OTTAWA - A Toronto-based insurance company is seeking $5 billion in damages from a number of U.S. hedge funds and investment bankers, alleging that they participated in a short-selling scheme that "severely harmed" the company.
On July 14, the Ontario Securities Commission approved proposed rule amendments from The Canadian Depository for Securities Ltd., allowing it to enforce new U.S. rules regarding short selling.
The move by the Toronto-based OSC closed the barn door after the short-sellers had escaped, according to a complaint that Fairfax Financial Holdings Ltd. filed July 26 in Superior Court in New Jersey's Morris County. It alleges violations of various state laws, including the New Jersey Racketeer Influenced and Corrupt Organizations Act, and asks for treble damages.
Fairfax has operations in the United States.
One firm named in the suit, Stamford, Conn.-based hedge fund SAC Capital Management LLC, is also the subject of a similar lawsuit filed by another Canadian company. In February, Biovail Corp., a pharmaceutical company based in Ottawa, filed a $4.6 billion lawsuit against SAC, a $7 billion fund headed by well-known investor Steven Cohen, and several other hedge funds, accusing them of conducting a scheme similar to the one outlined by Fairfax.
At the heart of the lawsuit are short-selling strategies dating back several years. John D. Gwynn, an analyst with Memphis, Tenn.-based Morgan Keegan & Co. Inc., is singled out for allegedly collaborating with certain hedge funds to develop "extreme criticisms" of Fairfax to support their shorting strategies.
He "continued [a] relentless litany of negative reports in support of his clients' enormous short positions, rebroadcasting ... standard criticisms, inventing others and consistently attempting to neutralize the increasingly positive news out of Fairfax," the lawsuit states.
Morgan Keegan spokeswoman Kathy Ridley called Fairfax's claims "outrageous."
"While it is not our practice to comment on any prospective litigation, we believe these claims are outrageous and defamatory," she was quoted as saying in the Memphis Commercial Appeal newspaper.
The proposed amendments to Canadian rules require participants using the Toronto-based CDS' Canada-U.S. cross-border services to comply with the new short-selling rule, known as Regulation SHO, in the United States.
"Under the rule amendments, CDS will have the authority to close out a fail-to-deliver position of a participant using the cross-border services in certain equity securities trading in the U.S. that are on a U.S. SRO list of securities experiencing substantial and persistent failures to deliver," a CDS spokeswoman said.
"Regulation SHO's closeout requirements were designed to address problems with failures to deliver in certain equity securities," the CDS said in a press release.
Regulation SHO defines ownership of securities, specifies aggregation of long and short positions, and requires broker-dealers to mark sales in all equity securities "long," "short" or "short exempt."
The CDS is owned by major Canadian banks and the members of the Toronto Stock Exchange and the Investment Dealers Association of Canada. The majority of the CDS' owners are also users of its clearing and depository services.
The CDS initiative firms up the stance that the IDA, a Toronto-based organization with quasi-regulatory powers over its members, took nearly two years ago. The IDA said at the time: "It is our expectation that members trading directly or indirectly on SEC-regulated markets will adjust their trading practices to comply with this rule. Failure by a member to comply with this rule may be considered to be engaging in a 'conduct or practice that is unbecoming or detrimental to the public interest' and therefore a breach of IDA Bylaw 29.1."
"The OSC initiative is a good one, for sure," said Jim McGovern, chairman of AIMA Canada, a Toronto-based chapter of the global Alternative Investment Management Association Ltd. of London. He also is president and chief executive of Toronto-based Arrow Hedge Partners Inc. "As for Fairfax, I think their financial results speak for themselves."
Fairfax launched its lawsuit the day before it announced that it was restating earnings due to accounting errors.
The impact of the restatement will be a decrease in shareholders' equity as of March 31 by upwards of $220 million.
As for short selling itself, "there's nothing wrong with it, per se; it is just a way of casting a vote in the marketplace," said Tristram S. Lett, deputy chairman of AIMA Canada and managing director, absolute-return strategies, at Integra Capital Management Corp. of Toronto. "On the other hand, in the hands of unscrupulous operators, it can do real damage to a company."