REGULATORS WORLDWIDE ACT
TO RESTRICT SHORT SALES

Countries around the world have responded quickly to the emergency order issued by the Securities and Exchange Commission (the Commission) on September 18, 2008, which temporarily banned short sales of the stocks of 799 financial companies in the United States through October 2, 2008, unless extended by the Commission for up to an additional 20 days.¹

This Alert provides an overview as of September 25, 2008 on the actions taken by the regulators of some of the world’s major financial markets restricting or regulating short sales.

United States Update

Identifying Covered Financial Institutions: On September 21, the Commission issued an amendment to the Order (the Amendment) to address “current and anticipated technical and operational concerns” triggered by the application and interpretation of the Order.

The Order identified 799 financial firms in its Appendix A as “Included Financial Firms,” meaning their stock would be subject to the short sale restrictions set forth in the Order. In response to criticism that the list omitted certain issuers that should have been classified as financial institutions, the Amendment authorized the listing markets to select the specific financial institutions the securities of which would be covered by the Order. The Commission directed each national securities exchange to publish a list on its Internet website of the listed companies (expected to include banks, savings associations, broker-dealers, investment advisers and insurance companies, both foreign and domestic) with common equity that would be subject to the Order’s ban on short sales. By the Amendment, the Commission also authorized each exchange to exclude any issuer from the short sale restrictions if the issuer so chooses.

Exceptions to short sale restrictions

Futures contracts: The Order permitted short sales that occur as a result of automatic exercise or assignment of an equity option held prior to September 19, and the Amendment extends the exception to allow short sales that occur as a result of the expiration of a futures contract held prior to September 19.

Long call options: To allow for the creation of long call options, the Amendment permits short sales that occur as a result of assignment to call writers upon exercise.

Market making and derivatives: The Amendment extended for the duration of the Order an exception for “any person that is a market maker that effects a short sale as part of bona fide market making and hedging activity related directly to bona fide market making in derivatives on the publicly traded securities of any Included Financial Firm.” The Amendment also clarified that the exception extends to over-the-counter market makers and to bona fide market making and hedging activity related to market making in exchange traded funds and exchange traded notes of which Covered Securities are components—provided, however, that a market maker may not effect a short sale in a Covered Security if the market maker knows that the customer’s or counterparty’s transaction will result in the customer or counterparty establishing or increasing an economic net short position in the issued share capital of an Included Financial Firm.

Sales of restricted securities: The Amendment also clarified that the Order does not apply to sales of Covered Securities pursuant to Rule 144 of the Securities Act of 1933.

United Kingdom

The Financial Services Authority (FSA) introduced new provisions to its Code of Market Conduct to prohibit the active creation or increase of net short positions in the stock of publicly quoted, UK incorporated banks or insurers through January 16, 2009.

In addition, as of September 23, the FSA now requires daily disclosure of all net short positions in excess of 0.25 per cent of the ordinary share capital of the relevant companies held at market close on the previous working day. The FSA indicated that it is poised to extend this approach to other sectors as it deems necessary, though to date requests for such extensions (particularly from companies related to the property sector) have been resisted. These provisions will remain in force until January 16, 2009, although they will be reviewed after 30 days, and the FSA will publish a comprehensive review of the rules on short selling in January.

Australia

In consultation with the Australian Securities Exchange (ASX), the Australian Securities and Investments Commission (ASIC) announced three measures to apply from September 22 until the implementation of the Australian government’s short-selling legislation:

1. Removing all securities from the ASX Approved Product List for naked short sales;



2. Clarifying and, in doing so, narrowing the permitted class of covered short sales; and



3. Introducing reporting requirements through the ASX for permitted covered short sales.

The practical effect of these measures was to require most short sales to be covered. Since that announcement on September 19, ASIC has continued to assess actions taken by other international regulators, specifically the US, the UK, France, Germany, Switzerland, Ireland and Canada’s Ontario province, and as a result made the following modifications to its announcement:

1. Contrary to its announcement on September 19, ASIC would no longer permit covered short sales for all listed stocks (subject to a limited authorized market-maker exception); and



2. ASIC will reassess and advise the market in 30 days, whether or not it will at that time, or at a later date, reopen covered short sales for non-financial stocks.

On September 23, ASIC issued further clarification to market participants regarding the prohibition on short selling to ensure that fair and orderly markets continue. ASIC had prohibited naked and covered short selling of all securities and managed investment products quoted on licensed markets in Australia, subject to certain exceptions. Since its initial announcements, ASIC has reviewed the operation of the market, consulted with ASX and the industry, and considered what regulators were doing in other markets. As a result, ASIC decided to carve out from its prohibition on covered short sales the following transactions, participants and situations:

• Hedging for existing positions: Market makers would be permitted to hedge pre-September 22 positions arising from its business of dealing as principal in equities, options or derivatives (whether OTC or exchange-traded) to fill orders received from clients or to respond to a client’s request to trade before September 22.



