The U.S. Securities and Exchange Commission (SEC) has modified and extended until August 1, 2009, requirements for certain institutional investors to report equity security short sales activity to the SEC on Form SH. In addition, the SEC has taken formal action to permanently adopt rules prohibiting “naked” short selling and has extended until July 31, 2009, a temporary rule requiring participants in a registered clearing agency, and any broker-dealer from which such a participant receives trades for clearance or settlement, to promptly close out failures to deliver in connection with short sales. The effect of these actions is to retain, with some changes, the emergency measures relating to short selling that the SEC adopted in a flurry of emergency orders in September 2008. For a description of those orders, as well as related actions in the United Kingdom, see McDermott’s On the Subject “SEC and FSA’s Recent Short Selling Orders” issued October 2, 2008.
The Reporting Extension
While all of these extensions were expected, marketplace participants had held out the hope that the Form SH reporting requirements, applicable to investors controlling portfolios of at least $100 million of U.S. registered equity securities, would be permitted to expire. Instead, the SEC lessened the burden of the reporting requirements by revising the position reporting threshold to $10 million (from $1 million), eliminating certain reporting requirements relating to intraday positions and moving the filing date with respect to a week’s trading activities to the end of the following week (instead of the Monday filings that were initially required). It should be noted, however, that (after a two-week transitional period) the new $10 million threshold will now include short positions held prior to September 22, 2008, with respect to which reporting was not required in the original emergency order. During the two-week transitional period (ending October 31) filers will have the option of not including pre-September 22 positions, but at the cost of applying the previous $1 million reporting threshold. Positions that exceed .25 percent of an outstanding class of publicly traded stock will continue to require disclosure regardless of whether the monetary threshold is met. In all instances it will also continue to be the case that no reporting is required if a person subject to the reporting obligation has effected no short sales since its most recent previous Form SH report or if all the short sales that it has effected since the most recent previous report qualify for reporting exceptions.
Under the modified and extended regime, Form SH filings will continue to be confidential, with the SEC placing reliance upon the trade secret and financial regulatory reporting exceptions under the Freedom of Information Act. Confidentiality will be automatic and need not be requested by the filer. In addition, the SEC has imposed technical changes in filing format to facilitate its examination, compilation and comparison of the information contained in Form SH filings. Because the Form SH revision and extension was adopted as an “interim final” rule without undergoing the usual comment process, the SEC has requested comments on the form and related rules (including whether it should be further extended) by December 16, 2008.
Click here to view the Form SH revision order.
Extension and Revision of Naked Short Selling Restrictions
Acting to cure what may have been technical failures in its emergency adoption of two previously proposed rules under the Securities Exchange Act of 1934, the SEC permanently adopted antifraud rule 10b-21 and permanently amended rule 203 of Regulation SH (which governs short sales). Rule 10b-21 provides that it is a manipulative or deceptive device or contrivance to submit an order to sell an equity security if the seller deceives a broker-dealer, a clearing agency participant or a purchaser about the seller’s intention or ability to deliver the security on or before the transaction settlement date and the seller in fact fails to make the delivery. In adopting the rule in its final form, the SEC amended it slightly to clarify that it applies only to equity securities and to state that rule 10b-21 is not intended to limit or restrict the applicability of the general antifraud provisions of the federal securities laws, with particular reference to rule 10b-5. The latter point could be of some significance, particularly because, as the SEC noted in its adopting release, a private right of action is available under rule 10b-5 but, in view of subsequent court decisions with regard to the implication of private action rights, probably will not be under rule 10b-21.
Click here to view the release promulgating rule 10b-21 in final form.
The amendment to rule 203 permanently eliminated the option market maker’s exemption to the requirement to close out failures to deliver when a stock becomes a “threshold security”—i.e., a security with a defined level of failures to deliver. For practical purposes, this amendment will have no effect until the expiration of the now-extended emergency rule (Exchange Act rule 204T), which generally requires clearing agency participants or responsible broker-dealers to immediately close out delivery failures, subject to slightly less onerous regimes in the case of bona fide long sales and bona fide market making activities and a substantially more liberal regime in the case of sales under rule 144 under the Securities Act of 1933 (applicable because it can be difficult to remove restrictive legends from rule 144 stock). If such an immediate close out is not effected, the clearing agency participant and any broker or dealer from which it receives orders (including market makers) may not accept or effect a short sale without first either borrowing the subject security or entering into a bona fide arrangement to borrow it. Because market making gives rise to important differences in treatment, the SEC also used the release promulgating the permanent amendments to rule 203 as the occasion to discuss the factors that distinguish market making from other kinds of trading activities.
As in the case of the Form SH amendments and extension, the SEC adopted rule 204T on an interim final basis and requested comment on it, including its continuation, by December 16, 2008.
For the releases promulgating these amendments, see the following links: