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Canada needs to toughen short selling rules to weed out abuse, market watchers say

Canada needs to crack down on a certain type of short selling because a growing number of bad apples are abusing the system for everyone, market watchers say.Short selling is an investment strategy that allows people to make money when they think the price of a stock is about to decline.A conventional investor makes money by buying a stock he or she thinks is undervalued, and then waits for the price to improve before selling it for a profit. But a short seller makes money when a stock price declines. They do that by borrowing a stock owned by someone else, selling it to collect the money, and then replacing the borrowed stock by buying it off someone else once the price has dropped. It's a controversial strategy with plenty of detractors. But even critics acknowledge it can provide a valuable service to everyone in the market by rooting out fraud.In recent years, Canadian companies such as Sino-Forest, Shopify, Valeant, Home Capital and many others have found themselves targeted by short sellers, with the shorts having various degrees of impact in each of those cases.Short sellers who expose the truth about misdeeds by companies may provide a valuable service. Short selling becomes abusive, and problematic for the market, when a small minority of investors bend the truth to make money through panic. "Both as a financial hedging instrument and as a tool to root out bad behaviour, short selling will always have an important role in our capital markets," said Walied Soliman, the global chair of law firm Norton Rose Fulbright Canada. "But abusive short selling is ... market participants who ... use either exaggerations or misrepresentations to drive their narrative."Canada 'targeted'This type of market manipulation seems to be on the rise in Canada. Canada is "highly targeted by the U.S. [shorts] because it's an easier target, there's weaker rules here," said investor John Mastromattei. Soliman said that the way securities laws are set up give an unfair advantage to abusive short sellers because companies and investors who buy companies on the way up have to play by a much different rule book.Anyone buying up a large enough chunk of a company has to disclose that to regulators. Their public statements are closely scrutinized, and their future buying and selling is bound by myriad rules. Executives at companies have to choose their words carefully when talking to the media, for fear of letting news slip that investors and regulators didn't hear about first.That's not true for short sellers. They can largely operate in secret until they choose to go public. "If an issuer were to put out what we see from shorts, they would be the subject of class action lawsuits and regulatory arm slapping immediately," Soliman said. He suggests implementing disclosure rules for shorts as a reasonable first step to addressing the problem. European Union rules mandate that short sellers must tell regulators when their position is as small as 0.2 per cent of a company, and let the public know when they top 0.5 per cent.Many high profile companies have found themselves the target of short sellers in recent years. (Michael Nagle/Bloomberg)"I would like to see early warning disclosure requirements for short sellers," Soliman said. "I would like to see statutory rights of action against market participants who knowingly either exaggerate or misrepresent."Soliman said he would like to see a crackdown on a type of abusive s ...Read more

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