Demystifying the economy | Why is short selling allowed?

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The approach taken by short sellers like Spruce Point Capital – which most recently took on Saputo – is not immune to controversy. But we must not forget that it can offset potentially excessive optimism in the markets.

That’s what authorities are reminding, saying that activist short sellers publicly announcing a short position in a company’s stock can provide new insights to help ensure that the stock price more closely reflects the value underlying an action.

Regulators also point out that in order to succeed, an activist short seller must, at the very least, enjoy some credibility and that their theory must raise enough doubts about a company to convince shareholders. existing investors to sell their shares and, potentially, other investors to short the security or not to buy it.

If a short seller achieves his goal, then that means his theory has convinced the market and caused the stock to fall.

If, however, an investor engages in activities that could deceive other investors or are intended to artificially manipulate a company’s stock price, the integrity of financial markets could be compromised.

“It is not prohibited for a short seller to file a report and publicly express a negative opinion on a stock security. If the report is based on facts, the publication is in no way an attempt at manipulation. If, however, the facts put forward are false and are intended to move the price of a share, that is a completely different matter,” commented portfolio manager Lucas Blouin of the firm Medici.

“Generally, professional short sellers are aware of the laws and can navigate the limits of the latter. Some may be tempted to exaggerate the potential consequences arising from problems or threats attached to a business. By using carefully chosen language and disclosing their positions in their report, they generally avoid getting themselves into trouble,” he says.

The Canadian Securities Administrators (CSA) are aware that there seems to be a perception that militant short selling is on the rise in the country and playing a negative role in the markets. So much so that consultations were held during the pandemic to see if regulatory intervention was necessary.

The CSA point out in a recent document that while traditional shareholder activism is a well-accepted practice and widely seen as an effort to improve the real value of companies for shareholders, short-seller activism is often viewed differently.

“Activist short sellers argue that they create value by contributing to market efficiency. Some go so far as to describe their business as a front-line defense mechanism against fraud and the losses that follow. »

The CSA notes that militant short sellers say they target Canadian companies because Canada is “breeding ground” for corporate crime and that their research plays an important role in shaping prices by uncovering new information .

Few mechanisms

Also according to the authorities, the companies targeted may be reluctant to file a complaint about behavior that they consider problematic in the context of a campaign, for fear of provoking an in-depth examination of the allegations made.

In Canada, securities legislation does not provide a mechanism for issuers or investors to seek damages from activist short sellers for statements made in the context of campaigns.

In terms of sanctions, the CSA have tools to tackle militant short selling activities that are instances of fraud, market manipulation or the dissemination of misleading statements in the market. However, many misrepresentation violations of securities law require proof of illegal conduct and the materiality of the statement and its impact on the market.