A Canadian Story on Naked Short Selling

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Whichever side you’re on, there’s no doubting that this controversial stock strategy is pissing off the small cap companies and their supporters in Canada.

What are we talking about? Naked short selling.

This complex and often misunderstood strategy plays a significant role in the dynamics of stock trading, especially impacting small-cap, less stable companies.

Biovail Corporation, once Canada's largest publicly traded pharmaceutical company, found itself in a high-profile controversy centered around this very issue in the early 2000’s.

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🔥 Biovail Corporation

Founded in the late 1980s, Biovail quickly rose to riches, becoming Canada's largest publicly traded pharmaceutical company by the early 2000s.

At its peak, Biovail reached a market capitalization of approximately US$7.4 billion.

The company specialized in "controlled-release" technology, an innovative approach to drug delivery that set it apart in the competitive pharmaceutical industry.

Biovail's products, including its notable anti-hypertension drug Tiazac, were sold in over 50 countries worldwide.

What is naked short selling?

In traditional short selling, an investor borrows shares of a stock with the intention to sell them, hoping to buy them back at a lower price. The profit comes from the difference between the selling price and the repurchase price.

Naked short selling bypasses a crucial step in this process. Instead, sellers sell shares they have not borrowed or, in some cases, that may not even exist. This can lead to more artificial shares in circulation.

More (artificial) shares out = more dilution = lower share price.

Is it even legal?

In Canada, and other countries, naked short selling is a gray area in terms of legality - but if you ask someone in the industry, its fair game for anyone.

In the US, illegal. 

Biovail gets shorted

In 2003, the Biovail controversy began with SAC Capital's involvement. SAC Capital, a well-known hedge fund, requested a stock analysis report from Camelback, an Arizona-based firm, causing large fluctuations in it’s stock price.

Biovail's management alleged that part of the reason for their stock's volatility was naked short selling. 

They claimed that certain hedge funds and market players were deliberately selling large volumes of un-borrowed Biovail shares, creating a false market surplus and driving down the stock price.

They suggested a coordinated effort to manipulate the market for financial gain at the expense of the company and its shareholders - a bold accusation.

In March 2006, a "60 Minutes" story on Biovail focused on allegations made by the company against hedge funds and stock analysts. Biovail claimed these entities were engaging in a coordinated effort to manipulate its stock price through negative reports and naked short selling.

The segment brought national attention to the controversy surrounding Biovail's stock volatility and financial practices.

Legal Battle

Biovail took legal action against the alleged perpetrators of the naked short selling. The outcomes of these lawsuits were mixed, with some settlements and some cases being dismissed.

And for investors, confidence was shaking which caused even more decline in share price.

Canadian regulatory authorities, including the Ontario Securities Commission, faced pressure to scrutinize the practice of naked short selling and ensure market fairness.

📉 Fall out

In March 2008, the SEC sued Biovail and some former executives for overstating earnings and misleading investors, resulting in a $10 million settlement by Biovail.

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This legal action affirmed Gradient Analytics' critical analysis of Biovail, highlighting concerns about company retaliation against analysts.

Subsequently, "60 Minutes" faced criticism for its coverage of Biovail's story.

In September 2010, Biovail Corporation merged with Valeant Pharmaceuticals International.

Eugene Melnyk, the founder of Biovail Corporation and owner of the Ottawa Senators up until September of 2023, played a major role in highlighting the effects of naked short selling.

In 2011, the Ontario Securities Commission banned Eugene Melnyk from senior roles in public companies in Canada for five years, imposing fines totaling over $565,000 for violations of securities laws.

IIROC's recent focus on naked short selling, particularly in small-cap companies, mirrors past market dramas like Biovail's.

This shows regulators' commitment to evolving, although their competence is questionable.

👋 Colton, Stock Monster.

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