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. Last Updated: 07/27/2016

Brokers Swallow Loss After 'Short Sale' Goes Sour

Top Moscow brokers are swallowing hundreds of thousands of dollars in losses after one firm failed to deliver promised shares of a blue-chip energy company, traders said Wednesday.

The market regulatory association is planning meetings this week with all parties involved after a group of 10 to 12 member firms complained that the Presnenskaya brokerage had signed contracts with them to provide millions of Mosenergo shares -- then was unable to come up with the goods.

"It's extremely detrimental to the marketplace," said one trader, who asked not to be identified. "It could have had a big domino effect, but looks like it's under control."

Traders were reluctant to disclose names of the dozen or so brokerage firms burned by Presnenskaya's "selling short," but one said the group included mainly reputable, active trading houses. Three dealers estimated overall losses at about $250,000, calculating the prices brokers could have bought shares for under contracts negotiated with Presnenskaya before a sudden rise in Mosenergo's price last week.

While the dealers would not have paid Presnenskaya in advance, they likely would have made commitments to other clients to provide Mosenergo shares, which they then felt an obligation to buy at a higher market price, one trader explained.

Because Presnenskaya is not a member of Paufor -- the Professional Association for Stock Market Participants -- options are limited, a Paufor official said.

"We cannot do anything, but we'll try to have a meeting together to solve this problem," said Denis Jouravlev, head of Paufor's disciplinary committee. He suggested a "kind of round table with all parties," which other traders said would take place Thursday.

Jouravlev said he believed it was the first time Paufor was asked to mediate in a dispute over "selling short," or making contracts to sell stock you don't yet own.

The story, according to Paufor and market players, goes like this: Last week, share prices in Mosenergo -- one of the most heavily traded Russian issues -- were unusually volatile, at one point dropping to $0.16 per share from as high as $0.22. Presnenskaya, which claims it had been defrauded earlier by another brokerage, signed contracts to sell 5 million Mosenergo shares. It counted on the share price dipping further, after which it would buy up the shares, sell them at the contract price and pocket the difference. But Mosenergo suddenly rallied along with the broader market, making it impossible for Presnenskaya to cover its promised trades.

Brokers said selling short is nothing new to the Moscow market, but the size of Presnenskaya's risk was unusual. One trader said the company was likely in over its head.

"I don't think they had anywhere near the assets to even contemplate covering this kind of trade," said the trader, who asked not to be identified. "These are probably inexperienced people who didn't realize what they were creating."

The story is complicated by the fact that Presnenskaya claims another firm, Paufor member Reptos Group, reneged on a deal of its own, further draining Presnenskaya's resources, Jouravlev said. Presnenskaya then appealed to Paufor on March 21 to step in and help resolve the conflict, he said.

A Presnenskaya official reached Wednesday declined to comment.

A Reptos official said his firm's failure to settle promptly with Presnenskaya had nothing to with Presnenskaya's subsequent default on its other trades.

"These two things -- short selling by Presnenskaya of Mosenergo and our transaction with Presnenskaya -- are not connected," said Andrei Okhotkin, head of investment at Reptos.

"Short selling is short selling, risking very much because of the unstable situation of the market," he said.

Okhotkin said that Reptos signed a $37,000 contract Feb. 23 to buy 150,000 Mosenergo shares from Presnenskaya. He said Reptos did not exactly default on that deal, but there had been a "misunderstanding" that the two companies would work out between themselves.

"Of course we could fulfill all of the points of our contract, but there are some details, some nuances, and because of those we did not fulfill it," he said. "We discussed this point with Presnenskaya and will solve it."

He said the $37,000 Reptos owes Presnenskaya is small potatoes compared with the outstanding debt of Presnenskaya. Five million Mosenergo shares on the market today would fetch more than $1 million.

Jouravlev said Paufor rules dictate two courses of action when members fail to complete transactions. One is a hearing before the club's disciplinary committee, the other is bringing the case to Paufor's arbitration court.

He said the matter will likely be discussed at Paufor's board meeting Friday, adding that the dispute will likely go to the disciplinary committee. In February, a firm called Invest-Import bilked Paufor members of some $500,000 before vanishing. Jouravlev said this case was different because Presnenskaya is a fully registered company, where the other was fly-by-night and "did not exist."

The whole predicament reflects the nascent Russian market's lack of sophistication and feeds into its risk factor, another trader said.

"It's part of the systemic risk," said Anton Kudriashov, head of equity trading at Renaissance Capital. "With smaller firms, especially non-Paufor members, the risk is higher so you have to be very careful."

Part of the problem in the case is that because Presnenskaya is not a Paufor member, it does not have access to trade on the Russian Trading System, an electronic trading system. That makes it harder for Paufor to monitor trades.

"We can control the trades if we have access to them, but how can we control something we don't have access to?" said Irene Saavedra, chief administrative manager at Paufor.