On September 17 and 18, 2008, the Securities and Exchange Commission adopted a series of orders pursuant to its statutory emergency powers that restrict certain short selling activities and require certain institutional managers to report their new short positions.
These orders have been widely reported in the press as the prohibitions against shorting the securities of approximately 800 publicly traded financial institutions, restricting the deceptive practice called “naked shorting,” and requiring institutional managers to report their new short positions to the SEC on Form SH. These orders were set to expire at 11:59 P.M. on October 1 and 2, 2008. The Commission announced on October 1 that it has extended these emergency orders until 11:59 P.M. on October 17, 2008. The Commission‘s emergency powers only allow these orders to remain in effect for a maximum of 30 days from initial adoption. The Commission also adopted the guidance previously issued by the Staff of the Division of Trading and Markets, which provided details on the technical and operational implementation of these orders. In addition, the September 17 and 18 orders and rules imposed a “hard” delivery requirement for short sales of “T+3”, eased restrictions on the ability of issuers to repurchase their securities under Rule 10b-18, repealed the options market maker exception to Regulation SHO, and reiterated the illegality of “naked short selling” under the federal antifraud rule. These additional measures were extended on October 1 as well, until October 17, 2008.
The Commission announced these actions through a press release accompanied by two separate orders of the Commission. We observe some substantive distinctions between the press release and these orders.
In the press release, the Commission cited the ongoing work of the United States Congress to enact legislation to stabilize the American economy. The extensions are intended to afford Congress the time necessary to complete its work on this legislation. The Commission announced its intention to terminate the September 17 and 18 orders on the third business day after enactment of the legislation, but in no event later than October 17. However, the text of the extending orders themselves only refers to the October 17 date, and only the press release mentions the legislation, presumably implying further action by the Commission to terminate the September 17 and 18 orders if the legislation is enacted before October 17.
We observe further differences between the orders that have been posted by the SEC and the press release. The press release indicates that the Commission extended all of the previously adopted emergency orders, as described above. However, the orders that were posted on October 1 only apply to the “naked shorting” order and the 10b-18 repurchase order. We think this is simply a matter of delay in publishing the remaining extension orders, given the clarity of the press release. We also note that the press release stated the Form SH reporting requirements and the “T+3” hard delivery requirements may be converted into interim rules. As interim rules, they would be subject to public comment and, if adopted, would become permanent rules as they may be modified following the comment process. If adopted as rules, they would extend well beyond the October 17 expiry.
In the orders effecting these extensions adopted on October 1, the Commission reiterated its concerns for the “potential of sudden and excessive fluctuations of securities prices generally and disruption in the functioning of the securities markets that could threaten fair and orderly markets.” The Commission stated in its press release announcing the extensions the pros and cons of short selling activities. The Commission noted “that short selling plays an important role in the market for a variety of reasons, including contributing to efficient price discovery, mitigating market bubbles, increasing market liquidity, promoting capital formation, facilitating hedging and other risk management activities, and importantly, limiting upward market manipulations.” The Commission also pointed to some of the negatives of short selling: “there are circumstances in which short selling can be used as a tool to mislead the market. For example, short selling can be used in a downward manipulation whereby a manipulator sells the shares of a company short and then spreads lies about a company‘s negative prospects. This harms issuers and investors as well as the integrity of the market. This kind of manipulative activity is particularly problematic in the midst of a loss in market confidence.” The Commission determined that short selling activity could lead to diminished confidence in the overall financial system: “For example, in the context of a credit crisis where financial institutions face liquidity challenges, but are otherwise solvent, a decrease in their share price induced by short selling may lead to further credit tightening for these entities, possibly resulting in loss of confidence in these institutions.”
We note that the U.S. Senate voted to approve the stabilizing legislation on October 1, and the measure now moves to the U.S House of Representatives for deliberation. We will continue to monitor the progress of this legislative and regulatory activity.