Get Shorty: Europe’s Crackdown on Short Selling (Westlaw Business)

January 20, 2011

People walk in front of a shop of French luxury fashion brand Louis Vuitton decorated for the Christmas holiday season in Bordeaux, south-western France, December 23, 2009. REUTERS/Regis DuvignauBy Christopher Elias,  (Westlaw Business)

Radical changes to Europe’s system of financial regulation are under way and with them a harmonisation of securities rules as Europe turns a corner on the drive to create a single European Securities and Markets Authority with more stringent disclosure requirements. But with not all European regulators striking the same note, the move for greater scrutiny and heightened disclosure expectations over short selling and shareholdings is making sluggish progress forward.

Hoping to re-tune European securities rules are four new pan-European agencies that will comprise of three European supervisory authorities (ESAs) to oversee banking, insurance and securities markets, together with a broader European Systemic Risk Board (ESRB), whose job it is to warn of dangers building in the financial system.

The remaining three agencies will consist of a European Banking Authority (EBA) based in London, a European Securities and Markets Authority (ESMA) based in Paris and a European Insurance and Occupational Pensions Authority (EIOPA) in Frankfurt.

The European Securities and Markets Authority was created on the 1 January 2011 and takes on the role of Committee of European Securities Regulators (CESR) in drawing up common, harmonised rules for the EU finance sector and protecting it from systemic problems.

ESMA will provide guidelines and recommendations to national authorities and financial market participants which, although not legally binding, national authorities will be required to make every effort to comply and must explain if they do not intend to comply.


ESMA, in its earlier incarnation as the Committee of European Securities Regulators (CESR), has already taken steps to produce a more uniform playing field across Europe, publishing final recommendations for a pan-European short selling disclosure regime.

ESMA’s recommendations were that significant net short positions held in shares admitted to trading on European Economic Area (EEA) regulated market or a Multilateral Trading Facility be disclosed where the primary market for those shares is located in the EEA. The recommendations included a combination of private and public disclosures depending on the size of the position held. Disclosures are triggered by the following positions:

1. When a short position reaches 0.2% of the company’s issued share capital, a private disclosure would have to be made to the regulator of the most liquid market for the shares in which the position was held. Increases in short positions would trigger further disclosure obligations in increments of 0.1% over that threshold;

2. Upon a short position reaching the threshold of 0.5% of the company’s issued share capital and any additional increments of 0.1% thereafter a public disclosure must be made to the competent authority as well as to the market as a whole;

3. In calculating whether a disclosure is required, market participants should aggregate any position which provides an economic exposure to a particular share, including positions held in exchange-traded and over the counter derivatives, as well as short positions in cash markets.


The proposals set out a minimum level of disclosures although not all countries have implemented the recommendations equally. In the UK, for example, the FSA choose to largely maintain its existing disclosure rules relating to short selling in financial companies and rights issues only.

The FSA also chose to maintain its existing more stringent disclosure thresholds. Under FSA rules, holders of net short positions at or above just 0.25 per cent of the issued share capital of the company are required to make a public disclosure with further disclosures required if the position changes by 0.1%. Net short holders are also required to announce any 0.25 per cent net short positions on rights issues.

The FSA has indicated that it will await pan-European rules to cover short positions outside of the finance sector. France too has taken a similar position as the UK, although unlike in the UK, failure to disclose a short position can still constitute market abuse.

Spain, Italy and Germany on the other hand have taken bolder stances, seeking to implement changes ahead of any pan-European regime. Naked short selling remains banned or effectively prohibited in these countries and Spain has pushed ahead to adopt ESMA’s recommendations on short selling disclosures wholesale ahead of a European directive.


The importance of harmonising some of the discrepancies between EU disclosure rules was highlighted recently by the very public fallouts resulting from the less than public share acquisitions by Porsche and Louis Vuitton and Moët Hennessy.

Porsche recently won a U.S. lawsuit against two hedge funds that had claimed they suffered $2 billion (£1.3 billion) in damages following Porsche’s undisclosed acquisition of a 30% stake in Volkswagen. Porsche managed to achieve one of the largest short squeezes in history after it secretly accumulated an additional 30% shareholding in the German listed Volkswagen via cash settled options, leaving virtually no free shares left in the market. With a lack of shares to buy, Volkswagen’s shares quadrupled in value in a day – making Volkswagen temporarily the largest company in the world by market capitalisation.

Unlike in the UK, where the Disclosure and Transparency Rules (Disclosure of Contracts for Differences) Instrument 2009 rules require the disclosure of cash settled options, German rules do not, allowing Porsche to add to its 42.6% stake with an additional 30% of Volkswagen shares through derivatives of this sort.

Unfortunately for hedge funds Elliott Associates and Black Diamond Offshore their claims against Porsche were dismissed by U.S. District Judge Harold Baer late last year, holding not that secretive acquisitions of this sort were legal but that what happens in Germany, stays in Germany. Judge Baer applied the earlier U.S. Supreme Court decision of Morrison v NAB which stated that investors buying shares in foreign companies could not use the American legal system to claim damages for alleged securities fraud.

Elliott Associates and Black Diamond Offshore had entered into swap agreements that stood to benefit from a decrease in the share price of Volkswagen. They claimed that because they entered into the swap agreements in New York that these should engage “domestic transactions in other securities” within the scope of §10(b) of the Exchange Act and Rule 10b-5.

The court ruled that such a narrow reading of the principle set out in Morrison v NAB was inconsistent with the Supreme Court’s intention to curtail the extraterritorial application of §10(b). It held that a domestic “buy order” for securities traded abroad and one party’s location of execution in the U.S. were insufficient to engage §10(b).


A similar hole in French disclosure rules was exposed by Louis Vuitton and Moët Hennessy’s (LVMH) acquisition of a chic 14.2 per cent stake in Hermès International, the French luxury goods rival.

Markets were shocked and confused as to how LVMH had managed to acquire a 14.2 % stake at a 54% discount to the prevailing market price, particularly given that French disclosure rules require that shareholdings of 5%, 10% and 15% be disclosed.

The trick involved entering into cash-settled equity swaps with two banks, which were then amended at the last moment to be equity settled rather than cash settled. Similar to German disclosure rules, cash settled swaps are not required to be disclosed under French laws, allowing LVMH to hold a 14.2% cash settled position for almost two years in secret.

It was only once the swaps were amended and exercised that LVHM disclosed to the French regulator Autorité des Marchés Financiers (AMF) that it had picked up a 14% stake without tripping any of the disclosure thresholds. For more information on LVHM’s acquisition and other sneaky securities transactions please see Westlaw Business Currents article Avantgarde Acquisitions: Sneaky Stakebuilding Exposes Disclosure Flaws.


For those U.S. parties operating in or in reference to Europe, the decision in Elliott and Black Diamond v Porsche confirms that U.S. courts will take short shrift with losses incurred on essentially foreign assets. Provided the objectionable activity lies outside of the U.S., then U.S. litigations will unlikely to be able to engage U.S. securities rules.

The creation of a single European Securities and Markets Authority represents a significant step forward towards the creation of a harmonised set of security rules in Europe. Past experience, however, tells us that rarely are EU rules applied equally by national regulators and as such discrepancies will likely persist between member states. Perhaps the best we can hope for is that greater consistency exists tomorrow than exists today.

This article was first published by ThomsonReuters’ Westlaw Business Currents, a leading provider of legal analysis and news on governance, transactions and legal risk. Visit Westlaw Business Currents online at

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