Caitlin Sainsbury is a partner in the commercial litigation group of Borden Ladner Gervais LLP.
Short-sellers who publish critical research reports have come under fire lately for their role in driving down the share price of companies they report on and otherwise making life difficult for certain publicly traded companies.
Valeant Pharmaceuticals International Inc., for example, has accused short-seller Citron Research of making "demonstrably false statements about our business" and of "mislead[ing] investors," while Nobilis Health Corp. has sued Anson Canada and others for $300-million in damages relating to an alleged "scheme" perpetrated by Anson to drive down the share price of Nobilis.
Since the release of Citron's report that was critical of Valeant, Valeant's share price has dropped by more than 90 per cent. Nobilis's share price dropped by more than 60 per cent, although it has since rebounded.
While it is certainly not implausible to suggest a company could be the subject of unfair attacks by short-sellers, the regulatory framework currently in place provides sufficient protection by virtue of the prohibitions in place against market manipulation and other wrongdoing. Holding a long position and putting out an inaccurate promotional report on a security could be market manipulation and illegal in the same way that being short and putting out an inaccurate negative piece could be.
In 2013, for example, the British Columbia Securities Commission issued a notice of hearing alleging that Jon Richard Carnes, the man who ran the "Alfred Little" financial blog, perpetrated a fraud when he anonymously published a negative report about Silvercorp Metals Inc. that drove down its share price and Mr. Carnes profited from a short position he held in Silvercorp shares. While the BCSC ultimately dismissed the allegations against Mr. Carnes, short-sellers are not immune to regulatory scrutiny when engaging in activity that is outside the bounds of securities laws.
In an environment where regulators are constrained by resource restrictions and the primary source of information on a public company's financial health is the company's own public disclosure, short-sellers provide an important market check for investors. Notably in Canada, the Muddy Waters Research report released in 2011 alleging that Sino-Forest Corp. falsified accounting records and misled investors was a catalyst for a special committee investigation into the irregularities as well as an Ontario Securities Commission hearing now in its second year.
In addition, short-sellers can spark legitimate debate about the true value of a company, both with other investors and with the companies themselves. In the United States, Bill Ackman has been stacked against long advocates such as Bronte Capital in a lengthy public discourse about the merits of Herbalife International Inc. This is exactly the kind of debate that promotes greater market transparency through increased information access for investors and ultimately increases market efficiency. Short-sellers risk exposure to potentially unlimited losses on short positions so typically do not take such positions lightly.
The 2008 ban on short selling imposed by the U.S. Securities and Exchange Commission in the face of the financial crisis exposed one of the significant problems with restricting short-selling – a decrease in market liquidity. A 2012 article published in Current Issues in Economics and Finance found that banning short-selling does not prevent share prices from falling, and further, the bans seem to "have the unwanted effect of raising trading costs, lowering market liquidity and preventing short-sellers from rooting out cases of fraud and earnings manipulation."
It is ultimately in the best interests of market participants to have short-sellers affording that key liquidity function, all the while keeping a check on potentially overvalued companies and providing a "sober second thought" on public company disclosures.