Davis Polk & Wardwell Newsflash

Proposed Short Sale Restrictions

April 8, 2009

In an open meeting held today, the Securities and Exchange Commission voted unanimously to issue proposals to revive restrictions on short sales in equity securities.  The Commission indicated that its forthcoming release would seek comment on five proposed rules that adopt two alternative approaches to short sale restrictions:

Price Tests – These proposals include:

  • an “uptick” rule that would limit short selling to (A) a price above the price at which the immediately preceding sale was effected (“plus tick”), or (B) the last sale price if it is higher than the last different price (“zero-plus tick”) (the “Uptick Rule”); and
  • an “upbid” rule that would limit short selling to a price at or above the current bid when that bid is above the previous bid (the “Modified Uptick Rule”).

Circuit Breakers – These proposals include:

  • a “circuit breaker” rule that would halt short selling in a security upon a substantial price decline in that security (the “Circuit Breaker Halt”); and
  • two “circuit breaker” rules that would limit short selling in a security by applying either the Uptick Rule or the Modified Uptick Rule, in each case upon a substantial price decline in that security (respectively, the “Circuit Breaker Uptick Rule” and the “Circuit Breaker Modified Uptick Rule”).

It is not a foregone conclusion that the Commission will adopt any of these proposals.  In their prepared remarks, some of the Commissioners noted that the Commission had only recently, in 2007, eliminated price test restrictions for short sales after studying their impact and effectiveness over a period of several years, and also noted the success of other recent initiatives to address short sale issues, particularly Interim Final Temporary Rule 204T concerning fails to deliver.  The Commission is under considerable public pressure from members of Congress and others to impose constraints on short selling, and Commissioner Paredes in particular warned against taking action in response to political pressure.  The discussion at the open meeting also suggested that the Commissioners were aware of the possibility of a court challenge to any steps they may take to reimpose restrictions on short selling, given the lengthy administrative record developed in connection with the Commission’s 2007 rulemaking.

The proposing release is expected to ask nearly 200 questions, including questions that pose alternatives to the five proposed rules.  In all, Commissioner Walter stated that there are at least 14 alternative approaches covered in the release.  The release will be published in the Federal Register shortly, and comments will be due within 60 days of publication.

Uptick Rule

The Uptick Rule is substantially similar to the original short sale rule, Rule 10a-1 under the Securities Exchange Act of 1934, which was recently eliminated by the Commission after an extended pilot program (the “Original Uptick Rule”).  Rule 10a-1 was in effect from 1938 to 2007.  Like the Original Uptick Rule, the Uptick Rule would permit short selling only when the short sale price is at a plus tick or a zero-plus tick.

Unlike the Original Uptick Rule, the Uptick Rule is based on the consolidated tick from all markets.  The Original Uptick Rule allowed the primary exchanges (NYSE and Amex) to use their own tick.  This change reflects the primary markets’ significant decline in market share in trading in their own listed securities.

Modified Uptick Rule

The Modified Uptick Rule would allow short selling of a particular security at a price equal to or above the consolidated best bid in the security so long as the consolidated best bid is above the immediately preceding consolidated bid.  Under the Modified Uptick Rule, short selling would not be permitted on a down bid – that is, when the current consolidated best bid is below the immediately preceding consolidated bid.  The Modified Uptick Rule would allow short selling on an upbid even if the prior last sale was at a higher price.

The Modified Uptick Rule is substantially similar to the bid test set forth in Rule 3350 of the National Association of Securities Dealers that was in effect until its required repeal by amendments to Regulation SHO in 2007.

Circuit Breaker Halt

The proposed Circuit Breaker Halt is a new, targeted approach to short sale restrictions.  The Circuit Breaker Halt would halt all short selling in a security when the price of the security falls by 10% in a day, and seeks comment on other levels.

The Commission proposed the Circuit Breaker Halt to avoid imposing continuous monitoring and compliance costs at a time when the security at issue is trading within a non-volatile range and short selling may benefit the market by, among other things, increasing liquidity.  The Circuit Breaker Halt would focus short sale restrictions on times when concerns regarding “bear raids” are the greatest.

Circuit Breaker Uptick Rule and Circuit Breaker Modified Uptick Rule

The Commission also proposed a combination of a circuit breaker and the Uptick Rule or the Modified Uptick Rule.  Under these proposals, once a circuit breaker were triggered in a stock, short sales could only be effected on a plus tick or zero-plus tick as in the Uptick Rule, or on an upbid, as in the Modified Uptick Rule.

Like the Circuit Breaker Halt, each of the Circuit Breaker Uptick Rule and Circuit Breaker Modified Uptick Rule would reduce monitoring costs during most trading conditions.  However, each would require greater programming costs than the Circuit Breaker Halt, because market participants must be prepared to limit their short selling to upticks or upbids at times when the circuit breaker is triggered.


To judge the impact of the proposed short sale alternatives, it is crucial to know what exemptions will be provided.  The proposals only apply to NMS Securities, which are listed equity securities.  They do not apply to over-the-counter bulletin board securities, options or convertible or other debt securities.  The Original Uptick Rule did not include a blanket exemption for equity trading by options and other derivatives market makers, while the Commission’s temporary ban on short selling in financial stocks did. The discussions during the open meeting indicated that a number of previous exemptions will be included in the proposals, particularly those that are viewed as preserving or enhancing liquidity, such as exemptions relating to restricted stock, riskless principal transactions, syndicate transactions and odd lots.  The proposals will not include an exemption for derivatives market makers.


The Commission also will seek comment on changing the operation of the proposed rules from that of the Original Uptick Rule, to accommodate the new post-Regulation NMS trading environment.  The Commission indicated that it would seek comment on an approach similar to that used in the Order Protection Rule under Regulation NMS (Rule 611).  This approach would require broker-dealers entering short sale orders to have policies and procedures reasonably designed to prevent the short sales from being entered at prices that would violate the short sale price test.  This approach would allow the broker-dealer entering the order, rather than the executing market, to ensure compliance with the price test, to accommodate the current practice of active traders of closely controlling the execution of their orders.

Other Issues

The proposals would not apply to after-hours trading, or to foreign transactions unless they were arranged in the U.S.  Other key issues raised by a short sale price test include its interaction with Regulation NMS requirements and its application to forward sales of equity securities.  The proposing release should address these issues.


If you have any questions about the matters covered in this newsflash, please contact any of the lawyers listed below or your regular Davis Polk contact:

Annette L. Nazareth, Partner*
202-962-7075 | annette.nazareth@dpw.com

Lanny A. Schwartz, Partner
212-450-4174 | lanny.schwartz@dpw.com

Gerard Citera, Counsel
212-450-4881 | gerard.citera@dpw.com

Robert Colby, Counsel
202-962-7121 | robert.colby@dpw.com


*Admission pending in DC; practicing in DC under the supervision of partners of the firm.

Davis Polk & Wardwell