I need your help.
No, Canada needs your help.
Today, I urge you to read this Letter in its entirety because what you read can and will affect you.
After you read it, you can take immediate action by CLICKING HERE.
In just a bit, I am going to ask you to do something.
Something that could prevent the complete failure of Canada’s market.
But first, let me explain.
Canada is Failing and it’s Getting Worse
Canada’s equities market is like any other exchange in the world.
It consists of buyers and sellers that exchange goods – in the case of the stock market, securities.
But unlike many other places, Canada is at a major disadvantage.
You see, investors need to have the right information – the right market data – so that they can make proper decisions.
This is straight forward stuff for anyone who trades stocks.
But what you don’t know is that most Canadians – and those who trade Canadian stocks – have information that is likely both inaccurate and incomplete.
And that means Canadian investors are at a serious disadvantage.
Let me explain.
Why the TSX Venture is Failing Revisited
Four years ago, I wrote:
“The biggest and most important aspect of any stock-trading platform is transparency.
Investors should be able to see exactly how many bids and sell orders are available for a stock at any given time – especially for an exchange that has minimal liquidity and therefore is much easier to manipulate. This is how investors calculate at what price he/she should place a buy or sell order.
The depth of the market can be seen using a paid service called Level II that gives you access to the order book in real time. I have always said that anyone who trades should pay for such a service. However, even with this service, you’re far from being protected.
Multiple Trading Platforms
Many retail investors I speak with have no clue that there are multiple parallel trading platforms for the stocks they buy in Canada.
…There are now many alternative market centers that process trades for stocks listed on the TSX and TSX Venture. Some of these include Alpha Trading Systems, Chi-X Canada, Pure Trading, Omega ATS, and dark pool Match Now.
According to Stockwatch:
“Alternative trading systems in Canada handled 33.7 per cent of trading volume during the week ended May 3, 2013.
…The Toronto Stock Exchange and the TSX Venture Exchange handled the other 66.3 per cent.
…Looking at securities listed only on the TSX, the exchange captured 61.2 per cent of volume. Chi-X handled 18.3 per cent, Alpha had 11.7 per cent and together the other ATSs handled the rest, 8.8 per cent.”
As you can see, these alternative trading systems handle a large portion of the trading volume in Canada, yet most regular Canadian investors don’t see this because most quote systems do not include transactions from all the different platforms.
Furthermore, while volume of trade can be seen by the select few quote platforms that incorporate the volume between these exchanges, (few) of them combine them in the same bid/ask level II depth because they are being traded on different platforms via parallel order books.
In other words, while you may be trading a stock on one platform, that same stock is being traded on different platforms at the exact same time.
This not only removes transparency – especially for the average retail investor – but it also removes visible liquidity for any particular stock.
The retail investor using his/her online trading quote system doesn’t stand a chance – especially when playing on an exchange with little volume, such as the TSX Venture.”
If you think things have gotten better, think again.
Today, there are now 13 trading platforms facilitating the sale of securities in Canada.
And a whopping 41% of the volume traded in Canadian securities originated from platforms outside of the TSX and the TSX Venture:
When it comes to ETF’s, the visibility is even more opaque.
According to Invesco:
“…in 2016, the TSX represented only approximately 39% of total ETF trading volume, with the remaining 61% taking place on alternative venues…
… The result is that many ETF investors may be trading with inaccurate or incomplete price and liquidity information. Without the whole picture, market efficiency suffers and investors may struggle to obtain an accurate price for their securities.”
What’s worse is that, according to Aequitas, 100% of retail investors don’t have a full view of the market data at all:
Most online brokerage platforms only show what happens on the TSX and the TSX-V.
When you see the price for a stock on your online trading platform but see a different price on Bloomberg, now you know why.
That is neither fair, nor transparent.
What do you think?
But what does that mean?
It means unless you’re a professional trader or trading firm paying astronomical amounts of money for consolidated real-time market data, you’re not trading with the right information.
