Comment Summary on Short Sales, Concept Release No. 34-42037; October 28, 1999; File No. S7-24-99

Association of Publicly Traded Companies

Electronic Traders Association
Electronic Trading Group, LLC
Managed Funds Association
North American Securities Administrators Association, Inc.
Sierra Trading Group, L.P.
The Specialist Association

Durham & Jones

Morgan, Lewis & Bockius, LLP
Orrick, Herrington & Sutcliffe (Market XT)
Shearman & Sterling
Willkie Farr & Gallager

Charles Schwab

Cornerstone Securities Corporation
Hill, Thompson, Magid & Co., Inc.
Interactive Brokers, The Timber Hill Group
Morgan Stanley Dean Witter

National Association of Securities Dealers, Inc.

The Boston Stock Exchange
The Chicago Stock Exchange
The New York Stock Exchange
The Chicago Board Options Exchange
The Pacific Exchange

II. INTRODUCTION

On October 28, 1999, the Commission issued a release (Concept Release)² seeking public comment on the regulation of short sales of securities. Rule 10a-1³ (short sale rule or Rule) under the Securities Exchange Act of 1934⁴ (Exchange Act) governs short sales of securities.⁵ Rule 10a-1 generally covers short sales in any security registered on a national securities exchange (listed securities) if trades of the security are reported pursuant to an "effective transaction reporting plan" and if information as to such trades is made available in accordance with such plan on a real-time basis to vendors of market transaction information.⁶ Rule 10a-1(a)(1) provides that, subject to certain exceptions, a listed security may be sold short: (i) at a price above the price at which the immediately preceding sale was effected (plus tick), or (ii) at the last sale price if it is higher that the last different price (zero-plus tick). Conversely, short sales are not permitted on minus ticks or zero-minus ticks, subject to narrow exceptions. The operation of these provisions is commonly described as the "tick test."

The Commission adopted the tick test after considering the effects of short selling in downward moving markets. In adopting this approach, the Commission sought to achieve three objectives:

(ii) preventing short selling at successively lower prices, thus eliminating short selling as a tool for driving the market down;

(iii) preventing short sellers from accelerating a declining market by exhausting all remaining bids at one price level, causing successively lower prices to be established by long sellers.

The Commission issued the Concept Release to examine ways to modernize our approach to short sale regulation to provide the most appropriate regulatory structure for short sales.⁷ The release solicited comment on eight concepts regarding short sale regulation:

The Commission received 2250 comment letters in response to the Concept Release. (As of 9/22/2003, the Commission has received 2777 comment letters.) Of the commenters who addressed the issues raised in the Concept Release,⁸ the majority favored some changes to the Rule and most opposed elimination of Rule. The comment letters provide us with information that will allow us to determine whether to propose changes to the Rule and the scope of such changes. ⁹

III. SUMMARY OF COMMENTS¹⁰

A. Introduction

The Commission received more than 2250 comment letters in response the concept release. The majority of the comment letters were submitted electronically by individual investors and discussed short sale regulation of non-exchange listed securities. However, twenty-five of the comment letters were received from market participants such as broker-dealers, self-regulatory organizations, electronic communications networks, and law firms on behalf of their clients.¹¹ All commenters agreed that short sale regulation should prohibit the practice of selling short as a manipulative device.

Of those twenty-five comment letters, eighteen addressed the concept of eliminating the short sale rule entirely. Nine supported eliminating the short sale rule,¹² and nine were in favor of retaining the Rule with amendments to accommodate changes in market conditions.¹³ In general, the comment letters in support of retaining a short sale rule expressed concern about the use of short selling as a market manipulation tool. However, those comments that expressed support for eliminating the Rule argued that market surveillance and enforcement actions should provide adequate protection from manipulation. They also cited substantial changes in the market that render the rule obsolete. Many comment letters opposed short sale restrictions in advancing markets.

Eight commenters discussed the concept of suspending the short sale rule when a security or the market is above a threshold price. Five commenters favored suspending short sale rule when a security or the market is above a threshold price¹⁴ including two who believed the rule should apply only if a stock falls below 5-10% of the previous days close.¹⁵ Three commenters opposed suspending the short sale rule when the security or market is above a threshold price did not believe that the exception would make a significant enough difference and the exception may make to regulation too complicated.¹⁶

Twelve comment letters addressed the concept of providing an exception for active daily trading volume securities (ADTV).¹⁷ Six comments favored the exception because securities with a high ADTV and a significant public float are more difficult to manipulate than less liquid securities.¹⁸ Three commenters opposed the exception.¹⁹ The NASD proposed a variation of the concept, for instance, using of a trend indicator and a minimum price variation of 5 cents to suspend short sale regulation when a security of a market is above a threshold price instead of a high ADTV exception.²⁰

Eight commenters addressed whether short sale regulation should focus restrictions on certain market events and/or trading strategies.²¹ Only one comment letter favored the proposal²² and six opposed the concept.²³ In general, the comments in opposition of this concept opposed prohibiting all short sales during certain market events such as mergers, acquisition, tender offer, or option's expiration dates, or the opening and close of trading. One commenter was undecided.²⁴

Thirteen commenters discussed an exception for hedging transactions and the parameters of such an exception.²⁵ Eleven favored a hedging exception,²⁶ and two opposed such an exemption.²⁷ In general, those in favor of including a hedging exception were broker-dealers who noted that short sales as hedges are not intended to drive down a securities price because they result in economically neutral positions. Those commenters who opposed a hedging exception generally preferred eliminating the short sale rule.

Ten commenters discussed amending the short sale rule to respond to after hours trading and decimalization.²⁸ Nine of the commenters were in favor of amending the rule²⁹ Generally, those comments thought that the short sale rule should be applied to after hours. One commenter requested that the consolidated tape hours be extended or let ATS's use their own price.³⁰ Many of the commenters expressed concern that a minimum price variation of 1 cent will render the tick rule insignificant. One commenter opposed amending the rule to respond to after-hours trading and decimalization and instead preferred eliminating the Rule altogether.³¹

Seven commenters addressed revising the Rule 3b-3 definition of a "short sale",³² and each favored re-defining the rule.

By far, the concept of extending short sale regulation to non-exchange listed securities attracted the most comment letters. We received over 2200 comments from individuals requesting that the securities quoted on Nasdaq SmallCap, OTCBB, and Pink Sheets be subject to short sale regulation. Of the 25 comment letters from the industry, ten discussed extending short sale regulation to non-exchange listed securities.³³ Eight were in favor³⁴ and two of those eight suggested extending NASD Rules 3350 and 3370 to Nasdaq SmallCap, OTCBB, and Pink Sheets.³⁵ Two comment letters opposed extending the Rule to those markets.

