SEC Adopts Short Sale Price Restrictions

On February 24, 2010, the Securities and Exchange Commission ("SEC") adopted, by a vote of 3-2, a new short sale pricing rule. Rule 201 under Regulation SHO of the Securities Exchange Act of 1934, as amended ("Exchange Act") restricts the short selling of stock when the price of the security has dropped by 10 percent or more in one day. Once the 10 percent circuit breaker is triggered, only short sells above the current national best bid ("NBB") will be permitted through the end of the following day.

Rule 201 is intended to preserve investor confidence and promote market efficiency by preventing potentially manipulative or abusive short selling from further driving down the price of a security. In addition, Rule 201 will enable long sellers to sell their shares before any short sellers once the circuit breaker is triggered. Rule 201 includes the following features:

• Covered Securities. Rule 201 generally applies to all equity securities that are listed on a national securities exchange, whether traded on an exchange or in the over-the-counter market.
• Short Sale-Related Circuit Breaker. The circuit breaker would be triggered for a security any day that its price declines by 10 percent or more from the security's price on its principal listing market as of the close of regular trading on the previous day.
• Duration Of Price Test Restriction. Once the circuit breaker has been triggered, the alternative uptick rule would apply to short sale orders in that security for the remainder of the day as well as the following day.
• Implementation. Rule 201 requires trading centers to establish, maintain and enforce written policies and procedures that are reasonably designed to prevent the execution or display of a prohibited short sale. There will be exemptions from Rule 201 for:
• 1. Orders where a broker-dealer identifies the price as above the NBB at the time the order is submitted to the trading center.
  2. Sales where the seller owns the security but there will be a delay in delivery.
  3. Certain odd-lot transactions.
  4. Short sales in connection with over-allotments and "lay-off sales."
  5. Certain international or domestic arbitrage transactions.
  6. Short sales that facilitate a riskless principal transaction.
  7. Transactions on a volume-weighted average price ("VWAP") basis.

The vote was divided among party lines, with Chairman Mary Schapiro and Commissioners Elisse Walter and Luis Aguilar supporting the adoption of Rule 201. Commissioners Kathleen Casey and Troy Paredes dissented from the decision to adopt Rule 201. In particular, they noted the absence of empirical evidence that short sale price restrictions counteract rapid market declines.

Rule 201 will become effective 60 days after the date of publication of the adopting release in the Federal Register. Once effective, market participants will have six months to comply with the requirements. The adopting release has not yet been published. Additional details will be provided once the adopting release has been issued.

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