A US hedge fund has attacked the accounting and governance of a litigation finance firm, sending its shares down sharply and shining a spotlight on such techniques. Litigation finance is a large, overwhelmingly US, market.

UK-listed litigation finance firm Burford Capital said yesterday that a devastating “short-attack” on its shares last week was consistent with illegal activity. It has hit back at claims by US-based hedge fund Muddy Waters, which claimed the firm’s accounts were questionable and that it was poorly run. 

Burford’s market capitalisation more than halved to £1.2 billion ($1.45 billion) last week from £2.6 billion in just two days, on August 6 and 7.
“Burford’s market-leading business today is the same as Burford was a week ago. What has changed is that a substantial amount of market value was wiped out by activity we believe is consistent with illegal market manipulation that has nothing to do with Burford’s business. That is wrong and that is illegal,” Christopher Bogart, Chief Executive Officer of Burford, said.

Burford hired lawyers and began to probe dealing in its shares. It said preliminary findings showed there was “evidence consistent with illegal market manipulation”.

Litigation is a niche area within what can be described as alternative investment. At the same time, controversy over short-selling practices and alleged market manipulation raise a number of compliance and market conduct issues.

“While Burford continues to analyse the data, it has made regulatory authorities and criminal prosecutors aware of these preliminary conclusions and Burford is considering its own options,” the firm said in a statement yesterday. The company has retained the law firms of Quinn Emanuel Urquhart & Sullivan LLP, Freshfields Bruckhaus Deringer LLP and Morrison & Foerster LLP in connection with these matters.

The statement referred to two practices that are now illegal: “spoofing” and “layering”.

Spoofing is the placement of a high volume of trading orders at a price equal to or better (i.e., lower) than the best-bid-best-offer price and subsequently cancelling these orders to move the price in a given direction without actually concluding any trades. Layering is similar to spoofing, except that instead of placing and cancelling a high volume of orders at the best offer price, the manipulator places these orders deeper in the order book, at prices above the best offer. 

The Burford statement examines some of the share movements after Muddy Waters had tweeted about a forthcoming short attack. In “the several hours” after that tweet, about £90 million of sell orders were placed and cancelled without being filled, it said.

On August 7, a day on which over 28 million Burford shares traded, Burford’s share price suffered its greatest declines over just ten single minute periods with very low volumes of executed sales and very high volumes of cancelled sales orders, Burford said.

A report in the Daily Telegraph quoted Gotham City Research, an investment firm, saying it defended short sellers, arguing that they should be “applauded for their work” (12 August). Gotham’s American boss Daniel Yu was quoted as saying that scrutiny of Burford was “long overdue”. “The company has had the privilege of raising cheap public capital and enjoying an absurdly high valuation.” Gotham says it does not hold Burford stock.