[Endless Short Selling Controversy] ① 7 out of 10 Who Sold Stocks They Didn't Own Are Foreigners... 'Full Resumption' Is Out of the Question

Foreigners Account for an Overwhelming Share of All Illegal Transactions
Mandatory Contracting on a Dedicated Platform and Computerization of Loan Transactions Must Be Implemented

The Securities and Futures Commission under the Financial Services Commission held a regular meeting on the 8th and imposed a fine of 1.063 billion KRW after reporting that Kepler Shubra sold 41,919 shares of SK Hynix common stock that it did not hold. It was judged to be illegal naked short selling. In addition, 10 companies including Deutsche Bank, Macquarie Bank, and Nova Scotia Asia Bank were fined a total of 205.5 million KRW for delayed reporting of net short selling positions and violations of disclosure obligations. These were unfair acts abusing short selling.

Despite strengthened management and supervision by financial authorities, illegal short selling is still rampant. In particular, foreign investors are frequently engaging in illegal short selling, causing strong resentment among individual investors. Accordingly, discussions on the full resumption of short selling have disappeared, and there is a growing call to further strengthen the monitoring infrastructure to detect illegal short selling.

Illegal Short Selling by Foreign Investors on the Rise

Illegal short selling is divided into 'naked short selling' and 'unfair acts such as market manipulation abusing short selling.' Under the current Capital Markets Act, only borrowed short selling, where stocks are borrowed before selling, is permitted. Naked short selling is prohibited. In the case of Kepler Shubra, naked short selling was conducted, while the other companies committed 'unfair acts such as market manipulation abusing short selling.'

According to the Financial Supervisory Service (FSS), the number of violators who received fines or penalties for illegal short selling was 4 in 2020 and 14 in 2021. All were foreigners. Last year, out of 28 violators, 25 were foreigners, accounting for 89%. This trend has not changed this year. As of the end of August, 27 violators were recorded, with 19 foreigners accounting for 70%. This has solidified the perception that 'illegal short selling = foreign investors.' Especially considering the active investigations by the FSS into illegal short selling until recently, it is widely expected that the proportion of foreigners among violators will increase further.

The first fine imposed this year was also on a foreign company. In March, the Securities and Futures Commission fined ESK Asset Management 3.87 billion KRW and UBS AG 2.18 billion KRW. They were caught placing sell orders on EcoPro HN and SK stocks, respectively, which they did not hold last year. In June, the French asset management company AUM Invest also received a fine from the Securities and Futures Commission.

Senior Research Fellow Hwang Se-woon of the Korea Capital Market Institute analyzed, "From 2010 to April 2022, there were 127 cases of fines or warnings related to illegal short selling (71 fines, 56 warnings). Among them, 119 cases, or 94%, involved foreigners, indicating that illegal short selling is mainly committed by foreigners." He added, "Considering the large participation of foreigners in short selling transactions, the proportion of illegal acts is very high."

The total fines and penalties related to illegal short selling imposed from the beginning of this year until last month amounted to 10.18 billion KRW, more than four times last year's 2.35 billion KRW. Despite strengthened management and supervision by financial authorities, illegal acts have not been eradicated, and controversies over short selling continue. To eradicate illegal short selling, the FSS established a dedicated short selling investigation team in June last year. They focus on investigating large block trades outside regular hours, adverse information such as clinical trial failures, and whether short selling exceeds the hedge quantities of futures market makers involved in market manipulation. Notably, this year, penalties were raised from fines to surcharges for the first time, addressing criticism that previous penalties were too lenient to be effective. Nevertheless, illegal short selling was detected.

In a state of urgency, the FSS convened compliance officers of foreign securities firms on the 7th and ordered strengthening of internal controls to prevent illegal short selling. They emphasized thorough checks of short selling order processes, internal control system maintenance, and employee training. The FSS plans to strictly inspect the appropriateness of securities firms' short selling order acceptance and processing during investigations and examinations.

The market does not expect foreign illegal short selling to decrease despite these strong measures by financial authorities. Moreover, the fact that ESK Asset Management, which was the first to be fined for illegal short selling in March, filed an appeal lawsuit against the financial authorities adds uncertainty. ESK Asset Management filed a lawsuit at the Seoul Administrative Court against the Securities and Futures Commission, requesting cancellation of the fine imposition, claiming the decision was unfair. Since foreign companies have opposed fines as unfair, there may be a series of lawsuits led by ESK Asset Management. Given that legal disputes are already underway in the first fine case, it is doubtful whether the Securities and Futures Commission will impose severe penalties in the future, considering the possibility of foreign capital outflow or lawsuits.

Need to Strengthen Illegal Act Detection Systems

There is a strong call to strengthen detection and monitoring systems rather than just imposing fines to eradicate illegal short selling. Senior Research Fellow Hwang Se-woon said, "The standards for punishing unfair trading acts have already been considerably strengthened, so market monitoring must continue to be enhanced to ensure effective detection and punishment."

Currently, the Korea Exchange's Market Surveillance Headquarters' Special Short Selling Inspection Team monitors in real time and immediately conducts inspections when detecting abnormal quotes such as large short selling orders or sudden surges in short selling orders. During this process, they request related data such as securities lending contract information from financial investment companies for analysis. If suspicious illegal transactions are confirmed, they notify the FSS. The FSS detects illegal short selling based on suspicious transaction data received from the exchange and its own investigations. The short selling investigation team, established last year, conducts planned investigations into large short selling before the disclosure of adverse information.

From the beginning of this year to August, the exchange reported 80 suspicious illegal short selling cases to the FSS: 47 in the KOSPI market and 37 in the KOSDAQ market (including violations in both markets). Last year, the total number of detected cases was 94. Considering the continuous increase in suspicious transactions, it is clear that eradicating illegal short selling remains difficult. Ultimately, there is a call for the monitoring system to function properly.

A financial investment industry official said, "We expected that the strengthened fines would raise awareness of illegal short selling among domestic and foreign financial firms, but illegal acts continue in the market," adding, "It is most important to strengthen market monitoring so that rapid detection prevents evasion of surveillance."

The most important foundation to block naked short selling is to promote computerization of securities lending transactions and ultimately mandate contract execution on a dedicated lending transaction platform. Senior Research Fellow Hwang Se-woon emphasized, "It is important to improve internal control systems related to short selling and securities lending in financial companies and to enhance computerization levels to minimize the possibility of naked short selling." An FSS official said, "Since the penalty severity was only recently increased from fines, awareness of illegal short selling seems weak," and added, "We plan to continue strengthening inspections of unfair trading abusing short selling."

This content was produced with the assistance of AI translation services.