Short Sellers Get a Warning to Come Clean

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A Hong Kong hedge fund broke a record when, from 2017 to 2019, it built the U.K. stock market’s biggest-ever short position. But history is more likely to remember the trade as the first to be punished by Britain’s markets regulator for not being made public. Asia Research & Capital Management Ltd. took the Financial Conduct Authority into uncharted territory in this episode, and it shows.

The FCA said last week it was satisfied that ARCM didn’t deliberately seek to dodge rules requiring it to reveal more than 150 trades it made when shorting Premier Oil Plc. The position was a hedge against a $425 million credit exposure. ARCM took no profit on it while it remained unseen, and it’s not clear investors lost money because they weren’t aware. Although the short covered some 17% of Premier’s shares, the lapse was one error of ignorance repeated over and over.

But ARCM was slow to come clean to the FCA when it realized in October last year it was in breach, the regulator said. The market finally got full disclosure in December.

How to set a punishment that captures all this? The regulator’s rubric says it starts with a number reflecting the actual or potential harm caused by the misdemeanor in question. Typically, that's the revenue related to the bad behavior. Then the FCA levies a fine as a percentage of that figure based on the seriousness of the breach.

Unhelpfully, there were no revenues here to serve as a guide. So the FCA effectively imagined a corresponding long position in Premier stock, and totted up the changes in its value each time ARCM modified its hedge. The cumulative value of these increments was 333 million pounds ($430 million), the FCA says — the appropriate measure of damage. Whether the calculation is the best or most comprehensible proxy is open to debate. But you have to start somewhere.

The regulator then decided the lapse was a mid-ranking offence — neither minor nor a premeditated crime causing others big losses. As a result, it determined a 0.5% fine, or 1.7 million pounds, was fitting. But given ARCM made one error that compounded, the FCA felt that was a bit high. So it applied a 25% haircut, and then its standard 30% discount for settling, to arrive at a 870,000-pound penalty.

ARCM has since addressed the problem with its controls. For many observers, the fine will seem low given the hedge was part of a trade which, following Premier shares’ collapse this year, was profitable for ARCM. Yet it’s hard to believe ARCM is feeling relieved. The non-disclosure didn’t facilitate those profits, and even if the firm can afford the fine, it faces the reputational damage.

The FCA’s reasoning does make sense. It’s signaling that this is as serious as offences get before entering its really ugly categories. It knows the difference between mistaken and deliberate misconduct and will reward firms that cooperate to resolve cases quickly. Fair outcomes often depend on applying discretion rather than following a formula. The snag is that it can look like you’re making it up as you go along.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

©2020 Bloomberg L.P.

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