[Q&A] "Illegal Short Selling More Common in European IBs... Mostly Due to Position Management Issues"

Announcement of Interim Investigation Results on Illegal Short Selling by Global IBs
9 Companies, 164 Stocks, Worth 211.2 Billion KRW
Independent Improvement Demanded Apart from Short Selling Systemization Development

Ham Yong-il, Deputy Director of the Capital Markets Department at the Financial Supervisory Service. Photo by Dongju Yoon doso7@

The Financial Supervisory Service (FSS) conducted a comprehensive investigation into illegal short selling targeting 14 global investment banks (IBs) and detected illegal short selling worth 211.2 billion KRW across 164 stocks at 9 firms. Investigations are still ongoing for the remaining 5 firms.

On the 6th, the FSS announced the 'Interim Results of the Global IB Illegal Short Selling Investigation and Future Plans.' The main causes of illegal short selling were identified as △insufficient procedures for returning loaned or collateral-provided stocks △submission of short selling orders before borrowing confirmation △poor balance management between internal departments △manual input errors, among others.

The FSS plans to initiate disciplinary procedures as soon as additional investigations into the detected global IBs are completed. They also intend to promptly conclude investigations into the remaining 5 firms.

Below is a Q&A session with Ham Yong-il, Deputy Governor of the Capital Markets and Accounting Division.

- How serious is the level of illegal short selling found in the global IB investigation?

▲ Overall, issues with balance management are more prevalent than direct unfair trading problems such as insider information use. For the 9 firms identified so far, the issues may be practical problems within the balance management system or possibly flawed system design. Most relate to balance management. European IBs were detected more frequently than American IBs.

- Among the detected IBs, are there any confirmed cases of prosecution referral?

▲ It is currently premature to predict whether prosecution referrals will occur. Decisions by bodies such as the Securities and Futures Commission will be needed, considering the progress of sanctions for each firm.

- Have any global IBs that received fines filed administrative lawsuits during ongoing prosecution investigations?

▲ Of the 9 firms, 2 have been referred for prosecution. One case is ongoing, and additional cases are emerging, so nothing has been finalized yet. The scale may increase or decrease, but it cannot be confirmed at this time.

- Some view the penalties for illegal short selling as lenient and the fines as small. What is your opinion on this?

▲ If the penalties are deemed insufficient, stronger sanctions should be considered in consultation with the Financial Services Commission in the future.

- When do you expect to start the disciplinary procedures against illegal IB activities?

▲ If necessary, the Special Short Selling Investigation Team will announce the timing.

- To what extent do you assess the intentionality behind the illegal short selling?

▲ There was no connection to unfair trading. In cases of naked short selling, even if it stems from poor balance management, if the order was placed at a point when the issue was or could have been recognized, it can be considered intentional.

- Besides Hong Kong, is there cooperation with overseas financial authorities regarding the detection of illegal short selling?

▲ Besides the Hong Kong Securities and Futures Commission (SFC), Singapore is also involved. However, due to confidentiality, it is difficult to disclose all details about relationships with overseas authorities.

- Why was the specific investigation period for the global IB illegal short selling chosen?

▲ Short selling resumed in May 2021. The investigation period covers from May 2021 to the end of 2023. Although the entire period is subject to ongoing investigation, it is not feasible to cover everything.

- Is there any problem with short selling using DMA, which simplifies order placement?

▲ DMA (Direct Market Access) is a method that matches orders directly without going through securities firms’ order execution. DMA does not skip procedures; it only increases speed within the securities firm's server.

- You requested global IBs to establish effective countermeasures. Regarding the previously announced computerized short selling system, did you require the establishment of a 'proprietary balance management system'?

▲ We did not request this with the intention of preemptively legislating mandatory proprietary balance management systems. Some global IBs have balance management issues. Since there may be problems related to short selling orders, we asked them to reflect and improve based on the facts confirmed first. If mandatory proprietary balance management system legislation is enacted, guidance will be provided to foreign IBs. If there are differences between global IBs’ own methods and Korean legislation, the global IBs will need to make adjustments.

- When will the final investigation results be announced? Will the short selling ban period (until June 28) be extended?

▲ Extending the short selling ban period is under the authority of the Financial Services Commission. The investigation of the remaining 5 firms will require considerable time. It is not possible to say when the investigation will conclude. The FSS has mainly investigated 'long positions.' Since the Special Short Selling Investigation Team has been launched and the Korea Exchange has established a dedicated short selling monitoring department, short position (short selling) investigations are expected to continue.

- What is the scale of illicit gains obtained by foreign IBs through illegal short selling? Also, what are the plans for recovery measures?

▲ The scale of illegal short selling violations is not equivalent to illicit gains. Legally, the amount of illegal short selling orders must be aggregated. The amount of illicit gains is not large. Considering procedural issues, there are even cases of losses. The purpose of fines is both punishment and recovery of illicit gains. Fines are imposed based on the order amount. Considering the recovery purpose, the fines are deemed sufficient.