Trading on index rebalances is not a new phenomenon, but something far more harmful befell investors in lithium mining company Lake Resources after its share price was artificially inflated to gain entry into the S&P/ASX 200 last Monday.
Before being earmarked for inclusion in the main Australian benchmark on 3 June, the company self-promoted to retail investors on platforms such as Twitter and identified itself as a future top five lithium producer, according to an article by the Australian Financial Review (AFR).
This promotion included favourable research reports authored by Red Cloud, Canaccord Genuity, Roth Capital and Lodge Partners, which were paid for in company stock and options.
This eventually saw Lake Resources’ market cap hit a peak of AUS$3bn, making it eligible for ASX 200 inclusion.
Naturally, the company’s arrival in the large-cap benchmark was welcomed as good news as it would receive backing from passive funds including 11 ETFs.
Lake Resources’ share price subsequently rallied 9% between 3 June and 17 June, the final session before joining the ASX 200.
On Monday 20 June, however, the firm’s CEO Stephen Promnitz unceremoniously departed and appeared to dispose of all 10.2 million of his shares just five minutes before the company debuted in the large-cap index.
Not only did this net Promnitz an estimated AUS$11.1m but hedge funds short sold around 45 million shares in the lead-up to the company’s arrival in the ASX 200, a decision which paid dividends as its share price collapsed 48.4% in a week.
Responding, Promnitz told AFR the Lake Resources board asked him on 31 May to help transition the company to a new CEO. After resigning on 17 June, he said it was “standard practice” for outgoing CEOs to “immediately sell their stock positions”.
Regardless, a company entering a headline equity index while losing more than 71% of its value in under three months ought to raise eyebrows.
It raises questions such as how discretionary index providers like S&P Dow Jones Indices (SPDJI) should be when selecting and deleting constituents from their indices.
Furthermore, it potentially shows why passive rules on size and liquidity need to be supplemented with due diligence on corporate governance, especially in situations such as Lake Resources, which had previously exercised expired share options and performed irregular filings on changes in directors’ interests, AFR reported.
Michael Hutchens, founder of financial modelling software firm Modano, commented: “The outcome of all this madness was an enormous transfer of wealth from the retirement savings of mums and dads via their 'safe' index funds – and foolish retail investors buying into the paid hype – into the hands of short sellers and greedy executives who knew exactly how this was all going to end.
“I am really not sure how you fix something so fundamentally broken yet not technically illegal.”
Following Lake Resources’ eventful start as an ASX 200 constituent, Red Cloud posted another report on 21 June in which mining analyst David Talbot described the company’s share price collapse as “a great investment opportunity”. It subsequently fell an additional 10.8%, as at 27 June.