Originally published September 17, 2008

Keywords: SEC, short selling, broker-dealer, options market maker, Rule 203(b)(3), Rule 10b-21, tick test

On September 17th, the Securities and Exchange Commission (SEC) took three coordinated actions designed to combat "naked" short selling (i.e., a short sale where seller does not actually borrow the stock and fails to deliver it in time for settlement). The SEC's actions will apply to the securities of all public companies and are effective at 12:01 a.m. ET on Thursday, September 18, 2008.

First, the SEC adopted, on an interim final basis, a new rule requiring a short seller's broker-dealer to deliver securities by the close of business on the settlement date (e.g., three days after the sale, or T+3, for equities). If a short sale violates this "close out" requirement, the short seller's broker-dealer will be prohibited from further short sales for all of the broker-dealer's customers (not just the original short seller) in the same security unless the broker-dealer locates and pre-borrows the shares required to settle future short sales. The SEC will request comment on this rule despite the rule's immediate effectiveness.

Second, the SEC approved a final rule to eliminate the options market maker exception from the close-out requirement of Rule 203(b)(3) in Regulation SHO. This rule change will be effective five days after publication in the Federal Register.

Third, the SEC adopted Rule 10b-21 under the Securities Exchange Act of 1934 (Exchange Act), which was proposed earlier this spring as an attempt generally to address abusive naked short selling.1 Rule 10b-21 effectively provides that it is a violation of the antifraud provisions of Section 10(b) of the Exchange Act for any short seller, including a broker-dealer acting for its own account, to deceive others (e.g., broker-dealers, other participants of a registered clearing agency, or purchasers) about the seller's intention or ability to deliver the securities sold short in time for settlement, and to subsequently fail to deliver those securities on or before the date delivery is due. Rule 10b-21 is effective immediately.

With many commenters suggesting that the SEC should consider reinstating the "tick test" (or adopt other restrictive measures), it will be interesting to see if the SEC views today's actions as final solutions or the first steps towards additional rule-making efforts. If you have questions regarding the new rules, please contact the Mayer Brown attorney with whom you normally communicate or any of the attorneys below.

Footnote

1. See Securities Exchange Act Release No. 57,511 (Mar. 17, 2008), 73 Fed. Reg. 15,376 (Mar. 21, 2008) available at http://www.sec.gov/rules/proposed/2008/34-57511fr.pdf.

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