By James Hamilton, J.D., LL.M.
Against the backdrop of roiling markets, the SEC adopted rules to curb abusive naked short selling that go beyond its previously issued emergency order, which was limited to the securities of financial firms with access to the Federal Reserve's Primary Dealer Credit Facility. These rules, effective on September 18, will apply to the securities of all public companies, including all companies in the financial sector. They signal the SEC’s zero tolerance for abusive naked short selling, said Chairman Christopher Cox.
These rules were adopted to preserve fair and orderly markets pursuant to the SEC’s powers under Section 12(k)(2) of the Exchange Act. The Commission explained that its finding of an emergency is solely for purposes of Section 12(k)(2) and is not intended to have any other effect or meaning or to confer any right or impose any obligation other than set forth in this order.
Pursuant to Section 12(k)(2), in appropriate circumstances the Commission may issue summarily an order to alter, supplement, suspend, or impose requirements or restrictions with respect to matters or actions subject to regulation by the Commission.
As explained in Release No. 34-58572, the SEC acted out of a concern that there is a substantial threat of sudden and excessive fluctuations of securities prices and disruption in the functioning of the securities markets that could threaten fair and orderly markets. There is the possibility of unnecessary or artificial price movements based on unfounded rumors regarding the stability of financial institutions and other issuers exacerbated by naked short selling. The Commission’s concerns have gone beyond that limited amount of financial institutions that were the subject of its earlier emergency order.
There is also concern that some persons may take advantage of issuers that have become temporarily weakened by current market conditions to engage in inappropriate Moreover, sudden and unexplained declines in the prices of securities have raised questions about the underlying financial condition of an issuer, which in turn can create a crisis of confidence without a fundamental underlying basis. In turn, this crisis of confidence can impair the liquidity and ultimate viability of an issuer, with potentially broad market consequences.