B. Specific Comments Concerning the Eight Concepts

Several commenters provided specific, in-depth comments on the eight concepts raised in the Concept Release. We have summarized these comments in the order they were raised in the Release.

1. Threshold Approach

One of the concepts the Commission sought comments on was the suspension of the tick test when a security's price is above a threshold price. By suspending the tick test when the security or the market is above a threshold price, short sellers could sell without regard to price movements. The tick test would apply at any time the price of the security dropped below the threshold. This concept was proposed in response to criticism that the short sale rule does not allow relatively unrestricted short selling in advancing markets.

Three commenters opposed a threshold approach. The National Association of Securities Dealers (NASD) (480) vigorously opposed suspending short sale regulation when a security is above a threshold price. Regarding a market-wide threshold approach, the NASD maintains that abusive short selling is aimed at individual stocks, not whole markets, and therefore the movement of an entire market would have little predictive value with respect to short selling violations.³⁶ Further, the NASD contends that the current rule allows relatively unrestricted short selling in advancing markets since up-bids or zero-plus-bids generally outnumber down-bids or zero-minus-bids. This is true whether the price of the security is advancing above a pre-established threshold or below it according to the NASD. Finally, the NASD maintains that such a proposal would be difficult to administer and would create more problems than it would solve.

The Electronic Traders Association (ETA) (327) is also opposed to the threshold approach. The ETA asserted that the concept introduces "more artificiality and uncertainty" by creating a "two stage tick test." In addition, the ETA maintains that a threshold approach creates uncertainty especially when a security hovers near the threshold price. Finally, the ETA questions how such an approach would apply to a security "listed on Nasdaq and a component of the DJIA and S&P 500 on just on day?"

Five commenters favored the threshold approach. The Boston Stock Exchange (BSE) (332) supported a threshold approach only if applied on a on a stock-by-stock basis. According to the BSE, the threshold price should be based on the primary market's closing sale in each particular stock. According to the BSE, using a threshold test for regulating short sales will not impose an undue burden on short sellers. If a stock drops below its threshold price then the tick test would apply. The BSE feels that short sellers will be able to monitor the price of individual stocks to determine if the current last sale is above or below the previous day's closing price in order to decide whether the short sale rule is in effect.

The Chicago Board of Options Exchange (CBOE) (32) also favored the threshold approach. CBOE noted that conditioning the ability of investors and market makers to effect short sales on a plus tick or a zero plus tick when the market for a security is generally advancing imposes unnecessary delays, costs, and inefficiencies in conducting short sales. Moreover, CBOE asserts that a threshold approach will probably be necessitated by the impending reduction in the minimum price increment associated with decimalization. CBOE contended that decimalization would increase price volatility and increasing intermittent minus or zero-minus ticks where the overall market for a security is advancing.³⁷

While retail broker-dealer Charles Schwab (Schwab) (310) preferred eliminating the short sale rule, it did support the threshold approach if the Rule is not eliminated. According to Schwab, allowing unrestricted short selling as long as the market is 10% to 20% lower than the previous day's close would recognize that only downward movements in the price of a security could possibly justify short sale restrictions.

2. Exception for Actively Traded Securities

The second concept the Commission solicited comment on was an exception to the short sale rule for actively traded securities. This concept's basis is similar to some of the Commission's other anti-manipulation rules that assume that highly liquid securities are less vulnerable to manipulation and abuse than securities that are less liquid. The Commission theorized that the approach taken to other rules such as Rule 101 of Regulation M might be effective for regulating short sales.

The commenters favored the concept of allowing an exception for actively traded securities. One broker-dealer, Morgan Stanley Dean Witter (MSDW) (481), remarked that the stocks of highly capitalized companies are sufficiently liquid that it would be difficult to affect a bear raid on such stocks. MSDW contended that short selling activity on such securities would not alter market participant's perceptions of the price discovery process for these stocks. Further, MSDW states that since the Rule was first adopted the markets have become more efficient and transparent making it more difficult for short sales to artificially influence the price of large-cap, liquid securities. Finally, MSDW noted that the exchanges have developed sophisticated, automated surveillance procedures and transaction audit trails over the past 20 years that would make harder for short sales to manipulate actively traded securities.³⁸

One electronic communications network, Island, Inc. (431), supported the adoption of an exclusion from the Rule for actively traded securities. Island contends that such an exclusion would provide an appropriate balance between the Commission's asserted regarding manipulative short selling and short selling used to accelerate a decline. Specifically, Island stated that the Commission should be less concerned with downward price inhibitors for actively traded securities because it can be extremely costly and less likely to occur with these securities. Further, Island noted that with sophisticated surveillance monitoring activity on a real-time basis, short selling actively traded securities with manipulative intent is unlikely to go undetected.³⁹

The BSE (332) agreed that short selling practices in certain highly liquid issues do not raise substantial manipulation concerns. However, the BSE maintained that the threshold concept is a better approach than specifically exempting issues on trading volume. The BSE argues that the process by which a particular security would be measured to qualify as a "highly liquid" security would be subject to continual reevaluation based on many factors which influence the market in the security. Further, the BSE contended that it would be difficult for market participants, especially specialists, to determine which issues are exempt and at what particular time they become exempt.

The CBOE (32) commented the Commission should exempt actively traded securities from the short sale rule since securities with high average trading volumes and significant public floats are more difficult to manipulate. In addition, the CBOE contended that price manipulation in these securities through short selling would be more likely to be discovered because they are followed closely by the investment community. Finally, CBOE agreed that the same approach that was applied to Regulation M for actively traded securities should be applied to the short sale Rule.⁴⁰

3. Short Sale Restrictions for Certain Events and Strategies

The third concept proposed by the Commission is the concept that short selling only be regulated or prohibited during specific market conditions. Recognizing that certain market events and trading strategies may make a security more vulnerable to abusive short sale activity, the concept contemplates short sale regulation during corporate events such as mergers, acquisitions, or tender offers. In addition, the Release sought comments on possibly prohibiting short selling during significant corporate or market events.

