On July 15, 2008, the Securities and Exchange Commission (“SEC”) issued an emergency order1 to ban “naked” short selling in the securities of Freddie Mac, Fannie Mae and 17 of the largest commercial and investment banks. This order required that anyone effecting a short sale in these securities arrange in advance to borrow the securities and deliver them at settlement. On September 17, 2008, the SEC issued another temporary order, SEC Release No. 34-58572 (“Naked Short Selling Order”), to ban any “naked” short selling of the securities of all publicly traded companies, including all companies in the financial sector. The Naked Short Selling Order expires on October 1, 2008.
Further, due to ongoing concerns within the financial markets regarding perceived artificial price movements based on rumors involving financial institutions and other issuers, exacerbated in part by active and potentially widespread short selling, on September 18, 2008 the SEC issued a series of three emergency orders focused on the present crisis within the financial markets. Each of these emergency orders expires on October 2, 2008. The first emergency order, SEC Release No. 34-58592 (the “Short Selling Order”), prohibits any person from engaging in any short selling transactions involving publicly traded securities of 799 financial companies listed in the order. However, registered market makers, block position holders, and market makers who are obligated to quote in the over-the-counter market are exempted from the short selling prohibitions included in the Short Selling Order.
As stated in the Short Selling Order, the SEC indicated its belief that, “short selling is contributing to the recent, sudden price declines in the securities of financial institutions unrelated to true price valuation,” and further noted that “[s]uch price declines can give rise to questions about the underlying financial condition of an issuer, which in turn can create a crisis of confidence, without a fundamental underlying basis.” The stated purpose of the Short Selling Order is to prevent “short selling from being used to drive down the share prices of issuers even where there is no fundamental basis for a price decline other than general market conditions.”
The financial companies covered by the Short Selling Order were selected primarily based upon each company’s securities industry classification code, or “SIC” code. Given the reliance on such SIC codes, certain financial companies in similar industries to those covered by the Short Selling Order appear to have been omitted. As a result of these omissions, on September 21, 2008 the SEC issued an amendment, SEC Release No. 34-58611 (the “Short Selling Order Amendment”), to expand the coverage of the Short Selling Order to a broader scope of financial companies.
In addition to the 799 financial companies covered by the Short Selling Order, the Short Selling Order Amendment delegates to each national securities exchange the authority to select the individual financial institutions to be covered by the Short Selling Order. These financial institutions must be in one of the following categories: banks, savings associations, broker-dealers, investment advisers, and insurance companies, both foreign and domestic, and the owners of any of these entities. However, issuers may notify the exchange to be excluded from this list of covered financial firms. The New York Stock Exchange (“NYSE”), The American Stock Exchange (“AMEX”) and The Nasdaq Stock Market LLC (“NASDAQ”) have each published lists of additional companies that are covered by the Short Selling Order Amendment.
The appropriate links for each list are provided below:
- NYSE List: http://www.nyse.com/about/listed/1222078675703.html?sa_campaign=/internal_ads/callouts/09222008seclist
- AMEX List: http://www.amex.com/amextrader/tdrInfo/data/axNotices/2008/reg08040.ShortSaleBanList.pdf
- NASDAQ List: http://www.nasdaqtrader.com/Micro.aspx?id=options_sec_shortsalelist
Moreover, the Short Selling Order Amendment retains the exception contained in the Short Selling Order related to legitimate market making in derivative securities of any of the protected financial institutions. However, this exception is amended to require that, for new positions, “a market maker may not sell short if the market maker knows a customer or counterparty is increasing an economic net short position in the shares” of one of the covered financial firms.
The second emergency order issued by the SEC on September 18, 2008, SEC Release No. 34-58591 (the “Short Sales Reporting Order”), requires that institutional investment managers report new short sales made by any managed accounts having an aggregate fair market value on the last trading day of any month of any calendar year of at least $100,000,000. This Short Sales Reporting Order report must be submitted electronically to the SEC on the newly created Form SH on the first business day of every calendar week immediately following a week in which a covered institutional investment manager effected any short sales. However, on September 21, 2008, the SEC issued an amendment, SEC Release No. 34-58591A, to the Short Sales Reporting Order to permit non-public filing of Form SH, which will only become available to the public via the SEC’s EDGAR system two weeks after its due date.
Form SH requires the disclosure of the number and value of securities sold short, except for short sales in options, as well as the opening, closing, and largest intraday (including the time) short positions for the relevant security during each calendar day of the prior week. However, an institutional investment manager need not report short positions on Form SH if the short position constitutes less than 0.25% of the class of the respective securities and the fair market value of the short position is less than $1,000,000.
In addition, on September 19, 2008, the SEC’s Division of Enforcement announced that it is expanding its investigation into possible market manipulation in the securities of certain financial institutions. As a result, the SEC will require market participants with significant trading activity in financial issuers or positions in credit default swaps, such as hedge funds, broker-dealers and institutional investors, to disclose those positions and provide certain additional information under oath. As part of this investigation, the staff of the Division of Enforcement will have the authority to obtain any necessary documents and testimony by subpoena.
Lastly, the third emergency order issued by the SEC on September 18, 2008, SEC Release No. 34-58588 (the “Issuer Repurchase Order”), reduces restrictions on the ability of issuers to repurchase their own securities. Specifically, the Issuer Repurchase Order temporarily alters the safe harbor for issuer repurchases set forth in Rule 10b-18 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) to provide additional flexibility and certainty to issuers undertaking repurchase transactions during the current market conditions. Among other things, the Issuer Repurchase Order temporarily suspends the time of purchase condition and increases the volume of purchase condition to 100 percent of the average daily trading volume in the subject security. The SEC stated its intention that the Issuer Repurchase Order “will give issuers more flexibility to buy back their securities, and help restore liquidity during this period of unusual and extraordinary market volatility.”
Given the recent market turmoil there is some thought that the SEC may extend these emergency orders and implement permanent rules addressing short selling concerns. However, as of today, the SEC has not issued any definitive guidance whether it will do so.