CSA consultation takes on heightened importance amid market manipulation concerns
If there’s any good that could have come out of the recent drama surrounding GameStop, it’s the attention that’s been called to apparently excessive practices of short selling in the securities markets. And given this current context, a consultation launched by the Canadian Securities Administrators (CSA) in December seems almost prescient.
In a new note, John M. Picone, David Kelman, and other legal experts from Cassels cited CSA Consultation Paper 25-403: Activist Short Selling, wherein it solicited input from the public and stakeholders on concerns about how short selling could potentially impact Canada’s capital markets.
“Advocates of activist short selling suggest that the practice contributes to market efficiency and price discovery by identifying and correcting artificially inflated positions,” the experts from Cassels said. “Critics, however, focus on the inherent harm caused to the public market by deliberate attempts to destroy shareholder value for personal gain.”
In Canada, such concerns are exacerbated by what many believe to be an inadequate regulatory framework of deterrence and protection against such misconduct. Activist trading seen recently in the U.S. may also be mirrored in “copycat” cases above the 49th parallel.
Picone and his co-authors cited the CSA’s empirical analysis of activist short-selling in Canada between January 2010 and September 2020. In it, the CSA found short sellers tended to gravitate toward issuers and sectors where there was perceived overvaluation, including the pot sector which was targeted by 35% of new campaigns.
Larger issuers tended to be the target, with median and average market capitalization of targets amounting to $867 million and $4.5 billion, respectively. Three quarters (75%) of short-selling targets saw their share prices decrease on the day of the first campaign announcement, with the negative impact lasting up to one month afterward.
“Of all 116 campaigns, 40% involved allegations of fraud directed at the issuer, with the most common type of fraud allegation being a stock promotion (or ‘pump and dump’) scheme,” the experts at Cassels noted. Around 29% of issuers targeted by short sellers suffered a negative outcome aside from lower share prices.
Around three fourths (73%) of short sale targets responded one way or another to campaigns against them, including ejecting top executives, bringing in an auditor or independent investigator, and pursuing legal action against the propagators of the campaign.
Regulators may combat undesirable activist short selling by acting on general prohibitions against market manipulation, making misleading statements, and fraud that are baked into Canadian securities regulation.
However, the authors from Cassells noted that the evidentiary threshold required under such legislation is seen as prohibitive to effective prosecution, particularly given rising use of social media as a vehicle for short sellers to amplify their message. Canadian securities law they added, currently provides no mechanism for issuers or investors to directly seek damages against activist short-sellers for statements they make in the course of a short selling campaign.
“Given these concerns, the CSA is considering regulatory intervention that specifically targets activist short selling,” they said. “The recent trend of individual investors banding together to seek their own redress against short sellers increases the potential need for intervention by the CSA.”