Generally, the commenters expressed concern about this concept. Most commenters remarked that a well-constructed Rule should eliminate the need to have separate tests for certain events and strategies. For instance, the BSE (332) noted that while market events may add volatility, short selling should continue to be permitted as long as there is a tick test. Others believe that regulating or prohibiting short sales during specific market conditions would be difficult to administer and would offer little benefit. The NASD (480) commented that high volatility associated with mergers, acquisitions, and tender offers are precisely the times when short sale regulation can best preserve orderly markets. The CBOE (32) agreed that it would be ill advised to suspend the short sale Rule during these critical periods.⁴¹

4. Excepting Hedging Transactions

A large number of comments concerned the concept of excepting hedging transactions from the requirements of the short sale rule. The Release sought comment on whether hedged short positions should be excluded from calculating a person's net position and whether an exception should be added to the Rule that would cover short sales conducted exclusively for the purpose of establishing a bona fide hedge. Presently, short positions and short sales related to hedging activity are treated the same under the Rule as any other short activity. The Commission sought comment on the definition of the term "bona fide hedge", excluding hedged short positions for the purposes of calculating a net position, and the scope of an exception covering short sales offset by equivalent securities.

Generally, commenters supported a hedging exception to the Rule.⁴² MSDW (481) asserted that application of the short sale Rule to hedging transactions places unnecessary regulatory restraints on conduct that does not implicate the underlying concerns that the Rule was intended to address. To the contrary, the MSDW stated that hedging is a risk management technique that should be encouraged not hindered.⁴³ Morgan, Lewis & Bockius (MLB), commenting on behalf of clients who engage in hedging activity, also supported the adoption of an exception to the tick provision of the short sale Rule for bona fide hedging transactions. Similarly, the Managed Funds Association (MFA) (427) advocated a broad exception to the Rule for hedging transactions because short selling is an integral part of many hedging strategies if the Rule is not repealed.⁴⁴

The BSE (332) argued that short positions and short sales related to bona fide hedging should not be treated the same under Rule 10a-1 as any other short activity. The BSE contended that price manipulation seems less likely for certain trading strategies that are designed to hedge against a potential decline in price of the underlying security. The BSE argued that short hedging should not be delayed by the tick test restriction on economically neutral hedging.

While the CBOE (37) advocated the elimination of the short sale rule, it argues that if the Rule is retained there should be an exemption for hedging activity by options market makers. The CBOE contended that the current short sale test significantly impedes efficient hedging activity associated with a market makers affirmative and negative obligations designed to maintain a fair and orderly market. Specifically, the CBOE argued that a market maker needs to be able to hedge some of his exposure by taking an offsetting position in a related instrument (i.e., other options, futures in the case of index options, and/or the underlying stock). Under current short sale regulation an options market maker tries to hedge his position by purchasing puts. Purchasing long puts in a declining market is time consuming, uncertain, and cost prohibitive according to the CBOE. Hence, CBOE maintained that options market makers should be able to sell the underlying security short or sell a different option short without compliance with Rule 10a-1 would lower risks for the market maker which would be passed onto investors in the form of price improvement.

In the Release, the Commission specifically asked whether the current definition of "bona fide hedge" is appropriate and adequate. The Commission received some specific comments on this question. One commenter, MLB (463), advocated the use of the hedging definition adopted by the Commission in Rule 11a1-3(T) under Section 11(a). Section 11(a) of the Exchange Act generally prohibited a stock exchange member from effecting transactions on any exchange for its own account with certain exceptions. MLB noted that the exception in Rule 11a1-3(T) allows members to participate in bona fide hedge transactions involving a long or short position in an equity security and a long or short position in a security entitling the holder to acquire or sell such equity security. MLB further recommended that the definition in Rule 11a1-3(T) be expanded to cover situation where the offsetting position is a futures contract, repurchase agreement, swap agreement or similar agreement because the same delta analysis applies.

Other commenters suggested less specific changes to the definition. For instance, the BSE (332) stated that the Commission should broaden the definition of bona fide arbitrage to accommodate greater flexibility in permissible trading relationships. The BSE cautioned, however, that in order to review and establish appropriate oversight controls to prevent abusive practices, the firms that establish and claim an exemption to the tick test or net position requirement must create and maintain a record of the basis for claiming the exemption, identifying the components and have the record approved by the firm's compliance office.

Another commenter, CBOE, recommended adopting a hedging exemption from Rule 10a1-1 for short sales by or on behalf of options market makers when such short sales involve exchange-listed stock underlying the options market maker is obligated to buy and sell. Specifically, in order to be eligible for the exemption, the stock the market maker seeks to short must (1) underlie an option class to which the market maker has been appointed; (2) act as a hedge for the market maker's pre-existing or contemporaneously established positions; and (3) in the case of a stock underlying an equity options, (i) the market maker's net delta position is not greater than 20 deltas short⁴⁵, or (ii) the options position being hedged is no more than 20% out-of-the-money.

Willkie Farr & Gallagher (WFG) (488), writing on behalf of a group of broker-dealers⁴⁶, supported a hedging exemption but strongly opposes any attempt to write an exclusive definition of the positions that would be deemed to constitute a hedge. WFG claimed that in the past the Commission wisely avoided attempting to give an exclusive definition to such terms as "block positioning", "bona fide arbitrage", "risk arbitrage" and "bona fide hedge" because any such definition would rapidly become obsolete as the markets and trading practices changed. Instead, WFG argued that the exception should allow for model-based (e.g., delta) hedging, adjustments to existing hedges and unwinding of hedges. According to WFG permissible models should be devised by each individual firm that are reasonably calculated to result in an economically hedged position and should apply to risk arbitrage in connection with exchange offers and stock-for-stock mergers as well as other hedging situations.⁴⁷

5. Revise Short Sale Regulation in Response to Market Developments

In seeking comment on Rule 10a-1 the Commission noted two potential changes in the securities markets that may affect the operation of short sale regulation: (1) after-hours trading sessions, and (2) decimalization.

a. After-hours Trading Sessions

The Commission noted that securities trading has expanded beyond the regular trading hours of 9:30 to 4:00 p.m. The tick test of Rule 10a-1 operates relative to the last reported price on the Consolidated Tape. The Consolidated Tape does not currently operate after the close of regular trading hours. As a result, short sales can only executed at a price above the closing price on the Consolidated Tape, which could greatly limit the ability to execute short sales in after hours trading.⁴⁸

MSDW (481) stated that the Commission should suspend the application of the short sale rule when the consolidated tape is not operating. MSDW suggested that it would be extremely difficult to effect a manipulation through repeated short selling when the consolidated tape is closed because prices are not disseminated broadly. MSDW did not believe that allowing each ECN to use its own transactions as a reference is advisable as this would result in different ticks at different ECNs occurring at the same time.

