On February 24, 2010, the SEC announced the adoption of a new short selling price restriction rule, and the final text of the new rule was officially released on February 26. The rule will amend Regulation SHO under the Securities Exchange Act of 1934 by adopting a short sale “circuit breaker” that will be triggered any time a stock experiences a price decline of at least 10% in one day. Once triggered, short selling in the stock will only be permitted at prices above the current national best bid.
This post summarizes the basic elements of the new rule, which represents the first short sale price restriction adopted by the SEC since it eliminated the former “uptick rule” in 2007.
The basic elements of the new rule are as follows:
- Short Sale-Related Circuit Breaker: The circuit breaker would be triggered for a security any day in which the price declines by 10 percent or more from the prior day’s closing price.
- 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.
- Securities Covered by Price Test Restriction: The rule 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.
- Implementation: The rule 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.
- Effective Date and Compliance Date: The rule will become effective 60 days after the date of publication of the release in the Federal Register, and then market participants will have six months to comply with the requirements.
As noted in previous posts, this rule is the result of a long and deliberative process by the SEC. The SEC first proposed a set of alternative price test restrictions for public comment in April 2009. The SEC held a Roundtable on the subject on May 5, 2009, and in August 2009 it extended the comment period for the April 2009 proposal, in particular to seek additional comment on the “above national best bid” price test. That test, which would only allow short selling at a price above (as opposed to at or above) the current national best bid, is in fact the price test contained in the new rule adopted by the SEC last week.
As mentioned above, this new rule represents the first short sale price restriction adopted by the SEC since 2007, when it eliminated former Rule 10a-1, commonly known as the “uptick rule”. That rule, which was enacted by the SEC in 1938, prohibited investors from short selling an exchange-listed security unless the sale price of the security had previously ticked upward. The rule remained virtually unchanged until the SEC authorized a study in 2004 to assess the functionality and necessity of the price tests restrictions in place at that time. Following the year-long pilot study, the Commission ultimately eliminated all short sale price test restrictions in 2007.
The SEC reconsidered the imposition of a short sale price rule following the unprecedented events and market turmoil in 2008. As Chairman Schapiro stated during the open meeting last week on the 24th:
Today’s rule grows out of the lessons learned two years ago when the market began to drop precipitously. . . In arriving at the rule we are considering, the Commission was cognizant of the benefits that short selling can provide to the markets. . . However, we also are concerned that excessive downward price pressure on individual securities, accompanied by the fear of unconstrained short selling, can destabilize our markets and undermine investor confidence in our markets. Today’s rule addresses these concerns in two ways: First, it will prevent short selling, including potentially manipulative or abusive short selling, from further driving down the price of a security that has experienced a 10 percent price decline. Limiting the potential for abuse is an important goal of these rules. And, second, it will enable long sellers to stand in the front of the line, and sell their shares before any short sellers once the circuit breaker is triggered.
