On April 10, 2009, the Securities and Exchange Commission ("SEC") requested comments for proposed amendments to Regulation SHO under the Securities Exchange Act of 1934 ("Exchange Act"). Release No. 34-59748, File No. S7-08-09. The SEC is proposing two approaches to restrictions on short selling—one approach is the "Short Sale Price Test" and the other is the "Circuit Breaker Price Test." The SEC is also proposing a requirement that a broker-dealer mark certain sell orders "short exempt."


Comments on the proposals should be submitted on or before 60 days after the proposals are published in the Federal Register (publication expected in the very near future). The proposed implementation period is three months from the effective date of the amendments.

Background on Short-Selling Restrictions and Circuit Breakers

The SEC adopted former Rule 10a-1 (the "tick test" or "uptick rule") in 1938 to restrict short selling in a declining market, and the core provisions remained virtually unchanged for almost 70 years. As market systems and trading strategies changed over time, the SEC added exceptions to the former Rule 10a-1 and granted numerous written requests for relief. In July 2004, the SEC adopted Rule 202T of Regulation SHO, which established procedures for the SEC to temporarily suspend short sale price tests for a prescribed set of securities, so that the SEC could study the effect of price-test restrictions and compile evidence and data. In July 2007, after a careful, deliberative rulemaking process carried out in multiple stages from 1999 through 2006, and after extensive public comment and staff studies, the SEC eliminated all short sale price test restrictions, and prohibited any self-regulatory organization ("SRO") from having a short sale price test.

Also as background, in the past, the SEC has approved proposals to restrict or halt trading if key market indexes fall by specified amounts. For example, such restrictions were approved in response to the October 1987 market break. All stock exchanges and FINRA currently have rules or policies to implement coordinated circuit breaker halts.

Now, because of the extreme market conditions we are currently facing, the SEC has received requests from many commenters to consider imposing restrictions with respect to short selling, in part based on the belief that such action will help restore investor confidence. The SEC has always believed that short selling provides the market with important benefits, including market liquidity and pricing efficiency, but that short selling may be used to illegally manipulate stock prices. The SEC now believes that either a short sale price test restriction or a circuit breaker rule may be appropriate to address the recent change in market conditions and the erosion of investor confidence.

The Proposals

One of the SEC's proposals suggests implementation of two possible alternative "Short Sale Price Tests" that would be implemented market-wide and on a permanent basis. These are the "Proposed Modified Uptick Rule" and the "Proposed Uptick Rule," and could be implemented through a policies-and-procedures approach, a straight prohibition approach, or some combination thereof. The Proposed Modified Uptick Rule would require trading centers to have policies and procedures reasonably designed to prevent the execution or display of a short sale order in a covered security at a down-bid price. A "down-bid price" is defined as a price that is less than the current national best bid or, if the last differently priced national best bid was greater than the current national best bid, a price that is less than or equal to the current national best bid. Also, a trading center's policies and procedures must be reasonably designed to permit the execution or display of a short sale order of a covered security marked "short exempt" without regard to whether the order is at a down-bid price. Specific requirements are proposed as to when a broker-dealer may mark a sale order "short exempt."

As an alternative to proposing a Short Sale Price Test based on the national best bid, the SEC proposed a modified version of former Rule 10a-1 to provide the public with an opportunity to comment on the utility of such a price test, especially in light of the recent changes in market conditions. This is the "Proposed Uptick Rule," and would use the last sale price as the reference point for short sale orders. Specifically, it would provide, in effect, that no short sale order may be transacted below the last sale price, if the trades are reported pursuant to an effective transaction reporting plan, and if information as to such trades is made available in accordance with such plan on a real-time basis to vendors of market transaction information. Paragraph (c) of Rule 201 sets forth several exceptions to promote its workability, and these are based on exceptions contained in former Rule 10a-1 and exemptive relief granted pursuant to that rule. The exceptions are further discussed in the Release.

In addition to or as an alternative to the two Short Sale Price Tests discussed above, the SEC is proposing two different "Circuit Breaker Price Tests"—the "Circuit Breaker Halt Rule" and the "Short Selling Circuit Breaker Price Test." The Circuit Breaker Halt Rule is triggered when there is a severe price decline in a particular security, and it would prohibit any person from selling short that security, wherever it is traded, while the circuit breaker is in effect, subject to certain exceptions that are substantially identical to exceptions that were included in the Short Sale Ban Emergency Order, as amended by the SEC Sept. 21, 2008. This rule would operate in place of, or in addition to, a Short Sale Price Test restriction.

The second proposed Circuit Breaker Price Test is the "Short Selling Circuit Breaker Price Test" that is further delineated into a "Proposed Circuit Breaker Modified Uptick Rule" and a "Proposed Circuit Breaker Uptick Rule." Under the Proposed Circuit Breaker Modified Uptick Rule, once there is a 10 percent intraday decline in the price of a security from the prior day's closing price, as reported in the consolidated system, this would trigger a circuit breaker that results in a short sale price restriction. Under this rule, the short sale price restriction is based on the national best bid and is in place for the remainder of the trading day. Similarly, under the Proposed Circuit Breaker Uptick Rule, once there is a 10 percent intraday decline in the price of a security from the prior day's closing price, this would trigger the circuit breaker that results in a short sale price restriction and is based on the last sale price of the individual security. These Circuit Breaker Rules would be imposed in place of a permanent, market-wide short sale price test restriction, and would permit certain exceptions, similar to the Proposed Modified Uptick Rule and the Proposed Uptick Rule discussed above. The SEC believes the temporary imposition of these rules is appropriate; however, the SEC seeks comment regarding whether longer or shorter time periods would be more effective.

Finally, the SEC is proposing an amendment to Rule 200(g) of Regulation SHO, which would again require a broker-dealer to impose a "short exempt" marking requirement so that it would require "[a] broker or dealer to mark all sell orders of any equity security as 'long,' 'short,' or 'short exempt.'" The "short exempt" marking requirement would only be permitted if the seller is availing itself of the various exceptions to the application of the restrictions of the proposed uptick rule.