Island ECN (431) commented that the Commission should take steps to encourage the Consolidated Tape (or the consolidated quotation system if the bid test is adopted) to extend its operating hours or to encourage the creation of alternative to the consolidated tape and the consolidated quotation system. If Rule 10a-1 should continue apply in the after-hours market, Island wrote that Rule 10a-1 should be modified to allow ATSs operating in the after hours to rely on their own bid price as a reference price for compliance with the Rule. Market XT (328)⁴⁹ also urged the Commission to allow short sales to be effected on the ATSs based on their systems' last sale price for the purposes of the "tick" test when the Consolidated Tape is not operating since ATSs are the "functional equivalent of exchanges".

The Specialist Association (426) commented that after hour bids and offers and last sale prices should be collected, consolidated, and disseminated in the same way that they are during regular trading hours. Commission rules and industry plans governing firm quotation and last sale reporting must be reformed to incorporate last sales of ATSs and ECNs according to the Specialist Association. Once this is achieved, the Specialist Association contended that the short sale Rule can be applied in the same manner that it is during normal trading hours.

The BSE (332) recommended that there be a uniform standard of practice for after hours trading that supports the prophylactic effect that tick restrictions place on short sales. In particular, the BSE noted that tick restrictions are less effective if ATSs are allowed to execute short sale orders based on the primary session closing prices rather than the consolidated last sale price.⁵⁰

The NASD (480) argued that the short sale rule should apply to extended-hour trading since justification for short selling-the threats of abusive short selling, extreme volatility, and reduced liquidity due to the high risk to market makers-apply with equal, if not greater force, during the extended-hours trading.⁵¹ The NASD reasoned that the application of the short sale rule during this period will enable regulators to monitor short sales precisely as they do during normal trading hours and thus offer investors full protection of the regulation.

b. Decimalization

MSDW (481) asserted that if decimalization brings a one-cent minimum price variation (MPV) then the short sale Rule could be rendered "meaningless" because a minus tick could occur for a price change as little as one cent. Moreover, MSDW noted that there may be a problem monitoring the tick due to constantly flickering price changes. MSDW argues that the conversion to decimals is another argument for replacing the tick test with the bid test using five-cent increments for quotes so that short sale restrictions would be triggered by a five cent decline in the bid quote.

The Specialists Association noted that there should be a "larger measure of price change sufficient to trigger the short sale prohibition" when trading goes to pennies in a decimal environment. The Specialist Association thought that this will be necessary because there will be a significant increase in the number of daily market movements from one penny level to another and of successive up or down penny moves. Moreover, the Specialist Association believes that successive penny moves in the same direction will be less significant and convey less important information to the markets than successive up or down price moves in the current fraction increments. The Specialist Association recommended that "some larger measure of price change sufficient to trigger the short sale prohibition will be needed for stocks that trade in single pennies."

Willkie, Farr and Gallagher (WFG) (488) recommends that the Commission refrain from adopting amendments to Rule 10a-1 until decimalization is implemented in the market. WFG states that because the effects of decimalization are unknown, a better approach may be to watch the market response the effect of the current Rule 10a-1. However, in the event that there is insufficient time for the Commission to respond to decimalization by amending Rule 10a-1, WFG suggests that the Commission grant no-action positions pending the Commission's assessment of decimalization and short sale regulation.

6. Revise Definition of Short Sale

The Commission also sought comment on two issues associated with the definition of a "short sale" under Rule 3b-3. First, the Commission asked whether the definition should be altered to reduce the need for large single-entity, multi-service firms to aggregate positions. Second, the Release inquired whether the Commission should adopt additional regulatory measures to address manipulative strategies associated with temporary "long" positions⁵² under the current definition of "short sale".

a. Aggregation Issue

The commenters that addressed the issue of aggregation disapproved of the requirement that firms net all proprietary positions in order to calculate whether the firm is long or short resulting in subject to the tick test. WFG (488) and the New York Stock Exchange (NYSE) (467) note that the 1998 Blanc no-action letter regarding Aggregation Units, aggregating broker-dealer positions to determine the broker-dealer's net position with respect to its compliance with the Rule, is an expectable proposal in concept.⁵³ However, the broker-dealer firms WFG represents have experienced difficulty in devising procedures to meet the requirements of the Blanc letter.

Furthermore, the Electronic Trading Group (ETG) (474) asserted that in light of our "new global marketplace" the Commission should adopt a "single investment decision" rule rather than "aggregation units" or firm wide netting. The ETG argued that market participant buyers are limited to purchasing stocks on a minus tick or a zero-minus tick from sellers who are long. Also, individual traders at firms who are long individually may be hindered from selling because firm wide netting results in an overall short or flat position. The ETG explained that this impedes on market liquidity and, by adopting a "single investment decision" concept, market liquidity would be enhanced because more buyers would encounter more sellers. The ETG also contended that compliance monitoring costs for firms and regulators will decrease because the number of sales subject to the tick test will be reduced.

b. Manipulative Strategies

Rule 3b-1 defines a short sale and provides that a seller is deemed to own a security if, among other things, they own an option to purchase or acquire that security and exercise that option. The NYSE (467) noted observations of broker-dealers using long positions coupled with option strategies (put purchases), `a married put.' The NYSE asserted that these strategies have no intrinsic economic value when aggregating a position for purposes of the rule. The NYSE explained that aggressive selling follows in an effort to elude the tick restriction of Rule 10a-1.

However, the CBOE (32) encouraged the Commission to amend Rule 3b-3 to allow "all economically equivalent securities in defining a net long position." CBOE stated that a stock that is hedged by options should be considered in assessing whether a seller has a net long or a net short position because options market makers seeking to hedge options positions by selling the underlying stock may end up subject to the short sale restrictions. They argued that "stock is hedged by options positions simply does not present the concern about manipulation short selling that might be presented in absence of a hedge." Thus, the CBOE proposed that the Commission amend Rule 10a-1 to consider unexercised stock and derivative positions in assessing a seller's net position.

