Effective 12:01 a.m., on Sept. 22, the Securities and Exchange Commission (“SEC” or “the Commission”) amended the Emergency Order (the “Amended Order”) that it issued on Sept. 18, prohibiting short selling in the publicly traded securities of certain identified financial firms in four principal respects: (1) permitting national securities exchanges to add additional financial firms to the list of firms whose securities are subject to the ban and to delete firms from the list upon their request; (2) permitting short sales as a result of the automatic exercise or assignment of equity options or futures contracts held prior to the Sept. 19 effective date of the original Emergency Order and permitting short sales resulting from assignment of call options, including those written after Sept. 19; (3) extending the market maker exception from the shortsale ban, for the duration of the Order, and setting forth the conditions under which short sales effected as part of bona fide market-making and related hedging activity with respect to derivatives, exchange traded funds (“ETFs”) and exchange traded notes (“ETNs”) are exempt from the ban; and (4) expressly exempting short sales of Rule 144 securities from the ban. The Order, as amended, terminates on Oct. 2, 2008, subject to further extension by the SEC.
Additions to List of Included Financial Firms
The Amended Order expands the list of financial firms in Appendix A to the Sept. 18 Emergency Order to include the publicly traded securities of any issuer identified by any national securities exchange listing such securities as being a “covered security.” The Amended Order requires each of the national exchanges that list the common equity of any financial institutions to publish a list of the “covered securities” on its website. All clients should check the websites of the exchanges for updates to the list. The SEC has authorized the national securities exchanges to exclude from their lists those issuers that choose not to be covered by the short sale ban.
We are including links to the following:
New York Stock Exchange:
American Stock Exchange:
Short Sales Resulting from Options Assignments and Futures Settlements
The Amended Order exempts short sales that occur as a result of the assignment of an equity option, or in connection with the settlement of a futures contract, either of which were held prior to Sept. 19 (the effective date of the original Emergency Order), from the short-sale ban.
In addition, to allow for the creation of long call options, the Amended Order permits short sales resulting from assignments to call writers upon exercise by the holder of the option.
Extension of the Market Maker Exception
The exception for options market makers provided by the original Amended Order expired at midnight on Sept. 19. The amended Order extends the market maker exception from Sept. 22 until the expiration of the Order and permits short sales by any market maker, including an OTC market maker, as part of bona fide market making or hedging activity directly related to bona fide market making in derivatives, ETFs and ETNs in the publicly traded securities of firms subject to the ban. However, if a market maker knows that a transaction will result in a customer or counterparty establishing or increasing an economic net short position, then the market maker is banned from effecting a short sale in the security underlying the derivative, ETF or ETN.
The approach adopted by the Commission in the Amended Order stems from the fact that the SEC does not have regulatory authority over swap agreements. By prohibiting a market maker from selling short to hedge a swap agreement where the market maker knows that its counterparty will be creating or increasing its short exposure, the Commission is attempting to reach a result comparable to that achieved by the United Kingdom’s Financial Services Authority (“FSA”) through the FSA’s outright ban on transactions (including swaps), resulting in increased net short economic exposure in financial firm securities.
We anticipate that the practical effect of the ban on market makers selling short to hedge when doing so would be part of a transaction that creates or expands economic short exposure will be to cause market makers to seek extensive representations from their counterparties in the event that they agree to effect such transactions.
As we noted in a previous Alert, it is unclear how the SEC will ultimately view trading in any instruments that could potentially depress the trading prices of the identified financial firms’ securities.
Exemption for Short Sales of Restricted Securities
The Amended Order expressly exempts any sales of securities pursuant to Rule 144 of the Securities Act of 1933 from the short sale ban.