SECURITIES AND EXCHANGE COMMISSION
`
`17 CFR PART 242
`
`Release No. 34-61595; File No. S7-08-09
`
`RIN 3235-AK35
`
`Amendments to Regulation SHO
`
`AGENCY: Securities and Exchange Commission.
`
`ACTION: Final rule.
`
`SUMMARY: The Securities and Exchange Commission (“Commission”) is adopting
`
`amendments to Regulation SHO under the Securities Exchange Act of 1934 (“Exchange Act”).
`
`We are adopting a short sale-related circuit breaker that, if triggered, will impose a restriction on
`
`the prices at which securities may be sold short (“short sale price test” or “short sale price test
`
`restriction”). Specifically, the Rule requires that a trading center establish, maintain, and enforce
`
`written policies and procedures reasonably designed to prevent the execution or display of a
`
`short sale order of a covered security at a price that is less than or equal to the current national
`
`best bid if the price of that covered security decreases by 10% or more from the covered
`
`security’s closing price as determined by the listing market for the covered security as of the end
`
`of regular trading hours on the prior day. In addition, the Rule requires that the trading center
`
`establish, maintain, and enforce written policies and procedures reasonably designed to impose
`
`this short sale price test restriction for the remainder of the day and the following day when a
`
`national best bid for the covered security is calculated and disseminated on a current and
`
`
`continuing basis by a plan processor pursuant to an effective national market system plan. We
`
`believe it is appropriate at this time to adopt a short sale-related circuit breaker because, when
`
`triggered, it will prevent short selling, including potentially manipulative or abusive short selling,
`
`CFAD VI 1061 - 0001
`CFAD VI v. CELGENE
`IPR2015-01103
`
`

`
`from driving down further the price of a security that has already experienced a significant intra-
`
`day price decline, and will facilitate the ability of long sellers to sell first upon such a decline.
`
`This approach establishes a narrowly-tailored Rule that will target only those securities that are
`
`
`experiencing significant intra-day price declines. We believe that addressing short selling in
`
`connection with such declines in individual securities will help address erosion of investor
`
`confidence in our markets generally.
`
`
`
`In addition, we are amending Regulation SHO to provide that a broker-dealer may mark
`
`certain qualifying sell orders “short exempt.” In particular, if the broker-dealer chooses to rely
`
`on its own determination that it is submitting the short sale order to the trading center at a price
`
`that is above the current national best bid at the time of submission or to rely on an exception
`
`specified in the Rule, it must mark the order as “short exempt.” This “short exempt” marking
`
`requirement will aid surveillance by self-regulatory organizations (“SROs”) and the Commission
`
`for compliance with the provisions of Rule 201 of Regulation SHO.
`
`
`DATES: Effective Date: May 10, 2010
`
`Compliance Date: November 10, 2010
`
`FOR FURTHER INFORMATION CONTACT: Josephine J. Tao, Assistant Director;
`
`Victoria Crane, Branch Chief; Katrina Wilson, Staff Attorney; and Angela Moudy, Staff
`
`Attorney, Division of Trading and Markets, at (202) 551-5720, at the Commission, 100 F Street,
`
`NE, Washington, DC 20549-6628.
`
`SUPPLEMENTARY INFORMATION: The Commission is amending Rules 200(g) and 201
`
`of Regulation SHO [17 CFR 242.200(g) and 17 CFR 242.201] under the Exchange Act.
`
`Table of Contents
`
`I.
`II.
`
`Executive Summary
`Background on Short Sale Restrictions
`
`
`
`2
`
`
`CFAD VI 1061 - 0002
`
`

`
`
`
`A.
`B.
`C.
`D.
`
`III.
`
`
`
`
`
`
`7.
`
`B.
`1.
`2.
`3.
`4.
`5.
`6.
`7.
`8.
`9.
`
`
`
`
`
`Short Selling and its Market Impact
`History of Short Sale Price Test Restrictions in the U.S.