In fact, you’re not seeing the true liquidity or price of Canadian stocks at all.
Take a look:
It’s even less transparent when you look at data for less actively traded stocks:
This lack of data transparency can be detrimental to your investment decisions.
For example, on October 26, 2016, a named shareholder in Eastmain Resources Inc. sold 7 million shares through the facilities of the NASDAQ CXC alternative trading system.
This sale represented a whopping 94% of the volume that day.
But most retail investors and investment advisors did not see this until the Company issued a press release the next day.
Here’s what happened after the sale:
Do you think it’s fair that most investors didn’t see this transaction because it occurred on an alternative trading platform?
This lack of transparency is a major issue – one that even IIROC has acknowledged.
Via IIROC in March 2014:
“IIROC is concerned that firms engaged in the on-line retail trading business that provide limited market data may not be clearly describing the scope of the market data offered.
Clients that are unaware of the constraints of the market data provided may make uninformed and therefore sub-optimal order entry decisions.
IIROC believes it is important for firms to provide disclosure that describes the scope of market data provided to clients.”
The irony is that one of the most important aspects of trading stocks is transparency and timely disclosure; without a mandate for consolidated market data, we have neither.
The first step you can take to solving this very important issue and protect your future is to speak out.
Once you do, I will forward it over to the Canadian Securities Administrators (CSA) to show that industry professionals aren’t the only ones that realise there is a problem with the Canadian market. Then we can move forward to signing a petition.
I urge you to complete the survey. It will only take a minute but could go a long way in addressing this problem.
Unfortunately, transparency isn’t the only problem.
There’s another huge problem that when combined with the lack of market data transparency, could destroy the Canadian market.
Short Selling Runs Rampant
Short selling is believed (or so “they” say) to be a necessary part of the market, providing balance and efficiency.
While this may be true in some instances, especially with the advent of high frequency trading and ETF’s, the basic idea of short selling is completely absurd.
As I mentioned in a previous Letter:
“Short selling is simply selling stock you don’t have.
You borrow stock from someone (who likely doesn’t know you’re borrowing it), sell it, and hope that the stock goes down so you can buy it back at a cheaper price.”
To put that into context, it’s like saying:
You go away for vacation.
While you’re away, a stranger rents your house out on Airbnb without your knowledge.
You come home only to find your house is trashed – and now worth less than it was before.
You lose money on your house, but the stranger legally made money renting your house out.
It’s no secret that short selling can and often does hurt companies. While short selling can provide efficiencies in the market and create more liquidity, Canada’s market doesn’t stand a chance.
This is because of yet another Canadian regulatory hurdle.
This regulatory hurdle has caused short selling in Canada to run rampant – especially on Canada’s small cap exchange, the TSX Venture.
Just how much has short selling grown?
According to IIROC, short sales as a percentage of trades on the TSX Venture from Jan 2009-April 2010 averaged 4.39%.
But then, in the January 21, 2013 Short Sale Report, short sales as a percentage of trades on the TSX Venture averaged 6.89% for the two weeks prior.
Two years later, in the January 1, 2015 Short Sales Report, short sales as a percentage of trades on the TSX Venture averaged 7.90%.
In the most recent Short Sale Report, short sales on the TSX Venture averaged 8.57% – nearly double the average in 2009.
But why and how has short selling doubled? And what is the regulatory hurdle that may have caused this?
The Removal of the Uptick Rule
Back in October 2012, a wide number of so-called trading enhancements were implemented by the TMX Group, home to Canada’s two largest exchanges, the TSX and the TSX Venture.
From my Letter, Why the TSX Venture is Failing:
“On October 4, 2012, the TMX Group sent notice to confirm “trading enhancements,” set to begin on October 15, 2012.
The enhancements in the notice reflected recent regulatory amendments respecting short sale regulation, the introduction of a short marking exempt designation, amendments respecting dark liquidity on Canadian equity marketplaces, and functionality introduced as a result of client demand and market quality initiatives.
