James Dinan’s York Capital Management LP is under investigation from a Spanish regulator for allegedly using a banned trading technique in bets made against Bankia SA (BME:BKIA) (OTCMKTS:BNKXF), Spain’s mortgage giant.

he Comision Nacional del Mercado de Valores, or CNMV, is looking into whether York failed to cover its Bankia SA (BME:BKIA) (OTCMKTS:BNKXF) position in a ‘timely manner’.

York Capital Management’s naked share sale

In December, the Spanish regulator started a probe into bets made against Bankia shares before May 23, 2013 when the stock plunged 51% after terms of a Government bailout were disclosed.

As reported earlier, in May 2013, shares in the Spanish institution Bankia SA (BME:BKIA) (OTCMKTS:BNKXF) tumbled after the company released 11.5 billion new shares onto the market. The fresh issuance of shares was part of a plan to recapitalize Bankia, and set it up for the future. The new shares were given to retail investors in exchange for preferred shares they received in the early days of the European debt crisis. The shares took a 70% haircut on their value in the conversion.

The investors largely chose to offload the shares en masse in May 2013, taking another large discount in their value for the privilege of no longer being associated with the Spanish lender.

Citing a person familiar with the matter, Bloomberg reports that York Capital Management’s European focus fund had earlier invested in Bankia SA (BME:BKIA) (OTCMKTS:BNKXF) convertible debt and carried out the short sale to help offset any decline in the value of this investment. York executed the short sale just before the issuance of stock through the May 2013 recapitalization, and as a result, had a naked short position for a brief period of time.

James Dinan York Capital Management

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Outside its control

However, in a regulatory filing, James Dinan’s York Capital Management said the trade was reviewed by its compliance department and other parities, and that there were circumstances outside its control that prevented a timely delivery of shares to execute the trade. Moreover, its outside counsel and prime broker all reviewed the short sale prior to execution to ensure timely delivery of the shares needed to cover the transaction.

To stem market turmoil, during the global financial crisis, European and U.S. regulators temporarily prohibited short sale of stocks. The European Union regulators tightened their regulations by mandating investors to have already borrowed the stock, or have arranged to do so, on or before the day of the short sale.

If CNMV files civil charges against the hedge fund, they’ll be among the first under the European Union’s 2012 short-selling restrictions.

CNMV issued a statement in December indicating it had started six investigations to determine whether sales of Bankia stock that took place prior to the recapitalization complied with short-selling regulations.