Specifically, CBOE recommended that the Rule 10a-1 permit unrestricted short sales when a "market participant has a position of no more than 10 short deltas (the equivalent of 1,000 shares sold short)."⁵⁴ The CBOE also proposed that market makers be permitted to engage in unrestricted short sales as long as they maintain a position of up to 20 short deltas because of market maker's liquidity obligations. The CBOE reasoned that "as the delta of a position can vacillate rapidly during the day with a price of the underlying stock, so a more flexible standard that a delta-neutral one is needed."⁵⁵

7. Extend Short Sale Rule to Non-Exchange Listed Securities

The seventh concept the Commission proposed is whether Rule 10a-1 should be extended to apply to securities traded in the over-the-counter market (OTC). While current short sale regulations cover securities that are listed on an exchange, Rule 10a-1, or traded in the Nasdaq NMS, NASD rules 3350 and 3370, the Commission received thousands of complaints about market manipulation in the over-the-counter market sector, e.g. Nasdaq SmallCap, the Over-the-Counter Bulletin Board, and the Pink Sheets.

a. Industry Comments

The Association of Publicly Traded Companies (APTC) (932) favored extending short sale regulation to the Nasdaq Small Cap, OTCBB, and Pink Sheets in an effort to apply the same rule to securities trading in all markets. However, Hill, Thompson, Magid & Co (HTM) (425) argues that "expanding the framework for regulating short sales to the SmallCap and OTCBB markets is unnecessary." HTM explained that the same problems that lead Commission to re-evaluate the short sale rule as applied to exchange listed securities also apply to the SmallCap and OTCBB markets. Also, HTM argued that the Commission does not have the authority to extend the short sale regulations to this market sector under the Exchange Act of 1934, and it should not seek to expand its statutory authority to do so.

The NASD supported expanding short sale regulation to the SmallCap market. The NASD argued that extending the NASD's short sale regulation to include SmallCap securities will increase investor interest in these securities because it will decrease market manipulation and enhance the investor trust in Nasdaq Small Cap issues. Without short sale regulation, Nasdaq SmallCap securities are vulnerable to artificial pricing during an offering on Nasdaq. However, the NASD's proposal entails applying NASD's Rule 3350 to Nasdaq Small Cap securities, exactly as it is applied to NMS securities. Thus, qualified market makers in Small Cap securities would also be exempt from NASD's Rule 3350. The NASD did not state an opinion as to whether short sale regulation should be extended to the NASD's OTCBB, nor did it mention applying Rule 10a-1's tick test to Nasdaq Small Cap, OTC Bulletin Board, and Pink Sheets issues.⁵⁶

The Boston Stock Exchange (332) also suggested that the NASD's bid test should be extended to the Nasdaq Small Cap, OTC Bulletin Board, and Pink Sheets. The BSE reasoned that the issues traded on the Nasdaq Small Cap, OTC Bulletin Board, and Pink Sheets are not as liquid and prone greater volatility and possibly exposed to manipulation. Thus, they may necessitate "additional protective oversight mechanisms to minimize short selling abusive practices."

However, Willkie, Farr & Gallagher (WFG) (488) argued, on behalf of the firms it represents, that they opposed the concept of Rule 10a-1 being applied to Nasdaq NM securities. Instead, they favored of keeping the NASD's bid test applicable to Nasdaq NM issues is favorable. WFG noted that the issue of Nasdaq's registration as a national securities exchange will require the Commission to amend Rule 10a-1 to conform the application of the Rule in a dealer market. The firms WLF represent also urged self-regulatory organizations to establish a "single, workable approach to locating securities for borrowing before effecting short sales."⁵⁷

Durham, Jones & Pinegar (DJP) (491)⁵⁸ expressed concern on behalf of their clients of "the unrestrictive and unreported" short selling on the OTC market. DJP suggested that the Commission's objectives in its short selling regulations should also apply to non-exchange list securities because they are susceptible to manipulation by "unscrupulous traders with an open license to manipulate these SmallCap stocks." The Chicago Stock Exchange (CHX) (323) concurred and noted, "that in the interest of preserving fair and open markets for such changes [to Rule 10a-1] must be applicable to all equity markets."⁵⁹

HTM (425) did not support short sale regulation to all markets. HTM also maintains that short selling is a "legitimate market making function," and market makers add liquidity to the markets. They also claimed that "short selling abuses can be controlled with the anti-manipulation regulations already in place." HTM argued that the "the short sale rule has been shown to be a wholly ineffective means of controlling such manipulative behavior because it was not intended to be an anti-fraud mechanism."

b. Individual Comments

The Commission received approximately 2200 comment letters from individual investors regarding extending short sale regulation to the OTCBB, Nasdaq SmallCap, and Pink Sheets. A large majority of these letters were submitted in the form of mass electronic mail. While many different individuals submitted these letters, most of the letters are essentially the same and consistently raise the same concerns.

The largest group of letters, accounting for over 2000 of the comment letters received by the Commission, focused on small businesses.⁶⁰ This letter expressed concerns about market makers "defying the laws of supply and demand" and thus, "resulting in plummeting stock prices." The letter claimed that the absence of short sale regulation on the OTCBB "leaves the OTCBB listed companies prey to market manipulation." These commenters asked the Commission to hold the market makers "accountable by requiring by requiring mandatory disclosure of Market maker short positions on all OTCBB list stocks."

One group of similar letters refers to "outrageous" stock price "manipulation" by market makers through the short selling of "unlimited non-existent shares." These investors asked the Commission to regulate short sales in OTCBB stocks so that everyone can play the "game by the same rules." Another group of letters exhibiting a uniform pattern complained about " naked shorting" by market makers and offshore brokers.⁶¹ These letters contained identical language referring to "penny" stocks as "volatile" due to "rampant naked shorting" that has gone "unchecked."⁶² According to these investors, naked shorting must be abolished and reporting requirements should be established for issuers.

Another group of letters state "the values of all OTCBB companies are controlled by the market makers."⁶³ Also, the authors stated that marker makers are "beating the will" out of private investors because market makers can naked short without covering and do not have to report short positions. These letters not only encouraged the Commission to expand short sale regulation to cover the OTCBB, but also to adopt reporting requirements for market makers to disclose their short positions. While another group of letters stated "`naked short selling' of OTCBB securities should not be allowed."⁶⁴

The Commission received many other letters from individual investors that did not follow a pattern but expressed similar concerns. Many of these investors stated that they wanted the short sale rule to apply to SmallCap and the OTCBB stocks. These investors were generally concerned about manipulation of securities by short sellers and the need for short sale regulation and enforcement. Some of these comments expressed concern about the effect the absence of short sale regulation has on companies traded on the OTCBB.⁶⁵ Others commented on the behavior of market makers and possible manipulative activity associated with the short selling of OTCBB stocks.⁶⁶ Many of the letters from individual investors requested that the Commission require market makers to disclose short positions.