• Dual listed entities: Persons engaging in arbitrage transactions in relation to the securities of dual listed entities would be permitted to make covered short sales of the relevant securities in Australia.



• All exchange-traded options: Sales resulting from the exercise of exchange-traded options issued before or after September 22 would be permitted.



• Index arbitrage transactions: Although covered short sales as part of an index arbitrage are not currently permitted under ASIC’s class orders, ASIC has indicated that index arbitrage transactions that are unlikely to be a mechanism for market abuse should be allowed.



• Market makers: Following the lead of regulators in other jurisdictions cited in this Alert, ASIC has determined to grant further relief for market makers for transactions that satisfy all of the following requirements:
1. the market maker must be an entity that makes a market as set out in section 766D of the Corporations Act 2001;



2. the market maker must hold an Australian financial services license relating to making a market or relies upon an exemption so it does not need an Australian financial services license;



3. the covered short sale is a bona fide transaction to manage the entity’s risk arising from its market making activities; and



4. the market maker must not enter into a short sale in respect of a product if it knows the client’s transaction for which it is making the market will result in the client or counterparty establishing or increasing an economic net short position in respect of a product covered by the ASIC Class Orders.

If covered short selling is permitted, the short selling transaction needs to be disclosed in accordance with the reporting requirements of ASIC Class Order 08/751, which are equivalent to end of trading day net short sale position disclosure under the ASX Market Rules.

Belgium

Belgium’s Banking, Finance, and Insurance Commission (the CBFA) announced the following measures restricting short sales effective for three months beginning September 22, 2008:

1. Transactions of voting securities issued by financial institutions and traded on Euronext Brussels would be prohibited if the sales order may lead to delayed settlement and delivery of one of the securities, except for sales by intermediaries acting as market makers, liquidity providers or counterparties on block trades; and



2. Any person owning a net short position representing 0.25 per cent of the capital of one of the covered issuers must inform the CBFA within 24 hours of the change in such position.

Canada

On September 19, 2008, the Ontario Securities Commission (the OSC), the lead regulator of the Toronto Stock Exchange (the TSX), issued a temporary order (the Temporary Order) prohibiting short sales in the securities of the following financial sector issuers, subject to a few exceptions:

On September 22, 2008, following the Commission’s lead in amending its September 18 Order, the OSC amended the Temporary Order to expand the exceptions to the ban to include:

1. short sales conducted in accordance with the Universal Market Integrity Rules (UMIR) 3.1 Restrictions on Short Selling, sections 2(a), (b), (d) and (g), provided, however, that a market maker may not effect a short sale in the common equity securities of those financial section issuers if the market maker reasonably ought to know that the client’s or counterparty’s transaction will result in the client or counterparty establishing or increasing an economic net short position;



2. short sales conducted by a registered dealer acting as principal to facilitate a transaction with a client that has a current market value of $200,000 or more in a single transaction, or in several transactions at approximately the same time, provided that the position is liquidated or hedged as soon as possible;



3. short sales conducted in order to comply with UMIR Rule 5.2 Best Price Obligation;



4. short sales conducted by a person as a result of automatic exercise or assignment of an equity option, or in connection with settlement of a futures contract due to expiration of the option or future contract held prior to the September 22, 2008;



5. sales of restricted securities pursuant to an exemption from the prospectus requirements in accordance with applicable securities legislation; and



6. short sales conducted to adjust a pre-existing hedged derivative position in order to maintain the risk exposure that existed on September 19, 2008.

The amended Temporary Order will expire on October 3, 2008, unless extended by order of OSC.

On September 19, 2008, the Canadian Securities Administrators endorsed the OSC Temporary Order. Quebec’s Autorité des Marchés Financiers and the New Brunswick Securities Commission have also issued similar orders restricting short selling, and other provincial regulators in Canada are expected to follow soon.

France

Only 12 hours after announcing that its existing short sale regulations were strict enough, the Autorité des Marchés Financiers (AMF) adopted the following measures on September 19 to conform to the prevailing regulatory model, particularly in Europe, and to prevent regulatory shopping:

1. Short sales are prohibited on equity securities issued by credit institutions and insurance companies traded on French regulated markets (Euronext Paris, MATIF and MONEP), except for transactions by investment service providers acting as market makers, liquidity providers or counterparties for block trades.



2. Any investment service provider receiving a sell order for a covered security must require its client to deposit the securities to be sold prior to executing the order or obtain assurance that the client holds the subject securities through another custodian.



