Aug. 28 (Bloomberg) -- The London office of James Dinan’s York Capital Management LP may face civil charges from Spanish regulators for allegedly using a banned trading technique before last year’s bailout of mortgage giant Bankia SA.
The Comision Nacional del Mercado de Valores, or CNMV, notified Dinan’s firm in March it was scrutinizing a May 2013 short sale by the York European Focus Fund, according to a regulatory filing. The stock involved was Bankia, according to a person familiar with the matter, who asked not to be identified because the details are private. In December, the Spanish regulator started a probe into bets made against Bankia shares before May 23, 2013, when the stock plunged 51 percent after terms of a government bailout were disclosed.
The civil charges against York would be one of the first cases filed under a new regulatory code adopted by the European Union in 2012 to restrict short selling, blamed by many local officials for exacerbating the global financial crisis. Spain and Italy, two of the countries hit hardest by the European debt crisis, have both used emergency powers under the new code to temporarily ban any bets against local stocks.
“I have not seen a single case of even threatened enforcement” under the EU’s new short sale rule, said Christopher Leonard, an attorney in the London office of law firm Bingham McCutchen LLP, who has advised hedge-fund managers on complying with the restrictions. “It was inevitable that at some point someone would contravene the regulation, accidentally or on purpose, and that a regulator would seek to take action.”
Richard Swanson, York’s general counsel, declined to comment. In a regulatory filing, York said the trade was reviewed by its compliance department and other parties, and that there were circumstances outside its control that prevented a timely delivery of shares to execute the trade. The CNMV as a policy does not comment on its supervision process, according to a spokeswoman for the regulator.
Short selling is the practice of betting against stocks and other securities. In a short sale, a trader makes use of borrowed assets to bet on a decline in prices, hoping to buy them back later and pocket the price difference. The process of borrowing the stock from a third party and delivering it to the buyer is known as “covering” a short. A “naked short” is a banned practice in which investors sell a stock short without locating shares to borrow to complete the transaction.
The Spanish regulator is considering filing civil administrative charges against York Capital Management Europe (UK) Advisors LP for failing to cover a short position “in a timely manner,” according to documents that New York-based York filed with the U.S. Securities and Exchange Commission.
York, a New York-based manager that oversees about $19 billion, primarily in event-driven strategies, said in the filing that the firm’s compliance department, outside counsel and prime broker all reviewed the short sale prior to execution to ensure timely delivery of the shares needed to cover the transaction.
“It is the firm’s position that the failure of timely delivery was on account of circumstances completely outside of its control,” York said in the filing.
The potential enforcement proceeding was outlined in a “pliego de cargos,” meaning a list of civil charges, that York received on March 27, according to the filing. The SEC filing didn’t identify the stock involved.
During the global financial crisis, European and U.S. regulators temporarily prohibited short selling of stocks, claiming that the trading strategy was fueling market turmoil.
The U.S. and the European Union then tightened their regulations to make it harder to engage in naked shorting. The U.S. now requires investors to have a reasonable belief they can borrow shares to cover a short sale within three days; the EU requires investors to have already borrowed the stock, or arranged to do so, on or before the day of the short sale.
York’s European focus fund had previously invested in Bankia convertible debt and carried out the short sale to help offset any decline in the value of this investment, according to the person familiar with the matter. The firm executed the short sale just before the issuance of stock through the May 2013 recapitalization, and as a result, had a naked short position for a brief period of time, the person said.
York, founded by Dinan in 1991 with about $3.6 million in capital, joined a number of other hedge funds that sought to profit from the European debt crisis. Its European Focus fund, had almost $1 billion in assets, according to the latest figures available.
The unraveling of Bankia, once the third-largest lender in Spain with $330 billion in assets at the end of 2010, was a decisive factor in forcing the Spanish government to turn to the European Union for a bailout of the country’s financial sector. After Spain formed Bankia by merging seven regional savings banks, the lender raised more than 3 billion euros through a July 2011 initial public offering, with many of the shares being sold to the bank’s own depositors.
These common shares were almost wiped out in a recapitalization of the bank that took place in May 2013 under the terms of a 18 billion euro bailout agreement with the European Union. Holders of the convertible debt were forced to exchange the securities for common stock that equaled less than half of face value.
At the time, the CNMV said it would investigate the May 23 stock plunge, just before Bankia issued 11.5 billion new shares under the terms of the recapitalization.
In December, the Spanish regulator issued a statement saying it had started six investigations to determine whether sales of Bankia stock that took place prior to the recapitalization complied with short-selling regulations. The CNMV said it had been in touch with market supervisors in seven countries where sellers of the shares lived and had made 99 requests for information.
--With assistance from Macarena Munoz and Charles Penty in Madrid.