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New Short Sales Rules Provide for Flexibility in Pilot Project

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WASHINGTON (–With minor modifications only, the Securities and Exchange Commission finalized a new set of rules governing the short sales of securities that it proposed last fall and announced the participants in a pilot program on the elimination of the uptick rule, a program the new rule authorizes.

The key provisions of the new regulation, approved at a June 23 meeting but not posted in full until July 28, are: a requirement that broker-dealers mark sales slips for all securities “long,” “short” or “short exempt,” where the marking “short exempt” indicates that the seller is relying upon an exception from the uptick rule; a provision that allows the SEC to suspend the operation of the uptick rule for specified securities for an expected pilot program; a requirement that short sellers in all equity securities locate securities to borrow before selling; the imposition of additional delivery requirements on broker-dealers for securities in which a substantial number of failures to deliver have occurred; removal of the shelf-offering exception to Regulation M; and, finally, the issuance of interpretive guidance addressing sham transactions designed to evade Regulation M.

Reg M prohibits most short selling in the five days before the pricing of a security in an offering pursuant to a registration statement (see Previous HedgeWorld Story).

In its statement, the SEC noted that some commentators, including the Investment Company Institute and the North American Securities Administrators Association, and many smaller investors, have advocated more stringent short-sale regulation. Others, including the New York Stock Exchange, have argued in essence for the preservation of the status quo, including the uptick rule. A third group, including the Securities Industry Association, thought that the SEC should move more rapidly toward deregulating the field, for example by shortening the expected two-year pilot program to one year.

The SEC did change its plans in response to that third group of comments. It revised its plans for the pilot, saying that “we believe that a one-year pilot will allow the Commission sufficient time to gather and analyze data necessary to reach conclusions regarding trading behavior in the absence of short sale price restrictions. The Commission, however, may, by further order, terminate, extend the period of, or modify the pilot as it determines necessary or appropriate in the public interest or for the protection of investors.”

The SEC also announced the stocks that shall be exempt during the year beginning Jan. 3, 2005. It made this selection by working from the Russell 3000 index and excluded first the 32 securities in that index that are listed neither on Nasdaq nor the American Stock Exchange nor the New York Stock Exchange. Then it excluded issuers whose initial public offerings commenced after April 30, 2004. The SEC sorted the remaining securities into three groups, by the exchange on which they were listed, and ranked those in each group by average daily dollar volume over the last year. Finally, it selected every third stock from the remaining groups.

The pilot program now consists of 50% NYSE listed securities, 2.2% Amex listed securities and 47.8% Nasdaq NNM securities.

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Contact Robert F. Keane with questions or comments at [email protected].