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US Regulatory Brief: SEC proposes changes to short selling rules

For the first time in 27 years the SEC has proposed rules to relax some restrictions on short selling.

Under the proposal, called Regulation SHO, the SEC would conduct a two-year experiment for about 300 widely traded companies, eliminating rules that ban short selling when a stock's price is falling.

The SEC plan also would establish a uniform rule on when investors can engage in short selling.

According to SEC Chairman William Donaldson the goals of the proposal are to facilitate the benefits of short selling while controlling manipulative practices.

Details of Proposed Changes:

The Commission voted to propose new short sale regulation under Regulation SHO, which would modernise and replace Rules 3b-3, 10a-1, and 10a-2 under the Exchange Act. Regulation SHO would include the following.

* A uniform short sale price test, Rule 201, applicable to exchange-listed and Nasdaq NMS securities, wherever traded, that would restrict all short sales to a price above the consolidated best bid.

* Proposed Rule 201 would incorporate some exceptions in current Rule 10a-1, and include additional exceptions to address situations involving locked and crossed markets, short sales executed at a volume weighted average price, broker-dealer executions of customer "long" sales on a riskless principal basis, and short sales by broker-dealers to fill customer limit buy orders as required by the federal securities laws or rules of the self-regulatory organizations.
* A temporary Rule 202(T) that would suspend, on a two-year pilot basis, the operation of the proposed bid test of Rule 201 for a select group of liquid securities
* New "locate" and delivery requirements under proposed Rule 203 to address abusive so-called naked short selling

* Rule 203 would incorporate provisions of the existing SRO "locate" rules into a uniform Commission rule applicable to all equity securities, wherever they are traded.
* Rule 203 would also impose additional requirements on securities that have a substantial amount of failures to deliver.
* Rule 200 of Regulation SHO, which would define the term "short sale" to allow multi-service broker-dealers to aggregate their positions by separate trading units; and modify the definition of ownership of a security to address security futures products and unconditional contracts to purchase securities.

The Commission also voted to:

* propose amendments to Rule 105 of Regulation M (short selling prior to a public offering) to eliminate the shelf offering exception; and
* issue an interpretive release providing all market participants with guidance regarding the use of "married put" transactions when aggregating positions under current Rule 3b-3 for determining compliance with current Rule 10a-1 and Rule 105 of Regulation M. A "married put" is the purchase of an option to sell (i.e., a put option) a certain number of securities at a particular price by a specified time, bought contemporaneously with the same number of underlying securities.

The Commission will solicit comment on the proposals for a period of 60 days following their publication in the Federal Register.

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