Paul Simon is partner in the securities and capital markets group of Borden Ladner Gervais LLP.
While short sellers exercise ever more influence on Canadian public companies, the regulatory regime governing these speculators has remained somewhat static. As we've seen in the recent case of Valeant Pharmaceuticals International, a company's reputation can be formidably challenged and further scrutiny invited following the actions of a single player.
Companies responding to a short seller's report can face significant downward pressure on the market price of their securities. (A short sale occurs when the seller borrows stock from a brokerage, and sells it, expecting the price to fall. If it does, the seller will buy stock at the lower price to replace the stock that was borrowed.) Even if companies are able to successfully refute the short seller's assertions, the market price of their securities may be slow to recover – if they ever do. But Canadian securities regulators rarely pursue short sellers for alleged breaches of Canadian securities laws, so companies are left to defend against the accusations in the court of public opinion.
Short sellers often publish research reports with conclusions that are difficult to disprove and that force issuers to defend their public records. Issuers complain that these allegations effectively require them to prove a negative. Issuers are often constrained in responding in order to avoid divulging competitively sensitive information.
To insulate themselves from liability, short sellers ensure that there is sufficient disclosure about any assumptions made in their reports. Canadian securities regulations "prohibit any person from making misleading or untrue statements or from failing to state a fact that is required to be stated or is otherwise necessary to make a statement not misleading that could reasonably be expected to have a significant effect on the market price or value of securities." In response, short seller research reports include language indicating that they are based on assumptions that may not be independently verifiable without access to the issuer's confidential records (which, invariably, is never given).
In 2012, the Canadian Securities Administrators and the Investment Industry Regulatory Organization of Canada (IIROC) published a joint notice seeking input on the proposed regulation of short selling. Following consultation with industry participants and issuers, IIROC adopted certain amendments to its Universal Market Integrity Rules. Changes included requiring market participants to identify any trade that qualifies as a short sale at the time of order entry, thereby allowing IIROC and other regulators to collect information regarding short sale activity. The amendments allow IIROC to produce and disseminate semi-monthly reports on the proportion of short sales in the total trading activity of an issuer's securities. In addition, the Toronto Stock Exchange produces a semi-monthly consolidated short position report that sets out the aggregate short positions and the net change from the previous report for each issuer listed on the TSX.
While short sale orders need to be marked as a short sale, there is no requirement that a short seller's identity and overall short position be publicly disclosed. Rather, short positions in a particular company are aggregated and reported collectively. The investing public has access to information relating to the total short position in an issuer, but there is no way of knowing a single short seller's percentage.
Since a short seller is betting that the market price of a security will decrease, many commentators say it's important for issuers and the investing public to know the relative size of the short seller's position. The larger the position, the greater the incentive for placing downward pressure on the issuer's market price and the greater the financial return.
Although Canadian public companies have access to information regarding total short sale positions in their securities, they have no visibility into who the short sellers are or the respective size of their positions. It's only after a short seller publishes a report outlining their allegations against an issuer that their identity become known. But unless voluntarily disclosed, the issuer and investing public still have no way of knowing the size of the short seller's position. Without a legal requirement imposing public disclosure obligations, it's left to the issuer and the investing public to infer or – worse – make uninformed assumptions.