Fortescue shares hit after short-sale rage

On Tuesday, Fortescue went on the offensive against short sellers, noting that a registry search had revealed that 10 per cent of its shares were on loan - presumably to hedge funds shorting the stock.

But the iron ore miner's shares plunged 10 per cent yesterday in high-volume trading, when an expected buying frenzy to cover the short sales failed to eventuate.

"You would have expected under normal circumstances, if 10 per cent was short sold, to see a short-covering rally," said a Patersons Securities analyst, Alex Passmore. "[This] is strange."

The on-loan stock was understood to be owned by one of Fortescue's most stalwart backers, the New York hedge fund Harbinger Capital Partners, whose custodian, the Bank of New York, was believed to have lent it to short sellers without its client's permission.

Harbinger had little motive to lend its shares to short sellers, as it has been considering the sale of a portion of its 15 per cent stake in Fortescue and presumably would want the shares to trade at as high a price as possible.

Harbinger's senior managing director, Philip Falcone, did not respond to the Herald's request for comment.

But an industry expert made clear that Harbinger, a highly sophisticated investor which itself borrows shares of other stocks to short, would have needed to give explicit permission to its custodian to allow its Fortescue stock to be lent to short sellers.

"[The custodians] absolutely have to ask the client's permission," said Bryan Gray, the chairman of the Australian Custodial Services Association. "That's the rule everywhere."

The permission would have involved signing a form.

The Fortescue share registry implies the Bank of New York has employed sub-custodians in Australia - likely to include its local partner, National Nominees - to help manage Harbinger's stock.

ANZ Nominees holds an 8.58 per cent stake, but an ANZ spokesperson said it was not subject to any securities lending arrangements.

Mr Gray said sub-custodian arrangements generally placed specific prohibitions on securities lending, meaning the lending decisions were likely to have been made in New York.

Sources close to Fortescue blamed yesterday's share price fall on hedge funds manipulating the market by depressing the price even further, to make it cheaper to cover the short sales.

But Goldman Sachs JBWere's institutional dealing desk noted Fortescue's shares had fallen 41 per cent in the past two months, on par with similar falls in mining peers such as Lihir Gold, Atlas Iron and Kagara.

"It's not the hedge funds that are responsible for the fall in [Fortescue] but global factors," the investment bank said.

"Maybe an extra 5 per cent may have come from the [hedge funds], but in the big picture, this is a smokescreen . a non-issue."

Fortescue shares closed 81c lower at $7.14 on a weak day for resources stocks.