On February 24, 2010, the Securities and Exchange Commission adopted a rule that will restrict short selling on any day on which the price of a stock listed on a national securities exchange, whether traded on an exchange or in the over-the-counter market, declines by 10 percent or more from the prior day’s closing price.1 When such a “circuit breaker” is triggered under Rule 201 (the “alternative uptick rule”), short selling will be permitted in that security only if the price is above the current national best bid. The restriction will apply to short sale orders in that security for the remainder of the day as well as the following day. Under the rule, trading centers will be required to establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent the execution or display of a prohibited short sale.
The rule is a partial backtracking in the Commission’s position on short selling. Upon the adoption of Regulation SHO in 2004, an extensive pilot program was conducted to study the continuing effectiveness of the uptick rule, which was in place as Rule 10a-1 since 1938. That rule prohibited short selling in an exchange listed security except on a plus or zero plus tick. Based on the results of the pilot program, all price test restrictions on short selling were eliminated in July 2007.
During the severe market volatility which began in 2007, many market participants and issuers blamed short sellers for much of the drastic downturn in the markets, particularly as to securities issued by financial institutions, and urged the reinstitution of the uptick rule. The pilot program was perceived as an inadequate basis for eliminating the rule, since it derived data only during a generally rising market and did not observe the effects of the lack of an uptick rule during a declining market.
The SEC’s adoption of the alternative uptick rule is the latest in a series of actions taken to stem the erosion in investor confidence that resulted from the market meltdown. In 2008, the Commission adopted four temporary emergency orders, including orders that imposed pre-borrow requirements on short-sales for 19 financial institution stocks, a ban on all short sales for almost 1,000 financial stocks, short sale reporting obligations on Form SH, and a “hard delivery” requirement under Regulation SHO. Several of these temporary actions were adopted as permanent rules with some modifications. In addition, the SEC adopted Rule 10b-21, a short sale antifraud rule which specifically prohibits the use of deceptive practices in connection with effecting a short sale.
The newly adopted alternative uptick rule is the result of a lengthy deliberative process. In April of 2009, the SEC issued a proposal soliciting comments on several alternative versions of reinstituting the uptick rule on either a permanent or circuit breaker basis,2 held a Roundtable on Short Sale Regulation in May of 2009 and issued a release in August of 2009 requesting additional comments on certain aspects of the April 2009 proposal.3 More than 4,300 comments were received during the process.
The SEC stated that the newly adopted rule is intended to strike a balance between the recognized market benefits of short selling and the destabilizing effects and undermining of confidence caused by excessive downward price pressure on individual securities.
The rule will become effective 60 days after the date of publication of the release in the Federal Register, and then market participants will have six months to comply with the requirements. We will keep you advised of further developments in this area including additional details of the rule upon the issuance of the adopting release.