`Proposal to Adopt a Short Sale Price Test Restriction or Circuit Breaker
`Empirical Data Regarding Potential Market Impact of Short Sale Price Test
`Restrictions Submitted in Response to the Proposal and Re-Opening Release
`Discussion of Rule 201 of Regulation SHO
`
`A.
`Operation of the Circuit Breaker Plus Alternative Uptick Rule
`1.
`Covered Securities
`2.
`Pricing Increment
`3.
`Alternative Uptick Rule
`
`Circuit Breaker Approach Generally
`4.
`5.
`Circuit Breaker Trigger Level and Duration
`6.
`Determination Regarding Securities Subject to Rule 201 and Dissemination of
`Such Information
`Policies and Procedures Approach
`“Short Exempt” Provisions of Rule 201
`Broker-Dealer Provision
`Seller’s Delay in Delivery
`Odd Lot Transactions
`Domestic Arbitrage
`International Arbitrage
`Over-Allotments and Lay-Off Sales
`Riskless Principal Transactions
`
`Transactions on a Volume-Weighted Average Price Basis
`Decision Not to Adopt a Provision that a Broker-Dealer may Mark an Order
`“Short Exempt” in Connection with Bona Fide Market Making Activity
` Order Marking
`IV.
` Exemptive Procedures
`V.
` Overseas Transactions
`VI.
`VII. Rule 201 Implementation Period
`VIII. Decision Not to Implement Rule 201 on a Pilot Basis
`
`IX.
` Paperwork Reduction Act
`Background
`A.
`B.
`Summary
`1.
`Policies and Procedures Requirement under Rule 201
`2.
`Policies and Procedures Requirement under the Broker-Dealer and Riskless
`Principal Provisions
`Marking Requirements
`Use of Information
`Policies and Procedures Requirement under Rule 201
`Policies and Procedures Requirement under the Broker-Dealer and Riskless
`Principal Provisions
`Marking Requirements
`Respondents
`Policies and Procedures Requirement under Rule 201
`
`
`
`
`
`3.
`
`C.
`1.
`2.
`
`
`
`3.
`
`D.
`
`1.
`
`
`
`3
`
`
`CFAD VI 1061 - 0003
`
`

`
`
`
`2.
`
`3.
`E.
`1.
`2.
`
`Policies and Procedures Requirement under the Broker-Dealer and Riskless
`Principal Provisions
`Marking Requirements
`Total Annual Reporting and Recordkeeping Burdens
`Policies and Procedures Requirement under Rule 201
`Policies and Procedures Requirement under the Broker-Dealer and Riskless
`Principal Provisions
`Marking Requirements
`3.
`Collection of Information Is Mandatory
`F.
`Policies and Procedures Requirements
`1.
`Marking Requirements
`2.
`
`Confidentiality
`G.
`Policies and Procedures Requirements
`1.
`Marking Requirements
`2.
`
`Record Retention Period
`H.
`Policies and Procedures Requirements
`1.
`Marking Requirements
`2.
` Cost-Benefit Analysis
`A.
` Benefits
`1.
` Alternative Uptick Rule
`
`Circuit Breaker Approach
`2.
`3.
` Marking Requirements
`B.
` Costs
`1.
` Alternative Uptick Rule
`
`Impact on Market Quality
`a.
`b.
`Implementation and On-going Monitoring and Surveillance Costs
`i.
`Policies and Procedures Requirement under Rule 201
`ii.
`Policies and Procedures Requirement under the Broker-Dealer and Riskless
`Principal Provisions
`Circuit Breaker Approach
`2.
`Impact on Market Quality
`a.
`Implementation and On-going Monitoring and Surveillance Costs
`b.
` Implementation Period
`3.
` Marking Requirements
`4.
`Consideration of Burden on Competition and Promotion of Efficiency, Competition, and
`Capital Formation
`
`A.
`Competition
`
`1.
`Market Structure for Trading Centers and Broker-Dealers
`2.
`Discussion of Impacts of Rules 200(g) and 201 on Competition
`B.
`Capital Formation
`C.
`Efficiency
` Final Regulatory Flexibility Analysis
`Need for and Objectives of the Rule
`A.
`B.
