SEC Adopts New Short Sale Price Test

Advisory | February 26, 2010

On February 24, 2010, the Securities and Exchange Commission (SEC) amended Rule 201 of Regulation SHO to impose price restrictions on the short selling of stocks that experience a significant price decline. Under the amended rule, after the price of a stock declines by 10% from the previous day’s closing price, short sales of such stock may only be effected at a price that is above the current national best bid (CNBB). Thus, after this price decline occurs, short sellers may be providers of liquidity but cannot be takers of liquidity.

Amended Rule 201 includes the following elements:

  • Covered Securities. The amended rule imposes short selling price restrictions on any equity security that is listed on a national securities exchange, whether such security is traded on an exchange or in the over-the-counter market.
     
  • Short Sale-Related Circuit Breaker. The circuit breaker would be triggered after the price of a covered security drops by 10% or more from the prior day’s closing price.
     
  • Duration of Price Test Restriction. Once the circuit breaker has been triggered, the price test restrictions would apply to short sales in that security for the remainder of the day as well as the following day.
     
  • Effective Date. The effective date for the new rule is 60 days from the date of publication of the Federal Register release.
     
  • Implementation. Trading centers must establish, maintain and enforce written policies and procedures to implement the requirements of the amended rule within six months from the effective date.
     
  • Exceptions. The price test described above would not apply to the following types of transactions:

    — short sale orders priced above the CNBB at the time of submission;
    — sales where a seller owns the security, but there is a delay in delivery;
    — certain odd-lot transactions;
    — certain domestic and international arbitrage transactions;
    — over-allotment and lay-off sales;
    — riskless principal transactions; and
    — transactions on a volume-weighted average price basis.

The amended rule does not provide an exemption for market makers. However, the SEC will request a study of the effect of the amended rule on options market makers.

A more detailed analysis of the rule will follow after the release becomes available.

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