Amateur investors demand tougher penalties for illegal short selling

In an attempt to deter massive short selling of shares of anti-cancer drugmaker HLB, an army of some 2,200 retail investors flocked to the tech-heavy Kosdaq, 30 minutes before market closing on July 15. 

Dubbed the “K-stop movement,” the campaign mimicked a surprising case of retail investors in the US that thwarted hedge funds’ sophisticated plan of betting on the price fall of video game retailer GameStop. But the Korean version of the GameStop buying frenzy ended in failure, as the company’s stock price fell with other retail investors offloading in pursuit of short-term gain. 

Admitting that the mission ended in a complete failure, however, the Korea Stockholders Alliance that led the prearranged buying spree, said they somehow succeeded in having their voice heard. And that their campaign against short selling will go on, despite the risk of losing money.

“It was the KSA’s announcement of when to initiate its planned mass purchase of HLB stocks that resulted in failure,” a 48-year-old member surnamed Park said.

“Regardless of the results, we have achieved the initial goal of raising our voice against illegitimate short selling practices as well as uneven playing field between institutional and individual investors in the short selling market,” he said.

Short selling is a trading strategy in which investors sell stocks they have borrowed on the belief that share prices will fall in the near future. When the prices decline, they can buy back the stocks at lower prices, pocket the profit and return the shares to the original owner.

Anti-short selling campaigners like Park have been raising concerns over illegal but possible practices of “naked” short selling, saying the South Korean law to stop such attempts is too light.

Under the current law, those engaged in naked short selling can face a prison term of one year or more, or a fine amounting to three to five times the illegal profits. In the US, the unfair short selling of stocks to manipulate the price is subject to up to a penalty of $5 million or 20 years in prison. 

To protect retail investors from highly engineered plans by hedge funds, Korea needs to impose tougher sanctions on local brokerages involved in illegal short selling and taxation on their profits. The government should strengthen Korea Exchange’s role in monitoring hedge funds’ short selling practices, the group said.

The group‘s motive, however, remains vague, as their goal of protecting retail investors’ rights by taking collective actions, after all, could also disrupt the market.

Some also criticize that they are asking too much of the South Korean market regulator that has been quite conservative in terms of short selling practices.

In March last year, the FSC had imposed a six-month ban on short selling by institutional and foreign investors to bring stability to the local stock market hit by the COVID-19 pandemic. The temporary suspension was extended for another six months in August due to the virus resurgence. It has become permissible for large-cap stocks listed on the Kospi 200 and Kosdaq 150 indexes from May.

The KSA has been calling on the government to ban the practice of short selling stocks for the time being until it successfully implements protection measures.

The group is considering a second round of collective action, despite its failure on July 15. But they have also been warned by financial authorities that their massive buying of certain stocks is also unfair, defining it as “an act of encouraging stock purchases by specifying the timing.”

“The FSC and the Korea Exchange are closely monitoring unfair practices subject to legal sanctions. If any illegal actions are found, we plan to take strong action,” the authority said in a statement. 

Meanwhile, some market experts say that the government could allow short selling of all listed stocks by the end of this year, as its partial resumption had limited impact on the equity market.

“Short selling accounted for merely 5 percent of all stock transactions. The benchmark Kospi soared to 3,255.90 a week after the restart of short selling, indicating there is less connection between the investment strategy and stock market volatility,” said Seo Ji-myeong, professor of business administration at Sangmyung University.

“However, before making decisions on the matter, there is a great need for the government to respond to retail investors’ criticism of short selling by pushing for stricter legal sanctions on illegal acts. It should allow retail investors to have a longer borrowing period, which is currently a maximum of 60 days per transaction, while that of institutional and foreign investors is almost unlimited.”

By Choi Jae-hee (cjh@heraldcorp.com)