8. Eliminate Rule 10a-1

The Release acknowledges that short sale regulation has often been criticized. Therefore, as part of the Commission's comprehensive review of Rule 10a-1, comments were solicited regarding whether we should simply rely on anti-fraud and anti-manipulation measures to combat abusive short selling. Or does the potential for abusive short selling warrant preventative measures that are designed to defend against downward stock manipulation, such as Rule 10a-1.

a. In Favor of Eliminating the Rule

Schwab (310) supported the concept of eliminating the short sale rule because it believes that the Rule is "unnecessary, grossly over inclusive and ineffective means of addressing such fraudulent practices." Schwab stated that the Rule "interferes with best execution for retail customers" because short sellers are prohibited by the Rule from executing when there is a downtick or a zero-minus tick, thus, the buyer on the other side would may not be getting the best possible price.⁶⁷ However, Schwab proposed that if a security does fall below 10-20% of the previous days close, the short sale rule should be implemented. Schwab also explained that it believes there is nothing wrong with the practice of short selling because it may enhance market liquidity.⁶⁸ Finally, Schwab claimed that securities market manipulation is not necessarily prevented by the Rule and newer anti-fraud regulation and surveillance mechanisms have been created.⁶⁹

The Chicago Board Options Exchange (CBOE) (32) also supported abolishing short sale regulation because the Rule generally restricts the market from absorbing investor beliefs that the value of a security is overestimated, resulting in the inefficiency of the market.⁷⁰ The CBOE explained that the Rule impedes on liquidity, hedging,⁷¹ and the ability of market makers and specialists to assume larger positions that they could with short sale regulation. The CBOE remarked that not only are there differing markets with differing short sale regulations in the United States, but many U.S. securities are traded in foreign markets that may or may not have similar short sale rules. Furthermore, CBOE advised that without Rule 10a-1 short sale would still be subject to the anti-fraud and anti manipulation provisions of the Exchange Act.⁷²

Island (431) opposed "any regulation that inhibits the free-market pricing mechanisms found in an efficient market"⁷³ and argued that the short sale rule provides "no economic rationale." Island asserts that the short sale regulations should be more in line with foreign equity markets, derivatives markets, and commodity markets because those markets operate without a short sale rule.⁷⁴ While Island supported "natural market pricing mechanisms" as opposed to short sale regulations, it also supports the prohibition of the use of short selling as a manipulative device.⁷⁵

The comments that supported eliminating the Rule did not, in general, believe that short selling provides intrinsic value to the market. The ETA (327) commented that the costs of short sale restrictions, decreased liquidity, bookkeeping of margin, and monitoring, outweigh the any benefit that may result form the regulations.⁷⁶ Trimark (330) argued that certain transactions the Rule prohibits do not violate the goals the short sale rule promulgates, while other transactions the rule allows would be manipulative.⁷⁷ The Managed Funds Association (MFA) (427) remarked that the information available to investors should affect the market and the price a stock should reflect the current information available to investors.⁷⁸

Also, these comments stated that adequate anti-manipulation rules are would provide enough protection so that the Commissions goals regarding short sale regulation are met.⁷⁹ The Sierra Trading Group (39) favored utilizing monitoring and enforcement to control abusive manipulative short selling. Cornerstone (324) also supported elimination of the Rule, preferring the Commission monitor and enforce antifraud provisions.

b. Opposed to Elimination of the Rule

The NASD (480) noted that short sale regulation helps maintain an orderly market, but recognizes the need to modify the Rule to account for changing market conditions.⁸⁰ The NASD discussed the expansion of the market in the past years and how that may make the domestic securities markets just as vulnerable to `bear raids' and `piling on' as they were at the inception of the Rule. Also, the NASD envisioned a short sale regulation the treats all markets consistently, yet acknowledges the differences between auction markets and dealer markets.⁸¹

The NYSE (467) agreed that the short sale rule should be maintained as the Rule serves to protect individual investors, prevent fraud and manipulation, and promotes just and equitable principles of trade. Sherman & Sterling (424) supported retaining of the rule, but expressed concerns that the Rule restricts certain activities the goals of the Rule did not intend to preclude. Sherman & Sterling does not believe any empirical data exists that would change the need for short sale regulation since 1938 when the Rule was adopted.

Sherman & Sterling were concerned that without the rule the markets could become destabilized, resulting in the decay of investor perception of integrity in the securities markets.⁸² The North America Securities Administrators Association (NASAA) (321) strongly opposed the elimination of the short sale rule for the same reason. The BSE (332) strongly opposes abolition of the Rule because it believes the Rule is a "very effective safeguard in today's society." These commenters argued that investors see the Rule as security from short sellers depleting the value of their securities.

A few comments focused on the necessity for more disclosure of short positions. The Electronic Trading Group (ETG) (474) proposed to expand the short sale rule to require the all shorts sale to be identified on the recording device and a record kept and made public of the cumulative volume of all short sales at all times. The ETG argued that if open short interest information was disseminated to all market participants, market participant's reservation about short selling could be subsided. The Association of Publicly Traded Companies (APTC) (467) wrote that prompt disclosures of significant short positions would help the regulation short sales.⁸³

The Specialist Association (426) was concerned that if the Rule were abolished the result would be that short sellers would "precipitate panic selling by establishing severe downward market trends." The Specialist Association remarked that absent short sale regulation specialists may have difficulty maintaining the market stability specialist need to trade counter to downward market trends in their specialty stocks.

c. Eliminate the Tick Test

Island ECN (431) proposed that the current "tick test" be replaced with a bid test. Because the current "tick test" references reported last sale price, Island argued that current real-time market movements are not reflected.⁸⁴ As a result of these "substantial time disconnects with the real market price of the security" sporadic up-ticks and down-ticks are created that do not reflect the real-time movement of the bid/ask quotations in a security. Thus, Rule 10a-1 is difficult to comply with. Island argued that a better indication of the current market of a security is contained in a bid quotation. Island asserted that in a manual or highly automated environment, the tick test is extremely difficult to comply with. Thus, Island requested Rule 10a-1 be amended to use the bid price as a reference price.

The NASD (480) proposed that using a trend arrow, that evaluated more that one bid change, might be more reflective of market movement. Trades on Nasdaq are often reported out-of sequence, and it is difficult to ascertain the direction of the market based on the last sale price. The NASD conducted a study looking at "five changes prior to a short-sale trade and taking the majority direction as the trend for that security price" and found increased stability in the price indicator. The NASD also found that after applying a trend arrow concept on a small sample of stock for a day resulted in 20-30% less fluctuation than the current bid test.⁸⁵

Endnotes

¹ This summary reflects all letters received by September 1, 2000. However, the list of individual commenters has not been updates since June 1, 2000.

