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

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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 short selling that almost always originates on social media and stock message boards, by people putting out research designed to start a panic.

“Those who do that know full well that … investors jump away from these positions at the slightest notion that there could be something wrong,” he said. “The exaggerations end up resulting in a self-fulfilling prophecy.”

“In circumstances where it’s founded, go get them,” he said. “But don’t exaggerate and don’t misrepresent.”

Market manipulation

Soliman declined to name specific individuals or firms involved in the negative practice, citing confidentiality.

However, he said he worked with three companies in the past year who were targeted by abusive short sellers who made “either significant exaggerations or straight out misrepresentations.” In all three cases, it took a “monumental effort” for the companies to dispel allegations that had no merit and maintain the confidence of their investors.

The instinct for many investors, Soliman said, is to think that “where there’s smoke there’s fire.”

Mastromattei said abusive shorts take advantage of that. “Those kinds of shorts are the ones who see a little smoke and they add gasoline.”

Short sellers can provide a valuable service to investors by exposing fraud, but critics say sometimes their tactics are abusive. (Angelos Tzortzinis/Bloomberg)

He cites the ongoing saga of cannabis company Aphria Inc. as a good example. In December, the company was rocked by accusations by a short seller that the firm wasted hundreds of millions on foreign acquisitions that are essentially worthless.

The stock lost more than 50 per cent of its value in the three days that followed. While it has since recovered, a hostile takeover offer has emerged for the company, and investors are pursuing a class action lawsuit against the business over how it handled some of its dealings.

The Aphria saga is ongoing. While the truth of the matter yet emerge, Mastromattei said it’s a great example of how lax rules leave Canada open to abuse. “That’s where the regulator has to step in,” he said. “That’s market manipulation, you can’t do that.”

(In the interest’s of full disclosure, Mastromattei said he had no stake in Aphria before the original short selling story broke, but took a six-figure position in the company after the sell-off because he suspected it was overblown.) 

Boardroom ‘chaos’

The CBC reached out to the Ontario Securities Commission to ask whether the regulator is contemplating changes to their short selling rules. The agency referred us to the Canadian Securities Administrators, an umbrella organization that represents 13 provincial regulators across the country.

“The CSA is currently in the preliminary stages of a project that involves reviewing the nature and extent of abusive short-selling in Canadian capital markets,” spokesperson Ilana Kelemen said. “We are in the information-gathering phase of this initiative and cannot provide further details at this time.”

Until any changes happen, companies will remain fearful about finding themselves on the wrong side of a short campaign because of the damage that unfair ones can create. “The chaos that a short campaign causes inside a boardroom far outweighs the chaos that a proxy battle or hostile takeover causes,” Soliman said. 

“Because we don’t have a good enough defence for it.”

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S&P 500 posts highest close since November 8 on trade optimism

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NEW YORK (Reuters) – The S&P 500 posted its highest closing level since Nov. 8 on Friday as investors clung to signs of progress in the ongoing trade talks between the United States and China.

Investors assessed a slew of headlines on the talks, with top trade negotiators from the two countries meeting to wrap up a week of discussions on some of the thorniest issues in their trade war.

If the two sides fail to reach a deal by midnight on March 1, then their seven-month trade war could escalate.

“People are expecting some sort of positive news on trade and tariffs with China fairly soon,” said Peter Tuz, president of Chase Investment Counsel in Charlottesville, Virginia.

“But we won’t know until the end of next week,” he said, and, “there has been a lack of specifics.”

Optimism on the trade front and dovish signals from the U.S. Federal Reserve have driven the recent gains and left indexes well above their lows of December, when the market swooned on fears of an economic slowdown. The S&P 500 is now up about 19 percent since its late-December low.

The S&P 500 technology index was up 1.3 percent, leading gains among the 11 major S&P sectors, while the trade-exposed industrials index climbed 0.6 percent.

The Dow Jones Industrial Average rose 181.18 points, or 0.7 percent, to 26,031.81, the S&P 500 gained 17.79 points, or 0.64 percent, to 2,792.67 and the Nasdaq Composite added 67.84 points, or 0.91 percent, to 7,527.55.

Traders work on the floor of the New York Stock Exchange (NYSE) in New York, U.S., February 22, 2019. REUTERS/Brendan McDermid

All three indexes registered gains for the week, with both the Dow and Nasdaq posting a ninth week of increases.

