This article appears in the February 2021 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.
Ontario’s capital markets Modernization Taskforce has targeted abusive short-selling in its final report.
The task force recommended a prohibition on making misleading or untrue statements about a company in an effort to move its stock price or influence other investors. To prove a violation, the Ontario Securities Commission (OSC) wouldn’t need to establish that the false statements actually moved the market — only that there was an intent to mislead.
Walied Soliman, chair of both the task force and Norton Rose Fulbright Canada LLP, said during a technical briefing that this recommendation is designed to give the OSC the tools it needs to combat the spread of false information in the market — a growing challenge in the age of surging retail trading spurred on by Reddit threads.
The task force’s report suggested prohibiting misinformation would enable the OSC to tackle traditional “pump and dump” schemes and so-called “short and distort” campaigns more easily. The report stressed that this provision is not intended to capture the legitimate opinions of short-sellers or stock analysts.
The report also recommended measures that specifically target other forms of short-selling: manipulative shorting ahead of planned securities offerings and so-called “naked” short-selling.
Shorting stocks ahead of a securities offering to drive down the price before acquiring the same stocks on the cheap is already illegal, but the practice is “rife in the Canadian markets” among hedge funds, according to the report.
“This harms the company, its shareholders and the uninformed investors trading against the short-sellers,” the task force’s report stated.
To combat the practice, the task force proposed a straightforward prohibition on acquiring securities in a private placement or prospectus offering after shorting those same securities.
In addition, to address long-standing complaints about other sorts of abusive short-selling, the task force proposed that the Investment Industry Regulatory Organization of Canada adopt requirements for investment dealers to confirm that they can borrow a security before accepting a short order, along with a mandatory “buy-in” requirement for failed trades.
Front-running was another target of the task force. The report recommended expanding the prohibition on front-running to enable the OSC to go after anyone who seeks to take advantage of information they have about another investor in order to trade ahead of them.
The task force also proposed that facilitating securities law violations should be an offence. This would enable regulators to go after people or companies that enable boiler rooms to operate, for example.
In addition, the report recommended that the OSC be given the power to issue orders requiring that online content, including websites and social media posts, be removed or blocked when there is evidence of possible fraudulent conduct. Currently, regulators are often left merely issuing alerts to warn investors about unregistered and potentially fraudulent online activity.
The task force’s report also sought to tackle another chronic weakness in the current enforcement system: collecting monetary sanctions. The report recommended several measures, including stronger powers for freezing, seizing and liquidating assets; enabling the OSC to register liens for amounts owed under disgorgement orders; and a ban on issuing drivers’ licences and licence plates to people with unpaid sanctions.
The task force also recommended that ill-gotten gains collected by the OSC be returned to harmed investors through a process overseen by the provincial courts.
Other proposals included increasing the maximum penalties for securities offences to $5 million from $1 million for regulatory proceedings, and to $10 million from $5 million in quasi-criminal cases.
The report recommended expanding civil liability for misrepresentations in an offering memorandum beyond those made by just the issuer to include others responsible for disclosure in exempt-market deals, such as a deal’s promoters and the issuer’s directors. This would give the OSC the ability to ensure that civil liability for misrepresentations in a prospectus applies to novel deal structures that may be falling through the cracks.
To enhance access to compensation for harmed investors, the task force recommended the OSC designate a dispute-resolution service with the authority to issue binding recommendations. If implementing binding authority for the Ombudsman for Banking Services and Investments proves too difficult, the report said Ontario should go it alone and designate a homegrown alternative.
To make quasi-criminal investigations easier to pursue, the report recommended the courts be given the power to issue production orders that would require people and companies that are not under investigation to provide relevant records to OSC investigators.
However, the task force also recommended several curbs on the OSC’s investigative powers, such as giving the targets of OSC investigations “greater rights,” including the opportunity to contest evidence requests. The report stated there should be processes to address disputes over demands for evidence from OSC enforcement staff.
Furthermore, the task force recommended a statutory amendment to confirm that the OSC can’t require documents that are considered privileged (e.g., communications between a lawyer and client) be provided to OSC investigators.
The task force’s report also recommended expanding exceptions to the requirement to keep the contents of investigation orders confidential.