December 4, 2006
1. PCAOB Budget and Annual Accounting Support Fees
The Securities and Exchange Commission will today consider whether to approve the budget of the Public Company Accounting Oversight Board and will consider the annual accounting support fees under Section 109 of the Sarbanes-Oxley Act of 2002.
2. Proposed Amendments to Rule 105 of Regulation M
The Securities and Exchange Commission today will consider whether to propose amendments to Rule 105 of Regulation M (17 CFR 242.105). Rule 105 of Regulation M governs short selling in connection with a public offering. It is a prophylactic anti-manipulation rule that promotes a market environment that is free from manipulative influences around the time that offerings are priced. The rule fosters pricing integrity by prohibiting activity that interferes with independent market dynamics, prior to pricing offerings, by persons with a heightened incentive to manipulate. The current rule prohibits persons from covering a short sale with offering securities if the short sale occurred during a defined period prior to pricing. This defined period is often referred to as the Rule 105 restricted period and generally begins five business days before pricing and ends with pricing.
Follow-on offerings are often priced at a discount to a stock’s closing price prior to pricing. Short sales immediately before pricing can exert downward pressure upon a stock’s market price which can lower offering prices and reduce an issuer’s offering proceeds. A person with an expectation of receiving an allocation may attempt to generate a profit by short selling during the restricted period and covering with offering securities at the lower offering price in violation of the rule. Recently, the Commission has brought a number of Rule 105 enforcement actions. In addition, certain cases reveal attempts to conceal the covering prohibited by the rule.
The proposed rule would prohibit a person that has effected a short sale during the Rule 105 restricted period from purchasing securities in the offering.
3. Proposed Amendments to Rule 10a-1 and Regulation SHO
The Securities and Exchange Commission today will consider whether to propose amendments to Rule 10a-1 (17 CFR 240.10a-1) and Regulation SHO (17 CFR 242.200 et seq.) that would remove Rule 10a-1 as well as any short sale price test of any self-regulatory organization (SRO). In addition, the proposed amendments would prohibit any SRO from having a price test. The proposed amendments would also include a technical amendment to Rule 200(g) of Regulation SHO that would remove the “short exempt” marking requirement of that rule.
The Commission adopted Rule 10a-1 in 1938 after several years of considering the effects of short selling in a declining market. Rule 10a-1 provides that, subject to certain exceptions, a security may be sold short at a price above the price at which the immediately preceding sale was effected (plus tick), or at the last sale price if it is higher than the last different price (zero-plus tick). Short sales are not permitted on minus ticks or zero-minus ticks, subject to narrow exceptions. The operation of these provisions is commonly described as the “tick test.” The tick test applies only to listed securities, other than Nasdaq-listed securities, traded on an exchange, or otherwise.
In addition to the tick test of Rule 10a-1, the NASD and Nasdaq have adopted their own short sale price tests based on the last bid rather than on the last reported sale for purposes of determining the execution prices of short sales. These bid tests apply only to Nasdaq Global Market securities that are traded on Nasdaq or the over-the-counter market and reported to a NASD facility.
On July 28, 2004, the Commission issued an order creating a one year pilot temporarily suspending the tick test and any short sale price test of any exchange or national securities association for certain securities. The pilot was created so that the Commission could study the effectiveness of short sale price tests. The Commission’s Office of Economic Analysis and academic researchers provided the Commission with analyses of the empirical data obtained from the pilot. In addition, the Commission held a roundtable to discuss the results of the pilot. The general consensus from these analyses and the roundtable was that the Commission should remove price test restrictions because they do not appear necessary to prevent manipulation and their removal would not harm overall market quality. In addition, the empirical evidence did not provide strong support for extending a price test to either small or thinly-traded securities not currently subject to a price test.