Emergency Orders

On July 15, 2008, without using the traditional “notice and comment” procedure for agency rules, the SEC issued an emergency order, prohibiting anyone from effecting a short sale in 19 securities “unless such person or its agent has borrowed or arranged to borrow the security or otherwise has the security.”(74) This order took effect on July 21, 2008 and was extended through to August 13, 2008. Under these limitations, broker-dealers had to borrow or make formal arrangements to borrow the shares for the 19 listed securities before accepting a short sale order or effecting short sales in such securities. The emergency order was amended on July 18, 2008 so that these pre-borrow requirements did not apply to certain bona-fide market makers short sales of the 19 securities under Rule 144 of the Securities Act of 1933, and certain short sales by underwriters or members of any syndicate participating in distributions of the listed securities.(75) Otherwise, except in the case of certain threshold securities (those on lists maintained by the SROs) that were subject to persistent delivery failures, the rules allowed brokers to effect a short sale as long as they had reasonable grounds to believe that the security could be borrowed so that it can be delivered on time.

The Coalition of Private Investment Companies and the Managed Funds Association opposed the emergency restriction on short selling. In their letter to the SEC, they said: “Expansion of the emergency order to a broader list of stocks…will inflict substantial damage on the US equity markets. This damage would threaten the status of the US equity markets as the world’s equity markets of choice.” They said the rule would “undermine critical market activities… [and] make it more difficult, expensive and risky to sell short.” Further, “Restrictions on short sales distort the fundamentals that drive market prices and are…counter-productive because they remove liquidity and healthy skepticism from the marketplace.”(76) This emergency order expired in mid-August. On September 18, the SEC imposed a temporary ban on short sales of 799 financial stocks until October 2.(77) That list of stocks grew to nearly 1,000 issuers as the ban was extended until October 8, three business days after the Emergency Economic Stabilization Act of 2008 was signed into law.(78) On September 19, the SEC issued a temporary rule requiring reporting of short positions. That reporting obligation was later modified and extended to August 2009.(79)

On October 14, the SEC eliminated the options market maker exception to the close out requirement of Regulation SHO. As a result of the amendments, fails to deliver in threshold securities that result from hedging activities by options market makers will no longer be excepted from Regulation SHO’s close out requirement.(80) That same day, the SEC cleared a naked short selling antifraud rule (see earlier text).(81) The SEC also imposed and put out for comment an interim temporary final rule requiring that participants of a clearing agency registered with the SEC deliver securities by settlement date, or if the participants have not delivered shares by settlement date, immediately purchase or borrow securities to close out the fail-to-deliver position by no later than the beginning of regular trading hours on the settlement day following the day the participant incurred the fail-to-deliver position (see earlier text).(82)

The experience with the ban on short sales of financial stocks shows that the ban had adverse effects on investors, issuers, and the markets by increasing volatility, reducing liquidity, clouding price discovery, preventing effective hedging in rapidly declining markets, and severely impeding the convertible bond market.

SEC Chairman Cox later conceded in an interview with the Washington Post that “the biggest mistake of his tenure was agreeing in September to an extraordinary three-week ban on short selling of financial company stocks.”(83)