Hedge funds may have made more than £1bn from shorting shares in HBOS, whose £4bn rights issue faced intense pressure from investors betting on the share price falling.
Almost 15 per cent, or about 550 million, of the bank's shares are out on loan, according to Data Explorers. That stock will mainly be lent to funds who have sold the shares expecting to buy them back cheaper.
HBOS's last closing share price before the cash call was announced was 495.24p, but the shares plunged during the rights issue process. At the closing price of 264.5p yesterday, short funds who bought at the closing price before the cash call was announced on 29 April would have made 230.74p a share, or a total of £1.27bn.
Six funds have announced positions since the Financial Services Authority changed its rules to require the declaration of short holdings over 0.25 per cent for companies undertaking rights issues.
The first and biggest position declared was Harbinger Capital's 3.29 per cent, which it built before 20 June, when the FSA's new rules took effect. If the US hedge fund, run by Barclays Capital's former head of trading Philip Falcone, had bought its stake at the closing price before the rights issue, it would have made £281m by selling at yesterday's closing price.
Using the same calculations for Lansdowne Partners' 0.58 per cent stake, also declared on the first day after the disclosure rule came in, would give the US fund a profit of about £50m.
Other investors to declare short positions of 0.3 per cent or less were Jabre Capital Partners, Meditor Capital Management and three separate Marshall Wace funds.
Short sellers borrow shares they do not own and then sell them hoping to buy them back more cheaply if the price falls. The practice has come under intense scrutiny during the credit crunch as financial stocks have come under pressure amid accusations of rumour-mongering and market manipulation.
The FSA brought in its new rules after the shares of HBOS and other companies conducting or considering rights issues came under massive pressure. Though fears were mounting about the housing market and the economy, the FSA said it believed there was market abuse by funds taking short positions and driving down the price.
Morgan Stanley, one of the underwriters to HBOS's share sale, declared a 2.35 per cent short position in the bank yesterday. The holding exceeded the FSA's threshold on Friday so more than 2 per cent was bought that day, probably as a hedge against the falling price of the shares.
The FSA and US regulators have tightened rules on short selling because of fears that the practice is accelerating stock market falls.
More than $1.4 trillion (£701bn) of equities worldwide are on loan, about a third higher than at the start of last year, according to data provided by Spitalfields Advisors for Bloomberg.
Roger Lawson of the UK Shareholders' Association said that short selling in rights issues left too much scope for market manipulation because it is known that a lot of stock, much of it unwanted, is going to come on to the market. There is no suggestion that holders of any of the publicly disclosed positions is involved in market manipulation.
"The market is becoming speculative and what is happening is that the big players are distorting the market. One of the ways of doing this is by shorting," Mr Lawson said. The FSA has proposed bringing in further restrictions on short selling and Mr Lawson said the regulator should go ahead with additional measures.
Fund managers made at least $1.4bn (£700m) in July from bets against Fannie Mae and Freddie Mac, the giant mortgage finance companies, according to Bloomberg.
HBOS suffered from the actions of short sellers before the rights issue was announced. Shares of the parent of Halifax and Bank of Scotland slumped 17 per cent in a few minutes in March, a fall the authorities blamed on short sellers spreading malicious rumours to drive the price down. The FSA launched an inquiry to find the culprits.