⁵ A short sale is the sale of a security that the seller does not own or that the seller owns but does not deliver. See Rule 3b-3 under the Exchange Act, 17 CFR 240.3b-3.

⁶ Rule 10a-1 uses the term "effective transaction reporting plan" as defined in Rule 11Aa3-1 (17 CFR 240.11Aa3-1) under the Exchange Act. See 17 CFR 240.10a-1(a)(1)(i).

⁸ Over 400 of the letters were form letters submitted electronically by individuals. These letters raised specific concerns about short selling in the over-the-counter (OTC) markets.

⁹ All comment letters are available in File No. S7-24-99 at the Commission's Public Reference Room, 450 Fifth Street, N.W. Washington D.C. 20549.

¹⁰ The file number of each referenced comment letter is indicated in parenthesis.

¹¹ Association of Publicly Traded Companies (APTC) (932), Electronic Traders Association (ETA)(327), Electronic Trading Group, LLC (ETG) (474), Managed Funds Association (MFA) (427), North American Securities Administrators Association, Inc. (NASAA) (324), Sierra Trading Group, L.P. (39), The Specialist Association (426), Durham, Jones & Pinegar (491), Hill, Thompson, Magid, & Co.HTM)(425), Morgan, Lewis & Bockius, LLP (MLB) (463), Orrick, Herrington & Sutcliffe (Market XT) (328), Shearman & Sterling (424), Willkie Farr & Gallager (Willkie) (488), Cell Pathways, Inc (391), Charles Schwab (Schwab) (310), Cornerstone Securities Corporation (324), Interactive Brokers, The Timber Hill Group (329), Morgan Stanley Dean Witter (MSDW)(481), National Association of Securities Dealers, Inc. (NASD) (480), The Boston Stock Exchange (BSE) (332), The Chicago Stock Exchange (CHX) (323), The New York Stock Exchange (NYSE) (467), The Chicago Board Options) Exchange (CBOE) (32), The Pacific Exchange (PCX) (325), Island ECN (Island) (431), MarketXT (Orrick, Herrington & Sutcliffe)( 328), Trimark Securities (330).

¹² See Island (431), MFA (427), Schwab (319), Cornerstone (324), Trimark (330), CBOE (32), ETA (327), Sierra Trading Group (39), and Interactive Brokers (329).

¹³ See Shearman & Sterling (424), Specialist Association (426), APTC (392), BSE (332), NASAA (324), NYSE (467), Cell Pathways (391), ETG (474), and NASD (480).

¹⁴ See Schwab (310), BSE (332), MSDW (481), Sierra Trading Group (39), and CBOE (32).

¹⁷ See Island (431), MFA (427), Schwab (310), MSDW (481), CBOE (32), Sierra Trading Group (39), Hill Thompson Magid & Co. (425), Specialist Association (426), ETA (327), NASD (480), ETG (474), and BSE (332).

¹⁸ See Island (431), MFA (427), Schwab (310), MSDW (481), CBOE (32), and Sierra Trading Group (39).

¹⁹ See Hill Thompson Magid & Co. (425), Specialist Association (426), and ETA (327).

²¹ See Specialist Association (426), MFA (427), BSE (332), Schwab (310), NASD (480), CBOE (32), ETA (327), MFA (427), BSE (332), Schwab (310), NASD (480), CBOE (32), and ETA (327).

²³ See MFA (427), BSE (332), Schwab (310), NASD (480), CBOE (32), and ETA (327).

²⁵ See MFA (427), Sherman & Sterling, MSDW (481), Specialist Association (426), BSE (332), NYSE (467), NASD (480), MLB (463), PCX (325), CBOE (32), Willkie, Farr &Gallagher (488), Schwab (310) and Sierra Trading Group (39).

²⁶ See MFA (427), Sherman & Sterling, MSDW (481), Specialist Association (426), BSE (332), NYSE (467), NASD (480), MLB (463), PCX (325), CBOE (32), and Willkie, Farr &Gallagher (Willkie) (488).

²⁸ See Island (431), Specialist Association (426), BSE (332), NYSE (467), NASD (480), MSDW (481), Willkie (688), Sierra Trading Group (39), Market XT (328), and ETA (327).

²⁹ See Island (431), Specialist Association (426), BSE (332), NYSE (467), NASD (480), MSDW (481), Willkie (688), Sierra Trading Group (39), and Market XT (328).

³² See Sherman & Sterling (424), Specialist Association (426), BSE (332), NYSE (467), ETG (474) CBOE (32), and Sierra Trading Group (39).

³³ See Island (431, BSE (332), APTC (932), CHX (323), NASD (480), MSDW (481), Sierra Trading Group (39), Cell Pathways, Inc., Hill Thompson Magid & Co. (425), and ETA (327).

³⁴ See Island (431, BSE (332), APTC (932), CHX (323), NASD (480), MSDW (481), Sierra Trading Group (39), and Cell Pathways, Inc.

³⁶ The Specialist Association (426) also believes that short sale rule would not be improved by suspending it when trading occurs above some threshold price.

³⁷ CBOE (320) further added that it prefers permitting unrestricted short selling until the price of a security declines five or ten percent below the previous day's close.

³⁸ MSDW argued that for the purposes of exemptive treatment, any adoption of an actively traded concept should be more rigorous and exclusive than that found in Regulation M.

³⁹ The Specialist Association (426) was critical of arguments that suggest surveillance improvements "cannot prevent or slow short selling or mitigate the effects of such selling on the market as a whole."

⁴⁰ Charles Schwab (319) agreed that the risk of manipulation is low in actively traded stocks and supports the use of Regulation M requirements for an exception.

⁴¹ The CBOE (32) contended that to the extent that the Commission determines to limit short selling during such periods, option market makers should be exempt from such restrictions so that they can provide liquidity to meet the demands during these market events.

⁴² One commenter, however, outright opposed any hedging exemption. Charles Schwab (319) stated that such an exception "would only add to the list of privileges designed principally to benefit professional traders, while making the trading rules more complex for ordinary retail investors and broker-dealer order processing systems. Schwab instead supported an exception to the rule for actively traded securities or the "threshold" approach.

⁴³ Similarly, the law firm of Shearman & Sterling (424) believes that hedging activity should be "rewarded, not discouraged, because it is a risk reducing activity."

⁴⁴ Another commenter, The Specialist Association (426), thinks there may be "merit" to amending the Rule to permit the establishment of "market neutral" positions in securities and to permit sellers of securities to exclude such positions from calculations of their "net long" positions for the purposes of Rule 3b-3.

