[Debriefing] The ‘fat-finger’ error

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[Debriefing] The ‘fat-finger’ error

An employee of Samsung Securities made a little mistake that led to enormous consequences.

Debriefing looks into how one of the country’s leading brokerages failed to find such an enormous mistake, the fallout from the fiasco and what challenges face the company and the industry as a result.


Q. What happened?

On April 6, a clerical employee of Samsung Securities made an inputting error. Instead of sending 2,018 other employees of the company 1,000 won ($0.89) in dividends for the shares they held in their employer company, he or she sent them 1,000 shares for every share they owned.

That so-called fat-finger error - an industry term for an inputting error - resulted in the distribution of 2.8 billion “ghost” shares. In reality, there are only 89 million Samsung Securities shares.

The dividend payment was supposed to total 2.8 billion won. The ghost shares were theoretically worth 112 trillion won ? 30 times larger than Samsung Securities’ actual market capitalization of 3.4 trillion won at the time. (The company’s shares on April 6 traded for 38,350 won per share.)

Almost 2,000 of the employees receiving the shares realized it was mistake and didn’t take any action. But 22 employees tried to make some money and started selling shares.

Seven of them were merely experimenting and cancelled sell orders. But sixteen sold 5.01 million shares valued at 182 billion won.

Q. What was the impact?

On April 6, the price of Samsung Securities shares fell sharply, as much as 11.68 percent during the day with total trading volume sharply increasing to 13 million shares, which was 26 times larger than the previous day. Shares closed that day 3.02 percent lower than the previous day.

As Samsung Securities shares plummeted, the exchange initiated volatility protection mechanisms five times. The volatility protection mechanism only goes into effect when a share’s value rises or falls more than 10 percent. This allows the company’s shares to be traded at the previous day’s value for two minutes for both sales and purchases.

The selling of ghost shares by a brokerage’s own employees obviously raised ethical questions and tarnished the firm’s reputation. Samsung Securities has taken some action including buying back its own shares, which raised their value. But investors who lost money because of the major fluctuations in the price of the stock are continuing to demand that the brokerage compensate them. Analysts say this could cost Samsung Securities 40 billion won.

The country’s largest institutional investor, the National Pension Service, as well as other major institutional investors have announced that they will no longer trade through Samsung Securities.

Q. What exactly are ghost stocks?

Ghost stock is a comprehensive term referring to stock that doesn’t actually exist. Ghost stocks can be produced when a short seller sells a stock to a buyer without borrowing the stock. Such a practice often takes place in naked-short selling, a type of short-selling that doesn’t require the sellers to purchase the exact amount of securities they try to sell. But many countries ban naked shorting due to the high risks and only allow covered short-selling, which requires the purchase of the securities. Besides naked short-selling, ghost stocks can be made if an electronic trading system lacks internal control as seen in the case of Samsung Securities.

Q. How is it possible to trade shares that don’t exist?

There are two major factors: lack of oversight by the financial authorities and poor internal controls at Samsung Securities. The Financial Supervisory Service, the country’s financial watchdog, broadly stipulates that securities companies proceed with their transactions “appropriately” and don’t conduct monitoring of the brokerages’ electronic system processing dividend payouts and other transactions. The watchdog scrambled to launch an industry-wide probe after the fat-finger fiasco happened.

On Samsung Securities’ side, it failed to install preventive measure against such errors. The brokerage also didn’t follow the conventional stock issuance process that first requires the reporting to the Korea Securities Depository, a state-run organization that manages financial information related to securities transactions. Only then is a brokerage allowed to deliver securities. In Samsung’s case, its system was run in a way that sidesteps that conventional process.

Q. Is this the first time that a Korean securities company has been involved in a fat-finger trading error?

There have been several similar cases in Korea. In 2013, a trading algorithm at the now-defunct Hanmag Securities went wrong, processing false orders on 24 call options and 18 put options. The technical error caused 46 billion won in losses and eventually sent the company into bankruptcy.

That same year, KTB Investment & Securities also suffered a loss of 10 billion won on a mistake on an order of Kospi 200 futures. During the day the brokerage firm ordered 7,000 contracts, which drove the Kospi 200 future index up more than 5 percent.

Another fat finger case happened in early February when Cape Investment & Securities mistakenly sold put options far below the market price, around 20 percent cheaper, which was quickly picked up by retail investors. The brokerage suffered a 6.2 billion won loss, half of its net loss of 13.5 billion won in 2017.

Q. Have there been major international cases?

In recent years similar mistakes have occurred in the international financial market as financial transactions have become reduced to single inputs to a keyboard.

German financial company Deutsche Bank suffered from several fat finger mistakes in recent years. The most recent was in March, when the bank was supposed to transfer 28 billion yen ($249 million) to its Deutsche Boerse AG’s Eurex clearing house. Instead it transferred 28 billion euros ($33 billion) - more than the company’s market capitalization of $19.7 billion.

In 2015, the bank paid $6 billion to a U.S. hedge fund client, which it admitted was a mistake.

Another high profile case was a fat finger error that claimed the CEO’s position. In 2005, Japan’s Mizuho Securities suffered a 40 billion yen loss when an employee mistyped an order to sell a single share of J-Com, a recruitment company, for 610,000 yen and instead sold 610,000 shares of the company for 1 yen.

Q. Where did Samsung Securities’ error lead?

In the beginning, it caught people’s attention because of the sheer size of the mistake. But just as quickly it revealed a major moral hazard in the financial industry because sixteen people sold 5.01 million shares to make money they didn’t deserve, causing a lot of pain for unrelated investors at the same time. Retail investors of Samsung Securities got burned. It was later revealed that some of the workers discussed how they can cash out their ghost shares.

Q. What punishment do the employees face?

The Financial Supervisory Service only reported 21 of the employees to the prosecutors’ office as one made the sales out of pure curiosity. This month, prosecutors indicted eight of the employees and arrested three of them who had colluded in selling the shares, knowing that they were committing a crime.

Five avoided any charges because the prosecution deemed their intention less malicious than the eight people.

Along with criminal charges, the Financial Supervisory Service (FSS) will prohibit the brokerage from opening new accounts for six months, which is called a business suspension. The FSS also ordered the suspension of duties for Koo Sung-hoon, the chief executive of Samsung Securities, for three months and barred three former heads including Yoon Yong-am and Kim Suk from working as executives in other financial institutions for five years.

BY PARK EUN-JEE, LEE HO-JEONG [park.eunjee@joongang.co.kr]
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