The SEC continues its focus on abusive short selling by making interim final temporary rules permanent, enforcing short selling restrictions and seeking comments on an Alternative Uptick Rule.
In the past year, the Securities and Exchange Commission has placed considerable focus on abusive short selling. In the fall of 2008, the SEC issued interim final temporary rules to Regulation SHO designed to curtail abusive short selling and increase disclosure of short selling activity. On April 10, 2009, the SEC issued proposed amendments to Regulation SHO that would reinstate restrictions on short sales through either price restrictions or circuit breakers. An overview of these proposed amendments is discussed in our previous Corporate Alert “The SEC Holds Roundtable on Proposed Restrictions on Short Selling” available at http://www.drinkerbiddle.com/secroundtable.
The SEC’s focus on abusive short selling has continued throughout the summer. On July 27, 2009, the SEC issued a press release outlining the steps it has taken to curtail abusive short selling and to increase market transparency, including addressing the interim final temporary rules previously adopted in 2008. The SEC also increased its enforcement efforts by settling two cases alleging abusive short selling on August 5, 2009. In addition, on August 17, 2009, the SEC issued a proposal seeking comments on an Alternative Uptick Rule, a variation on the price restriction test previously proposed on April 10, 2009.
Interim Final Temporary Rules
In its press release dated July 27, 2009, the SEC announced that it made permanent, with limited modifications, interim Rule 204T of Regulation SHO, which was due to expire on July 31, 2009. The permanent Rule 204 seeks to reduce the potential for abusive naked short selling by requiring broker-dealers to deliver promptly securities subject to a short sale. Subject to certain exceptions, final Rule 204 generally requires market makers who have failed to deliver on a short sale to promptly borrow or purchase shares to deliver on the short sale by no later than the beginning of trading on the day after the failure first occurred (i.e., T+4). The SEC noted that since the fall of 2008, when interim Rule 204T was adopted, fails to deliver in all equity securities decreased by approximately 57 percent.
The SEC also let expire another interim final temporary rule, Rule 10a-3T on August 1, 2009. Rule 10a-3T required certain institutional investment managers to report weekly on Form SH their short sales and short positions in certain securities. Rather than making the rule permanent, the SEC announced that it would work with self-regulatory organizations to make publicly available on SRO websites (i) daily short sale volume information, (ii) individual short sale transactions on a one-month delayed basis, and (iii) data on fails to deliver twice monthly.
On August 5, 2009, the SEC settled claims with two option traders and their broker-dealers for alleged violations of Regulation SHO. The SEC claimed that Hazan Capital Management LLC (HCM) and TJM Proprietary Trading LLC (TJM) had engaged in abusive naked short selling by failing to locate shares before effecting a short sale and for failing to deliver by the delivery date. Without admitting wrongdoing, HCM and its principal owner and majority owner, Steven Hazan, agreed to disgorge $3 million and Hazan was barred from being associated with any broker-dealer for five years. Without admitting wrongdoing, TJM, one of its traders, Michael Benson, and Benson’s supervisor, John Burke, agreed to disgorge $541,000 and pay a fine of $250,000. Additionally, Benson is barred from being associated with any broker-dealer for three months and Burke is barred from supervising traders for nine months.
Additional Amendments to Regulation SHO
On August 17, 2009, the SEC issued additional proposed amendments to Regulation SHO proposing an alternative price restriction known as the “Alternative Uptick Rule.” Similar to the Modified Uptick Rule previously proposed by the SEC, the Alternative Uptick Rule allows short selling at a price above the current national best bid. Unlike the Modified Uptick Rule, the Alternative Uptick Rule prohibits short sales at a price equal to the current national best bid (or last sale price), subject to certain limited exceptions. Additionally, the Alternative Uptick Rule is more restrictive than the Modified Uptick Rule in that it only permits short selling at an increment above the current national best bid and, therefore, does not allow short sales to get immediate execution, even in an advancing market. Nevertheless, the Alternative Uptick Rule would not require monitoring of the sequence of bids and, as such, may be easier to implement. The SEC is also considering whether the Alternative Uptick Rule could be implemented in combination with a circuit breaker that only imposes the rule on a particular security when there is a steep decline in that security’s price.
The SEC intends to hold a public roundtable on September 30, 2009, to discuss securities lending, pre-borrowing and additional short sale disclosures. Drinker Biddle will continue to monitor the progress of these important proposals and will issue further alerts as events warrant.