When you try to fight one problem with another problem, the result is never positive. I will explain what’s happened in a bit.
But first, look at the one-year chart for the TSX Venture Composite since the rules were announced:
It doesn’t take a rocket scientist to break down the above chart.
Since the notice of the “Trading Enhancements Update” by the TMX, the TSX Venture has dropped like a rock.
The Death Spiral
When regulators forced the TMX Group to allow trading through alternative trading systems operated by third parties, it caused real-time transparency issues.
When you combine the lack of transparency in parallel trading platforms with the use of High-Frequency Trading (discussed last week), regulators had no choice but to eliminate the tick test rule, or uptick rule, for short selling.
Let me explain.
Discontinuing Price Restrictions of Short Sell Orders (Tick Test)
Historically, you could only sell a stock short if the price is higher than the last different price; simply put, you can only short a stock as it was moving up.
(This was know as the Uptick Rule.)
However, this rule only works when there is a strict sequence of orders in the order execution book; when bid/ask orders are placed in line on a first-come, first-served basis.
But with parallel trading systems, a definitive sequence of different prices can’t be established at any exact given point in time because one order book might show a downtick, while the other an uptick.
As a result, it would be extremely difficult to enforce the uptick rule.
By allowing competing trading platforms and encouraging HFT (which was believed to create more liquidity), regulators had no choice but to remove the tick test rule.
In the October 4th announcement, the rule was eliminated:
“TSX, TSX Venture Exchange (TSXV) and TMX Select will no longer constrain short sell orders to the last sale price. Short sell orders entered will be permitted to trade down to their limit price establishing a last sale price on a downtick. Short Crosses will no longer be constrained by the last sale price.”
This means we can now short a stock anytime we want.
That’s great news for short sellers, but for companies trying to raise money at higher prices to hire more staff or move their projects forward, this rule change can cripple them – especially under the liquidity constraints of the Canadian market.
It doesn’t take a lot of money to control a stock via short selling on the TSX Venture.
As a matter of fact, institutions often hammer stocks via short selling and back up their shorts with warrants they obtained in a previous financing. They often force the price of a stock down to finance the same companies they’re shorting to get a better financing price, or to force a company into a financing arrangement.”
The removal of the uptick rule has created a breeding ground for short funds to make a lot of money betting against companies – especially companies that trade on the TSX Venture.
When you consider that companies that trade on the TSX Venture are likely companies that are speculative and often negative cash-flow businesses, short selling can immediately hurt a company’s ability to finance.
Furthermore, short funds can use computer trading to add additional pressure on stocks to the downside by making it look like there is a lot of stock for sale. In other words, stock manipulation.
And yes, stock manipulation is illegal.
So how do they do this?
How to Manipulate Stock Through Short Selling
When the removal of the uptick rule was implemented on October 4, 2012, a short marking exempt designation (SME) was also introduced.
“The “short-marking exempt” designation is required to be applied to orders for qualifying accounts of arbitrageurs, market makers and “high-frequency traders” that typically generate a high volume and speed of orders on a fully automated basis, may have orders on both sides of the market on various marketplaces at the same time, and that adopt a “directionally neutral” strategy such that generally, the position in each security in the account is flat at the end of the trading day.”
In other words, as long as a firm adopts a “directionally neutral” strategy, such that generally, the position in each security in the account is flat at the end of the trading day, it doesn’t have to declare the short sale.
This was done because IIROC believes that the use of the SME order designation allows them to separately monitor the trading activities of those accounts which are actively buying and selling the same security without taking a directional position and that of actual short sale activity on accounts that may have adopted a “directional” position.
While this may have good intentions, it actually makes it easier for firms selling short to manipulate the price of stocks.
Here is Bloomberg’s take on Spoof Trading:
“Spoofing is when a trader enters deceptive orders tricking the rest of the market into thinking there’s more demand to buy or sell than there actually is.”
