On September 22, 2008, the Ontario Securities Commission (“OSC”) issued an amended and restated order (“Restated Temporary Order”) that amended the order of the OSC dated September 19, 2008 (“Original Temporary Order”) prohibiting the short sale of certain financial issuers listed on the Toronto Stock Exchange (“TSX”) that are inter-listed with exchanges in the United States (“Financial Sector Issuers”).1 The Original Temporary Order was issued by the OSC as a precautionary measure to prevent regulatory arbitrage with respect to short selling in Ontario of the Financial Sector Issuers as a result of initiatives by the Securities and Exchange Commission (“SEC”) and to promote fair and orderly markets in Ontario for trading in the securities of the Financial Sector Issuers. The SEC issued an amended order on September 21, 2008 and the Restated Temporary Order supports change made by the SEC. The Restated Temporary Order applies until October 3, 2008 unless extended by the OSC.
This IIROC Notice provides a reminder to Participants and Access Persons respecting their obligations generally in the handling of a short sale and specific guidance on the obligations of Participants and Access Person in complying with the Restated Temporary Order. As a result of the issuance of the Restated Temporary Order, this IIROC Notice revises and replaces guidance set out in IIROC Notice 08-0098 – Rules Notice – Guidance Note – UMIR – Reminder Respecting Obligations in the Conduct of Short Sales.
As part of its monitoring of market activity, IIROC undertakes surveillance of short selling activity on Canadian marketplaces. Given the concern with short selling activity evidenced by regulators in the United States and the United Kingdom, IIROC will increase its surveillance of short selling activity on Canadian marketplaces and, in particular, short selling activity in securities of issuers in the financial sector that are not covered by the Temporary Order. IIROC will report to the OSC and the Canadian Securities Administrators on trends in short selling activity on Canadian marketplace and on compliance with the terms of the Restated Temporary Order.
General Obligations in the Handling of Short Sales
Section 3.1 of UMIR provides that a Participant or an Access Person may not make a short sale on a marketplace unless the price is at or above the last sale price for that security or unless certain exceptions apply. Presently, securities which are inter-listed between an Exchange in Canada and an exchange in the United States are exempt from the price restrictions. This exemption continues in place but is superseded by the provisions of the Restated Temporary Order which, subject to the exemptions listed in the Temporary Order, precludes short sales in securities of a Financial Sector Issuer between September 20, 2008 and October 3, 2008.
Under UMIR, each Participant and Access Person has the obligation to settle any trade resulting from the entry of an order on a marketplace by or through the Participant or Access Person. Under Rule 2.2 of UMIR, a Participant or Access Person will be considered to have engaged in manipulative and deceptive behaviour if the Participant or Access Person enters a sell order on a marketplace without having “the reasonable expectation of settling any trade that would result from the execution of the order”. If a Participant or Access Person is aware that the particular security is not available to be borrowed, no short sale may be entered for that security. If a Participant or Access Person has executed a short sale which fails because the required securities could not be borrowed for settlement, no further short sale in that security may be made by the Participant or Access Person unless adequate arrangements have been made to borrow any securities that would be required for the settlement of the short sale.
Under Rule 6.2 of UMIR, any order that is entered on a marketplace that would on execution be a short sale must be marked as a “short” or “short exempt” order. Under Rule 7.1, a Participant must have adequate policies and procedures to ensure that orders handled by that Participant (including orders that have been directly entered electronically by clients) are properly marked. Each Participant is expected to have compliance procedures to test to ensure that orders are being properly marked.
In light of the concerns expressed and actions taken by securities regulators in Canada and foreign jurisdictions with respect to short selling activity, IIROC would expect that Participants and Access Persons will devote additional attention and resources to ensuring compliance with the requirements on the handling of short sales, including the Restated Temporary Order, at least until the securities regulators have determined what further action may be necessary.
Questions and Answers
The following is a list of the questions regarding the application of the Restated Temporary Order to trading in securities of the Financial Sector Issuers and IIROC’s response to each:
- Does the Restated Temporary Order only preclude a short sale of a Financial Sector Issuer on the TSX?
No. While each Financial Sector Issuer is listed on the TSX, the Restated Temporary Order precludes:
- the entry of an order that on execution would be a short sale on any marketplace on which securities of the Financial Sector Issuer trade;
- the execution of a short sale in an over-the-counter transaction.
- Does the Restated Temporary Order only apply to the common shares of the Financial Sector Issuer?
