Orestes Pasparakis is a partner at Norton Rose Fulbright in Toronto. Walied Soliman is global chair and Joe Bricker is an associate at the firm. Mr. Pasparakis and Mr. Soliman are co-chairs of the firm’s Canadian special situations team, which has played a leading role in some of Canada’s most high-profile hostile M&A and shareholder activist and defence mandates.
Short-selling – a strategy where an investor bets that a company’s shares will decline in price – plays an important role in our capital markets. It can help to ensure markets price in all relevant information, help investors hedge their positions and root out fraud and abuse.
However, Canada has recently seen numerous examples of abusive short-selling, where short-sellers attempt to profit from a short position by manipulating a stock’s price downward through false or misleading claims.
An Ontario court decision issued in December makes clear that for Canadian companies and investors subjected to abusive short-selling, currently available private remedies are proving increasingly inadequate.
Without legislative reform, there are serious risks to the credibility and global competitiveness of Canada’s capital markets, as well as risks of harm to investors.
In what’s known as the Harrington case, a Bermuda-based hedge fund alleged that a Canadian company and its investors were the victims of market manipulation by short-sellers. The fund applied to the Ontario Superior Court for an order against the Investment Industry Regulatory Organization of Canada (IIROC). If obtained, the order would have compelled IIROC to provide the fund with full logs of trading activity in the company’s securities, potentially allowing the fund to determine the culprits.
The court declined to issue the order and held that as a public regulator, IIROC does not have a duty to disclose trading information to an investor contemplating a private claim.
It also acknowledged perceptions that regulation of “short-selling is permissive and lax in Canada compared to other capital markets.” Yet the fact that investors had to sue (unsuccessfully) in an effort to obtain basic information about who maintained a short position, and their trading activities, is distressing.
Imagine you are the chief executive of a Canadian public company. Lawyers check every dot and comma of your public disclosure. Securities laws impose personal liability on you for anything inaccurate or misleading in financials. Yet short-sellers are seemingly free to employ abusive tactics and language and make outlandish claims.
How would you respond? You could:
- Try simply to get the truth out. But to paraphrase an old saying, short-sellers know a lie can travel far throughout the markets before the truth gets its pants on. Risk-averse investors may already have lost confidence before your story gets out.
- Sue for libel or some other civil remedy. Short-sellers will wear your suit as a badge of honour, though. As the Harrington case made clear, you may not even be able to find out who to sue.
- Seek a remedy under Canadian securities laws. But provisions against misleading statements or market manipulation do not contain a private right of action – in other words, a provision that gives companies or investors who are harmed the right to pursue the case themselves. They only allow the regulator to pursue the case, which is no sure bet. And even then, success requires proving a highly concrete market effect from a specific statement.
- Try to take the company private or engage in a merger or acquisition, but assuming you can find financing or a buyer, why do something that drastic?
These are the exact options we have canvassed with any number of CEOs over the past year. When you do that, it becomes clear that existing private remedies are not enough.
As a starting point, our legislators should require public disclosure of any net short position in a company’s securities past a certain threshold, including the name of the holder, size of the position and date the position was first acquired – just as they already do on the long side. In doing so, they would be following the precedent set in the European Union, among other jurisdictions. For instance, the EU requires disclosure to the regulator when a short position reaches 0.2 per cent of a company’s stock, public disclosure at 0.5 per cent and further public disclosure for every 0.1 per cent after that. In the capital markets, information is oxygen. Investors should not have to sue to find out who has taken out a major short position.
In addition, our legislators need to strengthen the provisions in our securities laws against misleading or untrue statements. These laws readily impose liability on companies and their directors and officers for misleading or untrue statements, without having to prove any market effect. The practical requirement to prove a precise market effect of false or misleading statements made by a market participant should be softened.
Our legislators should also consider a private right of action for companies or investors who are harmed by market manipulation, along the lines of the private remedies in the Competition Act. Of course, the right should be carefully tailored to ensure that free speech about companies and their securities is adequately protected.
Lastly, our regulators need to keep up the prosecutorial pressure on abusive short-selling. While recent prosecutions by the regulators in British Columbia and Alberta have not met with success, our regulators should not lose their nerve. They deserve credit for their increased scrutiny on abusive shorting. Because most activist funds entertain several ideas at any one time, continued attention will encourage abusive short-sellers to think twice about picking Canadian targets.
The inadequacy of private remedies against abusive shorts cries out for reform. Otherwise, Canada’s reputation as a ripe target for abusive short-sellers will be increasingly deserved.