`Significant Issues Raised by Public Comment
`C.
`Small Entities Affected by the Rule
`D.
`Projected Reporting, Recordkeeping and Other Compliance Requirements
`
`4
`
`
`
`
`
`
`
`
`
`
`X.
`
`
`
`
`
`XI.
`
`XII.
`
`
`
`CFAD VI 1061 - 0004
`
`

`
`
`
`Agency Action to Minimize Effect on Small Entities
`E.
`
` Significant Alternatives
`F.
`XIII. Statutory Authority
`XIV. Text of the Amendments to Regulation SHO
`
`
`I.
`
`Executive Summary
`
`
`
`In July 2007, the Commission eliminated all short sale price test restrictions. Prior to that
`
`time, short sale price test restrictions included Rule 10a-1 under the Exchange Act, also known
`
`as the “uptick rule” or “tick test” (“former Rule 10a-1”), that applied to exchange-listed
`
`securities,1 and the National Association of Securities Dealers, Inc.’s (“NASD”)2 bid test, Rule
`
`3350 (“NASD’s former bid test”), that applied to certain Nasdaq securities.3 The Commission’s
`
`removal of short sale price test restrictions followed a careful, deliberative rulemaking process,
`
`carried out in multiple stages from 1999 through 2006, and was open to the public at every stage.
`
`
`
`The Commission took a number of steps as part of that process, including seeking
`
`extensive public comment and conducting a comprehensive staff study to assess whether then-
`
`current short sale price test restrictions were appropriate. For example, beginning in 1999, the
`
`Commission published a concept release in which it sought comment regarding short sale price
`
`test regulation, including comment on whether to eliminate such regulation.4 In 2004, the
`
`Commission initiated a year-long pilot (“Pilot”) to study the removal of short sale price tests for
`
`approximately one-third of the largest stocks.5 Short sale data was made publicly available
`
`during this Pilot to allow the public and Commission staff (the “Staff”) to study the effects of
`
`eliminating short sale price test restrictions. The findings of third party researchers were
`
`1
`
` See infra note 41 and accompanying text.
`
`
`
`2 NASD is now known as the Financial Industry Regulatory Authority, Inc. (“FINRA”).
`
`
`
`
`
`
`
` See infra note 43 and accompanying text.
`
`
`
` See Exchange Act Release No. 42037 (Oct. 20, 1999), 64 FR 57996 (Oct. 28, 1999) (“1999 Concept Release”).
`
`
`
`3
`
`
`4
`
`
`5
`
`
`
`
`
`
` See Exchange Act Release No. 50104 (July 28, 2004), 69 FR 48032 (Aug. 6, 2004) (“Pilot Release”).
`
`
`
`
`
`5
`
`
`CFAD VI 1061 - 0005
`
`

`
`presented and discussed in a public Roundtable in September 2006.6 In addition, the results of
`
`the Staff study of the Pilot data were made publicly available in draft form in September 2006
`
`
`
` and in final form in February 2007.7
`
`
`
`Since then, there has been significant market turmoil. Concurrent with the development
`
`of the subprime mortgage crisis and credit crisis in 2007, market volatility, including steep price
`
`declines, particularly in the stocks of certain financial services companies, increased markedly in
`
`the U.S. and in every major stock market around the world (including markets that continued to
`
`operate under short sale price test restrictions).8 As market conditions continued to worsen,
`
`investor confidence eroded, and the Commission received many requests from the public to
`
`consider imposing restrictions with respect to short selling, based in part on the belief that such
`
`
`
` action would help restore investor confidence.9
`
`
`
`We determined that it was appropriate to re-examine the appropriateness of short sale
`
`price test restrictions and seek comment on whether to restore any such restrictions. Thus, in
`
`April 2009 we proposed two approaches to restrictions on short selling, one that would apply on
`
`a permanent, market-wide basis and another that would apply to a particular security upon a
`
`significant decline in the price of that security (the “proposed circuit breaker approach” or
`
`
`
` “proposed circuit breaker rules”).10
`
`
`6
`
` See http://www.sec.gov/about/economic/shopilottrans091506.pdf (the “Regulation SHO 2006 Roundtable”).
