An Exciting Week

Last week was an unusual week for retail investors. Instead of seeing large investment firms dominating the markets as usual, investors watched as a loosely organized band of Reddit users savaged institutional investors who had been betting on the decline of GameStop Corp (NYSE: GME).

Their strategy was relatively simple: knowing that Wall Street was short selling GME shares at a tremendous rate, and also believing that GME was undervalued, members of /r/wallstreetbets began buying up large volumes of shares and refusing to sell. This resulted in institutional investors not being able to cover their short positions, causing the share price to skyrocket. This is called a “short squeeze”.

By the close of markets on Friday, short sellers had suffered billions in losses as they were forced to cover their positions by purchasing shares at the new high price, to the extent they were able to purchase them.

In practical terms, we have just witnessed one of the single largest private redistributions of wealth in history, and possibly the birth of a new form of coordinated retail investment strategy.

More controversy erupted on January 28, 2021 when one of the online brokerage apps being used by retail investors purchasing GameStop shares, Robinhood, restricted trading of GameStop shares on its platform. As a result, many users were unable to sell their shares at the new high price, depriving them of potentially significant gains at the expense of Wall Street. Some have alleged that Robinhood’s move came as a result of pressure from Citadel Capital – one of Robinhood’s major partners – which was trying to prevent further losses. A class action has already been commenced.

Unsurprisingly, after witnessing history being made this week, many investors – big and small – are asking questions about market manipulation.

Market Manipulation in Canada

In Canada, many of the provinces’ securities legislation contains provisions prohibiting market manipulation.[1] The main provision in Ontario is s. 126.1(1)(a) of the Securities Act, RSO 1990, c S.5:

126.1 (1) A person or company shall not, directly or indirectly, engage or participate in any act, practice or course of conduct relating to securities, derivatives or the underlying interest of a derivative that the person or company knows or reasonably ought to know,

(a) results in or contributes to a misleading appearance of trading activity in, or an artificial price for, a security, derivative or underlying interest of a derivative, […]

(2) A person or company shall not, directly or indirectly, attempt to engage or participate in any act, practice or course of conduct that is contrary to subsection (1).

Notably, the provision prohibits conduct which a person or company “reasonably ought to know” falls into one of the two categories in paragraph (a). This means that a person or company may be liable despite having no actual intention of effecting either an artificial price or misleading appearance of trading activity.

In many provinces’ securities legislation, as above, there is a distinction between “artificial price” and “misleading appearance of trading activity”. The decisions of the Alberta Securities Commission (“ASC“) in particular are helpful to understanding what these different terms mean.

In Re Podorieszach [2004] ASCD No 360, the ASC described an “artificial price” as a “price that differs from the price that would result from the market operating freely and fairly on the basis of information concerning true market supply and demand”:

Normal-course transactions between buyers and sellers, operating at arm’s length, reflect real demand and supply; whatever the effect on price, it can be said to be a genuine market effect.  If, however, demand or supply is distorted, then price will likely also be distorted – no longer reflective of real market demand and supply, it will be artificial.

A variety of trading strategies can be used to create artificially high (or low) prices for securities. A few are set out below. One wonders whether a brokerage intentionally restricting trading of a security on its online platform in order to artificially lower a share price would also qualify.

On the other hand, “misleading appearance of trading activity” relates more to the bona fides of trading. It may or may not be directed at creating an artificial price.[2] Decisions dealing with “misleading appearance of trading activity” tend to look to the motivation behind the transactions. For example, “spoofing” may be considered a course of conduct which results in a misleading appearance of trading activity. In one case, the spoofing involved the use of non-bona fide direct electronic access orders, which were designed to impact the National Best Bid or Offer. The orders would then be cancelled before they could be filled.[3]

A more common example is wash trading, in which the buyer and seller of the securities are the same. Although appearing as a purchase-and-sale transaction like any other (and therefore creating the impression of trading),[4] the ultimate ownership has not changed; it is a ‘wash’. Wash trading is a deceptive practice which can be used to create the false appearance of market liquidity and generate artificial prices.

The British Columbia Securities Commission (“BCSC“) has created a list of “recognized hallmarks” of attempts to manipulate the market:

  • Wash trades;
  • Trading with the object of inducing others to purchase;
  • Trades or orders that lead to an artificial price for a security;
  • Trades or orders that create a misleading appearance of trading activity;
  • Orders made without a bona fide intention to deliver the cash or securities necessary to settle the trade;
  • Trades through nominee accounts;
  • Pre-arranged trades;
  • Market domination;
  • Uptick trades;
  • Involvement in opening and closing trades;
  • High closing; and
  • Uneconomic trading.[5]

Although market manipulation can clearly take many forms, the classic example is a “pump and dump” scheme, which often involve non-bona fide trading in order to create an artificial price the subject securities. The decision of the BCSC in  Re Lim, 2017 BCSECCOM 196 provides a good illustration.

In that case, two individuals acquired a dormant public shell corporation (called URBF) and began orchestrating purchases of URBF shares by themselves and other participants in the scheme. This was done in order to establish a price for, and create interest in, the shares. At the same time, the two individuals were also publishing “tout sheets” which declared that the URBF had “solved the global food crisis” with its “unique technology”. These sheets did not disclose that URBF had spent only $12,000 on equipment, had no other assets, and was not carrying on any business apart from promoting its shares.

Having artificially created a demand for the shares and increased their price (the “pump”), the two individuals then sold 4.8 million URBF shares to public investors for USD $4.8 million (the “dump”). The BCSC concluded that the two individuals had intentionally created an artificial price for the shares contrary to s. 57(a) of the BC Securities Act and imposed an array of sanctions.

Summing Up

The fallout from the GameStop short squeeze will be fascinating to watch. The SEC has signalled that it may be investigating Robinhood, and it is likely considering whether and how to respond to the short squeeze itself. Any steps the SEC takes will be watched closely by Canadian regulators.

Are you or your firm looking for assistance with a securities regulatory enforcement action? Please contact Peter Wardle and Evan Rankin.

[1] See e.g. Ontario Securities Act, RSO 1990, c S.5, ss 126.1(1)(a) and 126.4; British Columbia Securities Act, RSBC 1996 c 418, s 57; Alberta Securities Act, RSA 2000, c S-4, s 93(1), Saskatchewan Securities Act, SS 1988-89, c S-42.2, s 55.1; Nova Scotia Securities Act, RS, c 418, s 132A(1)(a); New Brunswick Securities Act, SNB 2004, c S-5.5, s 69(a).

[2] See e.g. Campbell, Re (2013), 36 OSCB 3630 (Ontario Securities Commission). However, this matter was not fully litigated as it was resolved on the basis of an agreed statement of facts and settlement agreement.

[3] K2 & Associates Investment Management Inc. (Re), 2018 ONSEC 52 at paras 5-6. See also De Gouveia (Re), 2013 ABASC 106 at para 107.

[4] De Gouveia (Re), 2013 ABCA 106 at para 49.

[5] Siddiqi (Re), 2005 BCSECCOM 416 at para 114.

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