[THE INVESTOR] Institutional investors usually rake in huge capital gains by trading equities after borrowing from individuals or pension funds. Local institutions have been more active in using their trading skills than their foreign counterparts on South Korean bourses.

It is illogical from one perspective that some -- but not all -- investors are allowed to sell others’ stocks at their own will. And the discontent among ineligible investors stems from the unfair situation that individual investors, who are banned from it, are placed in.

Financial authorities don’t seem to be willing to abolish the short selling system. There is no regulatory official at the Financial Services Commission or the Financial Supervisory Service who publicly highlights the unfairness and the side effects of the legal, but unfair, trading method.

The lukewarm stance is also applicable to the bourse operator Korea Exchange and the National Assembly.

However, several lawmakers are seeking to create a “period ceiling,” which would force institutions to return their borrowed stocks by completing a re-purchase of their previous sales – known as short covering -- within several months.

The short selling issue has come to the fore again in the wake of alleged stock-rigging involving Hanmi Pharmaceutical shares last Friday. While an investigation by financial regulators is underway, there is an allegation that a group of institutions conducted a large-scale short sale before the company publicized a negative factor.

There is a possibility that the institutions, in collusion with some insiders of Hanmi Pharmaceutical, exploited undisclosed information about the company. Further, as a positive factor was made public by the drugmaker shortly before the negative factor caused a fall in the value of the company’s shares, institutions with privileged information could sell the borrowed stocks at higher prices than they otherwise would.

So institutions engaging in short selling could reap even larger gains. After peaking at 620,000 won ($557) last Thursday, Hanmi Pharmaceutical’s share price nosedived 27.3 percent in just four sessions to close at 450,500 won Thursday. Its parent company Hanmi Science also took a blow.

Chances are slim that the suspected institutions will actively carry out a short covering of the Hanmi Pharmaceutical stocks in the near future, given investigators’ intensive monitoring of the incident. Ultimately, small investors and others cannot help but suffer great valuation losses at the present stage.

If short selling were prohibited, the institutions could not have traded massive shares -- even if they had access to insider information -- unless they had bought them in advance.

As the purchase of many shares usually requires a huge amount of cash, and influential stakes are usually sold at inflated prices, short selling is undoubtedly efficient for institutions who wish to acquire them temporarily.

The core problem begins when many local institutions actively resort to the National Pension Service to borrow stocks. The NPS can easily lend a large batch of shares on a certain percentage of service fees.

Their deals with the NPS are estimated to have increased as more and more angry individuals canceled share lending contracts with their brokerage firms. Their anger is ascribable to the paradoxical situation that their money entrusted with the pension operator is used as a tool to pull down prices of stocks held by small investors. Some even did not -- or still do not -- know that they had made the terms with the brokerages.

A lawmaker had sought to ban the NPS from lending stocks to institutions. But the movement fizzled out due to a lack of support from his colleagues in the Assembly.

The system obliging institutions to make their identities public after cnducting short sales is ineffective, too, because the fines for disclosure-rule violations are negligible. As long as financial authorities dismiss the ongoing criticism from small investors, the authorities’ pledges to root out unfair trading will remain empty.

They must not gloss over growing calls to either eliminate short selling or provide individuals with the same trading rights, as is the case in some overseas markets. At least, major pension funds should be barred from lending equities.

(theinvestor@heraldcorp.com)