`
`
`
`
` See http://www.sec.gov/about/economic/shopilot091506/draft_reg_sho_pilot_report.pdf and
`
`
`
`
`http://www.sec.gov/news/studies/2007/regshopilot020607.pdf. See also infra notes 48 to 62 and accompanying
`
`
`text (discussing findings of the Staff study).
`
`
`
` See Exchange Act Release No. 59748 (Apr. 10, 2009), 74 FR 18042, 18043 (Apr. 20, 2009) (the “Proposal”).
`
`
`
`
`
`
`
`7
`
`
`8
`
`
`9
`
`
`
`
` See id.
`
`10 See Proposal, 74 FR 18042.
`
`
`
`
`6
`
`
`CFAD VI 1061 - 0006
`
`

`
`With respect to the permanent, market-wide approach, we proposed two alternative price
`
`tests. The first alternative price test, in many ways similar to NASD’s former bid test, would be
`
`based on the national best bid (the “proposed modified uptick rule”). The second alternative
`
`price test, similar to former Rule 10a-1, would be based on the last sale price (the “proposed
`
`uptick rule”).
`
`
`
`With respect to the proposed circuit breaker approach, we proposed two basic
`
`alternatives. First, we proposed a circuit breaker rule that, when triggered by a significant price
`
`decline in a particular security, would temporarily prohibit any person from selling short that
`
`security, subject to certain exceptions (“proposed circuit breaker halt rule”). Second, we
`
`proposed a circuit breaker rule that, when triggered by a significant price decline in a particular
`
`security, would trigger a temporary short sale price test for that security. In connection with this
`
`alternative, we proposed two short sale price tests. One was the modified uptick rule – that is,
`
`we proposed a circuit breaker rule that, when triggered by a significant price decline in a
`
`particular security, would temporarily impose the proposed modified uptick rule for that security
`
`(“proposed circuit breaker modified uptick rule”). The other was the uptick rule – that is, we
`
`proposed a circuit breaker rule that, when triggered by a significant market decline in a particular
`
`security, would temporarily impose the proposed uptick rule for that security (“proposed circuit
`
`breaker uptick rule”).
`
`
`
`In addition, in the Proposal we inquired whether a short sale price test restriction that
`
`would permit short selling at a price above the current national best bid (the “alternative uptick
`
`rule”), would be preferable to the proposed modified uptick rule and the proposed uptick rule.11
`
`
`We sought comment regarding the application of the alternative uptick rule as a market-wide
`
`
`
`
` 11 See Proposal, 74 FR at 18072, 18081, 18082.
`
`
`
`
`
`7
`
`
`CFAD VI 1061 - 0007
`
`

`
`permanent short sale price test restriction or in conjunction with a circuit breaker.12 As a
`
`supplement to our request for comment in the Proposal and to help ensure the public had a full
`
`opportunity to comment on, among other things, the alternative uptick rule, on August 20, 2009
`
`we re-opened the comment period to the Proposal.13 In addition, on May 5, 2009, we held a
`
`Roundtable to Examine Short Sale Price Test and Circuit Breaker Restrictions (the “May 2009
`
`Roundtable”).14 Panelists included representatives of public issuers, investors, financial services
`
`
`
` firms, SROs and the academic community.15
`
`
`
`Although in recent months there has been an increase in stability in the securities
`
`markets, we remain concerned that excessive downward price pressure on individual securities
`
`accompanied by the fear of unconstrained short selling can undermine investor confidence in our
`
`markets generally.16 In addition, we are concerned about potential future market turmoil,
`
`including significant increases in market volatility and steep price declines. Thus, as discussed
`
`in more detail below, after considering the comments, we have determined that it is appropriate
`
`at this time to adopt in Rule 201 a targeted short sale price test restriction that will apply the
`
`alternative uptick rule for the remainder of the day and the following day if the price of an
`
`
`
` 12 See id.
`
`
` 13 See Exchange Act Release No. 60509 (Aug. 17, 2009), 74 FR 42033 (Aug. 20, 2009) (the “Re-Opening
`
`
`Release”).
