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Securities and Exchange Commission Announces Changes to Short Selling Rules

July 29, 2009

 

On July 27, 2009, the U.S. Securities and Exchange Commission issued a press release announcing various steps that it is taking to regulate and promote the transparency of short sale activities. In particular, the Commission announced it is:

  • Making Rule 204T of Regulation SHO permanent in new Rule 204;
  • Allowing the expiration of Exchange Act Rule 10a-3T and its corresponding requirement to file Form SH;
  • Working in conjunction with self-regulatory organizations to increase transparency regarding short sale activities; and
  • Hosting a roundtable on September 30, 2009 to solicit the views of interested parties on issues related to securities lending, pre-borrowing, and additional short sale disclosures.

Adoption of Rule 204 of Regulation SHO

In October 2008, the Commission adopted Rule 204T of Regulation SHO, on a temporary basis, as a measure designed to limit abusive “naked” short selling practices and reduce fail to deliver positions.[1] This rule will now be made permanent in Rule 204 of Regulation SHO. Rule 204 requires clearing agency participants to:

  • Deliver all securities for clearance and settlement on a long or short sale in any equity security by the close of business on the settlement date;
  • Close out any fail to deliver position resulting from short sales in any equity security by borrowing or purchasing securities no later than the beginning of regular trading hours one settlement day following the settlement date (i.e., T+4);
  • Close out any fail to deliver position resulting from long sales in any equity security by borrowing or purchasing securities no later than the beginning of regular trading hours on the third settlement day after the settlement date (i.e., T+6) — however, this additional time period is available only where the clearing agency participant is able to demonstrate on its books and records that such fail to deliver position resulted from a long sale;
  • Close out any fail to deliver position resulting from bona fide market making activities by borrowing or purchasing securities no later than the beginning of regular trading hours on the third settlement day after the settlement date (i.e., T+6); and
  • Close out any fail to deliver position resulting from a sale of securities that a seller is “deemed to own” pursuant to Rule 200 of Regulation SHO and intends to deliver as soon as all restrictions on delivery are removed — such as securities sold pursuant to Rule 144 under the Securities Act of 1933 — no later than 35 calendar days following the trade date.

In addition to the close out requirements discussed above, Rule 204 specifies the following:

Pre-Borrow Requirement: If any fail to deliver position is not closed out, the clearing agency participant and any broker-dealer from whom it receives trades must pre-borrow securities before accepting a short sale order from another person in that security, or effecting a short sale for its own account in that security, until the fail is resolved.

Early Close Out Credit: A broker-dealer may receive “pre-fail credit,” and therefore be exempt from the pre-borrow requirement by meeting specified conditions, including purchasing or borrowing enough securities to cover a fail to deliver position. This purchase or borrow must be executed no later than the end of regular trading hours on the settlement date.

Allocation of a Fail to Deliver Position: Clearing agency participants are permitted to allocate responsibility to close out a fail to deliver position to another broker-dealer for which it clears trades or from which it receives trades for settlement. The close out and pre-borrow requirements will then apply to that broker-dealer and not to the clearing agency participant.

Sham Close Outs: A clearing agency participant will not meet the requirements of Rule 204 if it enters into an arrangement to purchase or borrow securities, but knows or has reason to know that the securities will not actually be delivered.

Significant Differences Between Rule 204T and the Newly Adopted Rule 204: As discussed above, the requirements of Rule 204 are substantially similar to those in Rule 204T. The requirements of Rule 204, however, differ from those of Rule 204T as follows:

  • Participants may now close out fail to deliver by either purchasing or borrowing the securities in the following instances (Rule 204T only allowed purchases):
      • Closing out fail to deliver positions resulting from long sales;
      • When a broker-dealer obtains pre-fail credit by closing out a fail to deliver position prior to the applicable close out date; and
      • When a market-maker closes out a fail to deliver position;
  • To obtain pre-fail credit, a broker-dealer must purchase or borrow securities to cover only the amount of the fail to deliver position (Rule 204T required the broker-dealer to cover the full amount of the open short position);
  • The extended close out period for Rule 144 securities now applies to any other securities the seller is “deemed to own” (Rule 204T limited the extended close out period to Rule 144 securities only);
  • The extended close out period for securities the seller is “deemed to own” is now the 35th calendar day following the trade date (Rule 204T allowed until the 36th consecutive settlement day); and
  • Market-makers are now subject to the pre-borrowing requirement if a fail to deliver position is not closed out (Rule 204T exempted market-makers from this requirement).

Expiration of Rule 10a-3T and Form SH Filing Requirement

The Commission announced that it will allow Rule 10a-3T, the temporary short-sale reporting rule, and the corresponding requirement to file Form SH to expire. As a result, beginning on August 1, 2009, institutional investment managers will no longer be required to file Form SH to report their short sale activities. Consistent with prior Commission staff guidance that no reports would be due following the date the requirement to file Form SH expires, institutional investment managers will not need to file a Form SH with respect to any short sale activities occurring on or after Sunday, July 26, 2009.[2]

Increasing the Transparency of Short Sale Activity

In lieu of preventing the expiration of Rule 10a-3T, the Commission announced that it is working with SROs on a series of actions that are designed to increase publicly available information with regard to short sales. Within the next few weeks, the Commission expects that the following will be in place:

  • SROs will begin publishing on their websites the daily aggregate short selling volume for each individual equity security;
  • SROs will begin publishing on their websites information on a one month delay regarding individual short sale transactions in all exchange-listed equity securities; and
  • The Commission will publish twice-monthly reports on fail to deliver data for all equity securities.

Public Roundtable

The Commission announced that it will host a public roundtable on September 30, 2009, in order to solicit the views of interested parties on issues related to securities lending, pre-borrowing, and additional short-sale disclosures. Among other things, the roundtable will consider:

  • Adding a short sale indicator to tapes reporting transactions in exchange-listed securities;
  • Requiring public disclosure of large individual short positions; and
  • Imposing a pre-borrow or enhanced locate requirement on short sellers.

Conclusion

If you have any questions regarding Rule 204, Form SH, or the Commission’s announced intention to increase transparency regarding short sales, please contact the O’Melveny & Myers attorney with whom you work regularly or the lawyers identified in this Client Alert.


[1] For a discussion of the requirements of Rule 204T of Regulation SHO, please see OMM’s previous Client Alert here: http://www.omm.com/securities-and-exchange-commission-issues-new-rules-on-short-selling-09-18-2008/.

[2] See 17 CFR 249.326T (2009). See also Question 4 of “Division of Corporation Finance, Division of Investment Management, and Division of Trading and Markets Guidance Regarding the Commission's Emergency Order Concerning Disclosure of Short Selling” (http://sec.gov/divisions/marketreg/shortsaledisclosurefaq.htm).