Naked' short selling to be off limits in Canada
By PETER KENNEDY
00:00 EST Monday, February 16, 2004
VANCOUVER -- Canadian stockbrokers who engage in a controversial but
lucrative practice known as "naked short selling" are about to face
new restrictions that appear to be aimed at closing a loophole in
U.S. securities industry regulations.
When the restrictions take effect on Feb. 20, brokers in Canada will
be prevented from arranging to short U.S. securities on behalf of
clients or from inventory, unless they are able to make an
affirmative determination that the stock can be borrowed and
delivered to the customer on the settlement date.
It means Canadian brokers can still short U.S. stocks, a practice
that involves the sale of borrowed shares by people who plan to
replace the stock by buying it back at a lower price, allowing them
to pocket the difference.
The affirmative determination requirements for short sale orders are
part of amendments to the National Association of Securities Dealers
(NASD) Rule 3370.
One Canadian brokerage official said he believes Canada is merely an
incidental target of rules, which he said are aimed primarily at
U.S. market makers who trade on Nasdaq's lightly regulated Over the
Counter Bulletin Board.
"I don't believe it is to plug a Canadian hole, solely," said Warren
Funt, vice-president of member regulation at the Investment Dealers
Association of Canada. "But it will have that effect."
Until this week, Rule 3370 did not apply to brokers who are not
members of the NASD. As a result, brokers at Canadian firms, such as
Pacific International Securities Inc., Global Securities Inc., Union
Securities Ltd. and Raymond James Ltd., were able to generate
revenue by shorting U.S. securities on behalf of clients or from
inventory, on a non-borrowed basis.
But starting Friday, traders in the United States will be required
to ask Canadian dealers if they have borrowed the stock in instances
where they are attempting to short a U.S. stock on behalf of a
client. "If the answer is no, the U.S. dealer will not accept the
trade," said Doug Garrod, president of Global Securities.
Industry officials say the impact on revenue as a result of the
affirmative determination rule will not be known until the IDA
releases its trading review for the first quarter of 2004.
A compliance executive at one brokerage firm said naked short
selling has been a low-profile, high-money earner for brokers,
particularly in Vancouver's Howe Street district, and some have
already quit in advance of the rule taking effect. (The term "naked"
shorting applies to an unlimited form of short selling that can
cause wild gyrations in the price of stocks that are usually traded
over the counter in the United States.)
"It has been a huge revenue-making area for the brokers that are
doing it because you can charge higher commissions when you are
trading in the U.S.," the executive said. "The fact that U.S.
regulators have taken this action shows that this is a huge
problem," the executive added.
For instance, Global Securities and Union Securities are named in a
lawsuit launched in British Columbia Supreme Court in 2002 by U.S.
biotech firm GeneMax Corp., which became a magnet for short sellers
late that year.
In court documents, GeneMax accuses the brokerage firms of abetting
an illegal manipulation scheme, which allegedly included naked short
selling.
The brokers have asserted in a statement of defence that any long
and short sales of GeneMax shares were conducted in accordance with
applicable securities laws.
Two years ago, popular American short seller Amr (Anthony) Elgindy
was charged with insider trading and racketeering in what U.S.
authorities alleged was a scam involving two FBI agents.
