Originally published September 19, 2008

Keywords: SEC, naked short selling, securities, Section 12(k)(2), Exchange Act, equity option, UK Financial Services Authority, short sales

On September 18th, the Securities and Exchange Commission (SEC) issued three emergency orders under Section 12(k)(2) of the Securities Exchange Act of 1934 (Exchange Act) aimed at preventing the "substantial disruption of the securities markets" and stemming the use of short sales to drive down the share prices of certain issuers even where there is no fundamental basis for such price drops. These emergency orders follow on the heels of similar actions taken by the UK Financial Services Authority.1

First, the SEC adopted an emergency order prohibiting any person from short selling any publicly traded securities of the 799 financial firms listed in the order.2 Three exceptions have been crafted to the general prohibition under this emergency order:

  • Similar to the SEC's emergency order issued in July 2008 prohibiting "naked" short selling of 19 financial companies,3 registered market makers, block positioners and any other market maker obligated to quote in the over-the-counter market may effect short sales in the listed financial firms' securities provided that such short sales are made as part of a bona fide market making.
  • Any person may effect short sales resulting from an automatic exercise or assignment of an equity option held prior to when the emergency order took effect.
  • Market makers may effect short sales as part of bona fide market making and/or hedging activity that is related directly to bona fide market making in derivatives.

Unlike the first two exceptions, which presumably are available for the duration of this emergency order, the last exception expires at 11:59 p.m. EDT on September 19, 2008 (this may be extended by the SEC).

Notably, the emergency order does not contain a grandfathering clause to permit short sales effected as bona fide hedging of positions on dealers' books prior to the issuance of the order. This emergency order was immediately effective and is scheduled to terminate at 11:59 p.m. EDT on October 2, 2008, unless extended by the SEC.

Second, the SEC issued an emergency order that temporarily expands the safe harbor for stock repurchases by issuers under Exchange Act Rule 10b-18.4 In particular, the emergency order suspends the following conditions of the safe harbor:

  • The timing conditions in paragraphs (b)(2)(i), (b)(2)(ii) and (b)(2)(iii) of Exchange Act Rule 10b-18. For example, an issuer may, under the emergency order, effect a repurchase transaction that is the opening (regular way) purchase reported in the consolidated trading system.
  • The volume condition in paragraph (b)(4) of Exchange Act Rule 10b-18. Issuer repurchases may now be as large as 100 percent of the average daily trading volume reported for the security during the four calendar weeks preceding the week of the purchase.

All other provisions of Exchange Act Rule 10b-18 must still be complied by issuers wishing to avail themselves of the safe harbor. This order went into effect at 12:01 a.m. EDT on September 19, and is scheduled to terminate at 11:59 p.m. EDT on October 2, unless extended by the SEC.

Third, the SEC issued an emergency order that requires public disclosure of certain short sales by institutional investment managers.5 Specifically, an institutional investment manager that has filed or was required to file a Form 13F for the calendar quarter ended June 30, 2008, under Section 13(f) of the Exchange Act and Rule 13f-1(a) thereunder, will generally be required to file electronically new Form SH on the first business day of every calendar week immediately following a week in which the manager effected short sales in any equity security traded on a national securities exchange or quoted on an automated quotation system of a registered securities association.6 Form SH, which will be publicly available through the EDGAR system, must disclose the number and value of these securities sold short, 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. However, short positions that constitute less than one-quarter of one percent of a class of an issuer's securities and that have a fair market value of less than US$1 million do not have to be reported. This order will be effective at 12:01 a.m. EDT on September 22, 2008, thus the first Forms SH shall be required to be filed on September 29, 2008. This order is scheduled to terminate at 11:59 p.m. EDT on October 2, unless extended by the SEC.

The current guidance in the emergency orders leaves many questions unanswered. For example, it is not clear how the SEC will treat short economic exposure to the listed firms created through means other than short sales of those firms' securities, such as through short positions in index securities for indices in which the listed firms form a significant component. Thus, we expect to see further clarifications, likely in the form of FAQs, very soon.

Footnotes

1. For more information regarding the FSA's response, please see Mayer Brown's Client Alert, New FSA Rules on Short Selling, at http://www.mayerbrown.com/publications/index.asp.

2. See Securities Exchange Act Release 58,592 (Sept. 18, 2008) available at http://www.sec.gov/rules/other/2008/34-58592.pdf.

3. See Securities Exchange Act Release 58,248 (July 29, 2008) available at http://www.sec.gov/rules/other/2008/34-58248.pdf.

4. See Securities Exchange Act Release 58,588 (Sept. 18, 2008) available at http://www.sec.gov/rules/other/2008/34-58588.pdf.

5. See Securities Exchange Act Release 58,591 (Sept. 18, 2008) available at http://www.sec.gov/rules/other/2008/34-58591.pdf.

6. A copy of the Form SH is available at http://www.sec.gov/about/forms/formsh.pdf,and a copy of the instructions to the form is available at http://www.sec.gov/about/forms/formsh_instructions.pdf.

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