Short Selling in Connection with a Public Offering: Amendments to Rule 105 of Regulation M
A Small Entity Compliance Guide1
The Securities and Exchange Commission adopted amendments to Rule 105 of Regulation M to further safeguard the integrity of the capital raising process and protect issuers from manipulative activity that can reduce issuers' offering proceeds and dilute security holder value. Before Rule 105 was amended, it prohibited a person who sold short during a defined restricted period from covering a short sale2 with offering securities. Among other things, the amendments eliminate the covering element of the prior rule because of a proliferation of strategies designed to conceal the prohibited covering and continued violations of the prior rule. The amended rule makes it unlawful for a person to purchase securities in an equity offering if that person sold short the security that is the subject of the offering during the Rule 105 restricted period. Amended Rule 105 also adds three exceptions to the rule concerning bona fide purchases, separate accounts, and investment companies.
Regulation M Rule 105
Amended Rule 105 makes it unlawful for a person who sells short a security that is the subject of an offering to purchase in the offering from an underwriter or broker or dealer participating in the offering if the short sale occurred during the Rule 105 restricted period.3 Generally, the Rule 105 restricted period is the period which begins the five days before the pricing of the offered securities and ends with such pricing.4 Alternatively, the restricted period begins with the initial filing of a registration statement or notification on Form 1-A or Form 1-E and ends with the pricing. The rule is designed to prevent manipulative short selling just prior to the pricing of a follow-on or secondary offering and to facilitate pricing based on the natural market forces of supply and demand. Rule 105 is prophylactic. Thus, its provisions apply irrespective of a short seller's intent.
Highlights of the amended rule and release include:
What are the Exceptions to Amended Rule 105?
The adopting release for the amendments to Rule 105 can be found on the SEC's website at http://www.sec.gov/rules/final/finalarchive/finalarchive2007.shtml.
The proposing release for the amendments to Rule 105 can be found on the SEC's website at http://www.sec.gov/rules/proposed/proposedarchive/proposed2006.shtml.
Contacting the SEC
The SEC's Division of Trading and Markets is happy to assist small companies with questions regarding the obligations of Amended Rule 105 of Regulation M. The Division's Office of Interpretation and Guidance answers questions submitted by telephone at (202) 551-5777 or by email at email@example.com.
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 a rule adopted by the SEC, but it is not a substitute for any rule itself. Only the rule itself can provide complete and definitive information regarding its requirements.
2 Rule 200(a) of Regulation SHO provides that "the term short sale shall mean any sale of a security which the seller does not own or any sale which consummated by the delivery of a security borrowed by, or for the account of, the seller." 17 CFR 242.200. See also Key Points About Reg SHO available at http://www.sec.gov/investor/pubs/regsho.htm.
3 17 CFR 242.105.
4 The Rule 105 restricted period is the shorter of the period:(1) beginning five business days before the pricing of the offered securities and ending with such pricing; or (2) beginning with the initial filing of such registration statement or notification on Form 1-A or Form 1-E and ending with the pricing. Amended Rule 105(a).