On December 8, 2022, the Canadian Securities Administrators (CSA) published CSA Staff Notice 25-306 Activist Short Selling Update (Staff Notice 25-306) and Joint CSA and IIROC Staff Notice 23-329 Short Selling in Canada (Staff Notice 23-329). The Staff Notices review the CSA's consultation on activist short selling and invite further feedback on short selling more broadly. The comment period ended on March 8, 2023.

Background

The Universal Market Integrity Rules (UMIR) of the New Self-Regulatory Organization of Canada (New SRO)1 define a "short sale" as a sale of a security, other than a derivative, which the seller does not own either directly or through an agent or trustee. The security is sold at the current market price, with the expectation that the seller will be able to make a profit by purchasing the same or a related security later, at a lower price. While certain capital market participants have negative views on short selling, short selling is a legitimate practice that contributes to market liquidity and price discovery. It can also serve as an investment management strategy, through which long positions are hedged to mitigate portfolio risk.

On December 3, 2020, the CSA published CSA Consultation Paper 25-403 Activist Short Selling to facilitate discussion about activist short selling and its potential impact on Canadian capital markets. A variation of short selling, activist short selling occurs where a seller takes a short position in a security, before trying to drive down the security's market price by publishing information or analysis likely to have a negative effect.

The CSA, having received 23 comment letters, engaged in further consultation while monitoring international developments. The CSA published Staff Notice 25-306 to summarize their findings and stakeholder concerns. They also published Staff Notice 23-329 with the Investment Industry Regulatory Organization of Canada (IIROC) to seek feedback on broader short selling issues and the existing regulatory regime.

Activist Short Selling Update

The CSA found that there continue to be negative views associated with activist short selling and short selling in general. Such views were held primarily by issuers targeted in recent activist short selling campaigns. At the same time, less than 1% of Canadian issuers were targeted annually between 2012 and 2021 – in contrast with 3% of United States issuers and less than 0.5% of Australian issuers. Four themes emerged from comments received: (i) the use of social media; (ii) perception versus evidence; (iii) the short selling regulatory regime; and (iv) the need for regulatory change.

Use of social media

Many commentors expressed concerns about activist short sellers' use of social media, given the speed at which platforms can cause damage to an issuer's reputation and negatively impact market price before the issuer has an opportunity to respond. Some commentors also signaled a need for laws that ensure the preservation of evidence for review and identification, especially where activist short sellers rely on pseudonyms.

While the CSA acknowledged these concerns, they register problematic online conduct as part of a broader market trend not unique to activist short selling. Issuers, investors and activist short sellers increasingly use online platforms to promote their views. Unlike issuers, activist short sellers are not subject to a specific regulatory framework; however, the purpose of regulating issuers' public disclosure is, in part, to address information asymmetry between an issuer's insiders and the market, and activist short sellers do not generally have access to non-public information. The CSA also note that despite challenges with social media data, various stakeholders are monitoring platforms and developing surveillance tools.

Perception versus evidence

Although many stakeholders continue to hold negative perceptions, the CSA did not identify widespread market abuse related to activist short selling. Some commentors cited the lack of evidence of problematic activity as a reason to be cautious about the introduction of regulatory measures, and the CSA agreed. To the extent that new measures are considered, the CSA were of the view that they should be tied to evidence with potential market impacts scrutinized closely. Should the CSA see evidence that regulatory changes are required, such changes will be considered.

Need for regulatory change

The comments reflected a range of views on whether regulatory change is required. They included proposals for: guidelines or best practices; reporting and disclosure requirements; hold periods; advance notice to issuers; disclosure of interest requirements or standards; an expanded offence for misleading information; and civil liability for misleading information. While the CSA responded directly to each of the proposals in Staff Notice 25-306, they indicated that they have not received evidence sufficient to justify a regulatory response at this time.

Short Selling Under Review

The CSA believe that Canada's regulatory regime for short sales is consistent with principles published by the International Organization of Securities Commissions in 2009. Nonetheless, they acknowledge the comments received and consider it timely to review the general regime for currency.

Existing regulatory regime

Short selling is subject to Canadian securities legislation and New SRO requirements, formerly under the purview of IIROC.

Securities legislation requires a person who places an order for the sale of a security with a registered dealer to declare to the dealer if they do not own the security. Securities legislation and National Instrument 23-101 ­Trading Rules also prohibit activities that are manipulative or deceptive, which could apply to incidents of short selling.

The UMIR set out further requirements applicable to "participants" and "access persons" (as defined in the UMIR). Many of these are reporting requirements; however, manipulative or deceptive activities are also prohibited. This includes entering an order for the sale of a security without having a reasonable expectation of settling the resulting trade on the settlement date. The New SRO uses various means to monitor for potentially abusive trading activity and may intervene or refer matters for enforcement.

For additional context, Staff Notice 23-329 provides a history of IIROC's short selling requirements, a summary of studies conducted and rationale supporting the retention or removal of certain requirements.

Key points of consultation

Staff Notice 23-329 should be reviewed for its discussion of comments and questions of particular interest to the CSA. At a high level, the CSA query:

  • the need for, potential characteristics of and costs and benefits of introducing stronger pre-borrow requirements;
  • whether the current definition of and timeline associated with a "failed trade" are appropriate;
  • the need for and potential characteristics of any additional public transparency requirements of short selling activities or short positions;
  • the need for and potential characteristics of any additional reporting requirements regarding short selling activities;
  • whether specific reporting, transparency or other requirements should be considered for junior issuers, given the findings of IIROC's recent study of failed trades;
  • whether mandatory close-out or buy-in requirements similar to those in the United States and the European Union would be beneficial for Canadian capital markets; and
  • other aspects of short selling where stakeholders believe there is room for regulatory initiative.

Request for comment

Comments were accepted until March 8, 2023. For more information, please see the comments received.

Footnote

1. The Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association of Canada (MFDA) recently amalgamated to become the "New Self-Regulatory Organization of Canada" (New SRO). In this post, any references to IIROC refer to IIROC as it existed before January 1, 2023.

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