SEC Votes to Publish Proposed Short Sale Price Tests and Circuit Breakers

April 8, 2009

Today, the Securities and Exchange Commission unanimously approved publication of a release proposing multiple price tests and circuit breakers to limit short selling. According to Commissioner Walter, taking together all of the permutations suggested in the release, at least 14 variations are included in the Commission’s proposal.

Below is a preliminary summary of the SEC’s proposals, subject to update following publication of the release, which is expected within a week.

Price Tests:

  1. Reinstatement of Rule 10a-1’s uptick rule.
  2. Uniform bid test, akin to the SEC’s 2003 proposal, which would allow short sales to be effected at a price one cent above the consolidated best bid.

Securities Covered:

NMS securities (i.e., generally exchange-traded equity securities).

Commissioners Casey and Aguillar, in particular, discussed synthetic short sales, such as selling calls, buying puts and the use of various swaps.  Commissioner Aguillar also asked that Congress give the SEC jurisdiction over all financial products that are the economic substitutes for securities, particularly credit default swaps and reverse equity swaps.

Proposed Exceptions:

  • Riskless principal transactions
  • Arbitrage transactions, including international arbitrage
  • Odd-lot transactions
  • Syndicate transactions
  • After-hours trading, largely because of the lack of a consolidated tape
  • Overseas transactions, except that if a transaction is arranged in the U.S., even if executed overseas, the Commission would say that U.S. short sale restrictions apply, as with Rule 10a-1.

Market Making:

No exception is proposed to be included for market making activities. While the Commission will ask for comment about the potential impact on liquidity, it notes that NASDAQ did not seek an exception for market making.

Circuit Breakers:

Three variations of security-specific circuit breakers will be proposed. 

  1. Short sales would be prohibited for the remainder of the day if there is a 10% decline in the price of a particular security.  This circuit breaker could be adopted together with a market wide price test.
  2. Similar to the Modified Uptick Rule proposed by the four exchanges, if there is a 10% decline in the price of a particular security, short sales would be permitted only at a price that is above the last sale price for the remainder of the trading day.
  3. Alternatively, if there is a 10% price decline in the price of a particular stock, short sales would be permitted only at a price that is above the highest available bid.

Among the Commission’s questions relating to circuit breakers will be (a) whether 10% is the right threshold, and (b) if any exceptions are appropriate.

Roundtable on
Short selling:

A public roundtable is tentatively scheduled for May 5, 2009. While it is still in the planning stage, one of the key topics on the agenda will be the underlying economics of the various tests and the costs of implementing any new requirements and restrictions.

Comment Period

There will be a 60 day comment period to allow for responses to the nearly 200 questions asked in the release. 

Several of the Commissioners noted that they are specifically soliciting empirical data and concrete analysis on the various proposals.

Chairman Schapiro asked the staff to use the comment period to survey the experience of non-U.S. regulators about the costs and benefits of their local short sale rules as a source of relevant data.

Implementation Period:

The Commission will propose a three month implementation period.  Dr. Sirri noted that a shorter period would be needed to implement a circuit breaker rule and a longer period would be required to implement price tests.

Dr. Erik Sirri, participating in his last Commission meeting as Director of the Division of Trading and Markets, noted that the Division is expected to ask the Commission to adopt final versions of  Rules 10a-3T and 204T later this spring.

Gibson, Dunn & Crutcher LLP

Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have about these developments.  Please contact the Gibson Dunn attorney with whom you work, or any of the following:

Washington, D.C.
K. Susan Grafton (202-887-3554, [email protected])
Barry R. Goldsmith
(202-955-8580, [email protected])
Amy L. Goodman (202-955-8653, [email protected])
Brian J. Lane (202-887-3646, [email protected]
Ronald O. Mueller (202-955-8671, [email protected]
John F. Olson (202-955-8522, [email protected]
John H. Sturc (202-955-8243, [email protected])

James J. Moloney (949-451-4343, [email protected]

New York
Dennis J. Friedman (212-351-3900, [email protected])
Mark K. Schonfeld (212-351-2433, [email protected])
Edward D. Sopher (212-351-3918, [email protected])

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