Amendments to Exchange Act Rule 10a-1 and Rules 201 and 200(g) of Regulation SHO

A Small Entity Compliance Guide¹

Introduction

The Securities and Exchange Commission adopted an amendment to eliminate Rule 10a-1 and add Rule 201 of Regulation SHO under the Securities Exchange Act of 1934 to provide that no price test, including any price test of any self-regulatory organization (“SRO”), shall apply to short sales in any security. Rule 201 also prohibits any SRO from having a price test. In addition, the Commission amended Rule 200(g) of Regulation SHO to remove the requirement that a broker-dealer mark a sell order of an equity security as “short exempt” if the seller is relying on an exception from the price test of Rule 10a-1, or any price test of any exchange or national securities association.

Background

The Commission originally adopted Rule 10a-1 in 1938 to restrict short selling in a declining market. Paragraph (a) of Rule 10a-1 covered short sales in securities registered on, or admitted to unlisted trading privileges (“UTP”) on a national securities exchange (“listed securities”), if trades of the security were reported pursuant to an “effective transaction reporting plan” and information regarding such trades were made available in accordance with such plan on a real-time basis to vendors of market transaction information. Rule 10a-1(a)(1) provided that, subject to certain exceptions, a listed security may be sold short (A) at a price above the price at which the immediately preceding sale was effected (plus tick), or (B) at the last sale price if it is higher than the last different price (zero-plus tick). Short sales were not permitted on minus ticks or zero-minus ticks, subject to narrow exceptions. The operations of these provisions are commonly described as the “tick test” or the “uptick rule”.

With the elimination of Rule 10a-1, the Commission has also added Rule 201 which prohibits any SRO from having a price test. In addition, because the Commission has removed all current price test restrictions, and prohibited any price test by any SRO, the Commission also amended Rule 200(g) of Regulation SHO to remove the requirement that a broker-dealer mark a sell order of an equity security as “short exempt” if the seller is relying on an exception from the price test of Rule 10a-1, or any price test of any exchange or national securities association.

How does the elimination of Rule 10a-1 and the addition of Rule 201 affect small-business entities?

The entities covered by Rules 10a-1 and 201 include small broker-dealers, small businesses, and any investor who effects a short sale that qualifies as a small entity. When adopting the amendments, the Commission stated its belief that the effects of the amendments on small business entities will be minimal because the infrastructure necessary to comply with the amendments are, for the most part, already in place. For example, prior to the adoption of the amendments, the Commission established a pilot program (“Pilot”) which temporarily suspended the provisions of Rule 10a-1(a) and any price test of any exchange or national securities association for short sales of certain securities. In order to comply with the Pilot, market participants, including small entities, needed to modify their systems and surveillance mechanisms to exempt those securities included in the Pilot from current price test restrictions. Thus, the systems and surveillance mechanisms required to comply with the amendments are already in place. When adopting the amendments, the Commission stated its belief that any necessary additional systems and surveillance changes will be small because, due to the Pilot, systems are currently programmed to exempt many securities from price test restrictions prior to the close of the consolidated tape and exempt all securities from price test restrictions between the close of the consolidated tape and the open of the consolidated tape on the following day.

Moreover, because the amendments remove all price test restrictions instead of require new or modified restrictions, any changes to systems should be relatively minor. In addition, market participants should not need to purchase new systems, or increase staffing based solely on the implementation of the amendments. Any costs to modify, establish or implement existing or new supervisory and compliance procedures due to the amendments should be minimal because market participants already have in place supervisory or compliance procedures to monitor for trading activity that price test restrictions were designed to deter.

How does the amendment to Rule 200(g) affect small-business entities?

The Commission has amended Rule 200(g) of Regulation SHO to remove the “short exempt” marking requirement. Rule 200(g)(2) of Regulation SHO provides that a short sale order must be marked “short exempt” if the seller is “relying on an exception from the tick test of 17 CFR 240.10a-1, or any short sale price test of any exchange or national securities association.” Because the Commission removed all current price test restrictions, as well as prohibited any SRO from having a price test, the “short exempt” marking requirement will no longer be applicable.

Some market participants, including small business entities, may have to reprogram systems and update supervisory procedures due to the removal of the “short exempt” marking requirement. Sales of securities previously marked “short exempt,” however, will continue to be marked either “long” or “short.” Thus, the amendments will remove an alternative marking requirement.

Other Resources

The adopting release for the amendments to Rule 10a-1 and Rules 201 and 200(g) of Regulation SHO can be found on the SEC’s website at http://sec.gov/rules/final/2007/34-55970fr.pdf.

Contacting the SEC

The SEC’s Division of Trading and Markets is happy to assist small entities with questions regarding the amendments to Rule 10a-1 and Rules 201 and 200(g) of Regulation SHO. The Division’s Office of Interpretation and Guidance answers questions submitted by telephone at (202) 551-5777 or by email at tradingandmarkets@sec.gov.

¹ This guide was prepared by the staff of the U.S. Securities and Exchange Commission as a “small entity compliance guide” under Section 212 of the Small Business Regulatory Enforcement Fairness Act of 1996, as amended. The guide summarizes and explains rules adopted by the SEC, but is not a substitute for any rule itself. Only the rule itself can provide complete and definitive information regarding its requirements.

http://www.sec.gov/divisions/marketreg/tmcompliance/rules10a-200g-201-secg.htm