Brokers face stiff penalty for ‘naked’ short selling, warns CMA

Stockbrokers have to do due diligence or face penalties if they allow ‘naked’ short selling, the Capital Markets Authority (CMA) has said.

Brokers have been complaining the new Nairobi Securities Exchange (NSE) platform removed a system that verified whether a trader had the actual shares they were short selling—selling of borrowed stock for return later — creating a loophole allowing sales by those without specified numbers.

The CMA said it is the brokers’ responsibility to ensure their clients had the shares or the funds to complete deals.

“While automatic systems’ pre-validation during trading has been removed, the current legal and regulatory framework sufficiently addresses the noted risk,” the CMA said.

“In the event that the broker does not get a validation from the custodian before the execution of the sell order, the broker attracts a penalty.”

The illegal short selling occurs if client A wants to sell a million shares if the account has say 800,000. However, without pre-validation in the new system it means a client sends an instruction to sell a million shares and they only have 800,000, you will still sell and be exposed to a naked short of 200,000.

Naked short-selling can distort market prices by creating a false demand that could inflate stock prices.“If you have traded the shares and you do not have them when it comes to settling, you will buy them at a premium or they may create false demand for a share if the purchase is big,” a stockbroker who did not want to be named said.

The NSE said they were working to allow brokers to have visibility of shares through the Broker Back Office system for non-custodial trades.