Shorting Canada It is widely agreed that excessive short sale activity can cause sudden price declines, which can undermine investor confidence, depress the market value of a company’s shares and make it more difficult for that company to raise capital, expand and create jobs. This is particularly aggravating for entrepreneurial companies; the engines of new job creation. In the crash of 2008 short sale activity reached record levels and exacerbated the market turmoil, leading to one of the most severe economic declines in modern history.
Job formation is highest among pioneering companies, such as those in the computer, biotech and emerging growth industries. Studies show that approximately 80% of all new jobs come from small businesses or new companies in their fast growth phase; those that grow the fastest hire the most. However, because research, development and new product innovation are risky and often require multiple rounds of equity financing, short sellers often target these companies, to the detriment of America.
Short sellers are essentially traders that are hoping a company will experience problems (such as product delays or the inability to raise financing) so they may profit from the setbacks. These traders or trading machines make the most if a company struggles and goes out of business, and some short sellers actively work to make that happen. Aggressive shorters, and short selling pools, will sometimes hire stock “bashers”, people paid to post negative articles on blogs and message boards. Their goal is to put out negative news on a company or its products in an effort to cause the company problems and insure the stock declines so their negative bets pay off. Others will put up “flash orders” advertising to sell a large number of shares in an effort to drive down the price. Thus entrepreneurial companies not only need to fight the battles of developing new products and markets, they have to stave off the short sellers in the meantime. This growing culture of betting against a company for the sake of short-term trading profits (regardless of economic consequences) has negative economic repercussions. This trend has been fostered by:
• Technology that allows trader anonymity without consequence. Short sellers, like private hedge funds do not have to disclose their negative bets, whereas mutual funds and most institutions are required to publicly report their holdings.
• Brokerage firm procedures that make it easy for short sellers to borrow stock without informing the shareowner of the transaction or potential consequences.
• Internet forums and message boards that allow traders to quickly publish negative comments about a company, thus forcing down prices.
The repeal of the uptick rule, which had required traders to only short when it wouldn’t hurt a company’s stock price, and now allows shorting regardless of the company’s current stock price direction, enabling “piling on” trading.
As asset prices decline people feel less wealthy and spend less, which in turn causes real economic contraction. Economists recognize that investor confidence determines economic activity and Fed Chairman Bernanke recently commented that the economy could avoid a “double dip recession” as long as markets stayed healthy. Governments around the world are now struggling with how to stop the proliferation of short sellers that bet against the economic well being of their nation. This past summer Germany banned short sales outright in an attempt to quiet its markets during a run on the Euro.
How did things get this way?
Canadian authorities are lacking the necessary foresight and courage to properly assess the long term negative impacts of short selling on the Canadian economy.