SEC Imposes New Short Sale Price Limitation on Circuit Breaker Basis

On Feb. 24, 2010, the SEC voted to impose a price limitation on short sales of certain equity securities on a “circuit breaker” basis. Under the new “alternative uptick rule,” adopted as Rule 201 of Regulation SHO, if the price of a security listed on a national securities exchange declines by 10 percent or more as compared to the prior day’s closing price, short sales generally only will be permitted at a price above the national best bid for the remainder of the day as well as the next trading day. The SEC took this action less than three years after it eliminated Rule 10a-1, its prior short sale price test rule that dated back to the SEC’s origins in the 1930s, and eliminated any short sale price limitations imposed by any self-regulatory organization. The SEC is permitting market centers and broker-dealers six months to implement policies and procedures designed to comply with the alternative uptick rule.

According to the SEC, the rule (the text of which is not yet available) is intended to target securities experiencing significant intraday price declines. The alternative uptick rule was proposed following an extensive comment period, including a review of approximately 4,300 comments. In the end, the SEC concluded that the circuit breaker/alternative uptick rule was easier and less costly to implement and to monitor, and would cause less market disruption, than the numerous other proposals restricting short sales that the SEC put forth last year. The rule was approved by a 3-2 vote, with the two Republican commissioners voting against the rule primarily on the basis that there was a lack of empirical data in support of the measure.

Specifics of the Operation of the Rule

Under the alternative uptick rule, market centers such as exchanges and alternative trading systems will be required to establish, maintain, and enforce policies and procedures designed to prevent the display and execution of a short sale of any “NMS stock” (as defined in the SEC’s Regulation NMS) at a price equal to or less than the national best bid for such stock when the circuit breaker is tripped for the remainder of the day of the 10 percent decline and the next trading day. Market centers will also be required to monitor the efficacy of their policies and procedures relative to the alternative uptick rule, and to modify them to the extent necessary. The market center where an NMS stock is listed will be responsible for determining when a 10 percent decline occurs and for notifying the appropriate securities information processor for that NMS stock of the decline. Each of the three exclusive securities information processors will be responsible for disseminating to other markets that a circuit breaker has been tripped.

Limited Exceptions

The SEC also adopted a number of exceptions from the alternative uptick rule consistent with the exceptions that existed under prior Rule 10a-1. These exceptions include:

• short sale orders submitted by broker-dealers that, at the time of submission to a market center, are priced above the national best bid; broker-dealers will be required to establish and implement policies and procedures reasonably designed to assure compliance with the terms of this exception, and to monitor the efficacy of such procedures;
• short sales by sellers who are deemed to “own” a security but who nevertheless are technically considered short sellers due to delivery delays;
• certain short sales of odd-lot size;
• short sales in connection with international and domestic arbitrage;
• short sales by broker-dealers acting in a riskless principal capacity; and
• short sales at a volume weighted average price.

The SEC also adopted an amendment to Rule 200(g) of Regulation SHO to require those claiming an exception from the alternative uptick rule to mark such orders as “short exempt.” More details will be available once the SEC publishes the release discussing the adoption of the new alternative uptick rule.  

For assistance, please contact the following lawyers:

Amy Kroll, Partner, Broker-Dealer Group
amy.kroll@bingham.com, 202.373.6118

David Boch, Partner, Broker-Dealer Group
david.boch@bingham.com, 617.951.8485

Roger P. Joseph, Practice Group Leader, Investment Management; Co-chair, Financial Services Area
roger.joseph@bingham.com, 617.951.8247

Edwin E. Smith, Partner, Financial Restructuring; Co-chair, Financial Services Area
edwin.smith@bingham.com, 617.951.8615

Tim Burke, Practice Group Leader, Broker-Dealer Group; Co-chair, Financial Services Area
timothy.burke@bingham.com, 617.951.8620