`
`
`
`
`
`
`
` 14 See Exchange Act Release No. 59855 (May 1, 2009); Press Release No. 2009-101 (agenda and panelists
`
`
`
`included); Press Release No. 2009-88 (preliminary agenda included).
`
`
`
`
`
` 15 See http://www.sec.gov/spotlight/shortsales/roundtable050509/shortsalesroundtable050509-transcript.txt
`
`
`
`
` (unofficial transcript of May 2009 Roundtable).
`
`
`
`16 We note that investor confidence may include a number of different elements, such as investor perceptions
`
`
`about fundamental market risk, investor optimism about the economy, or investor trust in the fairness of
`
`
`financial markets as influenced by applicable regulatory protections. Although the latter can be directly
`influenced by Commission actions, the Commission does not have control over fundamental market risk and
`
`
`economic optimism. Thus, as used here, the term “investor confidence” refers to investor trust in the fairness of
`
`financial markets.
`
`
`
`
`
`8
`
`
`CFAD VI 1061 - 0008
`
`

`
`individual security declines intra-day by 10% or more from the prior day’s closing price for that
`
`security as determined by the covered security’s listing market.
`
`By not allowing short sellers to sell at or below the current national best bid while the
`
`circuit breaker is in effect, the short sale price test restriction in Rule 201 will allow long sellers,
`
`who will be able to sell at the bid, to sell first in a declining market for a particular security. As
`
`the Commission has noted previously in connection with short sale price test restrictions, a goal
`
`of such restrictions is to allow long sellers to sell first in a declining market.17 A short seller that
`
`
`is seeking to profit quickly from accelerated, downward market moves may find it advantageous
`
`to be able to short sell at the current national best bid. In addition, by making such bids
`
`accessible only by long sellers when a security’s price is undergoing significant downward price
`
`pressure, Rule 201 will help to facilitate and maintain stability in the markets and help ensure
`
`that they function efficiently. It will also help restore investor confidence during times of
`
`substantial uncertainty because, once the circuit breaker has been triggered for a particular
`
`security, long sellers will have preferred access to bids for the security, and the security’s
`
`continued price decline will more likely be due to long selling and the underlying fundamentals
`
`of the issuer, rather than to other factors.
`
`
`
`In addition, combining the alternative uptick rule with a circuit breaker will strike the
`
`appropriate balance between our goal of preventing short selling, including potentially
`
`manipulative or abusive short selling, from being used as a tool to exacerbate a declining market
`
`in a security and the need to allow for the continued smooth functioning of the markets,
`
`
`
` 17 See Exchange Act Release No. 48709 (Oct. 28, 2003), 68 FR 62972, 62989 (Nov. 6, 2003) (“2003 Regulation
`
`
`
`
`
`
`SHO Proposing Release”); see also Exchange Act Release No. 30772 (June 3, 1992), 57 FR 24415, 24416 (June
`
`
`
`9, 1992) (stating that former Rule 10a-1 was “designed to limit short selling of a security in a declining market,
`by requiring, in effect, that each successive lower price be established by a long seller”).
`
`
`
`9
`
`
`CFAD VI 1061 - 0009
`
`

`
`including the provision of liquidity and price efficiency in the markets.18 The circuit breaker
`
`approach of Rule 201 will help benefit the market for a particular security by allowing
`
`
`participants, when a security is undergoing a significant intra-day price decline, an opportunity to
`
`re-evaluate circumstances and respond to volatility in that security. We also believe that a circuit
`
`breaker will better target short selling that may be related to potential bear raids19 and other
`
`forms of manipulation that may be used to exacerbate a price decline in a covered security.
