A matter of concern or not?28 Jun 2021 11:33
Forward Selling: A Crime Against Shareholders
What are the motivations behind this practice?The motivations for the forward sellers are pretty obvious: they can make an almost guaranteed profit by selling shares at market prices, when they know that they are going to acquire the shares at below market prices. By selling the shares before they receive them, they are taking no risk that the price might decline after the issue process has completed. The practice also benefits brokers and advisers, who generate fees or commissions from the share issuance. From directors’ point of view, permitting forward sales may make it easier for them to issue shares, thus raising finance which supports the business (and supports the payment of their salaries). This is a particular issue for businesses that are not generating profits, including early stage businesses and pre-production natural resource companies – many of which regularly need to raise fresh capital
Under what circumstances can forward selling occur?
When we start to consider the circumstances under which forward selling can occur, the problems with the practice start to become evident. Firstly, in order for forward selling to be profitable the shares must be issued at below market prices. In the case of New World, the shares had been trading around 0.1p before the massively dilutive placing at 0.055p was announced. They still traded (in volume) at around 0.075p in the days immediately after the placing announcement, meaning an instant & substantial profit for the forward sellers.Forward selling takes place when companies enter into agreements such as “Equity Financing Facilities” (EFFs). These and similar agreements are even more iniquitous from shareholders’ point of view (and investors should regard the existence of such an agreement to be a “red flag”). They allow the subject company to periodically issue tranches of shares, at prices that are to be determined by reference to market prices, upon issue of a “subscription notice” to the EFF provider by the company.What happened in practice is that the EFF provider forward sold the shares it was procuring under the subscription notice during the period when the discounted subscription price was being determined, thus guaranteeing a profit, as described above.
What is the problem for shareholders?
The forward sellers make their profits at the expense of pre-existing (and often long-term) shareholders, who’s stakes are diluted and hence devalued.
A less obvious problem is that for this practice to succeed, there needs to be a strong market for the shares that the company is issuing to the forward sellers. One often finds very bullish comments about the worth of the company at such times, which can mislead investors and encourage them to overpay.There is obviously a strong incentive for the company or the forward seller to promote such commentary which misleads investors.
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