On January 4, 2024, in a press interview, the Governor of the Financial Supervisory Service of Korea (the “FSS”) stated that in addition to the two global investment banks against which severe sanctions (including criminal complaints and large sums of monetary fines) were imposed for short sale violations in December 2023, the Korean regulators have discovered additional short sale violation cases involving a number of other global investment banks. The Governor suggested that the FSS would soon disclose additional information about the pending investigation cases.
On the same day, President Suk Yeol Yoon also emphasized the administration’s commitment to eradicate “illegal” short sales in the Korean market. During a town hall meeting, President Yoon stated that the Korean government would consider extending a temporary short sale ban in the Korean market beyond June 2024 unless proper systems are put into place to prevent illegal short sale.
Against such backdrop, there have been significant changes in the approaches taken by the Korean regulators in respect of unfair trading cases, especially those involving short sale trades. As active enforcement by the regulators seems likely to continue in 2024, it may be worthwhile to further analyze potential issues and implications of the recent decisions and enforcement actions.
Firstly, the FSS had traditionally treated short sale breaches and market disruption cases as “administrative” matters which are subject to a monetary fine or penalty only, but recent enforcement actions indicate that the Korean regulators may take a more assertive stance for the regulatory violations regarding which penal provisions are available. It remains to be seen whether the FSS will continue to seek the application of criminal penalty provisions regarding the ongoing short sale violation investigations against the other global investment banks.
Secondly, the Korean regulators are likely to expand the scope of regulatory scrutiny, utilizing the new investigation unit, which was set up specifically for short sale cases, with a much larger number of dedicated investigators. In this regard, we note that the FSS issued a press release last year making it clear that it would conduct a comprehensive and thorough review of the short sale practices of major global investment banks, and that it intends to include Korean brokers as well as global investment banks’ end clients with whom the derivative trades have been executed. With reinforced investigative capabilities, the FSS is likely to focus on recurring patterns of short sale breaches, especially those that have occurred for an extended period of time.
Thirdly, in the past the Korean regulators tended not to pay close attention to issues pertaining to equity swaps, inter-aggregation unit transactions or specific stock borrow mechanisms. However, based on our experience in recent cases, we understand that the regulators are now more familiar with such issues and willing to examine details of the day-to-day trading activities of market participants.
Fourthly, a recent decision of the Securities and Futures Commission of Korea (the “SFC”) regarding certain block trade gives rise to important questions about to what extent hedging transactions would be recognized as legitimate and acceptable by the Korean regulators. In this regard, it would be necessary to closely monitor whether the regulators would issue a new ruling or guidance regarding the scope of permissible hedging transaction in a block deal context.
Finally, in the past, the Korean regulators typically issued a press release only after the final decision of the SFC had been rendered. However, more recently, the FSS started issuing press releases before conclusion of the sanction process by the SFC. In addition, the names of the relevant parties subject to the enforcement action have been disclosed in the news reports immediately after the press releases, giving rise to the need to control reputational damage and related PR issues throughout the course of the investigation before the investigation is actually completed.
As it is expected that the Korean regulators will continue to strengthen enforcement actions for short sale breaches, it would be prudent to closely monitor the trading activities and developments in the market, and seek assistance in case there is any inquiry or request from Korean regulators or the Korea Exchange.
