On September 17, 2013, the SEC’s Office of Compliance Inspections and Examinations (OCIE) issued a risk alert related to Rule 105 of Regulation M, which governs short selling prior to the pricing of certain offerings. This risk alert was issued the same day the SEC announced enforcement actions against 23 firms for violations of Rule 105. In the risk alert, the staffs of OCIE and other SEC Divisions provide guidance to the securities industry on compliance with Rule 105 based on their observations from related SEC enforcement actions and examinations conducted through OCIE’s National Exam Program (NEP).
A goal of Rule 105 of Regulation M is to deter the manipulation of market prices through short selling. Rule 105 makes it unlawful for a person to purchase securities in a firm commitment equity offering from an underwriter or broker-dealer participating in the offering if, during a restricted period (typically the period beginning five days before the pricing of the offering), that person sold short the security that is the subject of the offering. Certain exceptions apply for bona fide purchases, separate accounts, and investment companies.
The SEC has actively identified and punished violations of Rule 105. Since 2010, the SEC has collected over $42 million in disgorgement, penalties, and interest in connection with over 40 settled enforcement actions involving violations of Rule 105. Over 75% of these enforcement actions involved investment advisers (registered and unregistered).
The purpose of the SEC’s risk alert is to encourage firms to improve or implement policies and procedures aimed at compliance with Rule 105. To this end, the risk alert advises that firms can advance compliance with Rule 105 by:
- Providing training to their employees regarding application of the rule;
- Developing and implementing policies and procedures reasonably designed to achieve compliance with the rule by identifying, mitigating, and managing risks involving short sales in connection with follow-on or secondary offerings; and
- Enforcing their Rule 105 policies and procedures.
While NEP examination summary letters are not publicly available, the risk alert suggests that additional guidance can be gathered through reviewing the over 40 recent SEC enforcement actions involving Rule 105 violations, many of which are highlighted in an appendix to the alert. Another appendix to the alert includes a helpful list of reference sources relating to Rule 105.