In the case of short selling, a trader would show pressure on the sell side through stacked sell orders, but remove them if the market begins to move higher.
These stacked sell orders are often viewed – especially by retail investors with a lack of market data – as weakness in a stock.
You may be wondering: What happens if buyers come into the market? Wouldn’t the sell orders be on the hook to buy the stock?
You see, these sell orders are often in small board lots (usually 100 shares) so that anytime the lead sell order is hit, the firm only has to sell a few shares short.
When this happens, the computers automatically adjust their sell orders higher, while still maintaining pressure on the stock by maintaining the multiple stacked sell orders – often times behind a real sell order.
This allows the short sellers to put downward pressure on a stock without having to declare a short because they remain “neutral” by buying just enough shares to end up with a flat position in the account at the end of the trading day.
And because the uptick rule was removed, short funds can now downtick a stock and still short the next day.
What is Downticking?
Downticking is when a trader sells stock so that the most recent change in the share price is negative. This is usually done right before the market closes using very small amounts.
And since stock charts only follow the closing price of a stock, you can see how easy it is for a short seller to create a nasty looking downward chart by spoofing and down-ticking.
These practices are illegal but happen to many Canadian stocks.
Just ask the Ontario Securities Commission.
Most retail investors don’t see this type of activity because most trade without the use of Level II data. They only see the last bid/ask price, which as I already mentioned earlier, may not even be correct.
The next time you see a stock in the green for the whole day, only to end up in the red with less than a minute to go, you now know what could have happened.
The problem for Canadian regulators is that they can’t keep an eye on the thousands of stocks that trade every day.
Even when they do catch it, it’s extremely difficult to find the culprit behind the trades since the short sellers have multiple accounts at different financial brokerages and often work with other short sellers.
Furthermore, regulators often rely on complaints.
But how can a retail investor make a complaint if they don’t even see this “spoofing” or the down ticking because of the lack of mandate for consolidated market data?
Retail investors don’t get to see the Level 2 data because it’s expensive. How can an investor react to this type of predatory short selling?
How can an investor report manipulative trading to IIROC or the Canadian Securities Administrators (CSA) if they don’t have access to the data?
If there was a regulatory mandate to provide consolidated market data in Canada, we could make much more informed investment decisions.
If Regulators could mandate market data transparency with new short sale regulations such as the re-implementation of the uptick rule and more frequently updated short reports (currently only reported semi-monthly), then maybe we could prevent the Canadian market from failing.
I think these rules need to be changed immediately.
But that’s just the beginning.
The Dark Side of Short Sales: Short and Distort
“…short selling also has a dark side, courtesy of a small number of traders who are not above using unethical tactics to make a profit.
Sometimes referred to as the “short and distort,” this technique takes place when traders manipulate stock prices in a bear market by taking short positions and then using a smear campaign to drive down the target stocks.
…Short selling abuse like this has grown with the advent of the Internet and the growing trend of small investors and online trading.”
“Short and distort” participants have amassed fortunes driving Canadian companies into the ground.
And with the removal of the uptick rule and the introduction of the SME designation, predatory short selling became even easier.
Unfortunately, I have yet to see a regulator come down on illegal “short and distort” participants.
Do you think regulators should do more to prevent “short and distort” activities?
Combine the lack of required consolidated market data, the removal of the uptick rule, the introduction of the SME designation, with the illegal practice known as “short and distort,” and many Canadian companies and Canadian-born innovations listed on Canada’s stock market could be doomed to failure.
And it makes it even harder for retail investors to succeed.
In the U.S., they have already reintroduced an alternative uptick rule and news just broke that they are looking at bringing it back completely.
The regulators know that these practices not only hurt Canadian companies but that it can have serious consequences on our whole financial system.
Which is why…
Selective Short Sale Ban
On September 19, 2008, the Ontario Securities Commission (OSC) ordered a restriction on the short sale of 13 financial stocks.
