SEC Acts to Curb Abusive Short Selling and Enhance Transparency

The SEC made permanent a temporary rule reducing the potential for abusive naked short selling and acted to enhance the public availability of short sale information. Rule 204T was made permanent and new Rule 204 requires broker-dealers to promptly purchase or borrow securities to deliver on a short sale. The temporary rule, approved by the SEC in the fall of 2008, was set to expire on July 31. The SEC is also working with several SROs to make short sale volume and transaction data available through the SRO websites. This effort will result in a substantial increase over the amount of information presently required by Temporary 10a-3T.
That rule, which will expire on August 1, applies only to certain institutional money managers and does not require public disclosure.

The Commission also intends to hold a public roundtable on September 30 to discuss securities lending, pre-borrowing, and possible additional short sale disclosures. The roundtable will consider, among other topics, the potential impact of a program requiring short sellers to pre-borrow their securities, possibly on a pilot basis, and adding a short sale indicator to the tapes to which transactions are reported for exchange-listed securities.

While acknowledging that short selling can play a constructive role by, among other things, contributing to efficient price discovery and increasing market liquidity, the SEC said that short selling can also be used as a tool to manipulate the market.

Rule 204T was approved in response to continuing concerns regarding fails to deliver and potentially abusive naked short selling. In particular, the rule made it a violation of Regulation SHO and imposes penalties if a clearing firm does not purchase or borrow shares to close-out a fail to deliver resulting from a short sale in any equity security by no later than the beginning of trading on the day after the fail first occurs (T+4). An analysis conducted by the SEC which followed the adoption of the close-out requirement of Rule 204T and the elimination of the options market maker exception showed the number of fails declined significantly.

Due to the success of these measures in furthering the Commission's goals of reducing fails to deliver and addressing potentially abusive naked short selling, the Commission has made permanent the requirements of Rule 204T with only limited modifications to address commenters' operational concerns. In a naked short sale the investor sells shares short without first having borrowed them.

In the fall of 2008, the Commission also adopted Rule 10a-3T to require market participants to provide short sale and short position information to the Commission. The rule was temporary so that the SEC could evaluate whether the benefits from the data justified the costs associated with the rule.

Instead of renewing the rule, the Commission and its staff, together with SROs, are working to substantially increase the public availability of short sale-related information through a series of other actions that should provide a wealth of information to the Commission, other regulators, investors, and analysts.

As the work comes to fruition, it is expected that in the next few weeks the SROs will begin publishing on their websites the aggregate short selling volume in each individual equity security for that day. The SROs will also begin publishing on a one-month delayed basis information regarding individual short sale transactions in all exchange-listed equity securities. It is also expected that in the next few weeks the Commission will enhance the publication on its website of fails to deliver data so that fails to deliver information is provided twice per month and for all equity securities, regardless of the fails level.

In addition, the Commission is continuing to actively consider earlier proposals on a short sale price test and circuit breaker restrictions.

The SEC acted against the backdrop of global concerns in this area, recently the UK Financial Services Authority extended the short selling disclosure obligation without time limit. The obligation would have expired on June 30, 2009. The FSA believes that maintaining the disclosure obligation will help continue to minimize the potential for market abuse and disorderly markets in financial sector stocks. It will also enhance transparency in that sector. Disclosures will need to be made if a net short position exceeds 0.25% of a company’s issued shared capital or increases by 0.1% bands above that, for example, net short position reaches 0.35%. 0.45% and so on. The FSA also pledged to continue to engage in an international dialogue on short selling.

The German Federal Financial Supervisory Authority (BaFin) has extended its ban on naked short selling in the shares of financial companies to January 31, 2010. This is BaFin’s third extension of the prohibition, which was adopted in September of 2008.

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