3. Following the policy of the FSA in the UK, any person holding a net short positions in excess of 0.25 per cent of the capital of a covered company must disclose it to the AMF on the day after it crosses that threshold.

The AMF indicated that the foregoing restrictions on short sales would remain in effect for at least three months, subject to any adjustments that the AMF deems warranted by market developments.

Germany

Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin), the federal financial supervisory authority, imposed a ban beginning September 20 on short sales (transactions resulting in a short position) of shares of the following 11 companies from the financial sector:

The ban is due to expire on December 31, 2008 midnight, but will be reviewed on an ongoing basis. BaFin has excepted the following transactions from its ban on short sales: (1) “name-to-follow” transactions by lead brokers; (2) transactions of persons who have undertaken by contract to make binding buy and sell bids (e.g., market makers and designated sponsors) to the extent that such transactions are required for performance of their contractual obligations; and (3) short sales used to secure already existing positions.

Ireland

The Financial Regulator of Ireland amended the Market Abuse Rule, effective September 19, 2008, by adding new rules that prohibit short selling by any person, other than a market maker, of the stock of the Bank of Ireland, Allied Irish Banks Plc, Irish Life and Permanent Plc or Anglo Irish Bank Corporation Plc. In addition, the new rules require that, beginning September 23, 2008, each person who has an economic interest involving 0.25 per cent or more of the issued share capital to the banks named above on any business day shall disclose the name of the person who has the position, the company in which the position is held and the amount of that position. Such disclosure is required even if the size of the net short position has not changed since the previous disclosure. Market making positions are exempt from the disclosure rule. The new rules apply to any new short positions, including increases in existing short positions. If a person has an existing short position on September 18, 2008, the rule does not prevent that short position being continued, nor does it prevent trading to reduce or close out the short position. If a net short position arises, but does not arise because the person entered into transactions after September 18, 2008 to create that short position, then the prohibition on short selling would not apply, but the rule requiring disclosure of a 0.25 per cent net short position would apply. The new rules apply to spread betting and Contracts for Difference and all other ways in which an economic interest, whether direct or indirect, can be created. Although shorting the ISEQ index is covered by the rule, as drafted, the Financial Regulator does not propose to take action in relation to shorting of the ISEQ Index at this time, but has indicated that it will keep such transactions under review.

Italy

The Commissione Nazionale per le Società e la Borsa (the Consob) on September 22, 2008 declared that the sale of shares issued by banks and insurance companies listed and traded on the Italian regulated markets shall be supported, from the time of the order through the settlement of the transaction, by the availability of the relevant securities to the seller. In adopting this requirement, which remains in effect through October 31, 2008, the Consob acknowledged the actions restricting short sales of banking and insurance securities issued on September 22, 2008 by the regulators in Ireland, Germany, France, Luxembourg, Belgium and The Netherlands, as well as the preceding actions taken in the US and the UK.

Luxembourg

The Commission de Surveillance du Secteur Financier (the CSSF) announced on September 19, 2008 that it considered naked short sales incompatible with the regulatory requirements governing market conduct, in particular where such sales distort or manipulate the market. The CSSF therefore prohibited market participants from engaging in naked short sales where the underlying assets are stocks of a credit institution or insurance undertaking traded on a regulated market, whether for such participants’ own account or on behalf of clients. When executing a short sale on behalf of their clients, market participants must ensure that their clients are able to deliver the stocks on the settlement date.

Netherlands

After consulting with De Nederlandsche Bank N.V. (the Dutch Central Bank) and the other regulators responsible for the supervision of Euronext, the Authority for the Financial Markets (the AFM) announced prohibitions against naked short selling of shares issued by the following financial companies, which are traded on the Euronext Amsterdam Stock Exchange:

Like most of the other regulators adopting similar restrictions, the AFM’s prohibition against short sales applies to transactions executed by a seller for its own account or on behalf of third parties, with the exception of transactions performed by intermediaries acting as a cash market maker or counterparty in block trade transactions. All selling orders resulting in postponed settlement or delivery concerning shares of any of the issuers named above must be fully covered by the financial instruments that are the subject of the selling orders. The AFM announced the restrictions would remain in effect for a period of three months from September 22, 2008, subject to adjustment or withdrawal before the end of this term. Until official legislation is ratified, the AFM has requested each party having a cumulated net economic short position exceeding 0.25 per cent of the capital of one of the financial companies identified above to report such positions to the AFM immediately, but not later than on the next working day (T+1) after reaching that level.

Portugal

Conselho Directivo da Comissão do Mercado de Valores Mobiliários (CMVM), after consultation with its partners in the College of Euronext Regulators, issued an Instruction establishing special measures relating to short-selling.

