Corporate Law

• Delaware Cases Contain Surprises On Fee Advancement Bylaws

Securities Enforcement & Fraud

• Regulators Seek To Protect Retirees From Securities Fraud

Global Markets

• US, UK, And Australian Regulators Address Short-Selling Concerns

• Culture And Language Impediments To IFRS Universality

Securities Regulation & Disclosure

• Tips From The SEC On Using Corporate Websites For Disclosure

Financial Reporting, Taxation, & Accounting

• Changed Rule On Timing Of Deferred Compensation Now In Full Effect

• As Stocks Decline, Companies Bid Farewell To Goodwill

Download a .pdf of this issue

Selling short-selling short. The practice of selling securities short has angered regulators and market participants worldwide for centuries (laws in Holland barred short selling in 1610). Nevertheless, short-selling provides necessary and useful information to the market and, according to Australian law professor and consultant Paul Ali, may not produce the downward pressure on prices that its detractors claim. Short-selling does present one difficulty for the market: when it is a naked short sale—where the seller places sell orders for shares not yet owned, later making open-market purchases to fill the gap—it is invisible to the market until consummation.

Loan a misnomer. Invisibility is less of a concern in covered short sales, where the seller arranges a loan of equivalent shares, whether previously or simultaneously, usually collateralized by cash or other property. The seller then commits to sell the borrowed shares to a third party and redeems the shares from the lender, paying either with equivalent shares or from the collateral. In any event, the author asserts, the term "loan" is a misnomer, as the short-seller must obtain title to the shares before selling them; and the "redemption" is merely a repurchase of the collateral with independently acquired shares or an offset against the deposited property.

Naked not in fashion. The SEC's prudish attitude toward naked short sales is reflected in Regulation SHO. It requires that before a broker can accept a sale order where the seller does not have the shares to sell, the broker must have "reasonable grounds," founded on the seller's credible assurances or the known liquidity of the subject shares, that the seller will be able to borrow or otherwise obtain shares to cover the sale before settlement. Since the financial crises began in late 2008, the SEC went further, temporarily prohibiting any short selling of designated financial firms, penalizing brokers who fail to produce the shares needed to settle a short sale, and imposing disclosure obligations on fund managers describing their short positions. Unlike the American regulators, securities regulators in the United Kingdom had no rules prohibiting or specifically regulating naked short sales. In September 2008, however, the Financial Services Authority barred naked short sales in designated financial companies until January 2010 and required disclosure of large short positions overhanging from the prior period. Australia has taken an intermediate position, generally prohibiting naked short sales unless the shares trade in a liquid market as certified by the Australian Securities Exchange, a position also effectively abrogated in September 2008 when the Exchange revoked all permissions.

Run for cover. In contrast to the hostility shown to naked short selling, regulators' approaches to covered short sales have been relatively benign. Regulation SHO explicitly exempts covered short sales, and covered sales do not fall within the terms of the UK Financial Services Authority's prohibitions. Australia has achieved a similar result in a more roundabout way, claims the author. The Australian Securities and Investments Commission established particularized exemptions to the general rule (as enunciated in Australia's Companies Act) that a seller at the time of sale must have a clear right to transfer title to the buyer. The relevant exception permits "borrowing" arrangements that can settle within three days after the sale order and also requires disclosure. The worldwide financial crisis led to a bewildering series of orders and counter-orders from the ASIC, imposing, then lifting, then re-instating restrictions on short sales of financial stocks. When the dust settles, Australia may be back in harmony with the United States and the United Kingdom on letting covered short sales ride.

Abstracted from Journal of International Banking Law & Regulation, published by Sweet & Maxwell, 100 Avenue Road, London NW3 3PF, England. To subscribe, call 44(0)12 6438-8560; or visit www.sweetandmaxwell.co.uk. Editor's Note: The Australian Securities and Investment Commission continues to extend its prohibition of covered short-selling. For the extension announced on March 5, 2009, and lasting until May 31, 2009, see www.iht.com/articles/2009/03/05/business/short.php. The SEC is considering similar action; read www.boston.com/business/articles/2009/03/10/uptick_rule_may_return_mark_to_market
_changes_seen/. The action the SEC has already taken on short-selling is the subject of "The Bad And The Ugly Of Recent SEC Short-Sale Regulation" by Simon Lorne, Wall Street Lawyer, Vol. 12, No. 12, Pgs. 1, 4-9.