Illegal short sellers will now face life sentence in prison after the National Assembly approved the amendment.
The National Assembly has approved an amendment to the Capital Markets Act aimed at enhancing penalties for illegal short selling, per Business Korea.
Under this new law, individuals who profit illegally from short selling exceeding 5 billion won (around $3.79 million) could face severe penalties, including prison sentences of up to life imprisonment.
On September 27, financial authorities confirmed that the amendment, designed to overhaul the short selling system, passed the National Assembly on September 26.
The legislation mandates that institutional investors must establish an electronic short selling system, and both institutional and corporate investors are now required to implement internal control standards.
Approximately 101 companies, representing 92% of domestic short selling transactions, must adopt these electronic systems.
These firms will also be obligated to report stock balances and over-the-counter (OTC) transactions to the exchange, increasing their compliance responsibilities under the newly instituted central monitoring system.
Securities firms will need to annually verify the internal controls and electronic systems of institutional and corporate investors, following a checklist, and report the findings to the Financial Supervisory Service (FSS).
Non-compliance could result in fines of up to 100 million won.
To standardize short selling conditions for individual and institutional investors, the repayment period for loan transactions related to short selling will also be constrained.
Violations of this rule will incur fines of up to 100 million won, with loan terms extendable in 90-day increments for a maximum of 12 months.
Additionally, the amendment seeks to deter repeated illegal short selling by increasing administrative penalties.
Fines for unfair trading and illegal short selling will rise from three to five times the illicit profit to four to six times.
Offenders earning over 5 billion won from illegal short selling may now face the same enhanced prison terms as those engaging in unfair trading.
Administrative sanctions will be broadened, allowing regulators to restrict trading of financial investment products for up to five years and limit the appointment or reappointment of executives at listed companies.
This aims to tackle the high recidivism rate among financial criminals by effectively barring them from the market for a specified duration.
To combat the concealment of illegal profits, accounts suspected of being involved in unfair trading or illegal short selling can be frozen for up to six months, with a possible extension of an additional six months.
The amended law will take effect on March 31 of next year, providing time for the implementation of the electronic short selling system, which is expected to be operational by then.
However, restrictions on trading financial products and executive appointments will begin six months after the law is enacted, following public consultations.
Upcoming revisions to the enforcement decree will lower the short selling disclosure threshold from 0.5% to 0.01% of outstanding shares and reduce the collateral ratio for individual short sellers to match that of institutional investors, with completion expected by next month.
A representative from the Financial Services Commission (FSC) noted that limiting the loan repayment period for short selling transactions to 12 months, along with finalizing amendments to the Financial Investment Business Regulations, will lower the collateral ratio for individual short sellers from 120% to 105%, leveling the playing field.
The FSC official added, “With the electronic short selling system set to launch in March, the improvements to the short selling framework will be fully realized.
Our goal is to restore investor confidence and enhance the competitiveness of the South Korean stock market.”
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Korean regulators now impose billions in fines for illegal trading, particularly when ‘naked short selling’, increasing fees upwards of 5,000%.
The Financial Supervisory Service (FSS) of South Korea is ramping up its enforcement against short sale violations, shifting from treating these breaches as minor infractions subject to low fines to imposing substantial penalties based on the scale of the violations.
This change follows amendments to the Financial Investment Services and Capital Markets Act (FSCMA), which allow penalties to be calculated based on the volume of short sale orders, significantly increasing potential fines.
In March 2023, the Securities and Futures Commission (SFC), part of the FSS, applied this new penalty calculation for the first time, imposing fines on two institutional investors for engaging in illegal short sales.
One case involved an investor mistakenly placing sell orders for shares that were not yet available, leading to a naked short sale.
The other involved an error in inventory management, resulting in a similar breach.
The fines totaled KRW 3.87 billion and KRW 2.18 billion, respectively.
Recent enforcement actions highlight the regulators’ commitment to addressing short sale violations.
In December 2023, the SFC levied penalties of KRW 11.44 billion against a French financial group’s affiliate and additional fines against its Korean affiliate and a UK-based group.
By July 2024, the SFC imposed record fines of KRW 16.94 billion and KRW 10.23 billion on two Swiss-based financial group affiliates.
As investigations into global investment banks continue, it remains unclear whether even larger penalties will follow.
While the SFC has imposed significant fines, a recent court ruling overturned one of its penalties against a European broker for a naked short sale, deeming the fine excessive.
This case involved the broker mistakenly executing sell orders for the wrong fund, leading to a court challenge of the SFC’s authority in imposing such fines.
In a notable escalation, the SFC made a criminal referral in December 2023 for two global investment banks accused of failing to properly document their lending transactions, resulting in prolonged naked short sales.
This marked a significant shift as it was the first time Korean regulators sought criminal liabilities for short sale breaches.
In March 2024, the prosecutor’s office indicted one of the banks and its employees for violating laws against naked short sales.
As Korean regulators continue to maintain strict oversight on illegal short sale activities, it remains to be seen whether they will pursue criminal investigations into other market participants exhibiting similar patterns of behavior.
Interestingly, despite imposing more record fines in July 2024, the SFC chose not to refer any cases for criminal prosecution, highlighting the complexities of regulatory enforcement in this area, per IFLR.
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Also Read: South Korea Now Finds Banks Pursued Illegal Shorting Scheme
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