Excerpt from Current Issues and Rulemaking Projects Outline (November 14, 2000)

Section VIII.A.3. Current Disclosure, Legal and Processing Issues – Disclosure, Legal and Processing Issues – Syndicate Short Sales

a. What are “syndicate short sales”?

In a registered IPO or follow-on offering of equity and equity-related securities, the Agreement among Underwriters customarily will authorize the lead manager to sell securities in excess of the number of securities included in the firm commitment underwriting for the account of the syndicate. This “syndicate short position” could include:

• a “covered” short position equal to the securities registered to cover the underwriters’ option to purchase additional securities from the issuer -- this option to purchase additional shares is called the “overallotment option” or “green shoe,” and

• a “naked” short position equal to a specified percentage of the securities included in the firm commitment underwriting -- the AAU specifies the extent of the permissible naked short.

The “covered” short position customarily is 15% of the amount of the firm commitment underwriting. This limit is related to the limit on the size of the overallotment option set forth in National Association of Securities Dealers rules. In recent years, the “naked” short position has customarily been up to either 15% or 20% of the amount of the firm commitment underwriting. The size of the “naked” short position is not addressed in the NASD rules.

b. When is a syndicate short position established and how is it covered?

The short position is created at the same time securities in the firm commitment underwriting are allocated -- after effectiveness and pricing of the transaction. The syndicate short shares are sold at the public offering price. All purchasers of securities sold by the underwriting syndicate receive final prospectuses and identical forms of Exchange Act Rule 10b-10 confirmations reflecting the prospectus delivery requirement. No distinction is made between the firm commitment and short sale securities on the books and records of the underwriters, the transfer agent or any clearing agency. For all intents and purposes, the syndicate short shares are indistinguishable from all other shares sold under the registration statement.

The decision to create a syndicate short position (both “covered” and “naked”) is made by the lead manager, in its sole discretion, at the time of pricing. Most offerings have a short position at least equal to the underwriters’ overallotment option or “green shoe.” The decision to exercise the green shoe to cover a syndicate short position, if any, must be made within the period specified in the Underwriting Agreement, typically 30 days. The green shoe is often exercised almost immediately in transactions that trade at price levels significantly in excess of the public offering price in order to obviate the need to have a second “closing” with respect to the green shoe shares. However, in some transactions the decision to exercise the green shoe is not made until nearly the end of the 30-day period.

While there is usually a covered syndicate short, the creation of a naked syndicate short is less common. The naked short is more likely to be created in a transaction where the lead manager has reason to be concerned that the supply of securities offered for sale in the secondary market after the commencement of trading in the securities will significantly exceed the demand to purchase such securities, thereby creating downward pressure on the price of the securities that could adversely affect the investors who have purchased in the offering. These concerns may be based on the volatility of the overall market or the level or quality of demand for the securities being offered. The level or quality of demand refers to the ratio of indications of interest or conditional offers to the number of securities being offered and the extent to which the lead manager perceives that if the buyers receive allocations of securities they will be long term holders of all or a significant portion of those securities.

The “naked short shares” are delivered and paid for by investors at the same time as the firm commitment and covered short shares. In order to deliver the naked short shares, the underwriters may borrow shares which, in the case of an IPO, may be shares issued in the offering. In a follow-on offering, the underwriters may borrow either shares that were issued in the offering or shares that were outstanding before the offering. The syndicate bears the cost of borrowing those shares.

c. What prospectus disclosure is required with regard to the syndicate short position and the manner in which it is covered?

The fact that the underwriters may make short sales and may engage in short covering transactions must be disclosed in the “Plan of Distribution” or “Underwriting” section of the prospectus. The staff will raise comments if this disclosure does not address the following material points regarding any applicable short sale transactions. The disclosure may use the language set forth following each point or may be in other clear, plain language.

• The potential for underwriter short sales in connection with the offering -- for example, the disclosure may state: “In connection with the offering, the underwriters may make short sales of the issuer’s shares and may purchase the issuer’s shares on the open market to cover positions created by short sales.”

• What short sales are -- for example, the disclosure may state: “Short sales involve the sale by the underwriters of a greater number of shares than they are required to purchase in the offering.”

• What covered short sales are -- for example, the disclosure may state: “‘Covered’ short sales are sales made in an amount not greater than the underwriters’ ‘overallotment’ option to purchase additional shares in the offering.”

• How underwriters close out covered short sale positions -- for example, the disclosure may state: “The underwriters may close out any covered short position by either exercising their overallotment option or purchasing shares in the open market.”

• How underwriters determine the method for closing out covered short sale positions -- for example, the disclosure may state: “In determining the source of shares to close out the covered short position, the underwriters will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which they may purchase shares through the overallotment option.”

• What naked short sales are -- for example, the disclosure may state: “‘Naked’ short sales are sales in excess of the overallotment option.”

• How underwriters close out naked short sale positions -- for example, the disclosure may state: “The underwriters must close out any naked short position by purchasing shares in the open market.”

• When a naked short position will be created -- for example, the disclosure may state: “A naked short position is more likely to be created if the underwriters are concerned that there may be downward pressure on the price of the shares in the open market after pricing that could adversely affect investors who purchase in the offering.”

• The potential effects of underwriters’ short sales and underwriters’ transactions to cover those short sales -- for example, the disclosure may state: “Similar to other purchase transactions, the underwriters’ purchases to cover the syndicate short sales may have the effect of raising or maintaining the market price of the [issuer’s] stock or preventing or retarding a decline in the market price of [issuer’s] stock. As a result, the price of the [issuer’s] stock may be higher than the price that might otherwise exist in the open market.”

This disclosure is, of course, in addition to the other disclosure included in that section of the prospectus regarding stabilizing transactions. The disclosure addressing the foregoing points may be combined with that other disclosure.

d. Is the offer and sale of the “naked short shares” registered under the Securities Act?

Yes. It is the Division’s view that the offer and sale of all shares in the registered offering are registered under the registration statement. In this regard, “all shares in the registered offering” refers to

• the firm commitment shares,

• the covered short - or green shoe - shares, and

• the naked short shares.

Although the naked short shares are included in “all shares in the registered offering,” the number of shares specified on the cover page of the registration statement need only include the number of firm commitment shares and the green shoe shares. The number of shares specified on the cover page of the registration statement is understood to include an indeterminate number of naked short shares up to the extent permitted by the AAU. The “Plan of Distribution” or “Underwriting” section of the prospectus must describe the offer and sale of all shares in the registered offering.

The treatment of the naked short shares on the cover page of the registration statement set forth above differs from the method in which registrants register shares to be sold in “market making” transactions. With respect to “market making shares,” the registrant must include an indeterminate number of those shares on the cover page of the registration statement.

e. How do the anti-fraud and civil liability provisions of the federal securities laws apply to the offer and sale of the naked short shares?

In a registered offering, the anti-fraud and civil liability provisions of the federal securities laws apply to the offer and sale of the naked short shares in the same manner as the offer and sale of other shares in that registered offering.

http://www.sec.gov/divisions/corpfin/guidance/ci111400ex_regs-k_sss.htm