The Securities and Exchange Commission (“SEC”) announced a trifecta of emergency orders on Friday, September 19, 2008, to address the rapidly unfolding and unprecedented market events, and market participants rushed to implement new procedures in compliance with those orders.
- Most dramatically, the SEC announced a temporary emergency ban on short selling the securities of 799 financial services companies. http://www.sec.gov/rules/other/2008/34-58592.pdf (including an appendix containing a list of companies and sticker symbols).
- The SEC also issued an emergency order that will require certain institutional investment managers to report on new Form SH their short sales of other publicly traded equity securities that are effected on or after Monday, September 22.
- In addition, the SEC also issued an emergency order temporarily altering timing and volume conditions in order to expand the safe harbor in Rule 10b-18 to companies repurchasing their own shares. http://www.sec.gov/rules/other/2008/34-58588.pdf.
The orders are all dated September 18 and will remain effective until 11:59 P.M. Eastern Time on Thursday, October 2, 2008,1 although the SEC could determine to extend any or all of the orders until October 18, 2008.2
The SEC’s emergency steps came on the heels of similar action by the United Kingdom’s Financial Services Authority (FSA). Effective at midnight UK time on September 18, the FSA also temporarily banned short selling of financial stocks and added disclosure requirements, all in response to concerns that shares in UK banks were being targeted by short sellers.
These dramatic and coordinated cross-border regulatory actions also followed the SEC’s announcement on Wednesday, September 17, that it was adopting three trading rules aimed at curbing abusive short-selling of securities in all public companies. The three rules: (i) establish a requirement that short sellers and their brokerdealers deliver securities and close out short sale transactions no later than the close of business on the settlement date (three days after the sale transaction date, or T+3), thereby eliminating so-called “abusive naked short selling”; (ii) eliminate the options market maker exception from the mandatory close-out requirement for threshold securities found in Rule 203(b)(3) of Regulation SHO; and (iii) create an antifraud rule that prohibits short sellers from deceiving their broker-dealers or other market participants about their intention or ability to deliver securities in time for settlement.
A description of each of the emergency orders, and some preliminary reactions as to their implications for market participants, are presented below.
Emergency Short Selling Ban.
The SEC’s emergency ban prohibits short selling, as defined in Rule 200 of Regulation SHO, in “any publicly traded securities” of 799 financial companies identified in the appendix to the rule.4 The SEC compiled the list of affected issuers and securities based on the Standard Industrial Classification codes for banks, insurance companies and securities firms. Given the hasty nature of the emergency order process, the SEC will likely amend the emergency short sale ban to address corrections, modifications and additions to the list of 799 issuers and trading symbols; in fact, we understand that the SEC staff is working with the staff of the NYSE and NASDAQ to identify issuers whose securities should be added to the list.
The emergency rule lists the following, as the only exceptions to the ban on short selling of these securities:
- short sales by “certain bona fide market makers;”
- short sales occurring “as a result of automatic exercises or assignment” of previously held equity options; and
- as a one-day measure for the first effective day of the order, short sales effected by options market makers “as part of bona fide market making and hedging activities related directly to bona fide market making in derivatives on the publicly traded securities” of any of the 799 companies.
After issuing the emergency order, the SEC’s Division of Trading and Markets announced later on September 19 that it was recommending to the SEC a modification to the order that would extend this one-day exemption to the entire life of the emergency order. This modification would make the SEC’s order consistent with the FSA requirements described in more detail below.
Investment Manager Short Sale Disclosure Requirements.
In practical terms, the emergency order requiring disclosure of short sales applies to any institutional investment manager who has filed or was required to file a Form 13F for the calendar quarter ended June 30, 2008, under Section 13(f) of the Exchange Act and Rule 13f-1(a) thereunder. The new reporting requirements are modeled after Form 13F and incorporate many of the same definitions and concepts.5
The new disclosure order requires that any covered “institutional investment manager” submit a Form SH with the SEC on the first business day of every calendar week immediately following a week in which the manager has entered into any short positions with respect to a Section 13(f) security, except for any short position(s) for options. The Form SH must disclose, with respect to each Section 13(f) security that is not an option, the number and value of securities sold short for each Section 13(f) security during the day, as well as the opening short position, the closing short position, the largest intraday short position, and the time of the largest intraday short position for that Section 13(f) security on each calendar day in which the manager engaged in trading activity with respect to short sales.
A manager is not required to file a Form SH when no short sales of a Section 13(f) security have been effected since the previous filing of a Form SH. In addition, the disclosure requirement will only apply to short sales effected on or after Monday, September 22, the effective date of the order, until the emergency order is no longer in effect. Finally, the order provides that a manager is not required to report a short position that is otherwise reportable if: (1) the short position in the Section 13(f) security constitutes less than one quarter of one percent of the class of the issuer’s Section 13(f) securities issued and outstanding as reported on the issuer’s most recent annual or quarterly report (or any current report) filed with the SEC, unless the manager knows or has reason to know that such information is inaccurate; and (2) the fair market value of the short position in the Section 13(f) security is less than $1,000,000. The new order appears to require the reporting of all new short positions, even those that are offset by long positions. Under this interpretation, neither the SEC nor other market participants will likely be able to determine whether a manager is net long or net short at least until a manager files its next Form 13F 45 days after the end of the next calendar quarter.
