South Korea says two global banks conducted naked short selling as it probes the practice

South Korea’s financial regulator said it found $41 million worth of illegal short selling on domestic stocks by two global investment banks, ratcheting up its crackdown on the trading strategy that has been unpopular among retail investors.

The Financial Supervisory Service will “promptly” launch the process of imposing penalties, according to its statement Sunday that didn’t identify the banks. The banks breached rules for several months in 2022, and in 2023, by conducting naked short selling, the practice of selling shares without borrowing them first, the FSS said.

The enforcement will once again turn the spotlight on Korean authorities’ recent ban on short selling, which has been lauded by some domestic retail investors while being panned by others as meddlesome and political.

“Those suspicions that there has been market disturbance by illegal short selling were true,” the FSS said in a statement.

Naked short selling had been illegal in South Korea. But financial authorities surprised the market in early November, when they introduced a total ban on all types of stock short selling. Illegal short selling in the nation is “rampant,” the regulators said.

Many investors saw the ban to be a politically motivated move, ahead of April parliamentary elections, to win votes. Retail stock buyers in Korea often blame short sellers — who are mostly foreign investors — for stock price downturns and said the ban would restore market fairness.

One of the banks repeatedly overstated the number of borrowed shares in two Korean stocks in its system, the FSS said. The bank failed to detect the repetition before issuing sell orders based on the inflated figure. It belatedly borrowed more shares after selling, which breached rules, the FSS said.

The other bank over-counted the number of shares it actually owned in three Korean stocks and sold based on the overstated figure, the FSS said. The mismatch in owned shares and sold shares resulted in naked short selling, the regulator said.

The FSS’ latest findings come as it’s expanding probes into the past short-selling trades by 10 global investment banks that most actively handle hedge funds and other traders’ short-selling activities. Investigators will reinforce collaboration with the Securities and Futures Commission of Hong Kong, the FSS said.

In December, the FSS imposed a total fine of 26.5 billion won on BNP Paribas SA, its domestic brokerage unit, and HSBC Holdings Plc for naked short selling. The watchdog also asked prosecutors to investigate them.

Read: Why South Korea Banned Short Selling and What’s Next: QuickTake