Penalty for naked short-selling remains inefficient
Retail investors and civic groups are raising doubts over the efficacy of a move by financial regulators to introduce tougher punitive measures against people engaging in naked short-selling of shares.
The dispute centers on a decision by the Financial Services Commission (FSC) to slap heavier punishment — including fines and imprisonment — on those who are caught engaging in illegal short-selling practices on the local stock market. Naked short-selling refers to a trading practice where investors sell stocks without owning or borrowing them. This is generally illegal in most countries, including Korea.
The regulation took effect April 6. Violators will be slapped with fines of up to 5 times their undue profits or face at least a year behind bars.
The watchdog banned the short-selling of shares starting in mid-March last year for six months in the aftermath of an unprecedented stock fall triggered by the COVID-19 pandemic. The temporary ban has since been extended to May 2.
With the much-controversial short-selling of stocks set to resume as of May 3, retail investors are particularly raising their voice calling on regulators to further tighten their vigilance against naked short-selling.
Under the updated punishment rule, the FSC will not be able to carry out any preventive monitoring against those who engage in the illegal act before they make transactions, which retail investors argue leaves much to be desired.
They claim the authorities should take additional regulatory steps to monitor any illegal short-selling acts beforehand.
But the FSC says it is realistically impossible to devise any regulatory measures to monitor and prevent illegal short-selling activities in advance, as it cannot monitor every single transaction in real-time under the current technological environment.
Retail investors are demanding that the watchdog agency establish a computer monitoring system that can prevent naked short-selling beforehand. But experts argue chances remain slim that the watchdog agency will be able to do so due to technical difficulties at a time no other countries are running such a monitoring system.
“Even though a year has passed since authorities slapped the temporary ban on short-selling, little progress has been made over revising the unfair trading act,” an official from the Korea Stockholders Alliance said. “If short-selling resumes next month as scheduled, retail investors will continue to fall victim just like before.”
A number of retail investors have also posted an online petition on the Cheong Wa Dae website demanding that short-selling be abolished for the benefit of the local stock market.
“The regulator’s decision to extend the ban on short-selling is nothing more than a sloppy measure for the April by-elections,” a retail investor said in the petition. Thousands of people here have also supported posts in favor of abolishing short-selling.
Experts argue the authorities need to wait and see whether the toughened regulatory measures will have a practical effect in curbing naked short-selling.
“Despite retail investors’ concerns over short-selling, my view is that the updated regulation can have some effect, as this is a very toughened measure,” Hwang Sei-woon, an economist at the Korea Capital Market Institute, said.
“The FSC can further increase the level of penalty in the case that the measures do not generate tangible outcomes, but we still have to wait and see as of now,” he said.
The economist also said there stands a “very little” chance that authorities would be able to develop a preventive system against naked short-selling.
“No country across the world — including developed ones, such as the United States and those in Europe — operate such a system,” he said. “Generally speaking, it is very hard for any authority or government to devise a preventive system against any criminal acts, and this also goes for any issues on the capital market.”
Retail investors’ collective sentiment against short-selling reflects their mistrust of the system, which they argue is skewed in favor of institutional and foreign investors due to their power to mobilize massive financial resources.
The FSC, however, is expected to push for the resumption of short-selling as scheduled. Market watchers argue that retail investors will step up criticism against short-selling if the benchmark index drops for a few days after the short-selling resumes.
“Financial watchdogs will pay closer attention to the movement of the local stock market indices for a week after the planned resumption of short-selling next month,” an investment industry source said.
Data in the past showed that the KOPSI had not suffered from any “drastic and long-term” shock from a resumption of short-selling.
The main bourse jumped by 1.38 percent June 1, 2009, the first day after short-selling resumed after authorities slapped a similar temporary ban in October 2008 amid the global financial crisis.
In 2011, watchdogs also resumed short-selling of shares after a threemonth ban amid the European debt crisis, on Nov. 10 when the KOSPI dropped by 4.94 percent. But the fall did not last long, and it soon recovered to its previous level.
“Even though a year has passed since authorities slapped the temporary ban on short-selling, little progress has been made over revising the unfair trading act. ”