The British Columbia Securities Commission (“BCSC”) recently considered whether a short seller committed fraud and breached the public interest by making negative statements about an issuer that did not “fairly present the full results of the diligence underlying those statements”. This decision has important implications for public companies seeking help from securities regulators when short sellers publish negative research about them. Historically, public issuers have not received much assistance from regulators in these circumstances and have had to resort to defamation cases. The Silvercorp/Carnes case was a rare example of a regulatory intervention.

In Re Carnes,[1] BCSC Staff alleged that Jon Carnes had violated s. 57(b) of the Securities Act (British Columbia) (the “Act”) and breached the public interest. On September 13, 2011, using a false name, Carnes published a report critical of Silvercorp Metals Inc. (“Silvercorp”). Silvercorp is a TSX and NYSE listed mining company with assets in China. Carnes published the report four days before the expiry of $4.1 million of Silvercorp put options that his firm had purchased. Carnes’s firm made $2.8 million in profits when Silvercorp’s stock price on the NYSE declined from $9.20 (when the put options were purchased) to $6.30 (after trading closed on September 13).

In July 2011, after receiving an anonymous tip, Carnes and his team commenced research on Silvercorp with a view to taking a short position in its shares. Carnes retained a geologist consultant to review Silvercorp’s technical reports (the “NI 43-101 reports”) and filings with a Chinese governmental agency (the “Chinese Reports”). Despite some differences between the numbers in the Chinese Reports and the NI 43-101 reports, the consultant informed Carnes that the reports were prepared under different conditions, used different reporting criteria, and contained no “fatal flaws”. Carnes was nevertheless determined to write a negative report on Silvercorp.

Carnes retained[2] another geological consultant (the “Second Consultant”) to review Silvercorp’s geological data. Carnes’s team thought this consultant’s first report was “too soft”, “too vague” and not “damaging enough.”[3] The consultant therefore prepared a second report with an addendum, identifying problems in the NI 43-101 reports. He also noted that numbers in the Chinese Reports and the NI 43-101 reports should not match as they were prepared on a different basis and for different purposes.

On September 13, Carnes posted a negative report about Silvercorp on a website under the name Alfred Little (the “Alfred Little Report”) instead of his own. Alfred Little was a false name with false credentials.[4] The Alfred Little Report raised five main concerns regarding Silvercorp. Only one of Carnes’s concerns about Silvercorp was the subject of an enforcement proceeding before the BCSC.

Fraud allegations dismissed

The BCSC found it “clear that Carnes intended to write the most damaging report he could, to make the most money possible, and was prepared to write things in a way that connoted or implied things that were not explicitly said.”[5] Despite this, the BCSC determined that Carnes did not commit fraud[6] contrary to s. 57(b) of the Act.

The BCSC determined that, on a careful contextual review of the Alfred Little Report, the alleged fraudulent statements were not objectively false. Although the Alfred Little Report implied that the Second Consultant made certain negative statements about Silvercorp, Carnes was careful to not make that assertion explicitly. Carnes “clearly attempted to create the implication in the reader’s mind that the consultant found the investor presentation to be misleading but the Alfred Little [R]eport does not actually say that the Second Consultant found the investor presentation to be misleading.”[7] Even though Carnes did not “give a full and fair picture” of the Second Consultant’s opinion, the BCSC held that Carnes’s conduct fell short of deceit or a falsehood for the purpose of fraud.[8]

No breach of the public interest for the same conduct

The BCSC reviewed the evolution of the public interest power since the Ontario Securities Commission’s decision in Re Canadian Tire Corp.[8] After summarizing its application in Asbestos,[10] Biovail,[11] Donald,[12] Suman[13] and Waheed,[14] the BCSC noted that some of these cases required a showing of abusive conduct or else a breach of an animating principle of securities regulation not necessarily accompanied by anything abusive of the capital markets.[15] In the present case, Staff had alleged that Carnes breached the public interest for making the same statements that Staff had (unsuccessfully) alleged contravened s. 57(b) of the Act.

The BCSC concluded that when Staff alleges that certain conduct is specifically prohibited by the statute and fails to meet its burden, the same conduct should only be found to contravene the public interest in “very rare circumstances”:

In the enforcement context, where the Act prohibits specific conduct, and an allegation involving that type of conduct is found not to contravene the Act, then only in very rare circumstances would it be in the public interest to issue an order based on that same conduct. Generally, the conduct would need to be abusive of the capital markets in order to make such an order. A finding that a respondent had artificially structured their affairs with the intent of placing their conduct outside of the wording of the Act would also be relevant but not a necessary element of such an order.[16]

The BCSC explained its rationale as follows:

We recognize that when a panel issues an order in exercise of its public interest jurisdiction, the order has the effect of restraining or prohibiting conduct that is not prohibited specifically by legislation. Market participants should be able to structure their affairs within the context of the specific provisions of the Act, without fear of enforcement actions alleging wrongdoing that is not encoded in the Act, regulation or rules of the Commission.[17]

Having determined that Carnes’s conduct did not constitute fraud, the BCSC refused to find that Carnes breached the public interest and strongly cautioned against a broad application of the public interest power to restrain conduct that is not specifically prohibited.

The BCSC explained its rationale for endorsing a cautious approach to relying on the public interest in enforcement cases:

While we may find Carnes’ conduct unsavory, we do not find it was clearly abusive to the capital markets and therefore it is not necessary to make an order in the public interest. It is not our role to sanction conduct we find morally unsupportable.[18]

if we were to make an order in the public interest in this case, we would, in effect, be creating a new requirement for statements which would be something akin to “fair presentation”. That is beyond what the legislature has enacted. We have significant concerns about the implications of such a finding.[19]

Takeaways

  1. As in the Waheed case decided by the OSC, the BCSC in Carnes declined to make a public interest order where Staff alleged but failed to show an express statutory violation. The BCSC expressly recognized that “[m]arket participants should be able to structure their affairs within the context of the specific provisions of the Act, without fear of enforcement actions alleging wrongdoing that is not encoded in the Act, regulation or rules of the Commission.”[20] 
  2. Establishing fraud against a short seller requires Staff to prove more than the short seller’s knowing publication of a slanted opinion designed to maximize damage to an issuer’s stock price.
  3. The BCSC was not comfortable with the potential chilling effect that a public interest finding in Carnes may have had on persons who publish opinions about public companies.[21]