SEC Issues Emergency Orders to Halt Short Selling in Stocks of Financial Institutions and Require Hedge Fund Managers to Report Short Positions

On top of its actions earlier this week to curb abusive naked short selling, the SEC has temporarily prohibited short selling in financial companies to protect the integrity and quality of the securities market and strengthen investor confidence. The Commission acted in concert with the UK Financial Services Authority, which took similar action.

The Commission’s action, which is effective immediately, applies to the securities of 799 financial companies. The action effectively calls a time-out to aggressive short selling in financial institution stocks because of the essential link between their stock price and confidence in the institution. Release No. 34-58592. The emergency order will terminate at 11:59 p.m. ET on October 2, 2008; but the SEC may extend it beyond 10 days if it deems an extension necessary in the public interest and for the protection of investors, but will not extend the order for more than 30 calendar days in total duration.

The Commission also will temporarily require that institutional money managers report their new short sales of certain publicly traded securities. These money managers are already required to report their long positions in these securities. Separately, the SEC also temporarily eased restrictions on the ability of securities issuers to repurchase their securities. This change will give issuers more flexibility to buy back their securities, and help restore liquidity during this period of unusual and extraordinary market volatility.

The SEC banned short selling in the stocks of almost 800 financial institutions out of a concern that short selling in the securities of a wider range of financial institutions may be causing sudden and excessive fluctuations of the prices of such securities in such a manner so as to threaten fair and orderly markets. The Commission exercised its powers under Section 12(k)(2) of the Exchange Act, which allow the SEC to issue orders with respect to matters based on a determination that such an order is necessary to maintain or restore fair and orderly securities markets. The SEC believes that this emergency action will 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 SEC also issued a new disclosure rule requiring hedge funds and other large investors to disclose their short positions. Release No. 34-58591. Prepared by the staffs of the Divisions of Investment Management and Corporation Finance, the new rule is designed to ensure transparency in short selling. Hedge fund managers with more than $100 million invested in securities would be required to promptly begin public reporting of their daily short positions. The managers currently report their long positions to the SEC. The emergency order will terminate at 11:59 p.m. on October 2, 2008 unless further extended by the Commission.

Specifically, under the order, institutional investment manager who have to file a Form 13F for the calendar quarter ended June 30, 2008 will be required to file a report on new Form SH with the SEC on the first business day of every calendar week immediately following a week in which it effected short sales. Form SH must be filed electronically and will be publicly available on EDGAR.

New Form SH requires disclosure of the number and value of securities sold short for each section 13(f) security, except for short sales in options, and the opening short position, closing short position, largest intraday short position, and the time of the largest intraday short position, for that security during each calendar day of the prior week.

No filing, however, will be required when no short sales of a section 13(f) security have been effected since the previous filing of a Form SH. In addition, this disclosure requirement will only apply to short sales effected after the effective date of the order.

In addition, the money managers do not have to report short positions otherwise reportable if the short position in the section 13(f) securities constitutes less than one quarter of one per cent of the class of the issuer’s outstanding section 13(f) securities and the fair market value of the short position in the section 13(f) securities is less than $1,000,000.


In another emergency order, the SEC temporarily eased restrictions on the ability of securities issuers to repurchase their securities based on its determination that issuer repurchases can represent an important source of liquidity during times of market volatility. This emergency order will also terminate at 11:59 p.m. on October 2, 2008 unless further extended by the Commission. Release No. 34-58588.

Exchange Act Rule 10b-18 provides issuers with a safe harbor to effect repurchases within certain conditions. Historically, issuers have been reluctant to undertake repurchases without the certainty that their repurchases come within the safe harbor.

In the SEC’s view, temporarily altering the timing and volume conditions in the safe harbor will provide additional flexibility and certainty to issuers considering the execution of repurchases during the current market conditions. In these unusual and extraordinary circumstances, the SEC believes that altering the timing and volume conditions in Exchange Act Rule 10b-18 is necessary in the public interest and for the protection of investors to maintain fair and orderly securities markets and to prevent substantial disruption in the securities markets.

UK Financial Services Authority

Acting in concert with the SEC, the UK Financial Services Authority adopted a rule requiring both the disclosure of short positions on a daily basis in respect of financial institutions; and a prohibition in any active increase in a net short position in a financial stock by whatever instrument. There will be an exception for market makers to enable them to meet client demand. The prohibition will remain in force until January 16, 2009, during which time the FSA will review both its effectiveness and the general policy the authority wishes to adopt in respect of short selling. Also, The FSA stands ready to extend this approach to other sectors if it judges it to be necessary.

According to FSA Chair Callum McCarthy, the FSA acted out of a concern over the volatility and incoherence in the trading of equities, particularly for financial institutions. There is a danger in a trading system which allows financial institutions to be targeted and subject to extreme short selling pressures, said the chair, because movements in equity prices can be translated into uncertainty in the minds of those who place deposits with those institutions with consequent financial stability issues.