The SEC has issued two announcements recently relating to the regulation of short sales. First, on July 27, 2009, the SEC announced several actions aimed at preventing short sale abuses and increasing public disclosure of short sale information. More recently, on August 17, 2009, the SEC announced that it is seeking public comment on a new approach to short selling price test restrictions (uptick rule) that differs from the two approaches previously proposed.

Effects of the Actions Announced on July 27:

The actions announced on July 27 affect temporary rules enacted in October 2008 to stop short sale abuses. The SEC 1) made permanent a rule designed to curtail naked short selling, 2) allowed a short sale reporting interim rule to expire, and 3) announced a public roundtable on September 30, 2009, to discuss additional short sale measures. These actions are discussed in more detail below.

  • Permanent Amendment to Regulation SHO. Rule 204 of Regulation SHO makes permanent the provisions of the Interim Final Temporary Rule 204T which was adopted on October 17, 2008, and expired on July 31, 2009. Rule 204 requires that clearing firms or their participating broker-dealers purchase or borrow securities of like kind and quantity to close out any positions in which shares of equity securities have not been delivered by the close of business on the settlement date (a “fail to deliver”). Failure to satisfy the close-out requirement results in a penalty under which a clearing firm, or its participating broker-dealer, cannot accept a short sale order in the relevant security or effect a short sale in the security for its own account unless it first borrows or enters into a bona fide agreement to borrow the security (a “preborrow requirement”). The restriction remains in place until the clearing firm closes out the fail to deliver position by purchasing securities of like kind and quantity and the purchase has been cleared and settled.
  • Expiration of Rule 10a-3T. Interim rule 10a-3T under the Exchange Act expired on July 31, 2009. Rule 10a-3T required certain institutional investment managers to provide short sale and short position information for Section 13(f)securities 1 (excluding options) to the SEC on Form SH. Instead of making permanent the interim final rule, the SEC announced that it is working together with several self regulatory organizations (SROs) to increase the public availability of short sale related information through a series of other actions. The SEC has not yet specified which SROs it anticipates will participate. These actions include:
    • Daily Publication of Short Sale Volume Information. The SROs will begin publishing on their websites the aggregate short selling volume in each individual equity security for that day.
    • Disclosure of Short Sale Transaction Information. The SROs will begin publishing on their websites on a one-month delayed basis information regarding individual short sale transactions in all exchange-listed equity securities.
    • Twice Monthly Disclosure of Fails to Deliver Data. The SEC will enhance the publication on its website of fails to deliver data so that fails to deliver information is provided twice per month and for all equity securities, regardless of the fails level.
  • Public Roundtable. The SEC intends to hold a public roundtable on September 30, 2009, as part of its examination of whether additional measures are required to address short sale abuses and enhance market quality. The roundtable will focus on securities lending, pre-borrowing, and possible additional short sale disclosures. The roundtable of investors, issuers, financial services firms, SROs and academics will consider, among other things:
    • Adding a short sale indicator to the tapes;
    • Requiring public disclosure of individual large short positions;
    • A mandatory pre-borrow requirement (potentially on a pilot basis); and
    • Securities lending issues, such as compensation, disclosure, collateral and cash-reinvestment.

New Short Sale Prohibition Considered:

The August 17, 2009, release announced that the SEC is reopening the comment period to the “Amendments to Regulation SHO” (originally closed on June 19, 2009) to allow comments on a new “alternative uptick rule.” The alternative uptick rule would allow short selling only at an increment above the national best bid. This approach is an alternative to two previous approaches the SEC had proposed in April 2009: 1) a permanent market-wide short sale restriction based on either the last sale price or the national best bid and/or 2) a “circuit-breaker” approach that would restrict short sales for a particular security if the price of that security experienced severe declines.

The alternative uptick rule differs from the previous market-wide short sale prohibitions as it would not allow short selling at the current national best bid or last sale price. The SEC noted that because the alternative uptick rule would only permit short selling at an increment above the national best bid, it would not allow short sales to get immediate execution (even in an advancing market) and therefore would restrict short selling to a greater extent than either of the proposed market-wide short sale restrictions. The SEC recognized that this greater restriction could potentially lessen some of the benefits of short sales, such as increased market liquidity and greater pricing efficiency. The SEC also noted that the alternative uptick rule could possibly be implemented more quickly and with less cost than the prior proposals.

Comments on this alternative were due by September 21, 2009. The SEC particularly sought comments on the alternative uptick rule as a permanent market-wide approach and whether the alternative uptick rule should be combined with a circuit breaker approach.