Short-selling: In the interests of full disclosure

The passage of the Corporations Amendment (Short-Selling) Bill 2008 through Parliament on December 5, in its unamended form, will have major implications for financial planners. The legislation will permanently ban naked short-selling and increase the disclosure of covered short-selling.

It follows interim measures taken last year as regulators faced the fallout from the global financial meltdown, with the Australian Securities and Investments Commission (ASIC) announcing a ban on naked short-selling on September 19 — later extended to a ban on covered short-selling while the Government prepared its legislation in relation to disclosure of covered short sales.

Naked short-selling is when an investor sells shares they do not own without first borrowing the shares or ensuring that the shares can be borrowed, as is done in a conventional short sale. But there is an assumption that they will be able to find the stock to cover the trade in time for settlement.

An investor with a covered short-selling position has what ASIC deems an ‘exercisable and unconditional right to invest’, which means the investor has a binding stock lending agreement to acquire that stock.

Short-selling allows an investor to make a profit from falling share prices, either by selling stock that they do not own (naked short-selling) or by borrowing stock to sell (covered short-selling).

The new legislation will contain exemptions to allow investors to hedge risk.

The financial planning industry will be among several sectors that are caught up in the net of the new legislation governing short-selling.

Although the Government is yet to release the regulations of the legislation that will provide the detail, it is possible to determine who will be affected by the new legislation.

In its broadest form, the legislation will affect anyone who short-sells securities, management investment products and certain other products, along with brokers who sell these products on behalf of others.

The new disclosure regime will be comprehensive. It will place a positive obligation on brokers to ask clients if a sale is a covered short sale when they place an order.

There will also be a direct obligation on market operators such as the Australian Securities Exchange (ASX) to publicly disclose short-selling information it obtains from brokers.

Peak industry bodies view allowing the market to have some capacity to continue to engage in short-selling as a way of improving market liquidity.

However, Chartered Secretaries Australia (CSA) believes this goal must be balanced with the need to keep the market informed to restrict market manipulation, a view the Government appears to have considered of major importance.

The ramping up of the regulatory environment for short-selling will mean that financial planners have several additional duties to their clients.

Planners will have to advise investors that they must disclose to their broker when a sale is a covered short sale — that is, a short sale supported by a securities lending agreement.

And their brokers, as holders of Australian Financial Services Licences, will need to report the disclosed covered short sale to the relevant market operator, such as the ASX, so that it can publicly disclose the reported short sale information.

These disclosure requirements will apply to sellers inside or outside of Australia.

The ASX put in place interim measures last year whereby short-selling data is disclosed by brokers to the ASX each day and published the following day.

As CSA members deal with the ASX on a day-to-day basis and have a thorough working knowledge of the operations of the markets, they are well placed to provide a considered view.

One of our observations is that the higher levels of information available to the ASX should assist in protecting against the risk of an uninformed market and potential market manipulation.

As we also emphasised in a submission to Treasury in October, “Timing is everything and the more real-time disclosure, the more certainty there is that the market will be fairly informed”.

We have welcomed the Government’s move to require the disclosure of covered short-selling, and agree that no need exists to ban the activity altogether, given its role in price discovery.

We support the Government’s intention to review the short-selling regime at the close of the two-year sunset clause to ensure the benefits of the new regulation outweigh the costs of its introduction. And we suggest that the review could consider whether stock-lending arrangements should also be subject to market disclosure requirements.

Planners need to watch out for the publication of government regulations on the way the short-selling disclosure regime will operate.

The reason? Failure to comply with the disclosure requirements will be an offence.

Tim Sheehy is chief executive of Chartered Secretaries Australia.