`
`
`
`At the same time, however, we recognize the benefits to the market of legitimate short
`
`selling, such as the provision of liquidity and price efficiency. Thus, by imposing a short sale
`
`price test restriction only when an individual security is undergoing significant downward price
`
`pressure, the short sale price test restrictions of Rule 201 will apply to a limited number of
`
`securities, rather than to all securities all the time. As discussed in more detail below,20 in
`
`response to our request for comment on an appropriate threshold at which to trigger the proposed
`
`circuit breaker short sale price test restrictions, commenters submitted estimates of the number of
`
`
`securities that would trigger a circuit breaker rule at a 10% threshold.21 While commenters’
`
`
`
` 18 Where we use the terms “market efficiency” and “price efficiency” in this adopting release we are using terms
`
`
` of art as used in the economic literature proceeding under the “efficient markets hypothesis,” under which
` financial prices are assumed to reflect all available information and accordingly adjust quickly to reflect new
`
`
`
`information. See, e.g., Eugene F. Fama, 1991, Efficient capital markets: II, Journal of Finance; 46: 1575-1617;
`
`
`Eugene F. Fama and Kenneth R. French, 1992, The Cross-Section of Expected Stock Returns, Journal of
`
`
`Finance, 47: 427-465. It should be noted that economic efficiency and price efficiency are not identical with the
`ordinary sense of the word “efficiency.”
`
` 19 See infra note 36 and accompanying text.
`
`
`
`
`
`
`
`
` 20 See infra Section III.A.5. (discussing the circuit breaker trigger level).
`
`
` 21 See, e.g., letter from Mary Lou Von Kaenel, Managing Director, Management Consulting, Jordan & Jordan,
`
`
`
`
` dated June 19, 2009 (“Jordan & Jordan”); letter from John C. Nagel, Managing Director and Deputy General
` Counsel, Citadel Investment Group, John Liftin, Managing Director and General Counsel, The D.E. Shaw
`
`
`
` Group, and Mark Silber, Executive Vice President, Renaissance Technologies, dated June 19, 2009 (“Citadel et
`
`
`
`
`al. (June 2009)”); letter from Stuart J. Kaswell, Executive Vice President, Managing Director and General
`
`
`
`Counsel, Managed Funds Association, dated June 22, 2009 (“MFA (June 2009)”); letter from Ira D.
`
`Hammerman, Senior Managing Director and General Counsel, Securities Industry and Financial Markets
`
`
`Association, dated June 19, 2009 (“SIFMA (June 2009)”); letter from Daniel Mathisson, Managing Director,
`Credit Suisse Securities (USA), LLC, dated Sept. 21, 2009 (“Credit Suisse (Sept. 2009)”).
`
`
`
`10
`
`
`CFAD VI 1061 - 0010
`
`

`
`
`
` analyses (including the facts and assumptions used) and their resulting estimates varied,22
`
`commenters’ estimates reflect that a 10% circuit breaker threshold, on average, should affect a
`
`limited percentage of covered securities.23 Given the variations in the facts and assumptions
`
`underlying the estimates submitted by commenters, the Staff also looked at trading data to
`
`confirm the reasonableness of those estimates. The Staff found that, during the period covering
`
`April 9, 2001 to September 30, 2009,24 the price test restrictions of Rule 201 would have been
`
`triggered, on an average day, for approximately 4% of covered securities.25 The Staff also found
`
`that for a low volatility period, covering January 1, 2004 to December 31, 2006, the 10% trigger
`
`level of Rule 201 would have, on an average day, been triggered for approximately 1.3% of
`
`covered securities.26
`
`
`
`
`Thus, Rule 201 is structured so that the circuit breaker generally will not be triggered for
`
`the majority of covered securities at any given time and, thereby, will not interfere with the
`
`smooth functioning of the markets for those securities, including when prices in such securities
`
`are undergoing minimal downward price pressure or are stable or rising. If the short sale price
`
`test restrictions of Rule 201 apply to a covered security it will be because and when that security
`
`is undergoing significant downward price pressure.
`
`
`
`In addition, to help ensure the Rule’s workability, we are amending Rule 200(g) of
`
`Regulation SHO, substantially as proposed, to provide that, once the circuit breaker has been
`
`triggered for a covered security, if a broker-dealer chooses to rely on its own determination that
`
`
`
` 22 See infra note 306.
`
`
`
` 23 See infra note 307.