Taking into consideration the current market instability and acknowledging the need for intervention to prevent regulatory arbitrage, the CMVM emphasized the need for greater harmonization with the exceptional measures on short-selling which were being adopted in the various European jurisdictions. Therefore, the CMVM will not allow financial intermediaries that are members of the Euronext and PEX to accept or execute short-selling orders on shares issued by the following financial institutions and related securities without ensuring the availability of the securities to be sold at the time of transmission or execution of the order:

The restriction against short sales will not apply to market members that act in the capacity of market makers or enhance liquidity in the securities subject to such sales.

Russia

The Federal Service of Russian Federation on Financial Markets, in its Order of September 22, 2008, banned offers for sale of securities on stock exchanges if the seller does not possess the securities required for settlement and delivery and/or has not entered into transactions to acquire such securities by the end of the trading session of the same day.

Singapore

As of September 22, 2008, the Singapore Exchange (the SGX) had not yet announced a prohibition on short selling based on its finding that the trading of securities listed on SGX has been orderly and settlement has been timely despite the global financial uncertainties. Nevertheless, SGX announced that it will adopt the following actions to enhance the existing transparency in the market and to deter failed deliveries:

1. With immediate effect, SGX will publish the list of buying-in securities and the volume of shares sought at 11:00 a.m. every day via SGXNET and the SGX website. After completion of buying-in, SGX will publish the list of securities bought-in (which includes individual counters), the volume and dollar-value at 8:30 a.m. the following business day.



2. In addition to the current processing fee for buying-in of $30 per contract, there will be a penalty of 5 percent of the value of the failed trade, subject to a minimum of $1,000, for all trades executed after September 24, 2008. The fee will be reviewed from time to time to assess its effectiveness.



3. Market participants must not sell short in the buying-in market as it runs counter to the objective of buying-in. Accordingly, any failure to deliver shares in the buying-in market may be liable to a penalty of $50,000 and/or expulsion from participating in the buying-in market, effective September 25, 2008.

Spain

The Comisión Nacional del Mercado de Valores decided on September 22 to take the following actions, consistent with the other leading European financial regulators:

1. Remind all regulated market members of the existing rules that prohibit and penalize naked short sales, and urge them to ensure that their clients hold the subject securities before executing their orders to sell, either by serving as custodian for their client’s securities or obtaining explicit assurance that the client is not conducting a naked short sale; and



2. Require persons holding short positions over shares or cuotas partiicipativas issued by the 20 financial institutions listed below to disclose any short position exceeding 0.25 per cent of the outstanding stock of any of those institutions and to report any changes in such short position the day after such change:

Switzerland

The Swiss Federal Banking Commission (SFBC) in its press release of September 19, 2008 stated that naked short sales are not permitted and are not compatible with the requirements of the SFBC Code of Conduct for Securities Markets, in particular when used to distort or manipulate the market. The SFBC also reminded banks to make sure that when selling securities for clients they are able to deliver the securities on settlement date.

Also on September 19, 2008 SWX Swiss Exchange (SWX), in its Official Message 67/2008, reminded its participants that uncovered (naked) short sales are prohibited on SWX and explained that short sales are deemed to be uncovered if the relevant securities cannot be delivered punctually. Noting that the non-deliverability of the securities would be an indication that the applicable rules of conduct have been breached, SWX has pledged to initiate an investigation of such failures and take the necessary measures, which can extend to the suspension or termination of participation in SWX. Covered short sales remain fundamentally permissible.

On the same date, SWX Europe, a UK subsidiary of SWX, announced new provisions added to its Code of Market Conduct that would ban naked short positions in financial stocks until December 19, 2008.

Taiwan

On September 21, 2008, the Taiwan Financial Supervisory Commission (the FSC) announced a prohibition on the short selling of the shares of the components of the Taiwan 50 Index, the Taiwan Mid-Cap 100 and the Taiwan Technology Index, effective from September 22 until October 3, 2008.

The prohibition applies whenever the relevant stocks are trading below the closing price of the previous trading session. On September 24, 2008, the FSC announced and reinstated the prohibition on the short selling of all relevant shares that are trading below the closing price of the previous trading session effective from September 22, 2008 to October 3, 2008, unless extended by the FSC.

This Alert was prepared with the assistance of Stephanie Cao, Alexander Kolmakov, Matthew Buchan McDermott and Susan Tan.

¹ See DLA Piper Alert, Implications of the Global Credit Crisis and the US Government’s Response (September 21, 2008), which also noted that the Commission issued a second emergency order on September 18 requiring institutional investment managers to report, on a weekly basis, their daily short positions through October 2, 2008. Also see DLA Piper Alert, SEC Attacks Short Selling on Regulatory and Enforcement Front (September 22, 2008), which further develops these topics.

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