Thursday, May 19 2022

Foreign traders and hedge funds that shorted a small South Korean biotech company last year at the height of the coronavirus pandemic are set to lose more than $900 million after the price of action.

Short sellers of DIAC, whose trading on the Kosdaq was halted last March due to audit failures linked to financial issues, are expecting losses after the company splits and merges with its auto parts subsidiary Dual through a stock exchange.

Short positions were worth about $13.5 million at the time of the stock suspension and had risen to $930 million by last week, traders said. Less than 5% of DIAC shares were held short in the last transaction. Investors shorted the company due to uncertainty about the value of a cancer drug it was developing in clinical trials.

But since the trading halt, the stock’s value has jumped 69 times, while Dual shares have risen more than 1,500 times from 107 Won to 161,000 Won ($0.09 to $164) on the K-OTC market since September.

“The abnormally high share price will make short sellers pay dearly to settle cases,” said the head of a local brokerage familiar with the situation.

The surge in Dual shares has fueled concern among traders and hedge funds about possible stock manipulation and a lack of regulatory scrutiny of the merger.

They warned that the saga would negatively impact Korea’s reputation among international banks as the country tries to earn MSCI developed market status.

DIAC’s market capitalization hit more than 20 billion won ($16.6 billion) this week, more than that of LG Electronics and Samsung Corp, the de facto holding company of South Korea’s biggest conglomerate Samsung.

“The big shareholders of society seem to be playing with stocks,” said Won-il Lee, a former hedge fund manager and now an ESG consultant. “But the odd trade has gone unregulated for nearly a year. It shows just how unfair the market can be.”

Regulators approved the controversial merger this month after repeated delays due to a lack of disclosure from the company about the deal. Trading is expected to resume when the deal is finalized, with an early settlement date for short sellers tentatively set for March 11.

As part of the share exchange, one DIAC share will be exchanged for one Dual share. The latter stock began trading on the over-the-counter market in September before the merger and has surged since.

DIAC shareholders will be able to resume trading using the Dual shares given to them, but traders who short DIAC shares will have to return the borrowed shares to Dual shares and be forced to buy them at much higher prices.

“Because of the mechanism, it is likely to cause huge losses,” said a foreign bank trader.

Dual said in its merger filing that the company was being investigated by financial regulators, but it’s still unclear what the investigation is about.

Officials from Dual and the Financial Monitoring Service could not be reached for comment.

The Korea Exchange data did not specify which hedge funds were involved and only showed Morgan Stanley as the main short seller on behalf of its clients. Morgan Stanley declined to comment.

Traders have complained about the lack of protection for international investors. “I’m not sure there is any will at this time to intervene to ensure the market is stable and operating with integrity,” said a trader at a global investment bank.

Last May, South Korea lifted a 14-month ban on short selling against blue-chip stocks during the pandemic. Traders expect regulators to also lift the ban on small stocks after the March 9 presidential election, despite strong opposition from retail investors.

“It’s long because of this kind of [short selling] regulations and lack of protection for international investors,” the foreign bank trader said. “Nobody wants to intervene this time before the election. No one wants to protect a short seller.

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