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Decision on Violation Penalty for Uncovered Short Selling

The Financial Supervisory Authority of Norway (Finanstilsynet) has imposed a violation penalty of NOK 2 million on the British management company, Cazadores Investments Limited for breaching the prohibition against uncovered short sales. This is in addition to the confiscation of profits for violations of the prohibition on uncovered short selling with regards to selling shares in connection with the new issuance of Flyr shares last year.

This is the latest decision in a larger complex of cases where several investors have been imposed violation penalties for similar violations. Some of the cases are currently in the appeals process with the Norwegian Ministry of Finance.

According to the EU Regulation on Short Selling (EU No 236/2012), uncovered short selling is prohibited. This means that a seller must have secured access to the financial instrument in question, so that settlement can take place on the settlement date by meeting one of the following three conditions:

(a) the natural or legal person has borrowed the share or has made alternative provisions resulting in a similar legal effect;

(b) the natural or legal person has entered into an agreement to borrow the share or has another absolutely enforceable claim under contract or property law to be transferred ownership of a corresponding number of securities of the same class so that settlement can be effected when it is due;

(c) the natural or legal person has an arrangement with a third party under which that third party has confirmed that the share has been located and has taken measures vis-à-vis third parties necessary for the natural or legal person to have a reasonable expectation that settlement can be effected when it is due.

In this case, the Norwegian Financial Supervisory Authority’s view is that a capital increase in connection with an issuance must be registered in the Register of Business Enterprises and that a stock exchange announcement must be sent before the shares can “exist” and therefore be sold. If there is a sale of shares before a stock exchange announcement of a registered capital increase is sent, this will thus be considered as uncovered short selling. The Financial Supervisory Authority justifies this by stating that only at the time of the announcement can it be known whether the T+2 settlement can be carried out. A stock exchange announcement about the “expected date” for the delivery of shares in connection with issuance is therefore not considered sufficient security for settlement. Since the seller cannot guarantee delivery/settlement, there will still be uncertainty about the registration time for the capital increase in the Register of Business Enterprises.

It is this relevant point that many investors, especially foreign ones, misunderstand how EU/EEA and Norwegian rules are implemented and practiced in Norway.

In this specific case, the Norwegian Financial Supervisory Authority concluded that Cazadores Investments Limited did not have a “fully valid claim” or a “reasonable expectation of settlement” at maturity when they sold the shares before they were actually issued.

Cazadores Investments Limited was also criticized for not reporting its net short position, which was well above the 0.1% threshold. The decision can be read in its entirety here.