On September 17 and 18, 2008, the Securities and Exchange Commission (the "Commission") issued three emergency orders restricting certain short selling practices. These orders:

  • ban the failure to deliver a security upon settlement of any long or short sale of an equity security, effectively prohibiting the practice of "naked" short selling in any equity security;
  • prohibit all persons from engaging in any short sale of a publicly traded security in nearly 800 financial institutions and other financial companies, subject to certain exceptions; and
  • require that certain institutional investment managers report to the SEC on a weekly basis specified information regarding their short sales of securities.

These orders were issued pursuant to Section 12(k)(2) of the Securities Exchange Act of 1934 ("Exchange Act"), which allows the Commission, in an emergency, to summarily take action by order to maintain or restore fair and orderly securities transactions or to reduce, eliminate, or prevent the emergency from causing substantial disruption to the securities markets.

The September 17, 2008 order took effect at 12:01 a.m. EDT on Thursday, September 18, 2008 and will terminate at 11:59 p.m. EDT on Tuesday, October 1, 2008, unless further extended by the Commission. The September 18, 2008 order banning short selling in financial companies' securities took effect at 12:01 a.m. EDT on Friday, September 19, 2008 and will terminate at 11:59 p.m. EDT on Wednesday, October 2, 2008, unless further extended by the Commission. The September 18, 2008 order requiring reporting of short sales by institutional investment managers takes effect at 12:01 a.m. EDT on Monday, September 22, 2008 and will terminate at 11:59 p.m. EDT on Wednesday, October 2, 2008, unless further extended by the Commission. The exercise of the Commission's emergency authority in this regard is limited to 30 calendar days in total duration.

Market Developments Leading to the Emergency Orders

In a July 2008 Section 12(k) emergency order, the Commission first noted that "naked" short selling has threatened to disrupt the United States' financial markets. "Naked" short selling is the practice of selling a security that the seller does not own without first borrowing the security or making arrangements to borrow the shares. Specifically, in the July 2008 emergency order, the Commission cited events surrounding Bear Stearns' liquidity crisis and its ultimate sale to JPMorgan Chase & Co. to illustrate that the dissemination of rumors can erode consumer confidence in an issuer, which, in turn, can cause stock prices of that issuer and others to fall. Further, the Commission cited press reports describing rumors regarding (i) purported liquidity problems faced by certain financial institutions, and (ii) the fact that counterparties to financial institutions have been unwilling to provide credit and other sources of liquidity.

In the wake of the July 2008 order, the Commission continues to be concerned that certain persons may seek to take advantage of issuers that have become temporarily weakened by current market conditions in order to engage in inappropriate short selling activities. Noting "sudden and unexplained declines" in stock prices that accompanied a series of tumultuous events in the financial company sector (including the Chapter 11 bankruptcy filing by Lehman Brothers, the announced proposed sale of Merrill Lynch to Bank of America, the possible sale of Morgan Stanley to Wachovia, and the federal investment in and takeover of AIG, Fannie Mae, and Freddie Mac), the Commission is seeking to further prevent crises in the securities markets generally and to strengthen overall investor confidence.

Temporary Restrictions on Short Selling, Naked Short Selling, and Similar Trading Activities

As a result of these developments, the Commission concluded in these emergency orders that it was necessary to impose enhanced securities delivery requirements and to exercise its emergency powers under Section 12(k)(2) of the Exchange Act. In the September 17 order, the Commission added and made effective a temporary Rule 204T to Regulation SHO, the set of regulations covering short selling and securities borrowing activities. The temporary rule requires any participant of a registered clearing agency, subject to certain exceptions, to deliver securities to the clearing agency for clearance and settlement on a long or short sale by the settlement date (usually three business days after the trade date) and to close out any fail to deliver position at a clearing agency for a long or short sale by the beginning of the settlement day following the settlement date. This order also amends Rule 203(b)(3) of Regulation SHO to eliminate the options market maker exception from Regulation SHO's close-out requirement.

The September 17 order also adopts Rule 10b-21, which deems it a "manipulative or deceptive device or contrivance" for purposes of Section 10(b) of the Exchange Act for any person to submit an order to sell an equity security if the person deceives a broker or dealer, a clearing agency participant or a purchaser about the person's intention to deliver the security on or before the settlement date, and the person actually fails to deliver to security on or before the settlement date.

The first September 18 order prohibits any short sale in the publicly traded securities of 799 financial companies listed in the order. This order provides limited exceptions for bona fide market making activities by over-the-counter market makers and option market makers, and for short sales that occur as a result of the automatic exercise or assignment of an equity option held prior to the effectiveness of this order as a result of the expiration of the option.

Required Reporting of Short Sales by Institutional Investment Managers

The second September 18 order requires an institutional investment manager that exercises investment discretion over securities covered by Section 13(f) of the Exchange Act and that filed or was required to file Form 13F for the June 30, 2008 calendar quarter to file a report on Form SH with the Commission electronically on EDGAR. A Form SH report will be due on the first business day of each week immediately following a week in which the investment manager effected any short sale in a security covered by Section 13(f) of the Exchange Act, other than an option. For each security that has been sold short, the Form SH must reflect the number and value of securities sold short during the day, as well as the opening short position, the closing short position, the largest intraday short position, and the time at which such largest intraday short position occurred for that security. The order includes a de minimis exception for short positions in securities that do not exceed specified amounts. This reporting requirement also applies only to short sales effected after September 22, 2008, the effective date of the order. The first Form SH would be due on Monday, September 29, 2008.

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