[Invest&Law] "Overseas IBs Engage in Naked Short Selling Using Domestic Securities Networks"

First Case Applying Criminal Penalty Clause for 'Illegal Short Selling'
Uncooperative Investigation Attitude of Overseas IBs as a Variable

The prosecution is focusing on proving charges by assigning even veteran investigators who were handling the Kakao investigation to the ‘illegal short selling investigation team.’ In response, foreign investment banks (IBs) have countered by appointing senior lawyers from major domestic law firms Kim & Chang and Bae, Kim & Lee LLC. It is known that Kim & Chang has been responding since the financial authorities’ investigation before the prosecution’s inquiry began.

BNP Paribas Hong Kong branch is accused of placing short selling orders without borrowing stocks worth a total of approximately 40 billion KRW across 101 stocks including Kakao from September 2021 to May 2022. Hong Kong HSBC is accused of illegal short selling without borrowing stocks worth about 16 billion KRW across nine stocks including Hotel Shilla from August to December 2021. The Financial Services Commission’s Securities and Futures Commission reported these companies to the prosecution for illegal short selling in December last year.

Photo by Yonhap News

◆ "Symbiotic Structure of ‘Jeonju’ and ‘Seonsu’ Roles" = The prosecution views that behind the repeated illegal short selling by massive foreign capital lies a structural problem where ‘Jeonju’ (money providers) and ‘Seonsu’ (players) coexist for huge profits. On the surface, overseas IBs conduct the short selling, but asset management companies that provide the funds earn high profits behind the scenes. Asset management companies pay high fees to IBs that execute stock trades, shifting investment responsibility to them.

They enter into contracts that confirm sell orders only within the range where hedging (risk diversification) is completed by layering typical TRS (Total Return Swaps). IBs have a structure that makes as many contracts as possible to maximize fees.

Unfair issues are also raised in the process where overseas IBs conduct short selling through so-called ‘custodian banks.’ If overseas IBs entrust their held stocks to custodian banks, securities firms receiving short selling orders may accept orders without verifying account balances, making naked short selling possible. Unlike individual investors who check real-time account information for stock trading, overseas IBs can conduct ‘free pass’ short selling through custodian banks, indicating a different starting point. It is known that overseas IBs effectively trade directly by borrowing parts of domestic securities firms’ computer networks.

This is why it is pointed out that naked short selling makes the domestic capital market a ‘predatory structure.’ Market participants’ profits and losses depend on how quickly large sums can be operated according to market conditions, but overseas IBs have maximized leverage by employing naked short selling, which is fundamentally blocked for individual investors.

However, it is uncertain whether the investigation scope will expand directly to foreign asset management companies. According to contracts between asset management companies and IBs, IBs voluntarily engaged in naked short selling to earn high fees. IBs are known to be uncooperative in the investigation, storing important internal documents overseas and omitting most of the requested materials.

◆ Southern District Prosecutors’ Office Becomes a Battleground Between Prosecution and Big Law Firms = In addition, the Southern District Prosecutors’ Office is handling investigations into companies with market capitalizations exceeding trillions of KRW. The comprehensive investigation into Kakao and its affiliates, with a market cap of 23 trillion KRW, is also conducted by the Southern District Prosecutors’ Office. The virtual asset issuer Wemade, with a market cap of 1.6 trillion KRW, is also under investigation there.

Kakao, which is under multiple investigations, has appointed five law firms including Bae, Kim & Lee LLC, Kwangjang, and Sejong for the SM price manipulation case. Wemade, which appointed Kim & Chang for the criminal case, is reportedly considering appointing another major law firm.

Meanwhile, there are criticisms that repeated rejections of investigation warrants have caused the loss of the ‘golden time’ for investigation. Last month, the Southern District Prosecutors’ Office requested arrest warrants for Lee Junho, head of investment strategy at Kakao Entertainment, and CEO Kim Seongsu regarding allegations of overpriced acquisition of a drama production company, but the court dismissed the requests.

Although the court acknowledged that evidence was secured, it ruled that "there is no risk of evidence destruction or flight considering the stable residence and attitude toward investigation and interrogation." Even if the prosecution proves substantial charges and files for detention, complex issues may delay trials, prolonging investigations into higher-ups.

Reporter Lim Hyun-kyung, The Law Times

※This article is based on content supplied by Law Times.

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