Given the number of swiftly adopted and amended—and then expiring— emergency and temporary SEC orders relating to short selling, we are providing a summary of the current status of these rules.1 On October 3, 2008, the SEC officially announced that its temporary ban on short selling financial stocks would expire at 11:59 p.m. ET on Wednesday, October 8, 2008.2 The termination of the ban is an automatic result of the terms of an earlier emergency order which stated that the ban would expire three days after the President signed the Emergency Economic Stabilization Act of 2008.
The ban on the short selling of financial stock was not the only action the SEC recently took, and not all of the temporary actions expire on October 8, 2008. In addition, the SEC extended emergency orders requiring that institutional money managers report new short sales, rules addressing naked short selling, a rule relaxing the Rule 10b-18 safe-harbor for issuer repurchases and a revision to Regulation SHO to eliminate the exemption for options market makers. Although the SEC included these actions in its emergency orders, it stated in a related press release that some of the rules will remain in effect following the expiration of the emergency orders. These included the hard T+3 close-out requirement, penalties for violation and the change to Regulation SHO and the new short selling anti-fraud rule, Rule 10b-21.3 The rules relating to reporting by institutional investment managers, naked short selling and Rule 10b-18 are set to expire on October 17, 2008, and cannot be extended any further by emergency order.
The SEC did, however, announce that it is in the process of issuing interim final rules with respect to the reporting of new short sales by institutional investors and restrictions on naked short-selling. Assuming the interim final rules will be effective upon publication in the federal register, the interim final rules will likely be issued in the next week. The SEC has not stated any intention to extend its order revising Rule 10b-18.
Institutional Money Managers Must Continue Reporting New Short Sales
Form SH requires disclosure of the number and value of securities sold short for each Section 13(f) security (except for short sales in options), the opening short position, closing short position, and the amount and time of the largest intra-day short position during each day of the prior week. No filing is required if the short position constitutes less the 0.25 percent of the issuer’s outstanding shares and the fair market value of the short position is less than $1 million.4
The SEC had twice reversed its decisions regarding whether or not Forms SH would be made public by the SEC, ultimately deciding that Forms SH will not be made public by the SEC as a matter of course, although they are subject to requests under the Freedom of Information Act.5 The SEC has also revised the instructions to Form SH since its initial emergency order6 and has issued a Q&A regarding its completion and submission.7
The amendments and reversed decisions are a sign that the SEC is trying to address the turmoil in real time but is also clearly listening to and considering the concerns of the market participants impacted by the orders. Although the SEC has announced its intention to make these rules final by issuing interim final rules, the rules will be subject to public comment and possibly future amendment. Market participants should take the opportunity to inform the SEC of any concerns.
The SEC Extends Its Emergency Orders Directed at Naked Short Selling
The SEC extended the emergency orders directed at naked short selling, including (1) the hard T+3 close-out requirement for naked short selling; (2) penalties for violation, which include prohibition of further short sales without mandatory pre-borrow; (3) repeal of exception for options market makers from short selling close-out provisions in Regulation SHO; and (4) Rule 10b-21, the naked short selling anti-fraud rule.8
The staff of the Division of Trading and Markets has provided some guidance as to the operation of the new rules.9 This guidance has been formally adopted by the SEC.10 The SEC has announced that these rules will continue after the expiration of the emergency orders. However, as noted above, it is unclear if this needs to be done through interim final rules or if they are already permanent.
SEC Extends Revised Rule 10b-18 Safe-Harbor Standards
The SEC also extended its order that has temporarily relaxed the Rule 10b-18(b)(2) timing condition to permit otherwise compliant Rule 10b-18 purchases to constitute the opening transaction in a reported or exchange-traded security, or to occur during the one-half hour before the scheduled close of trading on the primary market for the security.11 The SEC also has relaxed the Rule 10b-18(b)(4) daily volume condition to permit Rule 10b-18 purchases up to 100 percent of the average daily trading volume (ADTV) of the security.
All other requirements of Rule 10b-18, including limitations on the manner in which purchases are effected and the prices at which shares are acquired, remain applicable. The SEC concluded that temporarily relaxing the timing and volume conditions in the rule 10b-18 safe harbor “will provide additional flexibility and certainty to issuers that consider executing repurchases during the current market conditions.”
The SEC Continues to Investigate Short Sale Abuses and Market Manipulation
The SEC Enforcement Division as well as other agencies such as the New York Attorney General continue to seek information from “significant hedge funds and other institutional traders” of their past trading positions in specific securities (without specifying which securities), and state that those institutions will be “required immediately to secure all of their communication records in anticipation of subpoenas for these records.”12 The SEC is serious about going after illegal short selling. The SEC announced yesterday that it charged Beverly Hills, California-based Lion Gate Capital, Inc. and its principal Kenneth Rickel with illegal short selling in the securities of 14 publicly traded companies.13 Further announcements in the coming weeks may follow.
Other Related Short Sale Issues
Despite the frenzy of the SEC’s orders relating to short sales, keep in mind that there are other longstanding rules such as Regulation SHO, the insider trading rules, Rule 105 of Regulation M and Section 5 of the Securities Act that also continue to regulate short sale conduct. The SEC’s focus on short selling during this recent crisis clearly indicates that the SEC believes short selling, although an important part of an efficient market, can involve abuses.14 It is possible that after the presidential election, a new SEC could consider addressing short selling in a broader context.
Over the last year, for example, the SEC has experienced a number of set-backs in enforcement actions related to short selling in connection with PIPE transactions resulting in dismissals of its claims related to Section 5 of the Securities Act of 1933 and insider trading.15 Further, the recent CSX litigation16 has highlighted the explosive growth of derivative securities in the markets and has raised questions regarding the current disclosure requirements for short sales and derivatives on Schedule 13D. The SEC could address short sales and derivatives disclosure together in the long term. Additionally, the SEC may consider reinstating the uptick rule as has been called for by commentators, although it has presently not given any indication that it would do so.