September 22, 2008



SEC ATTACKS SHORT SELLING ON REGULATORY AND ENFORCEMENT FRONT

On September 19, 2008, the SEC took regulatory and enforcement steps to combat what it describes as “abusive short selling“ during this period of “market turmoil.“

These steps included issuing the following orders: a formal order of investigation into manipulative short selling; an emergency order prohibiting short selling securities of certain financial companies; an emergency order requiring the public disclosure of certain short sale positions; and an emergency order imposing a hard T+3 close out date for all short sales.

Each of these orders is currently in effect.

Formal Order of Investigation Regarding Illegal Short Selling

On the enforcement front, the SEC announced a “sweeping expansion of its ongoing investigation into possible market manipulation in the securities of certain financial institutions.“ With the issuance of a formal order of investigation, the Enforcement Division now has the power to subpoena documents and testimony relevant to its investigation into manipulative and “abusive“ short selling practices and illegal “rumor mongering.“

According to the SEC‘s press release, hedge fund managers, broker-dealers and institutional investors with significant trading activity in certain financial issuers or positions in credit default swaps will be required to disclose these positions, under oath, to the Commission.

These market participants also should anticipate subpoenas for documents and testimony not only from the SEC but from NYSE Regulation and FINRA as well. These agencies will be conducting separate parallel inquiries into short selling stock of financial institutions.

SEC Prohibits Short Selling Securities Of Certain Financial Companies

The SEC also issued an emergency order prohibiting short selling securities of approximately 800 public financial companies. There are several narrow exceptions to this prohibition on short selling:

  • Short selling by registered market makers, block positioners or other market makers obligated to quote in the over-the-counter market as part of bona fide market making activity;


  • Short selling in connection with an automatic exercise or assignment of an equity option held prior to the effectiveness of the order; and


  • Short selling by registered market makers as part of bona fide market making and hedging activity related directly to bona fide market making in derivatives of a covered security. However, this exemption was only in effect until 11:59 p.m. on September 19, 2008. The Staff has recommended to the Commission that this exemption be extended to cover the life of the order.


This emergency order will expire at 11:59 p.m. (Eastern) on October 2, 2008. Click here to read the order and the pertinent list of public financial companies.

Mandatory Filing Identifying Short Selling Activity

The Commission also issued an emergency order that requires all institutional investment managers that are currently required to file Form 13F to file a form with the SEC on the first business day of every calendar week immediately following a week in which the manager effected short sales.

As first released, this order provided that these disclosures would be become publicly available once submitted. On September 21, 2008, the order was revised to delay public availability of the information on Form SHO until two weeks after filing. It will require the following disclosures: name of issuer, cusip, short position at the start of day, number of securities sold short, value of securities sold short, short position at the end of day, largest intra-day short position, and time of day of largest intra-day short position. This reporting requirement is limited to those short positions that are either .25 percent or more of the class of the issuer’s issued and outstanding securities or where the fair market value of the short position is $1 million or greater. The first Form SH must be filed on September 29, 2008 and will cover short selling activities during the week of September 22, 2008.

This order is also set to expire on October 2, 2008. Unless the Commission extends the life of the order, only one Form SH filing will be required.

Order Imposing Hard Close-Out Date For Short Sales To Prevent Naked Short Selling


The Commission also entered an order designed to penalize naked short sellers. Short sellers and their broker-dealers must deliver securities by the close of business on the settlement date (three days after the transaction date). Any broker-dealer acting on a short-seller’s behalf that fails to comply with this close-out requirement will be prohibited from further short sales on behalf of any person in the same security unless the shares are pre-borrowed.

In connection with this order, the Commission also eliminated the options market maker exception from the close-out requirement of Rule 203(b)(3) in Regulation SHO. Options market makers are now subject to the same hard T+3 closeout requirements as all other market participants.