Yes. The Restated Temporary Order applies only to the trading of common securities of a Financial Sector Issuer. The following is the list of issuers covered by the Restated Temporary Order.
Name Root Ticker
Aberdeen Asia-Pacific Income Investment Company Ltd.
FAP Bank of Montreal BMO Bank of Nova Scotia (The) BNS Canadian Imperial Bank Of Commerce CM Fairfax Financial Holdings Limited FFH Kingsway Financial Services Inc. KFS Manulife Financial Corporation MFC Quest Capital Corp. QC Royal Bank of Canada RY Sun Life Financial Inc. SLF Thomas Weisel Partners Group Inc. TWP Toronto-Dominion Bank (The) TD Merrill Lynch & Co., Canada Ltd. MLC
- Does the Restated Temporary Order permit an exemption for “block facilitation”?
The Restated Temporary Order specifically permits a short sale to be conducted by a Participant acting as principal to facilitate a transaction with a client that has a current market value of $200,000 or more in a single transaction, or in several transactions at approximately the same time, provided that the position is liquidated or hedged as soon as possible following the completion of the short sales.
If the exemption provided in the Restated Temporary Order is not applicable, a Participant may facilitate a purchase by the client, by the Participant acting as agent in accumulating the stock in an average price account which is then journalled to the client at the average price. Alternatively, if the Participant is to facilitate the transaction as principal, the Participant would have to accumulate a long position as principal and then cross that position to the client. In the ordinary course, IIROC would consider this practice to constitute “double printing” and be contrary to Rule 2.2 of UMIR. For this reason, IIROC will consent to trade from the principal position to the client being executed “off-marketplace” in accordance with exemptions from Rule 6.4 of UMIR. A Participant who wishes to facilitate a client purchase of a block in this manner should contact Market Surveillance by fax at 416.646.7261 or by e-mail at [email protected] prior to commencing the accumulation of stock as principal.
- Can a Participant make a short sale from inventory in order to move the market price down to a level to facilitate a principal take-on trade from a client if the size and price of the trade have been agreed to between the Participant and the client?
Yes. Effective May 16, 2008, UMIR was amended with the issuance of Market Integrity Notice 2008-008 – Notice of Approval – Provisions Respecting “Off-Marketplace” Trades (May 16, 2008) that capped the obligation to fill better-priced orders in the case of certain pre-arranged trades and intentional crosses to the disclosed volume of better- priced orders. Once orders have been entered to displace the better-priced orders on all protected marketplaces, a designated cross may be executed on a marketplace or, if necessary, off-marketplace. Participants may enter orders of sufficient size to displace all protected marketplaces provided the total volume entered does not exceed the size of the designated trade.
- What is a Participant expected to do if it suspects a client is making or has made a short sale without declaring that the sale in fact is from a short position?
Securities legislation in each provincial jurisdiction requires that a person declare to a dealer handling a sell order that the sale would constitute a short sale. Rule 2.3 of UMIR provides that a Participant shall not enter an order on a marketplace if the Participant knows or ought reasonably to know that an order does not comply with applicable securities legislation. Under Rule 10.16 of UMIR, if a Participant believes that there may have been a violation of Rule 2.3 of UMIR, the Participant is under an obligation to diligently conduct a review and, if such review concludes that there may have been a violation, to provide a “Gatekeeper Report” to IIROC.
- What is a Participant or Access Person expected to do with respect to short sale orders for a security of a Financial Sector Issuer that were outstanding at the time of the issuance of the Restated Temporary Order?
If a Participant or Access Person has entered a short sale order on a marketplace that was still outstanding at the end of trading on September 19, 2008, the Participant or Access Person is expected to take reasonable efforts to remove the order prior to the opening of trading in the Financial Sector Issuer on the marketplace on Monday, September 22, 2008. If a Participant has received a client or non-client order for the short sale of a Financial Sector Issuer prior to the issuance of the Original Temporary Order, the Participant may not enter the short sale order on a marketplace or execute the order in an over-the-counter trade while the Restated Temporary Order remains in effect unless the execution of the short sale is exempted by the terms of the Restated Temporary Order.
- What steps should a Participant take to ensure that clients with “direct market access” do not enter short sale orders for a Financial Sector Issuer while the Restated Temporary Order is in effect?
