IN THE MONEY:Canada Regulators Review Naked Short-Selling
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08:56 ET
=DJ IN THE MONEY:Canada Regulators Review Naked Short-Selling
12 Dec 08:56
By Carol S. Remond and Steve D. Jones
A Dow Jones Newswires Column
(This column was originally published Wednesday.)
New York (Dow Jones)-Canadian regulators are considering adopting a
U.S.-like rule that would make it more difficult for investors to sell stock
short north of the border.
In a short sale, a security not owned by the seller is sold in anticipation
of a decrease in the stock's price.
In the U.S., short selling is generally limited by the ability of borrowing a
stock at the time of the sale. That rule, known as affirmative determination,
limits the ability of investors to short the stock of companies with small
amounts of free trading shares since their stock is often difficult to borrow.
Canadian investors face no such restriction and can sell short stock without
first borrowing it, a practice known as naked shorting.
But some investors and public issuers are complaining that naked short
selling in Canada can be used to manipulate the stock of U.S. companies.
Canadian regulators are considering whether to adopt some form of affirmative
determination rule that would link the ability to short a stock to that of
borrowing it.
The action by Canadian regulators is in the early stages, said Alex Popovic,
vice president of the Enforcement Department at the Investment Dealers
Association, the self-regulatory body of the Canadian securities industry.
Popovic said that by the end of the year the IDA hopes to determine whether
naked short selling is disrupting the market.
If naked short selling is deemed a problem, the IDA will next decide whether
it can be addressed by existing rules or whether new rules will be needed,
Popovic said.
"We are reviewing all the issues surrounding short selling and naked short
selling," said Jeffrey Kehoe, director of litigation for IDA's enforcement
department. Kehoe said calls from investors in bothAmerican and Canadian
companies and managers of some small cap companies prompted the review.
Canadian law says it is the responsibility of the seller to borrow and
deliver shares to the buyer and "it's being examined with the possibility of
changing it," said Steve Wilson, executive director of the British Columbia
Securities Commission.
The inquiry began four months ago and it isn't clear when it will conclude,
he said. The process is intended to discover problems with transactions that
move between the Canadian and U.S. trading systems. If the inquiry exposes
glitches "it's possible there may be changes, but that's not been determined
yet," Wilson said.
"The SEC has surfaced a number of significant cases of apparent abuse that
may involve Canadian brokers," said Wilson. Investigators are focused on how
short sellers utilize market makers in the two countries "to get around
affirmative determination rules" in the United States "and cause havoc once its
back in the U.S. system," said Wilson.
"There is some evidence that there is incongruity in the rules that could be
part of the problem," he said.
Wilson said a SEC enforcement lawyer brought up the issue in August. It was
one of several topics he discussed with SEC officials in a meeting in
Washington D.C. in late September.
A spokesman for the SEC declined to comment.
Even though the IDA is leading the inquiry Wilson said he has become involved
because British Columbia brokers participated in many of the transactions under
review. "It's not only BC brokers, but from other provinces as well in
Canada," he added.
The inquiry involves a "significant number of companies," not just one or two
that have complained about manipulative trading, he said. After combing through
thousands of transactions, officials are now focusing on those "affected by
trading behavior that appears similar," he said, but he declined to reveal
details of those transactions.
"I'm not sure these abuses areentirely taking place in Canada," he said.
"There could be abuses in the U.S. system as well."
He also said that many of the transactions "flow through several brokers"
not all of which are in either Canada or the United States. "It's not clear to
us who is pulling the strings on some of these transactions."
Last month, the IDA sent letters to several Canadian brokerages informing
them it's seeking to quantify problems relating to naked short selling. In its
letters, the IDA was seeking information about stocks in which those
brokerages failed to deliver shares for settlement purposes.
Canadian investors are not the only ones taking advantage from that country's
short selling rules. It's relatively easy, and legal, for U.S. investors to
trade through Canadian brokerages, thereby circumventing the U.S.' affirmative
determination rule requirement.
Kehoe declined to say what agencies were involved in the ongoing review but
he confirmed that both U.S. and Canadian securities agencies are involved.
In the U.S., NASD requires that when one of its members makes a short sale
for its own accounts or accepts a short sale for a customer, the member must
make an affirmative determination in writing. That determination must say that
the NASD member can borrow the security or will be able to provide it for
delivery on demand.
Market makers in the U.S. are exempt from the NASD's affirmative
determination rule when engaged in "bona fide market making activity" because
they provide needed liquidity to the market.
A few U.S. companies in recent months have complained that illegal short
selling has unfairly put pressure on the price of their stocks. These
companies, some of which have no proven business, have called upon U.S.
authorities to prevent naked short selling. Some of these companies have also
filed lawsuits in efforts to prohibit investors or market makers from shorting
their stock.
JagMedia Holdings Inc. (JGMHA) has filed suit against anumber of brokerage
firms over alleged failure to close the borrowing transaction. Most recently,
GeneMax Corp. (GMXX) of Blaine, Wash. has filed lawsuits in British Columbia
and Nevada against brokerages that it says engaged in illegal naked short
selling of its stock.
GeneMax has been the subject of two other In the Money columns. Those columns
questioned whether insiders would benefit most from limits on short selling and
GeneMax's connection to consultants Investor Communications International Inc.
of Blaine, Wash.
Some of the companies now eager to take on short sellers have also engaged
in recapitalization plans that limited the amount of free trading shares. Such
recapitalizations also made it difficult to short the stocks because there are
few shares available to borrow.
Some market watchers caution that a move to affirmative determination in
Canada will leave investors without any outlet to make Bearish bets against the
stock of companies with tight floats. Those investors say the change could open
the doors for promoters to inflate the price of these stocks without any market
mechanism to counter it.
By Carol S. Remond and Steve D. Jones; Dow Jones Newswires; 201 938 2074 .
(END) Dow Jones Newswires
12-12-02 0856ET |
