On April 8, 2009, the Securities and Exchange Commission (the "SEC") voted unanimously to seek public comment on proposed new restrictions on short selling in the U.S. public securities markets. The proposals, which were published on April 10th, comprise two approaches to restrictions on short selling. The first approach is a price test that would apply on a permanent and market-wide basis and would be based on either the national best bid price or the last sale price of a security. The second approach consists of a circuit breaker rule that would either temporarily prohibit short selling of a particular security or trigger a temporary short sale price test rule with respect to a particular security when there is a severe decline in the price of that security. The two approaches are not mutually exclusive, and any final rules may be based on a combination of approaches. As proposed, the rules would generally cover all securities (other than options) listed on a national securities exchange whether traded on an exchange or over-the-counter ("OTC"), but would not cover securities that are traded in the OTC market but not listed on an exchange.
In July 2007, the SEC eliminated all short sale price test restrictions. These included the "uptick rule" or "tick test" (former Rule 10a-1 under the Securities Exchange Act of 1934), which applied to exchange-listed securities, and the NASD's bid test, which applied to certain Nasdaq securities. However, the recent extreme market volatility, including steep stock price declines, experienced in the U.S. and all other major stock markets, and the resulting deterioration of investor confidence, has led the SEC to reconsider restoring restrictions on short selling.
The SEC has proposed two alternative price tests for restricting short selling on a market-wide basis, which it has identified as the "proposed modified uptick rule" and the "proposed uptick rule". Under the proposed modified uptick rule, which in many ways is similar to the NASD's former bid test, a trading center would be required to establish, maintain and enforce written policies and procedures reasonably designed to prevent the execution or display of any short sale order (other than certain "short exempt" orders that are generally consistent with exceptions under, or relief previously granted by the SEC from, former Rule 10a-1) at a down-bid price. A "down-bid price" is defined as "a price that is less than the current national best bid or, if the last differently priced national best bid was greater than the current national best bid, a price that is less than or equal to the current national best bid". A "trading center" is "a national securities exchange or national securities association that operates an SRO trading facility, an alternative trading system, an exchange market maker, an OTC market maker, or any broker dealer that executes orders internally by trading as principal or crossing orders as agent".
The proposed uptick rule is similar to the SEC's former uptick test and would prohibit short sales of a security (i) below the last price at which a regular way sale of the security occurred or (ii) at such last price unless such price is above the next preceding different price at which a regular way sale of such security was made. The proposed uptick rule would be subject to a number of exceptions to accommodate various trading strategies and systems in use today, in addition to the exceptions provided for in the proposed modified uptick rule. The SEC has expressed a preference for the proposed modified uptick rule, primarily because it believes that bid prices (used in the proposed modified uptick rule) provide more accurate pricing than do last sale prices (used in the proposed uptick rule) due to delays that can occur in reporting last sale price information and the fact that last sale price information is published in reporting sequence rather than transaction sequence.
The proposed modified uptick rule and the proposed uptick rule would apply only during periods when the national best bid is collected, calculated and disseminated, and thus not to much of the after-hours trading of listed securities. According to the SEC, both rules have been designed to allow relatively unrestricted short selling in up markets but to help prevent short selling, including potentially abusive or manipulative short selling, from being used to drive prices down or accelerate a declining market.
The proposed circuit breaker rules would affect only a particular security during a severe market decline in the price of that security. Under one proposed alternative, short selling in a security would, subject to exceptions substantially identical to those included in the SEC's Short Sale Ban Emergency Order issued in September 2008, be prohibited for the remainder of the trading day following a 10% or greater decline in the price of the security from its closing price on the prior trading day. If adopted, this circuit breaker would operate in place of, or in addition to, a short sale price test restriction. Under the other proposals, a 10% or greater price decline in a security from the prior day's closing price would trigger either a temporary modified uptick rule (i.e., a national best bid price test) or a temporary uptick rule (i.e., a last sale price test) applicable to trading in the security for the remainder of the trading day. If either of these circuit breakers is adopted, it would operate in place of a short sale price test rule. However, none of the circuit breakers would be triggered if the specified market price decline threshold is reached within 30 minutes of the end of regular trading hours.
In its proposal, the SEC acknowledged that short selling serves legitimate and valuable functions, including providing the markets with liquidity and price efficiency, combating upward stock manipulation, and facilitating hedging of long positions. The proposing release indicates that any restrictions adopted must be designed to limit any unnecessary impact on short selling and stresses that the SEC is seeking empirical data and concrete analysis regarding the costs and benefits associated with each proposal, as opposed to statements of opinion or belief. The comment period for the proposed rules ends on June 19, 2009, and the SEC has tentatively scheduled a public roundtable on the proposals for May 5, 2009. To provide market participants with sufficient time to modify their systems and procedures, the SEC has proposed that compliance with any rules adopted under the proposal be required three months after the effective date of the adopted rules.
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