The Ontario Securities Commission (OSC) and the Investment Industry Regulatory Organization of Canada (IIROC) have issued a joint press release encouraging the public to submit tips to the OSC and IIROC whistleblower programs on potential abusive trading in securities of Ontario reporting issuers, including abusive short-selling.  Please see our previous blogs on the OSC Whistleblower Program here and here.

The impetus for the press release is that some market participants may be engaged in abusive market manipulation involving improper short-selling practices that could reward wrongdoers from stock price fluctuation.[1] Those who provide information to the OSC Whistleblower Program may be eligible for awards of up to $5 million for tips that lead to an OSC enforcement action. The IIROC Whistleblower Service does not provide a reward.

The renewed regulatory scrutiny on short-sellers in Ontario has emerged after a heightened global regulatory focus on incidents of short selling and a number of recent high-profile activist campaigns against Canadian companies. Short-selling, a strategy where an investor trades in the expectation that a company’s shares will decline in price, is not illegal in Canada when it is not connected to a “manipulative” objective. Bona fide investors consider short-selling an important tool to help ensure stock prices reflect all relevant information, permit investors to hedge risk in stock positions and enhance overall capital market transparency.

Canada has recently seen numerous examples of alleged “short and distort campaigns” where short-sellers attempt to profit from a short position by manipulating a stock’s price downward through the dissemination of false or misleading claims, often in an anonymous fashion via the internet. It is when the short-seller is connected to the dissemination of this misleading information about a company that a regulator becomes concerned about the presence of improper market manipulation. Often, these “shorters and distorters” are resident in foreign jurisdictions, effectively out of the reach of the Canadian regulator. Sometimes regulators are asked to assist investors who oppose the short selling campaigns to collect evidence and we have commented on this in a past blog.

Regulatory enforcement actions against market participants involved in short and distort campaigns have historically been difficult to bring to successful conclusions due to the challenges associated with connecting the dissemination of misleading information to a particular short-seller. For example, in Re Carnes, Staff of the BC Securities Commission (BCSC) alleged that Jon Carnes had violated the BC Securities Act and breached the public interest. On September 13, 2011, using a false name, Carnes published a report critical of Silvercorp Metals Inc. (Silvercorp). Silvercorp was a TSX and NYSE listed mining company with assets in China. Carnes published the report four days before the expiry of $4.1 million of Silvercorp put options that his firm had purchased. Carnes’s firm made $2.8 million in profits when Silvercorp’s stock price on the NYSE declined from $9.20 (when the put options were purchased) to $6.30 (after trading closed on September 13).

The BCSC found it “clear that Carnes intended to write the most damaging report he could, to make the most money possible, and was prepared to write things in a way that connoted or implied things that were not explicitly said.” Despite this, the BCSC determined that Carnes did not commit fraud and declined to order a public interest remedy either. The BCSC determined that, on a careful contextual review, the alleged fraudulent statements were not objectively false. See our 2015 commentary on this case.

The call by the OSC and IIROC for whistleblower tips on manipulative practices by “shorters and distorters” is the latest attempt by the regulator to improve its chances of holding wrongdoers accountable.

The joint OSC/IIROC press release appears to anticipate the eventual adoption of an interim recommendation by Ontario Government’s Capital Markets Modernization Task Force published in July of this year that the OSC consider adopting a rule that would prohibit market participants and investors that have previously sold short securities of the same type as offered under a prospectus or private placement from acquiring securities under the prospectus or private placements.

[1] In a joint statement issued in April 2020, the Canadian Securities Administrators and IIROC stated that short selling activity represented a low percentage of total market activity and that there was no evidence that short selling activity was the driver of market declines at the time. The regulators nonetheless cautioned that they would continue to examine new information from any market participant, including issuers and the public, regarding suspected instances of abusive short selling and other forms of market manipulation.