Statement by SEC Staff:
Opening Statement at the SEC Open Meeting re: Amendments to Rule 10a-1 and Regulation SHO
Erik R. Sirri
Director, Division of Market Regulation
U.S. Securities and Exchange Commission
June 13, 2007
Good morning Chairman Cox and Commissioners. The Division of Market Regulation recommends that the Commission adopt amendments to Rule 10a-1 and Regulation SHO under the Securities Exchange Act of 1934, which would remove all restrictions on the execution prices of short sales. The amendments are designed to modernize and simplify short sale regulation, while providing greater regulatory consistency.
In December 2006, the Commission proposed amendments that would remove all current restrictions on the execution prices of short sales. The proposed amendments were based, in part, on the results from the 1-year Pilot program conducted by the Commission's Office of Economic Analysis that temporarily suspended the provisions of Rule 10a-1 and any price test of any exchange or national securities association for short sales in certain securities. The proposed amendments also were based on market developments that have occurred in the securities industry since the Commission adopted Rule 10a-1 — almost 70 years ago, in 1938. For example, the core provisions of Rule 10a-1 have remained essentially the same for almost 70 years. Over the years, however, in response to changes in trading strategies and systems used in the marketplace, the Commission has added exceptions to Rule 10a-1 and granted numerous written requests for relief from the Rule's restrictions. These requests for exemptive relief have increased dramatically in recent years in response to significant developments in the securities markets, such as the increased use of matching systems that execute trades at independently derived prices during random times within specific time intervals and the spread of fully automated markets. Moreover, we believe that the effectiveness of the tick test of Rule 10a-1 has been eroded by decimal pricing increments. The availability of a penny or sub-penny uptick substantially reduces the difficulty of short selling on an uptick.
We also note that the current environment for short sale regulation applies different tests to securities trading in different markets, and even to the same security trading in different markets. Rule 10a-1's tick test is based on the last reported sale and applies to securities listed on a national securities exchange. The NASD's and Nasdaq's bid tests are based on the last bid rather than the last reported sale and apply only to short sales in Nasdaq Global Market securities.
In addition, we note that smaller and more thinly-traded securities, such as Nasdaq Capital Market securities, OTCBB, and pink sheet securities, are not subject to any price test restrictions wherever traded. Such an application of price test restrictions seems anomalous given the greater difficulty of manipulating the price of a security as market capitalization and trading volume increase.
Because of the Pilot program, we have had the opportunity to analyze empirical data to help us determine whether changes to short sale regulation are necessary in light of current market practices and the purposes underlying short sale regulation. During the Pilot, the Commission's Office of Economic Analysis analyzed whether current price test restrictions are effective or necessary, in part or whole, for actively-traded securities or other securities. The study provided by the Commission's Office of Economic Analysis, as well as the academic studies the Commission has received and the Roundtable held in September 2006, provide clear economic support for our recommendation today to remove all current short sale price test restrictions. Generally, the studies and the Roundtable panelists urged removal of price test restrictions. In addition, the empirical evidence did not provide strong support for extending a restriction to either small or more-thinly traded securities. In fact, some of the studies suggested that price test restrictions may limit some of the important benefits of short selling, such as liquidity and price efficiency.
The Commission received 27 comment letters in response to the proposal. Most commenters advocated removing all price test restrictions. Some commenters, however, expressed concerns about the need to have price tests to prevent "bear raids." With respect to such comments we note that because of the Commission's concerns about the potential use of short sales to manipulate stock prices, the Commission's Office of Economic Analysis examined the Pilot data for any indication of an association between manipulative short selling and price test restrictions. The staff, however, did not find any such association.
Other commenters expressed concern about the lack of evidence supporting the removal of price test restrictions from smaller securities and, therefore, suggested removing price test restrictions from larger securities first, to allow time to study the impact of the permanent removal of such restrictions before any action is taken for smaller securities. We do not believe that such an approach would provide new results relevant to smaller securities. In addition, we are concerned that such a continuation would undermine a primary goal of these amendments of providing greater consistency and simplicity to short sale regulation.
I also want to note that although we believe that current price test restrictions are no longer effective or necessary, we recognize that there could conceivably be a need in the future for self-regulatory organizations to propose new price test restrictions. Thus, despite today's recommended rule amendments, a self-regulatory organization may file a proposal with the Commission to have a price test.
After considering the comments received, we recommend that the Commission adopt the amendments, as proposed. In particular, the amendments would remove the tick test of Rule 10a-1, and provide that no price test, including any price test of any self-regulatory organization, shall apply to short sales in any security.
I would like to thank Jamie Brigagliano, Josephine Tao, Lillian Hagen, and Victoria Crane in the Division of Market Regulation for their work on this rule. In addition, I would like to thank Chester Spatt, Stewart Mayhew, Amy Edwards, and Tim McCormick in the Office of Economic Analysis, and Janice Mitnick and David Dimitrious in the Office of General Counsel for their contributions to the release.
Thank you. We would be happy to answer any questions.