Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Thursday, June 21, 2007

SEC Tightens Rule on Short-Selling Prior to Offering

The SEC adopted on June 20, 2007 amendments to strengthen Rule 105 of Regulation M.  Rule 105 helps prevent abusive short selling and market manipulation. When a trader expects to receive shares in an offering, there is an incentive to sell short prior to pricing an offering and then cover that short position with shares bought at the reduced offering price. By doing so, the trader can cover the short sale with minimal risk, and generally lock in a guaranteed profit — to the detriment of the issuer and the other shareholders.

The amendments change the way the rule works to prevent this from happening. They replace the rule's current limitation on covering the short sales in the offering with a prohibition on purchasing in the offering after a short sale in the securities. This change was triggered by persistent non-compliance with the rule and a string of strategies to conceal the prohibited covering. Under the amended rule, if a person sells short during the restricted period prior to pricing, that person is prohibited from purchasing the offered security. See SEC Votes to Adopt Final Amendments to Rule 105 of Regulation M, Short Selling in Connection With a Public Offering.

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