBB, and the Ministry of Finance's, BBB-.

Any investment can carry risks, which is obvious. Today, when global central bank rates are at their peak, investing in government bonds may look interesting, because after the start of the rate cut cycle, prices for debt securities will go up.

There is an inverse relationship here. The current discount rate of the Central Bank of Kazakhstan is 16.75%, and having accumulated so many cheaper bonds, Freedom can expect the trend to reverse. The only thing to worry about is the low liquidity of the Sustainable Development Fund's securities, as Hindenburg indicates. That said, income can also be recorded when the bonds are redeemed.

Market information on the fund's bonds is available on the website of the Kazakhstan Stock Exchange.

Subjective/value judgements

This group, in our opinion, was the main problem with the report and contributed to the failure in the relegation game. Despite the presence of well-reasoned claims, the report is packed with a significant number of emotional and openly distorted judgements.

Accusations of sanctions circumvention

We must understand that working with russian citizens is not a direct violation of sanctions requirements. The latter relate specifically to restrictions on working with sanctioned individuals and organisations – the search for such individuals is one of the tasks of the KYC procedure.

We believe that Hindenburg is mixing up the definitions quite freely here and presenting everything as if any involvement with russian citizens constitutes a direct violation. It's no secret that a large number of russian clients have opened accounts in Kazakhstan or other jurisdictions and continue to be serviced by Freedom.

Another example pointed out by Hindenburg is assistance in transferring assets to clients of sanctioned institutions (in particular, Alfa-Bank). Again, we emphasise that if Freedom transferred clients who are not sanctioned persons themselves to its own service, this is not a violation. On the contrary, this is a civilised procedure that allows us to protect the interests of our clients. For example, we are still waiting for a solution to the problem with the frozen assets of the Ukrainian clients of Freedom Finance Ukraine LLC. A few days ago, this issue was raised at a meeting of the Parliamentary Committee on Finance, Taxation and Customs Policy, so we hope to speed up its resolution.

Connections with other companies

There are numerous places in the Hindenburg report where the deficiencies of partner companies are attributed to the subject of the assessment as evidence of guilt. In particular, the following:

"Freedom then moved cash out of Dubai using local, informal Hawala money transfer networks – a system that has become notorious for facilitating money laundering and terrorist financing."

We have to understand that the use of Hawala by some players for certain illegal activities does not mean that all those who use it are criminals. Most drug trafficking transactions are paid for in US dollars, but that does not make the rest of the users of this currency criminals. Similarly, with cryptocurrencies, it is very easy to show the connection between crypto and illegal transactions, but we should be interested in the direct legality of the transactions under investigation.

The second example is related to the Binance exchange, which Mind has already written about. Here, Hindenburg follows the standard pattern: "Binance is being sued by the SEC, and Freedom is cooperating with them – and that's bad." In fact, the crypto exchange announced the start of cooperation in Kazakhstan on 21 June, "16 days after the SEC filed the charges," as clarified by Hindenburg.

It is not worth reminding you that a verdict against Binance has not been passed. And it is even more incorrect to try to blame the organisation's partners.

The non-market nature of Freedom's own share price

The report says that FRHC shares are traded at high levels despite problems in the market or in the financial sector:

"For example, the global financial sector suffered in March 2023 with the implosion of Silicon Valley Bank and the crisis at Credit Suisse. Regional banks and brokerages sold off in March and have yet to fully recover. Yet Freedom’s stock was seemingly impervious to wider market forces, reaching a 5+ year high."

There is a chart of Freedom's share price and some of its peers as illustration (it is not very clear what Toronto-Dominion Bank is doing there).

As you can see, they used the standard technique of choosing the part of the graph that best supports the thesis. The chart begins immediately with a spike upwards from Freedom (on positive corporate news). When looking at the data more broadly (we took a period of one year), the dynamics of Freedom and another broker popular among Ukrainians, Interacrive Brockers (Nasdaq: IBKR, black line on the chart), are close.

Source: MarketWatch data

The selection of companies for comparison matters as well. To get a more complete understanding of how a particular company looks when compared to its industry peers, we recommend using larger samples. This can be done, among other things, on FinViz, where we applied the Financial → Capital Markets sector filter and selected a capitalisation of $2 billion and above. Here, you can see that both the dynamics and valuation of companies vary dramatically.

A separate point in the Hindenburg report emphasises the dominance of two small brokers in trading in FRHC shares, which, according to the authors, indicates the non-market nature of trading. However, Hindenburg's own attempt to play down these "non-market" shares looks even more strange.

The majority investors may be assumed to have supported the company's shares. In such circumstances, the sellers were trapped – they would have to buy back the borrowed shares anyway, but at a higher, not lower, price, as they had expected. In such circumstances, the price can rise well above fair levels on the back of the rush of demand.

Benziga.com analysts have also recorded unusual dynamics in Freedom derivatives. According to their data, the general attitude of large traders is split between 78% positive and 21% negative.

Anyway, sellers of shares are now recording their losses. So are those who immediately started selling, trusting the Hindenburg report.

How should one use the Hindenburg Research reports?

The report concludes as follows:

"Hindenburg Research is not registered as an investment advisor in the United States or have similar registration in any other jurisdiction. To the best of our ability and belief, all information contained herein is accurate and reliable, and has been obtained from public sources we believe to be accurate and reliable (…) However, such information is presented “as is,” without warranty of any kind – whether express or implied. Hindenburg Research makes no representation, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use. All expressions of opinion are subject to change without notice, and Hindenburg Research does not undertake to update or supplement this report or any of the information contained herein."

At the same time, Hindenburg points out that it is important for readers of the report to "do your own research and due diligence, consult your own financial, legal, and tax advisors before making any investment decision with respect to transacting in any securities covered herein."

This is exactly what we have done, detailing the areas in which such research should be conducted and the issues that should be given the most attention. Especially before making risky investment decisions.

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