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Short Sale Transactions in Canada: Striking a Balance Between Investor Protection and Market Efficiency

This piece asserts that Canadian market regulators must strengthen the laws governing short sale transactions. Namely, the piece finds that the Investment Industry Regulatory Organization of Canada (“IIROC”) and Market Integrity Officers should: (i) enhance the rules surrounding fraudulent statements affecting share prices; (ii) require more market participants to report their short sale activities; and (iii) define the “reasonable expectation” standard, which is used to measure an investor’s ability to settle transactions. Moreover, the article dispels two statements that commentators have made in previous years. Specifically, commentators have stated that Canadian regulators lack the legal capacity to govern naked shorting. They also contend that naked short selling poses serious threats to Canada’s capital markets. This article finds that, while there is room for improvement, Canadian regulators are well-equipped to handle the minimal threats posed by naked short selling. The paper also finds that covered short selling contributes to market liquidity, share price efficiency, and the discovery of corporate fraud and mismanagement. As such, regulators should be careful not to overregulate these transactions.