Written by Justin R. Lambert, Michael D. Mysak, Robert W. Staley and Alan P. Gardner
A recent decision of the Alberta Securities Commission appears to give short-sellers wide latitude to negatively comment on targets, and sets a potentially high burden on ASC Staff when seeking interim orders to address potentially damaging commentary.
“Short and Distort”
"Shorting" is selling a position before its price declines intending to buy it back when the price bottoms out. Because the profit realized from shorting a company's stock is directly correlated with a decline in the price of that company's stock, there is incentive for a short-seller to cause a price decline. One method a short-seller may use to cause the price of a company's shares to decline is to push misleading or untrue information into the market to induce people to sell their shares. This practice is colloquially called "short and distort".
The ASC Targeted a Short-Seller for Allegedly Improper Short-Selling Practices
On May 12, 2017, Badger Daylighting Ltd. released its financial results for the first quarter of 2017. The same day, Marc Cohodes announced that he had begun "shorting" Badger's shares and that he was launching a website as part of an activist campaign against Badger.
That same day, Veritas Investment Research—which describes itself as an independent equity research company—noted concerns with Badger's lower than anticipated quarterly earnings.
In the following weeks, Badger's stock fell 28 percent.
Cohodes had in the past alleged on Twitter that Badger was involved in illegal dumping of toxic substances. Then, on June 27, 2018, Cohodes tweeted a picture of a Badger dump truck in the dark, in the dump position with this text: "Just a sign of things to come with Badger Daylight and their ILLEGAL TOXIC DUMPING…$BAD this is not a Dumpsite but a field…Your Day is coming." Later, Cohodes alleged in a reply to a tweet that the substance allegedly dumped had been tested.
Cohodes took the position that the decline in the price of Badger securities was a result of its financial performance, not his tweets or allegations.
The Case Against Marc Cohodes
On August 3, 2018, ASC Staff issued a notice of application against Cohodes, seeking on an interim basis to prevent Cohodes from trading in securities of Badger and from "disseminating to the public, or authorizing the dissemination to the public, any statements relating to the business or operations of Badger he knows or reasonably ought to know are misleading or untrue." ASC Staff alleged that Cohodes was intentionally making false statements which he knew would cause or contribute to an artificial price for those securities—in effect, that he was using the "short and distort" strategy.
The ASC may make interim orders in the public interest to prevent and protect the capital markets until a full enforcement proceeding can be conducted.
To secure these interim orders, it must be shown on a prima facie basis that securities laws have been contravened. This requires that the evidence available supports the material aspects of the allegations made by Staff, and that the Commission finds the evidence credible and reliable.
ASC Staff alleged that Cohodes made misrepresentations in violation of section 92(4.1) of the Securities Act, and that he was liable for market manipulation in violation of section 93(a)(ii) of the Act.
In order to prove misrepresentation, it must be shown that the person or company knew or reasonably knew that the statements made were false, and there is a reasonable expectation that these misrepresentations would create an artificial price for these securities. When determining whether the misrepresentations would reasonably be expected to affect market price, regulators are to examine whether there is a substantial likelihood that a reasonable prospective investor would consider the information useful when deciding whether to invest at the price asked.
In determining whether there has been market manipulation in contravention of the Act, the ASC must show that:
(i) the respondent's impugned activity constituted or involved an 'act, practice or course of conduct relating to a security'; (ii) the activity may have resulted in or contributed to an artificial price for the security; and (iii) the respondent knew or reasonably ought to have known that the activity may have resulted in or contributed to an artificial price for the security.
Further, Staff must show that the respondent's statements would reasonably be expected to have a significant effect on the market price or value of a security. To show that this is the case, it must be determined whether there is a substantial likelihood that such facts would have been important or useful to a reasonable prospective investor in deciding whether to invest in the securities on offer at the price asked.
Upon examining in detail each of the statements made by Cohodes relating to Badger since May 2017, the tribunal found that ASC Staff had made out a prima facie case only that the June 27 tweet about illegal toxic dumping was untrue. However, the tribunal found there was insufficient evidence to show that market participants would actually find this statement authoritative and therefore capable of influencing and affecting Badger's share price. The Commission also noted that Badger’s stock closed down only 0.6 percent following the June 27 tweet.
The Commission refused to find Cohodes had committed an actionable misrepresentation.
Further, while the tribunal determined that the June 27 tweet was an "act" relating to Badger's shares, they did not find this "act" created the artificial price of the Badger shares, and therefore there was no market manipulation.
ASC Staff’s application was therefore dismissed.
Implications of the Cohodes Decision
In recent years, short-sellers have become increasingly aggressive, and on occasion reckless, in publishing commentary on short-selling targets, in their own names and using pseudonyms on stock chat bulletin boards. This activity has attracted the attention of Staff of various provincial securities commissions, ultimately prompting ASC Staff to take action in this case.
The Cohodes decision highlights the hurdles facing Commission Staff under the existing regulatory regime in addressing false or misleading statements made by short-sellers. Practically speaking, ASC Staff pursuing a short-seller for using a "short and distort" strategy must show that investors relied on that false information which materially impacted, or created an artificial price for, the securities of the target company. Cohodes demonstrates the practical difficulties faced by Commission Staff in seeking to meet this standard.
At least in Alberta, short-sellers or other activist investors continue to have broad latitude in the public statements they make about the companies they target. Even where the statements are false, and perhaps deliberately so, short-sellers may escape regulatory scrutiny if the statements are perceived to be insufficiently authoritative to materially impact, or create an artificial price for, a company's shares. Of course, while regulatory sanctions may not apply, those who make false statements about companies could well still face civil liability for defamation.