The Participant has the obligation to ensure that any orders entered on a marketplace or entered in accordance with applicable securities legislation and the requirements of UMIR. The Participant must therefore take steps that will prevent the entry of short sale orders contrary to the Restated Temporary Order. If the trading system of the Participant is not capable of blocking short sale orders in securities of a Financial Sector Issuer, the Participant must take steps to immediately notify each client that has such direct market access of the terms of the Restated Temporary Order and the Participant should monitor sell orders entered by such clients to ensure that the clients have not attempted to circumvent the Restated Temporary Order by not properly marking orders as “short”.
- Are there any exemptions from the Restated Temporary Order?
A short sale in a security of a Financial Sector Issuer may be made if the short sale is:
- part of a “Program Trade” (being a trade resulting from a series of market orders for the purchase or sale of particular securities underlying an index, which includes all S&P/TSX indices and sub-indices, if such trade is undertaken in conjunction with a trade in a derivative or Exchange-traded Fund the underlying interest of which is the index) made in accordance with the requirements of the TSX related to a “program trade” (e.g. the transaction must be for a least 80% of the component weighting of the index);
- pursuant to the Market Maker Obligations imposed by the TSX on the market maker for the Financial Sector Issuer or any Exchange-traded Fund of which the Financial Sector Issuer is a component provided the market maker (provided the short sale is made in accordance with conditions as set out in the Restated Temporary Order);
- for the account of a derivatives market maker and is made:
- in accordance with the market making obligations of the seller in connection with the security or a related security (including an Exchange- traded Fund of which the Financial Sector Issuer is a component), and
- to hedge a pre-existing position in the security or a related security;
- the sale of an Exchange-trade Fund;
- required as part of the “best price” obligation of a Participant to fill better-priced orders on a protected marketplace following the execution of a sale from a long position on another marketplace;
- conducted as a result of the automatic exercise or assignment of an equity option, or in connection with settlement of a futures contract, held prior to the issuance of the Restated Temporary Order due to expiration of the option or futures contract;
- of a security that is subject to a restriction on sale imposed by applicable securities legislation or by an Exchange as a condition of the listing of the security and the sale is made under an exemption from the prospectus requirements in accordance with applicable securities legislation; or
- conducted to adjust a pre-existing hedged derivative position in order to maintain the risk exposure that existed at the time the Original Temporary Order became effective.
- Under the Restated Temporary Order may a short sale be made in a security of a Financial Sector Issuer if the sale would be exempt from the price restrictions on short sales under Rule 3.1 of UMIR?
No. Unless the trade is exempt from the Restated Temporary Order under one of the exemptions described in the answer to question 8, a short sale may NOT be made in the securities of a Financial Sector Issuer even though such a transaction would otherwise qualify for an exemption from price restrictions on a short sale under Rule 3.1 of UMIR.
Rule 3.1 permits a short sale below the last sale price on behalf of an arbitrage account when the seller knows or has reasonable grounds to believe that an offer enabling the seller to cover the sale is then available and the seller intends to accept such offer immediately. There is not a similar exemption under the Restated Temporary Order. As such, a person engaging in arbitrage activity must receive an execution on the buy side before entering a sell order on a marketplace to “offset” the purchase. Similarly, algorithms for trading in securities of Financial Sector Issuers must be programmed to comply with the prohibition on the short sale of a Financial Sector Issuer (e.g. reconfigured to enter the buy-side orders first followed by the entry of the sell side only after the purchase has been completed) or otherwise disabled.
- Will marketplaces be able to “system enforce” compliance with the Restated Temporary Order for Participants and Access Persons?
Given the exemptions which are available under the Restated Temporary Order and the fact that the Restated Temporary Order may only be in effect until October 3, 2008, Participants and Access Persons should not expect that marketplaces will be able to provide a marketplace level solution during the term of the Restated Temporary Order.
IIROC has proposed amendments to UMIR to provide for a “Short Sale Ineligible Security”. Presently, those amendments are being reviewed by the securities regulatory authorities. Until such amendments can be implemented, the responsibility for compliance with the prohibition under the Restated Temporary Order is with the Participant and Access Person.
- 1The text of the Original Temporary Order is available on the website of the OSC at http://www.osc.gov.on.ca/Enforcement/Proceedings/RAD/rad_20080919_cert-fin-sect-issuers.pdf.
The text of the Restated Temporary Order is available on the website of the OSC at http://www.osc.gov.on.ca/Enforcement/Proceedings/RAD/rad_20080922_amend_cert-fin-sect-issuers.pdf.