An amendment to the Financial Investment Services and Capital Markets Act (the “FSCMA”) imposing stricter regulations on short selling passed the plenary session of the National Assembly on December 9, 2020 and will take effect on April 6, 2021.  On January 13, 2021, the Financial Services Commission (the “FSC”) pre-announced a proposed partial amendment to the Enforcement Decree of the FSCMA (the “Enforcement Decree”) that reflects matters delegated to the Enforcement Decree by the amended FSCMA. 

The amended FSCMA includes tougher short sale regulations.  For example, the amended FSCMA (i) provides for much stricter punishment, including imprisonment and penalty surcharges, compared to the existing law with a maximum penalty of administrative fine not exceeding KRW 100 million; (ii) prohibits a person who has short sold borrowed stocks after a plan for the issuer’s rights offering is announced and before the price of new stocks is determined from participating in the issuer’s rights offering; and (iii) requires lenders and borrowers to keep records of stock borrowing and lending (“SBL”) transactions and submit such records upon regulators’ request.  The proposed partial amendment to the Enforcement Decree sets forth the details of short sale regulations in line with the delegations by the amended FSCMA. 

The key ideas of the amended FSCMA and the proposed amendment to its Enforcement Decree are as follows:

1.   Prescription of Temporary Ban on Short Selling in FSCMA

The FSC may restrict short selling of borrowed stocks by limiting the scope and period of listed stocks at the request of the Korea Exchange (the “KRX”) for transactions that may undermine the stability of the securities market and the formation of fair prices.  With the amendment, the basis for such measure that had been included in the Enforcement Decree has been specified in the FSCMA, not in its Enforcement Decree.  For reference, the currently effective temporary ban on short selling has been extended and will partially resume on May 3, 2021. 

2.   Restricted Participation in Capital Increase by Individuals Who Engaged in Covered Short Sale Before Price of New Shares Determined After Plans for Capital Increase Publicly Announced

The amended FSCMA includes new provisions that prevent a person who short sells borrowed stocks after a plan for the issuer’s rights offering is announced and before the price of new shares is determined from participating in the issuer’s rights offering.  Under the amended FSCMA, anyone who short-sells designated stocks during the period prescribed by Enforcement Decree after a plan for the issuer’s rights offering is announced and before the new stock price is determined is prohibited from participating in the issuer’s rights offering, and anyone who fails to comply with this requirement will face penalty surcharges.  The proposed partial amendment to the Enforcement Decree defines the period in which short sellers’ participation in the issuer’s rights offering is restricted as “from the date after a plan for the issuer’s rights offering is announced to the base date for determining the issuance price as stated in the public announcement document submitted for the issuer’s rights offering.”  The proposed partial amendment also specifies certain exceptions that allow short sellers to participate in the issuer’s rights offering.  One of the exceptions that permit participation in the paid-in capital increase is when it is difficult to deem that the short sale affected the issuance price of the paid-in capital increase by purchasing more than the number of short sale orders after the short sale. 

3.   Inclusion of Obligation to Keep Information on Borrowing and Lending Transactions for Covered Short Sale 

Anyone who signs an SBL contract for short-selling borrowed stocks must keep such transaction data for five years and submit the data without delay when requested by the FSC and KRX.  The proposed partial amendment to the Enforcement Decree specifies the items of information to be retained and requires such information to be stored in electronic equipment that can protect the data from forgery or falsification. 

4.   Criminal Punishment and Fines for Illegal Short Sales 

The amended FSCMA also includes new provisions imposing criminal punishment and criminal fine for illegal short selling.  A person who short sells listed stocks using illegal methods that violate the short sale regulations, or a delegator or delegate of such illegal conduct, may face imprisonment for at least a year or criminal fine equal to at least three to five times of the amount the person gains from the illegal short selling.  Further, the FSC may impose penalty surcharges within the amount of short sale orders.  Under the proposed partial amendment to the Enforcement Decree, many factors are comprehensively considered when determining penalty surcharges, including the amount of short sale orders and profits generated from such illegal conduct.  With the addition of the new penalty provisions, existing provisions for imposing administrative fines were removed. 

The short sale regulations under the amended FSCMA are much stricter than before.  Further, the financial regulators have stated that, in cooperation with the KRX, they will develop methods to detect illegal short selling, expand their monitoring infrastructure, and take stringent measures against any violations.  To this end, the financial regulators explained that they will establish a system to monitor short sellers and transaction volumes in real time, shorten the regular investigation interval from six months to one month, and dedicate more human resources to better monitor illegal short selling. 

Considering the pre-announcement of the proposed partial amendment to the Enforcement Decree, details regarding the implementation of the stricter short sale regulations will likely be prepared soon.  To prevent the risk of violating the new regulations, investors and financial institutions should fully understand the changes introduced in the amendments, improve their internal control system, and monitor further legislative and policy developments.