SEC and FSA Clamp Down on Short Selling of Financial Firms
Elliot R. Curzon, Jennifer Epstein, David A. Vaughan, Richard L. Heffner, Alan Rosenblat, Patrick, W. Dennis and Darina F. O’Connor, Dechert LLP.
The US Securities and Exchange Commission (SEC) and the UK Financial Services Authority (FSA) have released regulations designed to limit short selling of financial firms and increase market transparency and liquidity. On 17 September 2008, the SEC issued an emergency order, adopting a new temporary rule imposing restrictions designed to curb naked short selling and the resulting delivery failures and a new anti-fraud rule applicable to short sellers who fail to deliver securities by the delivery dates (the ‘September 17 Order’).1 The FSA also had agreed to introduce new requirements to prohibit the active creation or increase of net short positions in publicly quoted financial companies from midnight 18 September 2008.
In this article (dated 24 September), we discuss three further emergency orders issued by the SEC on 18 September 2008, as amended by the SEC on 21 September 2008, and expand on the FSA’s short selling limitations announced on 18 September 2008, including further requirements and amended informal guidance issued by the FSA on 23 September 2008.
On 18 September 2008, the SEC released three further emergency orders to increase market transparency and liquidity. According to the SEC press release, the SEC, ‘acting in concert with’ the FSA, took these temporary actions to prohibit short selling in financial companies ‘to protect the integrity and quality of the securities market and strengthen investor confidence’. On 21 September 2008, the SEC released technical amendments to two of those orders.
Ban on short selling ‘covered securities’
The first of the three emergency orders imposes a ban on short selling in the securities of financial institutions (the ‘Financial Firms Order’).2 This action follows an SEC emergency order issued in July limiting short sales in Fannie Mae, Freddie Mac, and 17 other financial firms.3 In the Financial Firms Order, the SEC explained that ‘[r]ecent market conditions have made [the SEC] concerned that short selling in the securities of a wider range of financial institutions may be causing sudden and excessive fluctuations of the prices of such securities in such a manner so as to threaten fair and orderly markets.’ The SEC also states that the recent sudden price declines in a wide range of securities ‘can give rise to questions about the underlying financial condition of an issuer, which in turn can create a crisis of confidence, without a fundamental underlying basis. This crisis of confidence can impair the liquidity and ultimate viability of an issuer, with potentially broad market consequences.’4
The SEC amended the original Financial Firms Order on 21 September 2008, in order to ‘ensure the continued smooth operation of orderly markets, and to coordinate to the extent possible with similar actions restricting short sales by foreign regulators.’ The discussion below includes the details of the Financial Firms Order as revised by the amending order released on 21 September.5
To prevent substantial disruption in the securities markets, the Financial Firms Order (as amended) temporarily prohibits any person from effecting a short sale in the publicly-traded common equity securities of any issuer identified by any US national securities exchange listing such securities as being a financial institution (each a ‘covered security’ and collectively, ‘covered securities’). Each national securities exchange has published a list on its website of the individual listed companies with common equity that will be covered by the Financial Firms Order (as amended), and these lists are expected to include banks, savings associations, broker-dealers, investment advisers, and insurance companies, whether domestic or foreign, and the owners of any of those entities.6 The national securities exchanges are authorised to exclude any issuers that do not want to be treated as a covered security under the Financial Firms Order (as amended).