Falling share prices, margin loans calls and alleged short selling antics of market participants have dominated market commentary in recent weeks. The current difficulties experienced by, amongst others, A.B.C. Learning Centres Limited and Allco Finance Group Limited (who, following margin loan calls on shares held by directors, have been targeted by short sellers) has seen ASIC and ASX rushing to clarify and reinforce existing obligations with respect to share lending and short selling arrangements.
On 6 March 2008, the following statements were released:
- ASIC IR 08-03 - reminding market participants engaged in stock lending or stock borrowing that they should carefully examine their obligations to lodge substantial holding notices.
- ASX Media Release on short selling - clarifying disclosure obligations for market participants with respect to short selling.
- ASIC MR 08-47 - announcing that ASIC is concerned that some individuals may be spreading false and misleading information about listed securities to artificially provoke sales of securities and reduce their market prices, and reminding market participants of the offences relating to false and misleading statements.
The practice of stock lending relates to the transfer of securities from one party (the 'lender') to another (the 'borrower'), with the borrower obliged to return them (or equivalent securities) either on demand or at the end of an agreed term. It is often undertaken to 'cover' what would otherwise be short selling transactions under the Corporations Act 2001 and ASX market rules (see below).
ASIC has advised that, in its view, the borrower of securities will acquire a relevant interest in borrowed securities where they hold a presently exercisable and unconditional right to vest those securities. This does not represent a change in the legal position, but rather clarifies the application of current law to stock lending arrangements.
When contemplating such transactions, it is important to consider:
The disclosure obligations for lenders, the parties who
manage stock lending arrangements and borrowers that arise
as a consequence (Disclosure
Under section 671B of the Corporations Act 2001, an obligation to make initial substantial holding disclosure arises where a relevant interest is acquired in 5% or more of a listed company (or scheme). Any movement of 1% in that holding requires lodgement of a further notice. Where the obligation to lodge a substantial holding notice arises, it must be lodged:
- Within two business days of the holder becoming aware of their substantial holding; or
- If a takeover is on foot, by 9:30am on the next trading day of the financial market after becoming aware of the substantial holding.
ASIC has advised that it proposes to issue a consultation paper to consider means of streamlining the notification procedures.
- The takeover thresholds in section 606 of the Corporations Act 2001, which prohibit a person from acquiring relevant interests in the voting shares of a public/listed company (or scheme) if that person or someone else's voting power increases from a position below 20% to above 20% (or from a position above 20% to a higher position that is less than 90%) other than through one of the 'gateways' in section 611 (Takeover Provisions).
Accordingly, if it is proposed to borrow (or lend) stock, professional advice should be sought as to whether the arrangement could result in the acquisition of a relevant interest for the purposes of either (or both) of the Disclosure Requirements or Takeover Provisions.
Short selling refers to the practice of, effectively, agreeing to sell securities that are not held, in the hope of taking advantage of a drop in the price of the relevant securities. This allows the participant to purchase equivalent securities at a price lower than it agreed to sell them, prior to settlement of the trade. A 'naked short sale' occurs where the market participant enters such an order and does not have in place arrangements for delivery of the securities. This can be contrasted with a 'covered short sale', where delivery arrangements are in place, typically, by borrowing them.
Short selling gives rise to transparency and settlement risk issues, and accordingly is regulated under the Corporations Act 2001 and the ASX Listing Rules. In particular, a combination of legislative provisions and ASX rules require that:
- When asking a broker to execute a short sale, a client must inform the broker that the sale is a short sale.
- A broker must advise their client of the obligation to notify the broker of short sales.
- A broker must inform its clearer that the sale is a short sale, and must ensure that the clearer has secured a minimum 20% initial margin over the short position.1
- A broker must advise ASX as soon as practicable that it is executing a short sale.
- A broker must report to ASX their unsettled net short sale position as at 7.00pm by no later than 9.00am on the next trading day.
Further, ASX limits the class of listed securities in which 'naked' short selling can occur, determined on the basis of liquidity of the relevant securities and capitalisation of the relevant issuer.
Perhaps in response to recent media commentary, ASX has:
- Clearly stated that it must be informed of all short sales, whether naked or not. Previously, some market participants have taken the view that their disclosure obligations differed depending on the type of short sale.
- Announced that legislative amendments are needed to remove the scope for different interpretations of key obligations under the law, and to support the obligations that ASX imposes directly on brokers and indirectly via brokers on other market users.
- Confirmed that if it identifies a person failing to comply with their short selling obligations under the Corporations Act 2001 (in particular section 1020B(5)), it will refer the matter to ASIC for investigation and prosecution.
Following the ASX release it is no longer tenable for market participants to maintain that disclosure is only required in respect of naked short sales. Hopefully, this will result in improved disclosure with respect to short selling generally, and therefore greater market transparency.
False Or Misleading Rumours
Section 1041E of the Corporations Act 2001 provides that a person must not make a statement or disseminate information if (relevantly):
- It is false in a material particular or is materially misleading.
- Is likely to induce persons to dispose of or acquire financial products or to have the effect of reducing the price of securities.
- If the person does not care whether the statement or information is true or false, or knows or reasonably to have known it is false or misleading.
In response to concerns that some individuals are deliberately spreading false or misleading information to artificially provoke sales of securities and to reduce their market price, ASIC has advised that it will be vigilant in monitoring the market to ensure this type of behaviour is detected, investigated and prosecuted. Any person spreading a false rumour without properly investigating its truth risks breaching the prohibition, which carries a maximum penalty (for an individual) of five years imprisonment and/or a fine of $220,000.
The ASX and ASIC releases serve as a timely reminder of the need to carefully consider the implications of stock lending, short selling and the dissemination of market rumours. It will be interesting to see whether the current scrutiny and public debate (combined with the recent share price volatility of a number of high profile companies) results in regulatory reform. ASIC seems to suggest that, in its view, the current legislation is adequate, and that it is more a question of the enforcement of existing laws than legislative amendment that is required to ensure fair market trading practices. Only time will tell whether the government takes a differing view. It will also be interesting to see whether ASIC's current focus results in any prosecutions in respect of recent market events. This is certainly possible, with ASIC confirming on 11 March 2008 that it:
- Has made formal requests for information from a number of market participants about recent securities trading activities, focussing on conduct that could amount to market manipulation or insider trading.
- Is contacting the US Securities and Exchange Commission, the UK Financial Services Authority and the Hong Kong Securities and Futures Commission with a view to seeking their assistance on any international aspects.
1. This refers to the obligation on the clearer to secure from the client an initial margin of cover of not less than 20% of the contract price for the securities being sold short. The sum is payable in cash or shares, and is held on trust by the clearer until such time as the short sale has been covered by the purchase of the same number of securities from a third party - ASX Market Rule 19.8.2 and Schedule 6.
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