Luis Iturbe* | I published three articles on the sale of shares on credit in Expansion between 2008 and 2013, which I would like to revisit, without being repetitive. I now refer exclusively to two aspects which I denounced in those articles, which strike me as particularly alarming and which have not been considered either by “doctrine” or, sadly, by the regulator.
1. – The lender of shares. Cases exist where the owner of the shares agrees to lend them and sees a return on this loan. But it is surprising that some lenders are investment funds which maintain the shares in their portfolio and lend them despite in many cases suffering a loss of net asset value (NAV) because the fall in value is greater than the commission it receives for the loan. Although from a legal point of view this is unobjectionable one cannot forget this fact. In other cases it is not clear that the owner has explicitly agreed to lend the shares. When the shares are in international custodianship, does the regulator verify whether the real owner of the shares knows about the loan, and receives any commission for the operation? Although there is a clause in the custodianship contract which authorises it, would it not be a debatable clause?
I leave the issue open, but it seems to be that the market regulators should make their position clear on these aspects.
2. – The artificial creation of shares. Admitting that legally the economic (dividends) and political (vote) rights are not changes, in this case questionably, it is clear that new shares are created without the authorisation of the issuer.
An operator on credit sell shares which are, and remain, in the portfolio of the lender and, also, in that of the buyer, and so are in the market with two origins and titles, in other words twice. I have argued this in the articles published years ago in Expansion on these issue, it has been recognised in professional circles, even by the main defenders of these types of operations, but nobody, sadly, has analysed the legal background and its implications.
The stock market capitalisation, the value of a company in the market, results from multiplying the number of shares issued by their market price, which is nothing other than the balance between the supply of shares on sale and the demand to buy those shares. It insults the reader´s intelligence to recall that a greater price more shares on sale and vice versa.
Well then, if a borrower sells shares on credit for 5% of the capital, that is the same as the market assuming, in fact, an increase of 1X20, and with that, the market equilibrium price is based not on 100, for a supply of 100 shares, but 105, which will inevitably will have to be less than that which corresponds to 100. In other words, we are confronting a price altered by excess of supply.
I don´t know if this action breaches the Law of Anonymous Societies or not, given that an increase in the number of shares has been created without authorisation by the General Assembly. Commercial lawyers will have to study it and give their views, but, please do it, because it is a sufficiently important issue that it should not be left waiting for international criteria, which do not look as if they will be adopted.
It calls powerfully for the pressure to apply MIFID II, which protects the rights of the investor, and the recent sentence against the interests of financial intermediaries condemned to compensate clients and savers, coexist with the obvious neglect of all those responsible in an issue like “short selling” so prejudicial to the interests of small savers and investors and even the companies themselves and the market.
I had foreseen including as a third point the repetitive between downward activities by the shorts, with news in the media, which sometimes is an invaluable support for the objectives of the seller. I didn´t dare do it because it deals with something, sadly, undemonstrable. But it can be seen that there are no investigations for insider trading, not even when it is known that (the Banco Popular case) that the shorts have made a real break, moreover adding to the crisis of liquidity. Despite these facts being known, the issue has been forgotten.
I believe that the defence of the interests of the small shareholders/savers deserves a clear response to the two issues above.
*Luis Iturbe is former president of the Spanish Institute of Financial Analysts (IEAF)