Goldman Sachs Faces Scrutiny over Naked Short Selling Allegations

Korean fianancial authorities have launched an inspection into Goldman Sachs as the global investment bank is suspected of having participated in naked short-selling.

Naked-short selling is an illegal trading practice where one short-sells stocks without first borrowing them or ensuring that they can be borrowed.

The probe marks the first time a foreign brokerage firm is investigated for failure to settle short-selling transactions.

Korean financial authorities have found circumstantial evidence of foreign brokerage firms' naked short selling, but not real evidence yet. The Financial Supervisory Service (FSS) will thoroughly investigate the naked short selling allegations as there is growing concern over short selling among individual investors.

According to the FSS, the Seoul branch of Goldman Sachs received a short selling order from Goldman Sachs International, an overseas subsidiary, on May 30. The Seoul branch carried out the order, but failed to settle the transactions for some 1.39 million shares of 20 companies valued at about 6 billion won on June 1.

The FSS suspects that Goldman Sachs International placed the short-selling orders on the Seoul branch without having first borrowed them.

Goldman Sachs International bought 19 of the 20 outstanding stocks on June 1 and borrowed one stock on June 4 to settle the entire short-selling transactions.

"The failure to settle short selling has been confirmed in the investigation stage," an FSS official said. “We launched the inspection as investors are raising suspicions and are still not trusting short selling. The FSS will review the appropriateness of stock lending and short selling orders, including the possibility of naked short selling and will also make a check on reasons for short selling by Goldman Sachs International.”

This case reminded investors of the Samsung Securities fiasco two months ago where ghost shares were generated. On April 6, Samsung Securities allocated 1,000 shares instead of 1,000 won per share in a dividend payout process. As a result, 2.81 billion shares of ghost Samsung Securities stocks were newly created. The 2.81 billion shares dwarfed the company’s issued shares (89.3 million shares) and the issuance limit (120 million shares). Five million shares were sold in the market even though there was an in-house announcement that the ghost shares should not be sold off. Shares that did not exist were issued and actually traded.

Experts point out that it went the same for Goldman Sachs. The Seoul branch of Goldman Sachs placed a short selling order without confirming that the stocks had been borrowed. Once again, the case revealed the problems of the system. "There is no system to check the balance of each financial institution’s account during a short selling order stage," said an official at the Korea Exchange. This means that in the current system, even if a securities firm places a short selling order without borrowing stocks, no system can block it. Another accident happened in two months since the Samsung Securities incident.

If Goldman Sachs's naked short selling proves true, it will create a big firestorm. This is because the current law bans naked short selling that throws a monkey wrench into the capital market. Financial authorities have said that they took measures against naked short selling, asserting that it was virtually impossible to do naked short selling. The Financial Supervisory Commission and the FSS jointly announced anti-short selling measures to rectify the unlevel playing ground on May 28. Under these circumstances, naked short selling actually took place.

It is forecast that Goldman Sachs will hardly be able to avoid punishments for poor internal control work even if the case happened by mistake. The FSS can impose sanctions and penalties on financial institutions that violate regulations on short selling. If the FSS judges that Goldman Sachs committed naked short selling, the US financial giant will be fined up to 100 million won. If Goldman Sachs’s naked short selling was executed by mistake, simply a warning can be given to Goldman Sachs.

investors commented on Internet message boards that the Goldman Sachs case confirmed that naked short selling had been taking place. Although financial authorities dodged public anger for the abolishment of short selling after the ghost stock allocation case at Samsung Securities, it was found that short selling is still done on an unlevel playing ground so individual investors are expected to call for reform more strongly.