SEC Takes Action Against Potential Short Sellers For Manipulation

Short Sales - Securities Lawyer 101

Securities Lawyer 101 Blog

On September 16, 2013, the Securities and Exchange Commission (the “SEC”) brought enforcement actions against more than 20 broker dealers and other financial firms alleging violations of Rule 105 of Regulation M of the Securities Exchange Act of 1934 (“Rule 105”), which prohibits the purchase of securities in a secondary offering when the buyer has a short position in the same securities during a specified restricted period.

In the enforcement actions, the SEC alleges that each firm violated Rule 105 by selling short during the restricted period following a registered offering and then purchasing the same securities from an underwriter, broker, or dealer through a follow-on public offering.

The defendants include registered investment advisors, asset managers, registered broker-dealers, and trading firms. All but one of the firms agreed to settle with the SEC.

Rule 105 of Regulation M

Rule 105 proscribes purchasing securities in a firm commitment underwritten offering of public equity when one has made a short sale of such security during a restricted period (regardless of whether the firm has an economic long position), which is generally five business days prior to the pricing of the offering. The rule applies regardless of the trader’s intent, and promotes offering prices that ar set by natural forces of supply and demand rather than manipulative activity.

The SEC has stated that short selling close to a public offering can dilute offering prices and interfere with the capital raising process. Since the price of shares secondary offering is generally set at a discount to the closing price immediately before the offering, the SEC seeks to prevent investors from artificially depressing prices by aggressively selling short shares prior to the offering. These same short sellers would be able to then purchase shares in the offering at an unnaturally reduced price to cover their short sales.

The SEC implemented Rule 105 to protect the independent pricing mechanism of the securities market. The rule contains three safe harbors that allow investors to participate in public offerings after shorting the same securities: (1) bona fide purchases, (2) trading in separate accounts, and (3) purchases by registered funds when an affiliated investment company previously shorted securities.

The firms named did not intend to violate SEC regulations. But they did transgress, and, except for the lone holdout, have agreed to pay relatively hefty disgorgement, prejudgment interest, and penalties. For example, Southpoint Capital made total profits of $346,568 on its illicit trades. It is required to disgorge that money, pay interest of $17,695.76, and a penalty of $170,494, for a total of $534,758. Presumably they will be more mindful of the requirements of Rule 105 in the future.

Andrew J. Ceresney, Co-Director of the Division of Enforcement, said: “The benchmark of an effective enforcement program is zero tolerance for any securities law violations, including violations that do not require manipulative intent. Through this new program of streamlined investigations and resolutions of Rule 105 violations, we are sending the clear message that firms must pay the price for violations while also conserving agency resources.”

The settlements agreed upon by 22 of the 23 firms charged resulted in more than $14.4 million in monetary sanctions.

For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 101 Plaza Real S, Suite 202 N, Boca Raton, Florida, (561) 416-8956, by email at [email protected] or visit   This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute, legal and compliance advice on any specific matter, nor does this message create an attorney-client relationship. Please note that the prior results discussed herein do not guarantee similar outcomes.

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