These stocks included Canada’s Big Five banks: the Bank of Montreal, the Bank of Nova Scotia, CIBC, TD, and the Royal Bank.
It also included Canada’s largest insurance firms including Manulife Financial and Sun Life Financial.
This was done because the regulators wanted to prevent the banking system from collapse during the 2008 financial crisis and feared that rampant rumours spread by short sellers combined with the downward pressure of short sales would become a self-fulfilling prophecy.
Via the Star:
“This order (the restriction on short sales of 13 financial stocks in Canada) is being issued as a precautionary measure to prevent regulatory arbitrage with respect to short selling in Ontario of the securities of the financial sector issues and to promote fair and orderly markets in Ontario,” the provincial regulator said.”
In other words, the Canadian regulators were worried that short sales would drive down the price of financial stocks, which would lead people to believe the banks were in more trouble than they really were.
And this didn’t only happen in Canada.
Via the international law firm Eversheds Sutherland (US) LLP:
“…Due to ongoing concerns within the financial markets regarding perceived artificial price movements based on rumors involving financial institutions and other issuers, exacerbated in part by active and potentially widespread short selling, on September 18, 2008, the SEC issued a series of three emergency orders focused on the present crisis within the financial markets.
…The first emergency order, SEC Release No. 34-58592 (the “Short Selling Order”), prohibits any person from engaging in any short selling transactions involving publicly traded securities of 799 financial companies…
…The SEC indicated its belief that, “short selling is contributing to the recent, sudden price declines in the securities of financial institutions unrelated to true price valuation,” and further noted that “[s]uch price declines can give rise to questions about the underlying financial condition of an issuer, which in turn can create a crisis of confidence, without a fundamental underlying basis*.”
(*In other words, driving the price of a stock down becomes a self-fulling prophecy.)
The stated purpose of the Short Selling Order is to prevent “short selling from being used to drive down the share prices of issuers even where there is no fundamental basis for a price decline other than general market conditions.”
As you can see, short selling was banned for financial stocks because false rumours and misinformation were being spread, and manipulative short selling caused unjust downward pressure, leading to a decline in the share prices of the banks, which then led to a lack of confidence in the banks themselves.
Should the same principles not apply to ALL stocks?
The Time to Take Action is NOW
I get it. With ETF’s and HFT’s in play, short sales may be required to “balance” the market.
But predatory short sales should not be allowed.
There is a serious problem in Canada’s stock market – one that has not been addressed for many years.
When you combine the removal of the uptick rule, the introduction of the SME designation, AND a lack of consolidated market data, Canadian investors really are getting screwed.
If this is allowed to continue, I fear it will eventually lead to the failure of the Canadian market altogether as retail investors lose confidence.
That would be a shame because the Canadian capital markets is a HUGE part of the Canadian economy. It provides jobs and brings about innovation.
We need to fix this before it’s too late.
I have talked about this in-depth in the past but with recent events, I feel compelled to do it once again.
And I urge you to participate.
I am calling all investors, all market participants, brokers, deal makers, and the CEO’s of publicly traded companies to take action by participating in the following survey.
If we receive enough support, we’ll move forward with a petition like the one circulated in the U.S. by Jim Cramer that garnered thousands of signatures and led to the implementation of the alternative uptick rule.
Then the regulators will have to listen.
Consider this: the total listings for the TSX Venture has declined year-over-year:
- March 2013: 2,497
- March 2014: 2,437
- March 2015: 2,318″
Today, there are only 1639 listed issuers on the TSX Venture.
It’s time for the Canadian Securities Administrators to mandate access to consolidated market data AND put an end to illegal and manipulative short selling by first re-implementing the uptick rule.
If we can get enough people to participate, we can proceed with the petition process.
Let’s get on it.
If you want to save Canada’s market, forward this to your friends, your colleagues, and any other investor you know.
Seek the truth,
The Equedia Letter