On April 10, 2009, the U.S. Securities and Exchange Commission (the “SEC”) issued proposed rules that would amend Regulation SHO to restrict short selling activities based upon certain security market price trends (SEC Release No. 34-59748, the “Proposed Rule Release”). The proposed rules would apply to all national market securities, which include securities listed on the New York Stock Exchange, the American Stock Exchange and Nasdaq. The Proposed Rule Release contains two possible and alternative price trend restrictions – a “Short Sale Price Test” and a “Circuit Breaker” – and further alternative variations on each, for consideration by commenters. The Short Sale Price Test proposals would, effectively, be a return to a form of uptick rule that was eliminated by the SEC in July 2007. The SEC also has proposed an amendment to Regulation SHO that would require certain sell orders to be marked as “short exempt.” The Proposed Rule Release describes these alternatives and requests public comments.
Background
The Proposed Rule Release follows the SEC’s July 2007 elimination of the former short sale price test restrictions contained in Rule 10a-1 under the Securities Exchange Act of 1934 (the “Exchange Act”), often referred to as the “uptick rule” or “tick test” (the “Former Rule”). As a result of the elimination of the Former Rule, the requirement to mark certain sell orders as “short exempt” also was eliminated.
The elimination of the Former Rule followed a rulemaking process that lasted from 1999 through 2006 and included a pilot program during which the SEC collected data that was believed by the SEC to support the elimination of the Former Rule. That view has been challenged as a result of the recent turmoil in the financial markets.
Proposed Rule Alternatives
Short Sale Price Test Alternatives
Short Sale Price Test – Modified Uptick Rule. This proposed rule would impose a bid price test and require a “trading center” (as defined in Rule 600 of Regulation NMS) to maintain policies and procedures reasonably designed to prevent the execution or display of a short sale order at a “down-bid price,” unless the order is marked “short exempt.”1 As proposed, the modified uptick rule would permit a short sale order without an uptick in the after-hours market (i.e., during periods that the national best bid is not collected, calculated and disseminated). The modified uptick rule is modeled in part after the National Association of Securities Dealers’ bid test, which was in existence from 1994 to mid-2007.
Short Sale Price Test – Uptick Rule. This proposed rule would impose a prior sale price test and prohibit a short sale either below the price of the last sale or at the same price as the last sale, except when such price is above the next preceding different sale price, in each case as reported on a national market system. An order would be permitted to be marked “short exempt” if the seller relies on an exception from the sale price test, which may be one of the exceptions applicable to the proposed modified uptick rule, among others. This rule is, in essence, a modified version of the Former Rule, which was in existence for almost 70 years, and is similar to the New York Stock Exchange’s former sale price test.
Circuit Breaker Alternatives
Circuit Breaker – Circuit Breaker Halt Rule. This proposed rule would prohibit a short sale if the price of a security, wherever traded, decreases by 10% or more from the last price reported for the security on the prior day, except when the price decrease occurs within 30 minutes of the end of regular trading hours. Several exceptions to this proposed rule would be available for market making, hedging, and certain transactions in options. An order would be permitted to be marked “short exempt” if the seller relies on an exception from the circuit breaker halt requirement.
Circuit Breaker – Short Sale Price Tests. A proposed alternative version of the proposed Circuit Breaker rule has two variations that would tie the Circuit Breaker rule to price tests – the Modified Uptick Rule and the Uptick Rule. Like the first alternative Circuit Breaker rule, each of these proposed rules would be triggered when the price of a security, wherever traded, decreases by 10% or more from the last price reported for the security on the prior day, except when the price decrease occurs within 30 minutes of the end of regular trading hours. When triggered, the Circuit Breaker with Modified Uptick Rule would impose substantially the same requirements as the Short Sale Price Test – Modified Uptick Rule, and the Circuit Breaker with Uptick Rule would impose substantially the same requirements as the Short Sale Price Test – Uptick Rule. The requirement to mark a sell order as “short exempt” under each of these Circuit Breaker alternatives follows the corresponding Short Sale Price Test rule.
In each case, corresponding amendments would be made to Regulation SHO to require sell orders to be marked “long,” “short,” or “short exempt.”
Comments
Comments may be submitted to the SEC on the Proposed Rule Release by June 19, 2009. All comment submissions will be available for public viewing after submission. With regard to each alternative, the SEC has included a set of questions for which it seeks specific comments, such as, for example, whether a particular alternative would be more appropriate, or would address concerns of investor confidence, in light of current market conditions.
If you have any questions concerning the Proposed Rule Release or preparing comments on the Proposed Rule Release, please contact an attorney in the Investment Management or Capital Markets groups at Seward & Kissel.
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1 For example, an order could be marked “short exempt” if the broker-dealer executing the short sale has a reasonable basis to believe that certain conditions exist, such as: (i) the seller intends to deliver the security upon the removal of a restriction; (ii) the order is by a market maker to off-set an odd-lot position; (iii) the seller owns or is entitled to acquire equivalent securities; (iv) the order is off-set by an order to buy on a foreign market to cover the sale; (v) the order is by an underwriter with an over-allotment of securities or in connection with a rights or standby underwriting commitment; (vi) in connection with a riskless principal transaction; or (vii) in a sale at the volume weighted average price.
