SHORT and DISTORT

OSC CHAIR SAYS REGULATORS ARE MONITORING SHORTSELLING BUT THE BAR IS HIGH FOR ENFORCEMENT

Activist short-selling campaigns have shaken stock prices and grabbed headlines in Canada this year, leading some observers to question whether the country’s securities regulators are doing enough to police both the companies accused of a range of flaws and the short sellers whose commentary on social media can now move markets.

In an exclusive interview, Maureen Jensen, chair of the Ontario Securities Commission, told the Financial Post the OSC is committed to scrutinizing the new wave of activity for evidence of wrongdoing, but cautioned that the bar for enforcement is high.

“I would say to you that all regulators are l ooking at anyone who’s involved in doi ng these shorting campaigns to say: ‘Can we find evidence of fraudulent statements?’ And, if that’s the case, we will take action,” said Jensen.

“But it doesn’ t happen instantaneously and you actually have to let the whole scenario play out.”

Jensen declined to comment on any specific cases being probed by the OSC. But she said regulators around the world, including Canada’s largest capital markets watchdog, are on the lookout for so- called “short and distort” campaigns designed to spread rumours or false information in order to drive down stock prices.

“If they lie, we can go after them for spreading false information in the marketplace,” Jensen said. “If people are acting in concert to spread lies, that’s really market manipulation, but you have to be able to prove that, and that’s very difficult.”

Jensen acknowledged that there is pressure on regulators to go after short sellers, and she is quick to point out the difference between legitimate strategies and market manipulation.

“Everyone says … go after them, they’re short sellers. Well, there’s short and distort campaigns and then there is short selling. People have always shorted stocks when they didn’t like the story,” she said.

She also noted that a new breed of activist short seller does not necessarily fall into the “short and distort” category, despite the impact they can have on stock prices.

“Short selling has always been part of the market, but now people are using short selling to actually move the market, instead of ( just) hedging. What we’re seeing now are there are very large short sellers who actually have the business model of reviewing companies and seeing where there may be weaknesses, and then using shorting and social media, together, to impact the price of their stock.”

The focus tends to be on fairly illiquid stocks because “they can take enough of a short position to actually distort the price,” Jensen said. “The problem is there’s no rules against this.”

When it comes to enforcement, a regulator such as the OSC can take action only if there is an intentional spread of false information or market manipulation by short sellers, she said, adding that short-selling campaigns tend to be international in scope, which requires regulators to work together across borders to investigate concerns.

Canadian regulators who suspect a short- selling campaign is interfering with the proper functioning of markets don’t have to wait for an enforcement case to be built to take action, Jensen said. But the tools they have are not deployed lightly or without due consideration given to other potential market impacts.

The Investment Industry Regulatory Organization of Canada, for example, has the authority to deem any stock “short ineligible” for a period of time, if it appears to be under undue pressure.

“They can do that where they think that there’s a short and distort campaign going on. But you can imagine how difficult a decision that is because what happens if it is real, if the (short seller’s) information is real, and they stopped people from shorting it? That would be a huge negative reaction,” Jensen said. “People will blame them for not allowing people to get out of the stock, or to hedge bets against it. It’s always better to let the market work so that buyers and sellers can meet with the same information.”

Asked whether regulators would also look into short sellers’ claims against a targeted company, Jensen pointed to the case of Sino-Forest Corp., where an investigation by the OSC was triggered by a 2011 report from short-selling firm Muddy Waters LLC. In July of this year, the regulator found the timber company and some former executives had committed fraud.

“Any investigation is on both sides, because it would be completely inappropriate if we didn’t understand what the motivations are for any side in an investigation,” she said. “We have to.”

The pressure on regulators to go after short sellers is most likely due to a recent spike in activist short selling in Canada and high- profile cases such as mortgage lender Home Capital Group Inc., where short sellers have publicly identified their targets.

There were 21 short campaigns that targeted 16 Canadian firms last year, up more than threefold from six single campaigns in 2013, according to Activist Insight, a Londonbased firm that tracks global activism and governance.

Some who feel the campaigns are having a detrimental impact on the country’s capital markets would like regulators to make changes to trading rules and short sale reporting mechanisms that they say make it easier for short sellers to move stock prices down.

For example, some suggest the re-introduction of a “tick test” removed by IIROC in 2012, would tamp down disruptive short-selling activity. This rule prohibited a short sale unless it was at or above the last sale price for the security, which proponents say prevented short sellers from adding downward pressure to a stock price that was already falling.

But Jensen, who was senior vice-president of surveillance and compliance at IIROC before she joined the OSC in 2011, said the tick test was removed because it was inefficient and no similar rule existed to keep a share price from spiking. The tick test was supplanted by single stock circuit breakers designed to halt both spikes and dips at a certain point.

Jensen’s view is that the most effective way to deter short and distort campaigns is through enforcement — when there is evidence of wrongdoing — rather than through changes to market rules.

“It’s best to get at this issue through enforcement action,” she said. “We have to find the right case.”

SHORT SELLING HAS ALWAYS BEEN PART OF THE MARKET.