The OSC and SEC have issued temporary orders prohibiting short selling of certain financial companies' common equity securities until October 3, 2008.1 Thirteen Canadian cross-border issuers, listed in Appendix A to this bulletin, are affected by the OSC's order. The SEC's order affects all U.S. and non-U.S. banks, broker-dealers, investment advisers, savings associations and insurance companies listed on U.S. stock exchanges.2
Like the SEC's prohibition on "naked" short selling,3the regulators' prohibition on short selling the securities of financial firms is an attempt to reduce price volatility and contain the disruption of securities markets. Although short selling has not disrupted Canadian markets to the same extent as U.S. markets, the OSC believes its order is necessary as a precaution against regulatory arbitrage – that is, short sellers effecting transactions in dual-listed securities in Canada following the SEC's prohibition.
Market Making and Other Exemptions
The SEC and OSC are permitting several exceptions to the short-selling prohibition, including
- short sales in accordance with market making obligations;
- short sales made to hedge the exposure of a derivatives market maker, including a market maker in exchange traded funds or notes;4 and
- short sales to facilitate block transactions.5
For additional details about these exemptions as well as other technical exemptions from the SEC's and OSC's short-selling prohibitions, please feel free to contact us or refer to
- the SEC's Amended Emergency Order (September 21, 2008) www.sec.gov/rules/other/2008/34-58611.pdf,
- the OSC's Amended Temporary Order Prohibiting Short Selling (September 22, 2008) www.osc.gov.on.ca/Enforcement/Proceedings/RAD/rad_20080922_amend_cert-fin-sect-issuers.pdf and
- the Investment Industry Regulatory Organization of Canada's Restated Reminder Respecting Obligations in the Conduct of Short Sales (September 23, 2008) www.docs.iiroc.ca/DisplayDocument.aspx?DocumentID=4FF90709EB024D4EB6766356B18C0971&Language=en.
Disclosure of Daily Short Positions
In addition to the short-selling
prohibitions, the SEC is requiring certain institutional investment
managers to begin reporting their daily short positions. (SEC rules
already require long positions to be reported.) The affected
institutions are those that exercise investment discretion with
respect to accounts with a fair market value of US$100 million or
more holding equity securities listed on a U.S. stock exchange.
Specifically, institutions that filed or were required to file a
Form 13F6 with the SEC for the calendar quarter ended
June 30, 2008 will now also be required to file Form SH
www.sec.gov/about/forms/formsh.pdf
reporting
- the number and value of securities (except options) sold short;
- the opening and closing short positions; and
- the size and time of the largest intraday short position.
As an exception, a report will not need to be filed for a short position if its fair market value is less than US$1 million and constitutes less than 0.25% of the class of securities outstanding.7
Forms SH will be due on the Monday following any week in which short sales are made, beginning with short sales effected on September 22, 2008 through October 2, 2008 (unless the SEC extends the order for a maximum of 20 additional days). As a result, the first Forms SH will have to be filed on September 29, 2008 covering the prior week's short sales. The forms will initially be filed on a non-public basis but will be made public by the SEC two weeks after their due date.
Relaxed Restrictions on Issuer Repurchases of U.S.-Listed Securities
The SEC and the TSX have taken additional measures to increase liquidity in capital markets by temporarily relaxing the rules pertaining to issuer repurchases of their own securities. In the United States, Rule 10b-18 under the Securities Exchange Act of 1934 specifies conditions under which issuers may repurchase their own securities without risk of violating the anti-fraud or market manipulation rules. In Canada, the TSX rules permit normal course issuer bids under conditions similar to the conditions in Rule 10b-18. Until October 3, 2008 (unless the amendments are extended), the SEC and TSX have
- removed restrictions on issuer repurchases at the opening or near the closing of trading, and
- increased the permissible volume of purchases to 100%, from 25%, of the security's average daily trading volume.
The relief granted by the TSX
applies only to Canadian issuers that are interlisted on a U.S.
stock exchange. The normal course issuer bid rules are unchanged
for other issuers. 
Appendix A
Canadian Issuers Affected by OSC's and SEC's
Temporary Orders Prohibiting Short Selling
Aberdeen Asia-Pacific Income Investment Company Ltd.
Bank of Montreal
Bank of Nova Scotia
Canadian Imperial Bank of Commerce
Fairfax Financial Holdings Limited
Kingsway Financial Services Inc.
Manulife Financial Corporation
Quest Capital Corp.
Royal Bank of Canada
Sun Life Financial Inc.
Thomas Weisel Partners Group Inc.
Toronto-Dominion Bank
Merrill Lynch & Co., Canada Ltd.
Footnotes
1. The orders may be extended by the regulators. The SEC's notice states that it will not extend its order for more than 30 calendar days in total duration.
2. The SEC initially published a list of 799 affected entities, but to ensure all appropriate issuers are included, the SEC has now delegated responsibility for selecting the affected issuers to the U.S. stock exchanges. Issuers may contact their exchange if they wish to opt out.
3. For details on the SEC's naked short selling order, see our September 19, 2008 bulletin SEC Attempts to Stabilize U.S. Market by Prohibiting Naked Short Selling www.torys.com/Publications/Documents/Publication%20PDFs/CCM2008-21.pdf.
4. However, the orders prohibit market makers from selling short if they "know" (under the SEC's order) or "ought reasonably to know" (under the OSC's order) that a customer or counterparty is establishing or increasing an economic net short position in the relevant securities. The SEC is requiring that notice of this restriction be published on market makers' websites as soon as practicable.
5. Under the OSC's order, these transactions must have a market value of $200,000 or more in a single transaction, or in several transactions at approximately the same time, and the position must be liquidated or hedged as soon as possible. If these requirements cannot be met, a participant may facilitate a block transaction by either (i) acting as agent in accumulating stock in an average price account or (ii) accumulating a long position as principal and then crossing that position to the client. A participant who wishes to facilitate a block purchase in this manner should contact Market Surveillance by fax at 416-646-7261 or by email at surveillance@iiroc.ca before commencing the accumulation of stock as principal.
6. The SEC publishes a list of equity securities for which institutions have a reporting obligation, known as "Section 13(f) Securities" www.sec.gov/divisions/investment/13f/13flist2008q2.pdf.
7. The SEC has also provided instructions to Form SH www.sec.gov/about/forms/formsh_instructions.pdf.
The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.