`
`
`
` 24 See infra note 309.
`
`
`
` 25 See infra note 310.
`
`
`
` 26 See infra note 311.
`
`
`
`11
`
`
`CFAD VI 1061 - 0011
`
`

`
`it is submitting a short sale order to a trading center at a price that is above the current national
`
`best bid at the time of submission or to rely on an exception specified in the Rule, it must mark
`
`the order “short exempt.”27 The short sale price test restrictions of Rule 201 generally will apply
`
`to a small number of securities for a limited duration, and will continue to permit short selling
`
`rather than, for example, halting short selling when the restrictions are in place. As such, we
`
`believe that the circumstances under which a broker-dealer may need to mark a short sale order
`
`“short exempt” under Rule 201 are limited.
`
`
`II.
`
`
`
`Background on Short Sale Restrictions
`
`Short selling involves a sale of a security that the seller does not own or a sale that is
`
`consummated by the delivery of a security borrowed by, or for the account of, the seller.28 In
`
`order to deliver the security to the purchaser, the short seller will borrow the security, usually
`
`from a broker-dealer or an institutional investor. Typically, the short seller later closes out the
`
`position by purchasing equivalent securities on the open market and returning the security to the
`
`lender. In general, short selling is used to profit from an expected downward price movement, to
`
`provide liquidity in response to unanticipated demand, or to hedge the risk of an economic long
`
`position in the same security or in a related security.29
`
`
`
`
` 27 We note that, as discussed in more detail below, unless a sale order is marked “short exempt,” a trading center’s
`
`
` policies and procedures must be reasonably designed to prevent the execution or display of the order at a price
`
` that is less than or equal to the current national best bid.
`
`
`28 See 17 CFR 242.200(a).
`
`
`
` 29 See, e.g., Exchange Act Release No. 54891 (Dec. 7, 2006), 71 FR 75068, 75069 (Dec. 13, 2006) (“2006 Price
`
`
`
` Test Elimination Proposing Release”); 2003 Regulation SHO Proposing Release, 68 FR at 62974. In this
` adopting release, we use the terms “liquidity provider” and “liquidity taker,” and correlative terms, in their
`
`
`technical sense in the literature of market microstructure. See, e.g., Larry Harris, Trading and Exchanges:
`
`
`Market Microstructure for Practitioners, at 70 (2003) (an introductory textbook to the economics of market
`
`microstructure). As used therein, a liquidity taker is a buyer or seller (including a short seller) who submits an
`order designed for immediate execution, such as a market order or a marketable limit order, while a liquidity
`
`
`
`provider is a more patient buyer or seller (including a short seller) who submits orders that may or may not be
`
`
`executed, and thus provides depth to the market. This usage differs from the usage of the term “liquidity
`
`
`
`
`
`provider” to refer to a bank, central bank, or other financial institution or investor who provides cash financing
`or otherwise increases the money supply.
`
`
`
`12
`
`
`CFAD VI 1061 - 0012
`
`

`
`
`A.
`
`Short Selling and its Market Impact
`
`
`
`Short selling provides the market with important benefits, including market liquidity and
`
`pricing efficiency.30 Market liquidity is often provided through short selling by market
`
`professionals, such as market makers (including specialists) and block positioners, who offset
`
`temporary imbalances in the buying and selling interest for securities. Short sales effected in the
`
`market add to the selling interest of stock available to purchasers and reduce the risk that the
`
`price paid by investors is artificially high because of a temporary imbalance between buying and
`
`selling interest. Short sellers covering their sales also may add to the buying interest of stock
`
`available to sellers.31
`
`
`
`
`Short selling also can contribute to the pricing efficiency of the equities markets.32 When
`
`a short seller speculates or hedges against a downward movement in a security, his transaction is
`
`a mirror image of the person who purchases the security in anticipation that the security’s price
`
`will rise or to hedge against such an increase. Both the purchaser and the short seller hope to
`
`profit, or hedge against loss, by buying the security at one price and selling at a higher price.
