Forward selling of placing shares leads to public censure and fine
Cornhill Capital Limited has been publicly censored by the Disciplinary Committee of the London Stock Exchange. It was also fined £300,000, discounted for early settlement to £210,000.
The censure relates to breaches of the Rules of the London Stock Exchange between April 2015 and July 2015, when Cornhill was the placing agent for a placing of shares by for New World Oil and Gas Plc ("New World"), an AIM company. The placing was conditional on shareholder approval at a general meeting to be held on 19 May 2015. Following the placing announcement, Cornhill forward sold, on behalf of its underlying customers, a significant quantity of placing shares for settlement on 20 May 2015. These sales were on Exchange and were unconditional, so Cornhill became wholly reliant on the placing being approved by New World shareholders in order to settle its position. However, the New World shareholders did not approve the placing.
The Disciplinary Committee found that Cornhill had breached Rule 1020.3 and the guidance to Rule 1400, as it did not have adequate internal procedures and controls in place to manage its forward selling of New World shares to an amount of shares that it would be able to settle if the placing was not approved by shareholders, or have a clear and viable strategy in that contingency.
By entering into its forward sales of New World shares and failing to ensure that these trades were able to be duly settled, Cornhill engaged in a course of conduct which was likely to damage the fairness or integrity of the Exchange’s markets and caused, or contributed to, a breach of the Exchange’s Rules by other member firms in breach of Rules 1400.4 and 1400.5.
When the placing was not approved, Cornhill was unable to settle its forward sales, in breach of Rule 5000. As a result, other member firms were unable to settle their own onward sales where settlement was dependent on the receipt of stock from Cornhill (thereby also breaching Rule 5000).
The settlement situation in New World shares had a detrimental impact on the company, its shareholders and other market participants, as it caused trading in the shares to be suspended for approximately eight weeks until a second placing and open offer had concluded and the settlement situation had improved.
In addition, Cornhill breached Rule 1060 in that some of its trade confirmations stated that the trade was subject to the Rules, when the trades themselves were not executed on Exchange. Rule 1060 requires member firms not to inform a customer that a trade is subject to the Rules unless the trade is on Exchange.
The Exchange agreed to settle the disciplinary action by way of a Consent Order, taking into account that:
- there was no intent by Cornhill, rather the issues arose as a result of inadequate systems and controls;
- Cornhill co-operated fully with the Exchange’s investigation;
- Cornhill does not have any historic issues on its compliance record;
- Cornhill provided assurances that substantive remedial measures have been taken to ensure that such breaches do not reoccur, including extensive remedial work to its systems and controls; and
- Cornhill voluntarily compensated those of its advisory clients that suffered losses as a result of their trades in New World, at a financial cost.
The Exchange took the opportunity to give guidance to member firms in relation to the monitoring of trading and settlement positions. Member firms should ensure that their internal systems and controls are sufficiently robust so as to be able to identify and alert the firm when a trading position in a security becomes mismatched with the firm’s settlement position in that security. For example, a member firm may have a relatively flat trading position in a security but at the same time have a severe settlement backlog, either because the firm has not received delivery of stock due to failed purchases, or is awaiting settlement of purchases which were traded for extended settlement.
Monitoring of positions should also:
- reference the number of shares in issue; and
- be undertaken regardless of the monetary value of a particular position.
Even if an unsettled position is of low monetary value to a firm, it may, in terms of the number of shares in issue, be significant in terms of the impact it has on the firm’s counterparties and the overall settlement situation in the market. This is particularly relevant where the company may have an upcoming corporate action which is subject to a shareholder vote.
Member firms should have a clear strategy for ensuring settlement of any short position.