Summary

The Investment Industry Regulatory Organization of Canada (“IIROC”) has prepared a study of the relationship between price movement and short selling activity (“Price Movement Study”) for securities listed on the TSX Venture Exchange (“TSXV”) during the three-year period May 1, 2007 to April 30, 2010 (“Study Period”). A copy of the Price Movement Study is available on the IIROC website (www.iiroc.ca) under the heading “News Room” and the sub-heading “Publications”.

The Price Movement Study suggests that the steep price decline observed between July of 2008 and December of 2008 was neither caused by nor exacerbated by short selling activity and that the “tick test”1  was not an effective tool to restrict significant and rapid, system declines in prices.

Other Empirical Studies by IIROC

The Price Movement accompanies other studies on short sales and failed trades undertaken by IIROC including:

• a study of failed trades undertaken by Market Regulation Services Inc. in 2006 that, among other findings, determined that a short sale had a lower probability of failing than trades generally and that the principal reason for trade failures was administrative error (“Failed Trade Study”);2
• a study of trends in trading activity, short sales and failed trades that covered the three- year period May 1, 2007 to April 30, 2010 and generally rates of short selling were relatively constant throughout the Study Period and that rates of trade failure generally declined over the Study Period (the “Trends Study”); 3
• a prior study of trends in trading activity, short sales and failed trades that covered the period May 1, 2007 to September 30, 2008 and generally identified trends consistent with those identified in the Trends Study (“Prior Study”);4
• an analysis of the impact of the prohibition on the short sale of certain financial sector issuers listed on the Toronto Stock Exchange (“TSX”) that were also listed on an exchange in the United States that was in effect between September 22, 2008 and October 8, 2008 which found that the prohibition had a significant impact on market quality by reducing liquidity and increasing “spreads” while not having any effect on price volatility.5

Taken together, the results of the Price Movement Study and the other empirical studies indicate that the Canadian market has not had the problems with short sales, particularly naked short sales, and failed trades that may have been evident in other jurisdictions.

Purpose of the Price Movement Study

Since the fall of 2008, securities regulators in Canada and abroad have taken regulatory action to protect investors and market integrity in light of the current and unprecedented market turmoil. To address concerns of investors and marketplace participants, IIROC increased its regular monitoring of trading on equity marketplaces in Canada, including heightened surveillance of all short selling activity and rates of trade failure.

The analysis underpinning the Prior Study and the earlier Failed Trade Study was used in the formulation of the amendments in October of 2008 to the Universal Market Integrity Rules (“UMIR”) regarding short sales and failed trades.6  All of the empirical studies have informed the consideration of other proposals for the amendment of UMIR respecting short sales and failed trades that have been published for public comment concurrent with the issuance of this Rules Notice.7  In particular, the proposed amendments would:

• repeal the restrictions on the price at which a short sale may be made;
• require, subject to certain exceptions, that a Participant or Access Person to have made arrangements to borrow securities that would be necessary to settle any short sale prior to the entry of the order on a marketplace if:
  • the security has been designated by IIROC to be a “Pre-Borrow Security”,
  • the client or non-client account on whose behalf the short sale order is being entered has previously executed an “Extended Failed Trade” (a “failed trade” that was not rectified within ten trading days following the date for settlement contemplated on the execution of that trade), or
  • the Participant had executed, as principal, an “Extended Failed Trade” in that particular security,
• require a sell order from a short position to continue to be marked “short sale” but introduce an exemption from the short sale marking requirements for orders from certain types of accounts;
• change the use of the “short exempt” order designation to provide that it be used in connection with orders for the purchase or sale of a security by an arbitrage account, an account of a person with Marketplace Trading Obligations or certain institutional accounts that adopt a “directionally neutral” strategy in the trading of securities; and
• make a number of administrative and editorial changes.

The information in these studies is also intended to assist in focusing discussions on whether initiatives that have been introduced or may be considered by securities regulators in foreign jurisdictions regarding short sales or failed trades would be appropriate in the context of the Canadian market.

Summary of the Findings

Based on the data collected during the Study Period:

• the price of securities traded on the TSXV, all of which were subject to the tick test, fell farther and faster than the price of securities on the TSX which generally were exempt from the tick test;8  and
• during periods of rapid price decline, short selling activity in TSXV-listed securities declined to levels less than historical averages as measured by:
  • the number of short sales,
  • short sales as a percentage of trades,
  • short sales per issuer, and
  • short position as a percentage of issued capital; and
• during periods of rapid price decline, persons with a “short” position were net “buyers” of TSXV-listed securities.

The data for TSXV-listed securities during the Study Period suggests that:

• the steep price decline observed between July 2008 and December 2008 was neither caused by nor exacerbated by short selling activity; and
• the tick test was not an effective tool to restrict significant and rapid, systemic declines in prices.

• 1The “tick test” is the current requirement under Rule 3.1 of the Universal Market Integrity Rules that a short sale of a security may not be executed at a price which is less than the last sale price of that security.
• 2For a more detailed discussion of the Failed Trade Study and its results, see Market Policy Notice 2007-003 – General – Results of the Statistical Study of Failed Trades on Canadian Marketplaces (April 13, 2007).
• 3Reference should be made to IIROC Notice 11-0078 - Rules Notice – Technical – Trends in Trading Activity, Short Sales and Failed Trades (February 25, 2011).
• 4Reference should be made to IIROC Notice 09-0037 - Administrative Notice – General – Recent Trends in Trading Activity, Short Sales and Failed Trades (February 4, 2009).
• 5Reference should be made to IIROC Notice 09-0038 - Administrative Notice – General – Impact of the Prohibition on the Short Sale of Inter-listed Financial Sector Issuers (February 9, 2009).
• 6For particulars of the recent amendments, see IIROC Notice 08-0143 - Rules Notice – Notice of Approval – UMIR – Provisions Respecting Short Sales and Failed Trades (October 15, 2008).
• 7IIROC Notice 11-0075 - Rules Notice – Request for Comments – UMIR – Provisions Respecting the Regulation of Short Sales and Failed Trades (February 25, 2011).
• 8During the Study Period, approximately 64% of the value of securities traded on the TSX were in securities inter-listed between the TSX and an exchange in the United States and were exempt from price restrictions on short sales.