`
`The strategies primarily differ in the sequence of transactions. Market participants who believe a
`
`stock is overvalued may engage in short sales in an attempt to profit from a perceived divergence
`
`of prices from true economic values. Such short sellers add to stock pricing efficiency because
`
`
`
` 30 See id.; see also Exchange Act Release No. 29278 (June 7, 1991), 56 FR 27280 (June 13, 1991); Exchange Act
`
`
` Release No. 50103 (July 28, 2004), 69 FR 48008, 48009 n.6 (Aug. 6, 2004) (“2004 Regulation SHO Adopting
`
`
`
` Release”); Ekkehart Boehmer and J. Julie Wu, Short Selling and the Informational Efficiency of Prices,
`
`
`Working Paper, Jan. 8, 2009.
`
` 31 See, e.g., 2006 Price Test Elimination Proposing Release, 71 FR at 75069; 2003 Regulation SHO Proposing
`
`
`Release, 68 FR at 62974.
`
`
`
` 32 See id.
`
`
`
`
`
`
`13
`
`
`CFAD VI 1061 - 0013
`
`

`
`their transactions inform the market of their evaluation of future stock price performance. This
`
`evaluation is reflected in the resulting market price of the security.33
`
`
`
`
`Although short selling serves useful market purposes, it also may be used to drive down
`
`the price of a security or as a tool to accelerate a declining market in a security.34 In addition,
`
`short selling may be used to illegally manipulate stock prices.35 One example is the “bear raid”
`
`where an equity security is sold short in an effort to drive down the price of the security by
`
`creating an imbalance of sell-side interest.36 This unrestricted short selling could exacerbate a
`
`declining market in a security by increasing pressure from the sell-side, eliminating bids, and
`
`causing a further reduction in the price of a security by creating an appearance that the security’s
`
`price is falling for fundamental reasons, when the decline, or the speed of the decline, is being
`
`
`
` driven by other factors.37
`
`
`
` 33 See 2006 Price Test Elimination Proposing Release, 71 FR at 75069 – 75070; 2003 Regulation SHO Proposing
`
`
`
`
`
`
`
` Reelease, 68 FR at 62974. Arbitrageurs also contribute to pricing efficiency by utilizing short sales to profit
` from price disparities between a stock and a derivative security, such as a convertible security or an option on
`
`
`that stock. For example, an arbitrageur may purchase a convertible security and sell the underlying stock short
`
`to profit from a current price differential between two economically similar positions. See id.
`
`
`
` 34 See, e.g., Proposal, 74 FR at 18065 (noting that a short selling circuit breaker rule would be designed to target
`
`
`
`
`
`
`
` only those securities that experience rapid severe intra-day price declines and, therefore, might help to prevent
` short selling from being used to drive the price of a security down or to accelerate the decline in the price of
`
`
`
`those securities).
`
`
` 35 See, e.g., U.S. v. Russo, 74 F.3d 1383, 1392 (2d Cir. 1996) (short sales were sufficiently connected to the
`
`
`
` manipulation scheme as to constitute a violation of Exchange Act Section 10(b) and Rule 10b-5); S.E.C. v.
`
`
`
`
`
`Gardiner, 48 S.E.C. Docket 811, No. 91 Civ. 2091 (S.D.N.Y. Mar. 27, 1991) (alleged manipulation by sales
`
`representative by directing or inducing customers to sell stock short in order to depress its price).
`
`36 Many people blamed “bear raids” for the 1929 stock market crash and the market’s prolonged inability to
`
`
`
`
`recover from the crash. See, e.g., Steve Thel, $850,000 in Six Minutes – The Mechanics of Securities
`Manipulation, 79 Cornell L. Rev. 219, 295-296 (1994); Jonathan R. Macey, Mark Mitchell & Jeffry Netter,
`
`
`Restrictions on Short Sales: An Analysis of the Uptick Rule and its Role in View of the October 1987 Stock
`
`
`Market Crash, 74 Cornell L. Rev. 799, 801-802 (1989).
`
`
`
` 37 See 2006 Price Test Elimination Proposing Release, 71 FR at 75070; 2003 Regulation SHO Proposing Release,
`