article / 23 Aug 2023
The Swedish Financial Supervisory Authority (Sw. Finansinspektionen) announces decisions affecting the use of share loans in connection with private placements
According to Article 5 of the Short Selling Regulation (EU) No 236/2012, persons holding so-called “net short positions” are required to notify their position to the competent authority if the position reaches or falls below relevant thresholds. On 22 June 2023, the Swedish Financial Supervisory Authority issued four sanction decisions concerning the reporting of net short positions resulting from share loans in connection with a private placement.
Short selling refers to the sale of a security that is not owned by the seller at the time of sale. Instead, the seller has borrowed, or ensured that the security can be borrowed before the sale takes place. The sale of the security gives rise to a so-called net short position in the security, which must be notified to the competent authority, which in Sweden is the Swedish Financial Supervisory Authority (the “SFSA“), if it reaches 0.1 per cent of the issued share capital of the company concerned and each increment of 0.1 per cent above that. Similarly, a short position holder has an obligation to notify the SFSA if the position falls below previously reported thresholds.
On 22 June this year, the SFSA issued four sanction decisions for failure to notify the SFSA that net short positions had reached and fallen below the relevant thresholds in connection with the settlement of a private placement.
The SFSA’s decisions on sanctions
The background to the sanction decisions was the following. Three companies and one natural person (the “Investors“) participated in a private placement of new shares in a listed company (the “Issuer“). In order to enable delivery of the newly issued shares in the transaction before the new shares were registered with the Swedish Companies Registration Office (the “SCRO”), the issuing agent that handled the issue entered into a share loan agreement with existing owners of the Issuer. The issuing agent then delivered the borrowed shares to the Investors. Once the new shares were registered with the SCRO, the share loan was settled by the issuing agent returning the shares to the lending shareholders. In the press release announced by the Issuer in connection with the new issue, the loan structure described that two existing shareholders in the Issuer, for the purpose of facilitating the delivery of shares in the issue, had undertaken to lend shares to the investors and that the loaned shares were to be returned after the issue had been registered with the SCRO.
Before the SCRO had registered the newly issued shares, the Investors sold shares in the Issuer. The question of whether the Investors had taken net short positions in the Issuer arose and if so, whether they were required to notify their short selling positions to the SFSA in accordance with Article 5 of the EU Short Selling Regulation. Given that the Investors had taken net short positions in the Issuer, the SFSA would have reason to decide on a special fine in accordance with section 6(1) of the Act (2012:735) with supplementary provisions to the EU Short Selling Regulation since the positions had reached and fallen below the relevant thresholds on several occasions.
The Investors argued that they had not taken any net short positions in the Issuer and hence they were not obliged to notify the SFSA as required by the EU Short Selling Regulation. As a ground for their position, the Investors emphasised that they had not entered into a share loan agreement linked to the issue in question, but only an agreement with the issuing agent in connection with the signing of the application form. Neither the application form nor the pre-purchase information for the application form contained any information about share loans. Furthermore, the Investors emphasised that the ISIN code on the contract note provided that the issued shares would be delivered against payment of the issue proceeds. As the Investors were not aware of the share loan agreement and had not entered into a share loan agreement, their understanding was that the shares sold were those issued in connection with the new share issue.
The SFSA’s assessment included an analysis of the definition of short selling under Article 2(1)(b) of the EU Short Selling Regulation. In the analysis, the SFSA emphasised that the article does not contain any subjective criteria and, in light of this, the SFSA was therefore able to conclude that it was of no significance for the assessment whether the Investors were aware that the shares had been lent.
In its assessment, the SFSA also emphasised that the shares that were booked into the Investors’ custody accounts in connection with the settlement of the issue could hardly be newly issued shares since the directed share issue was registered a month after the settlement was carried out. The SFSA therefore concluded that the shares could only have come from the share loan that the issuing agent had undertaken to mediate between the three shareholders in the Issuer and the Investors. In its assessment, the SFSA also attached importance to the fact that the Issuer stated in its press release that the shareholders had undertaken to lend the shares to the Investors. The SFSA then considered that the net short positions only ceased when the newly issued shares were registered with the SCRO.
Given this and the fact that the Investors had not reported any net short positions, the SFSA decided to order the Investors to pay a special fine in accordance with section 6(1) of the Act (2012:735) with supplementary provisions to the EU Short Selling Regulation.
In order to facilitate settlement in connection with private placements and to enable delivery of shares DVP (delivery vs payment), settlement in private placements is usually structured either through share loans or through a so-called “quota value issue” (Sw. kvotvärdesemission). In cases where the share loan option is chosen, the share loan agreements are concluded between existing shareholders of the issuing company and the issuing agent handling the issue. The investors in the issue have no contractual relationship with the lending shareholders and typically do not know the origin of the shares being delivered. The investors also have no obligation to return any shares to anyone, but once the investors have paid the subscription price and received the shares, the investors have full control over the shares. The transaction structure means that the investors do not carry out a short sale as required by the short selling rules. The investors have no obligation to return any shares and therefore cannot benefit from a falling share price. It is therefore pointless for investors selling shares subscribed in a new issue to have to report net short positions.
The SFSA’s argumentation in the new sanction decisions suggests, however, that when assessing whether short selling has occurred, the SFSA only considers whether the security in question is borrowed or not. The purpose of the transaction, the fact that the seller has not itself borrowed the shares or that the seller has paid an issue payment to subscribe for shares did not affect the assessment in the cases in question. Of particular note is that the SFSA linked the timing of the closing of the net short position to the subsequent registration of the new issue by the SCRO. This is an event that investors are typically completely unaware of.
The decisions have been appealed to an administrative court and it therefore remains to be seen how the interpretation is finally determined. For reasons of caution, however, the starting point for the time being should be that the SFSA’s approach applies. In practice, this means that investors participating in private placements should be aware of requesting information about any share loans and, where applicable, notifying the SFSA if transactions are carried out that, according to the SFSA’s new interpretation, may result in net short positions.
The SFSA’s sanction decision concerns share loans in connection with private placements. Another type of transaction that contains share loans is so-called “over-allotment options” in connection with IPO offers where borrowed shares are initially sold to cover over-allotment in the transaction. It stands to reason that the SFSA will consider that investors who are allocated such borrowed shares in the offering may also hold reportable net short positions. In these transactions, however, there is the additional problem that investors may in practice receive a mixture of newly issued and borrowed shares with the consequence that it is in practice impossible for investors to assess their reporting obligations.