The number of New York Stock Exchange and Nasdaq stocks hitting 52-week highs hit 367, the most since mid-September and outnumbered those hitting year lows by the widest margin in six months.

Stocks briefly pared gains after U.S. officials briefed on the negotiations said more time is likely needed in the talks given China’s resistance this week to American demands for specific steps by Beijing to end forced transfers of U.S. technology and certain other policies.

Afterward, President Donald Trump said there was a very good chance the United States would strike a deal with China to end the trade war, and that he was inclined to extend his March 1 deadline to reach an agreement.

“Right now the downside risk has been not as steep, but there’s always a concern that something happens last-minute,” said Quincy Krosby, chief market strategist at Prudential Financial in Newark, New Jersey.

“Having a Chinese economy that stabilizes is constructive for global markets,” she said. “That’s what is key in terms of the market looking at the results.”

Kraft Heinz Co tumbled 27.5 percent, and was the biggest drag on the S&P along with a 1.7 percent fall in Class B shares of the company’s controlling stakeholder, Berkshire Hathaway Inc.

The packaged food company posted a quarterly loss, disclosed a Securities and Exchange Commission probe and wrote down the value of its iconic Kraft and Oscar Mayer brands.

Slideshow (2 Images)

Advancing issues outnumbered declining ones on the NYSE by a 2.99-to-1 ratio; on Nasdaq, a 2.45-to-1 ratio favored advancers.

The S&P 500 posted 64 new 52-week highs and three new lows; the Nasdaq Composite recorded 112 new highs and 21 new lows.

About 6.9 billion shares changed hands on U.S. exchanges. That compares with the 7.3 billion-share daily average for the past 20 trading days.

Additional reporting by Shreyashi Sanyal and Sruthi Shankar in Bengaluru; Editing by Chizu Nomiyama and Jonathan Oatis

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FCA sets $14 million annual target compensation for CEO Manley: filing

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FILE PHOTO: Fiat Chrysler Automobiles (FCA) CEO Mike Manley arrives at the memorial service held in honor of former CEO Sergio Marchionne in Turin, Italy, September 14, 2018. REUTERS/Massimo Pinca/File Photo

DETROIT (Reuters) – Fiat Chrysler Automobiles NV (FCA) has set an annual compensation target for Chief Executive Officer Mike Manley consisting of pay, cash and equity bonuses of $14 million, the automaker said in a regulatory filing on Friday.

Manley took over as the head of FCA last July after the abrupt departure of his predecessor Sergio Marchionne. The company paid its new CEO 600,442 euros ($680,240) for 2018 and he will receive a bonus for 2018 of $367,000 to be paid this year.

Manley also was granted FCA 180,364 shares for his work in 2018, which will vest in 2019 if the company meets certain targets. The fair value per share on the date those were granted was $16.61, FCA said.

His target annual compensation consists of a base salary of $1.6 million, and a bonus of $2.4 million and an equity award valued at $10 million, both linked to the company hitting certain performance targets.

Former CEO Marchionne received 6.6 million euros in compensation for 2018, which consisted of nearly 2 million euros in base pay and an annual bonus for 2017 of just over 4.6 million euros.

For the 2014 to 2017 time period, Marchionne also received 2.8 million FCA shares. The fair value per share was $14.84, FCA said.

FCA chairman John Elkann received a base salary of 1.7 million euros and no annual bonus.

Reporting by Nick Carey; Editing by Sonya Hepinstall

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Flattening U.S. yield curve in late 2018 ‘flashing red’ on economy: Fed’s Williams

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President and Chief Executive Officer of the U.S. Federal Reserve Bank of San Francisco, John Williams, addresses a news conference in Zurich, Switzerland September 22, 2017. REUTERS/Arnd Wiegmann/File Photo

NEW YORK (Reuters) – A flattening U.S. yield curve in December, which was close to being inverted, was “flashing red” about a deceleration in U.S. economic growth heading into 2019, despite some solid data at the time, New York Federal Reserve President John Williams said on Friday.

The yield curve flattens as the gap between short and long-dated yields narrow, suggesting investors’ worries about a slowing economy.

The yield curve inverts when shorter-dated yields rise above longer-dated ones. An inverted yield curve has preceded all U.S. recessions in the past 50 years.

Williams was giving closing remarks at a conference about quantitative tools, jointly sponsored by the New York Fed and the Atlanta Federal Reserve.

Reporting by Richard Leong; editing by Diane Craft

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