On June 13, 2007, the Securities and Exchange Commission voted unanimously to approve amendments to regulations governing short sales (Regulation SHO).  Regulation SHO, which became fully effective in January 2005, provides a regulatory framework governing short sales of securities.  Short sales are transactions in which the seller is not in possession of the shares of stock at the time the transaction is executed.

The commissioners voted to eliminate the provisions of rule 10a-1 that imposed a bid or tick test on securities and prohibited any short sale unless the price of the stock was rising.  The commissioners agreed that the rule (which had been unchanged since 1938) had become antiquated with the advent of decimalization and changes in market structure.  The decision to eliminate the rule was preceded by an exhaustive study that showed no empirical change to securities excluded from the tick test.

The commissioners also voted to approve other changes to Regulation SHO proposed in an amendment last March.  The proposal drew hundreds of comments from the public, many of whom felt that the proposal did not go far enough to protect investors from possible manipulative short selling.

Recognizing their concern, the commissioners decided to eliminate the “grandfather” exception under the rule 203 that excluded securities from the mandatory 13-day close-out period for short positions of securities that were neither delivered nor borrowed.  The exception applied to uncovered short positions that existed prior to the time that the stocks that had become “threshold” securities.  Threshold securities are those with at least 10,000 shares or .05 percent of total shares outstanding with uncovered short positions that persist for 5-days or more.  The commissioners also approved a requirement to close-out aged fails after 35 days applicable to shares issued under rule 144 of the Securities Act of 1933 governing private offerings.

Another provision applicable to options market makers submitted under the same amendment was not approved.  This provision will be re-proposed for further public comment in the future.  The proposed amendment would limit the mandatory close-out requirement for options market makers to either 35-days or 13-days following the expiration of their respective hedged position.