A Form SH must be filed electronically and it will be publicly available on EDGAR. No procedure for seeking confidential treatment of information filed with or transmitted to the SEC will apply to the information contained on a Form SH. The first Form SH will be required to be filed with the SEC on Monday, September 29th. Absent an extension or new rule, only one Form SH would need to be filed.
As noted above, the new order looks to definitions contained in Section 13(f) of the Exchange Act and Rule 13f-1 thereunder. These provisions define “institutional investment manager” to include, among others:
- any entity that either invests in, or buys and sells, securities for its own account, including banks, insurance companies, and broker-dealers, as well as corporations and pension funds that manage their own investment portfolios;
- any natural person or entity that exercises investment discretion over the account of any other natural person or entity, such as investment advisers that manage private accounts, mutual fund assets, or pension plan assets; and
- any foreign “institutional investment manager” if it uses any means or instrumentality of United States interstate commerce in the course of its business.
The term “Section 13(f) security” means equity securities of a class described in Section 13(d)(1) of the Exchange Act, and includes generally US exchange-traded (e.g., NYSE, AMEX) or NASDAQ-quoted stocks, equity options and warrants, shares of closed-end investment companies, and certain convertible debt securities. The SEC publishes an official list of Section 13(f) securities which can be found at http://www.sec.gov/divisions/investment/13flists.htm. Shares of open-end investment companies (i.e., mutual funds) are not included, but shares of exchange-traded funds ("ETFs") are on the SEC’s official list.6
Exchange Act Rule 10b-18 provides an issuer (and its affiliated purchasers) with a safe harbor from liability for manipulation solely by reason of the manner, timing, price and volume of their repurchases of the issuer's common stock. The SEC “determined that issuer repurchases can represent an important source of liquidity during times of market volatility," and therefore temporarily altered the timing and volume conditions in the safe harbor to "provide additional flexibility and certainty to issuers that consider executing repurchases during the current market conditions.” All other provisions of Exchange Act Rule 10b-18, including the manner and price of purchase conditions, were not altered by the order.7
Without any liability for manipulation under Section 9(a)(2) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 thereunder, issuers and affiliated persons are now permitted to make opening regular way purchases and purchases up to a market close and may greatly increase the amount of daily repurchases (from 25% of ADTV to 100% of ADTV) (subject to compliance with the one broker rule and the price condition). Even so, restrictions on trading while aware of material, nonpublic information remain in place, and given the proximity to quarter-end for many companies, it may be difficult – even with this relief – to embark upon new repurchase plans within the 10-day emergency relief window. To the extent that companies consider doing so, they should assess the release of known material results, particularly positive developments. Allowing companies increased flexibility in uncertain times to repurchase shares is an important step in stabilizing the market.
FSA Ban and Disclosure Requirement.
The FSA ban introduced two new provisions in relation to the short selling of stock in UK financial sector companies: a prohibition on the active creation or increase of net short positions in UK financial sector companies from midnight, UK time, Thursday, September 18; and a requirement for daily disclosure, beginning Tuesday, September 23, of all net short positions of 0.25% or more of the issued capital of the relevant company held at market close on the previous working day. A "net short position" for these purposes is that which gives rise to an "economic exposure to the issued share capital" of a company, and may be by way of any instrument (contract for differences, spread bet, option, etc.) that gives rise to such an exposure. A holder of economic interests may net its long and short positions in that company in determining whether it is subject to the FSA ban and in calculating whether the net short position is 0.25% or more.
The provisions have been implemented as part of the FSA's civil market abuse regime (and appear in the FSA's Code of Market Conduct). The provisions only apply in relation to net short positions in UK financial sector companies, which are defined as UK banks, UK insurers and UK incorporated parents of such banks or insurers. The FSA has published a list of such UK financial sector companies (prepared on a "best endeavors basis").
The provisions will remain in force until January 16, 2009, although the FSA has said that they will be reviewed after 30 days. The FSA has also noted that a comprehensive review of the rules on short selling will be published in January 2009.
Eliminating any remaining doubt that a new era of trading oversight is underway, the SEC also announced in yet another press release on Friday, September 19, a “sweeping expansion” of its investigation into possible market manipulation in the securities of financial institutions. Likely pursuant to its extraordinary powers to demand such information pursuant to Section 21(a) of the Securities Exchange Act of 1934, the SEC warned that “hedge fund managers, broker-dealers and institutional investors with significant trading activity in financial issuers or positions in credit default swaps will be required, under oath, to disclose those positions to the SEC and provide certain other information” as part of this expanded investigation.8
More rulemakings and interpretive releases are likely as well. The SEC’s Division of Trading and Markets Staff is likely to issue interpretive answers to frequently asked questions concerning the emergency orders, just as it did in connection with this summer’s emergency short selling rules.9 Among other issues, such FAQ’s may clarify that the order addresses only the equity securities identified by CUSIP in the attachment to the rule (and not, for example, registered debt, preferred shares, ETFs, securities futures or convertible securities), and may provide answers to multiple questions about hedging activities under the emergency short sale ban. The SEC’s emergency order temporarily banning short selling of financial stocks also indicates that more SEC action is under consideration by noting that the SEC “will continue to consider measures to address short selling concerns in other publicly traded companies.”10 Meanwhile, market regulators and participants are already looking ahead to what will happen when the short selling ban involving financial institutions, in particular, expires.11