Hong Kong’s SFC imposes $1.5m fine on SFM HK Management Limited over naked short selling

The Hong Kong Securities and Futures Commission (SFC) announces that it has reprimanded and fined SFM HK Management Limited (SFM) $1.5 million for failures relating to the short selling of Great Wall Motor Company Limited shares in 2015 on behalf of a fund it managed.

On August 28, 2015, Great Wall announced its proposed bonus issue of shares, which was equivalent to 200% of its existing issued shares and was subject to the fulfillment of certain conditions. The settlement date of the bonus shares was expected to be on October 13, 2015.

The SFC investigation found that on September 30, 2015, the fund’s custodian notified SFM’s trade support department of SFM’s entitlement to 1,616,000 bonus shares as a result of the fund’s pre-existing holding of 808,000 Great Wall shares.

SFM’s trade support team booked the 1,616,000 bonus shares into SFM’s trading system on September 30, 2015 without segregating them into a restricted account as required by SFM’s internal policy. As a result, the system indicated that a total of 2,424,000 shares of Great Wall were available for trading when in fact only 808,000 shares were available for trading at that point in time.

Based on the erroneous information shown in the system, one of the fund’s portfolio managers placed an order to sell 2,424,000 shares of Great Wall on October 2, 2015, causing the fund to become short by 1,616,000 shares in Great Wall.

Section 170(1) of the SFO prohibits “naked” or “uncovered” short selling. It is a criminal offence for a person to sell securities at or through a recognized stock market unless at the time of the sale, he has a presently exercisable and unconditional right to vest the securities in the purchaser of them, or believes and has reasonable grounds to believe that he has such a right.

Also, prior to the settlement date, Great Wall did not make any public announcement regarding the fulfillment of the conditions. The public did not have reasonable grounds to believe that they had presently exercisable and unconditional rights to vest the bonus share in the purchaser of them before the settlement date.

The SFC finds that SFM failed to act with due skill, care and diligence in dealing in the bonus shares, but also failed to diligently supervise its staff members and implement adequate and effective systems and controls to ensure compliance with the short selling requirements.

In making its decision about the sanctions against SFM, the regulator took into account a range of circumstances including that:

• there is no evidence to suggest that SFM had acted in bad faith in short selling the bonus shares;
• this incident is the second occurrence of a similar kind over a period of five years;
• SFM has taken remedial measures to strengthen its internal controls and systems; and
• SFM has an otherwise clean disciplinary record.