In an effort to address a long-standing concern about abusive short selling ahead of securities offerings, the Ontario Securities Commission (OSC) is proposing changes to its rules that would introduce a blanket prohibition on participating in an offering immediately after shorting a stock.
The OSC is proposing to adopt a broad prohibition on traders who sell a stock short in the five days leading up to the pricing of a prospectus offering or a private placement, from buying those same securities in the offering.
The proposed prohibition would apply regardless of whether the short seller knew about the upcoming offering; even if the short sales didn’t impact the price of the securities being sold; and even if the offering doesn’t represent a “material” fact or change.
In a notice outlining the proposals, the OSC said the changes aim to address two separate but related concerns — the risk of short-selling with inside knowledge of a forthcoming offering that enables a trader to lock in profits by covering their short by buying securities in the financing, and that the short-selling itself can drive down the price of the financing.
While there are already rules against insider trading and market manipulation, the regulator said it can be difficult to prosecute these kinds of violations, which require proving the trader had knowledge of the offering, that the financing was a “material” change, that the trading created an artificial price for a security, and that the trader knew that would happen.
Instead, the OSC is proposing a rule that “does not require proof of knowledge, materiality or effect on market price,” it noted.
The concern about short-selling ahead of an offering was raised by the Capital Markets Modernization Taskforce in its final report in 2021, the OSC noted.
“The taskforce found that short-selling in connection with prospectus offerings and private placements, and in particular bought deals pre-arranged with hedge funds who short the stock before the bought deal is announced, makes pricing and completion of offerings more difficult,” it said.
The proposals would implement the taskforce’s recommendation for addressing this concern, and the OSC said they are also “broadly aligned” with the U.S. Securities and Exchange Commission’s (SEC) rules in this area.
The proposals “also complement other initiatives to modernize short sale regulation by the Canadian Investment Regulatory Organization (CIRO),” it said — including its efforts to enhance settlement and discourage failed trades.
The proposals are out for comment until Sept. 3.