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

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Wednesday, September 17, 2008

SEC Adopts New Rules Against Naked Short-Selling

The SEC took several actions against "naked" short selling that will apply to the securities of all public companies, effective at 12:01 a.m. ET on Thursday, Sept. 18, 2008.  The agency's actions go beyond its previously issued emergency order, which was limited to the securities of financial firms with access to the Federal Reserve's Primary Dealer Credit Facility and which expired on Aug. 12, 2008.

The Commission's actions were as follows:

Hard T+3 Close-Out Requirement; Penalties for Violation Include Prohibition of Further Short Sales, Mandatory Pre-Borrow
The Commission adopted, on an interim final basis, a new rule requiring that short sellers and their broker-dealers deliver securities by the close of business on the settlement date (three days after the sale transaction date, or T+3) and imposing penalties for failure to do so.

If a short sale violates this close-out requirement, then any broker-dealer acting on the short seller's behalf will be prohibited from further short sales in the same security unless the shares are not only located but also pre-borrowed. The prohibition on the broker-dealer's activity applies not only to short sales for the particular naked short seller, but to all short sales for any customer.

Although the rule will be effective immediately, the Commission is seeking comment during a period of 30 days on all aspects of the rule. The Commission expects to follow further rulemaking procedures at the expiration of the comment period.

Exception for Options Market Makers from Short Selling Close-Out Provisions in Reg SHO Repealed
The Commission approved a final rule to eliminate the options market maker exception from the close-out requirement of Rule 203(b)(3) in Regulation SHO. As a result, options market makers will be treated in the same way as all other market participants, and required to abide by the hard T+3 closeout requirements that effectively ban naked short selling.

Rule 10b-21 Short Selling Anti-Fraud Rule
The Commission adopted Rule 10b-21, which expressly targets fraudulent short selling transactions. The new rule covers short sellers who deceive broker-dealers or any other market participants. Specifically, the new rule makes clear that those who lie about their intention or ability to deliver securities in time for settlement are violating the law when they fail to deliver.

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