⁴⁵ The change in the value of an option relative to a one dollar change in the value of the underlying stock is referred to as an option's "delta".

⁴⁶ Bear, Stearns & Co. Inc., Credit Suisse First Boston Corporation, Deutsche Bank Securities, Inc.; J.P. Morgan Securities Inc., PaineWebber Incorporated, Prudential Securities Incorporated, and Warburg Dillon Read LLC (collectively, the "firms").

⁴⁷ According to Willkie, broker-dealers should not have to receive advance approval from the Commission or a self-regulating organization to implement a risk-assessment model or hedging model and should be permitted to update their models as they deem appropriate as long as they continue to reflect a reasonable approach to risk measurement and the determination of risk offsets.

⁴⁸ The Commission noted that Rule 10a-1 permits exchanges to use the price of the last transaction on the exchange, rather than the last price reported to the Consolidated Tape, as the last reported price. Thus, an exchange operating an after-hours session could rely on this provision. ATSs cannot rely on this provision. Thus, short sales through ATSs must use the last price reported to the Consolidated Tape.

⁴⁹ Matket XT is represented by Orrick, Herrington & Sutcliffe, who sent a comment letter in on their behalf.

⁵⁰ Trimark (330), however, generally argued that third market makers should be allowed to execute short sale orders (during regular and after hours) on upticks of the stock's primary exchange, even if such an execution would be a downtick on the consolidated tape. Trimark contended that the consolidated tape is not "sacrosanct" and the stock's primary exchange almost always presents a clearer picture of the actual, current market of the stock.

⁵¹ The New York Stock Exchange (NYSE) (467) similarly agreed that the Rule should apply after hours "given the potential for trading abuses in market environment with lesser trading volume and greater volatility."

⁵² In particular, the Commission is concerned about such behavior as traders entering into arrangements with a counterparty to create a position in an equity security that is technically long by gives the traders no real economic stake in the equity security.

⁵³ See SEC No-Action Letter to Roger Blanc (November 23, 1998). ETG argued that in the Blanc letter the Commission left open the "possibility that the short sales were not intended to limit non-manipulative short sales."

⁵⁴ A delta is the measure of the relationship between an option price and the underlying stock price.

⁵⁶ The NASD is not certain how the Nasdaq becoming a national securities exchange will affect the OTCBB.

⁵⁷ WFG recommended that the NYSE's record keeping requirements be adopted so that there is at least some uniformity.

⁵⁸ DJP wrote on behalf of clients whose shares are quoted on the Nasdaq SmallCap, OTCBB, or Pink Sheets.

⁵⁹ Cell Pathway, Inc. also recommended that the Commission expand regulation of shorts sales to all currently unregulated markets.

⁶¹ For example, see, letter 389. A short sale becomes a "naked" short sale when the short seller does not intend to borrow and deliver stock to settle the transaction.

⁶⁵ See, e.g., Deborah Clement (33) expressed concern about the impact of "rampant manipulation" by the OTCBB market makers on "honest, hard working companies (and their shareholders), who are only trying to make the American dream a reality." Ian G. Archibald (101) stated that the practice of market makers holding significant short positions in OTCBB stocks has done "serious damage" to legitimate companies. Another commenter, Alan Lockhart (93), complained that individual investors are "tired" of investing in growing companies only to see the "market makers naked short an issue killing the opportunity for an upcoming company to grow."

⁶⁶ See, e.g., Commenter Jeffrey Abrams (301) noted that "market makers pretty much put the bid and ask where they want it" and they short sell stocks on the OTCBB even when there is no shares to be barrowed which is "the most blatant manipulation by market makers...". William J. Henderson (359) wrote that "allowing [market makers] and other professional traders to naked short a stock give them unfair advantage over us little people because we have to put up front money without respective broker to even have a short selling account, if our broker will approve a short/margin account."

⁶⁷ Schwab noted that there are hidden costs of the short sale rule. They also contend that the complexity of the short sale rule poses problems to the individual investor who does not hold the same level of influence in the market yet is not eligible for the exceptions available to institutional trader.

⁶⁸ Schwab believes that short selling plays a role in allowing investors to act on the possibility that the price of a security will decline, possibly preventing issuer fraud, such as manipulating earnings or misstating facts.

⁶⁹ Schwab noted that there have been more instances where market participants have manipulated the price of a stock up, as opposed to downward pressure.

⁷⁰ Sierra Trading Group believes that price discovery is more efficient without a short sale rule, which leads to benefiting investors.

⁷¹ In the event that the Commission opts to retain the short sale rule, CBOE proposed a hedging exception for market makers as discussed above.

⁷² CBOE supported the Commission retaining reporting requirements to the extent that they may help with surveillance or inspection purposes. CBOE believes that the costs associated with reporting are far less that the cost associated with the current Rule.

⁷³ The Managed Funds Association agreed with the concept of letting equity markets freely absorb changes in market conditions.

⁷⁴ Island noted that the NASD adopted a short sale rule in an effort compete with New York to attract issuers to list on Nasdaq.

⁷⁵ As previously noted Island believes that in light of the difficulty of eliminating the short sale rule, Rule 10a-1 should contain an exemption for actively-traded securities, a bid test instead of a tick test, and operate in an after-hours.

⁷⁶ Interactive Brokers, the Timber Hill Group, commented that the costs to broker-dealers associated with complying with the Rule, administrative burdens, have increased over time.

⁷⁷ Again, Trimark proposed amendments to the rule based on a belief that the Commission will not eliminate the rule.

⁷⁸ The MFA proposed a phase out of the short sale rule. First, the Commission should adopt an actively traded exemption, and then the rule should be phased out.

⁷⁹ However, the NASAA pleaded with the Commission not rely on monitoring or enforcement to prevent abusive short selling.

⁸⁰ However the NASD caveat a hasty change of the rule in light of the rapidly changing marketplace.

⁸¹ The NASD explains that because of the number of market makers and their locations, trade reports are not consecutive and, thus, not sequential on the tape.

⁸² Cell Pathways, Inc. supported retaining the Rule in the interests of protecting investors.

⁸³ Unless new safeguards against short sale manipulation are created, the APTC opposed elimination of the Rule.

⁸⁴ Hill, Thompson, Magid & Co. (425) agreed that the "tick test" does not "significantly influence the association between stocks and short selling."

⁸⁵ The NASD also proposed this theory in response to the imminent decimalization.

Summary of Comments
SEC Concept Release: Short Sales

Release No. 34-42037 (October 20, 1999)
File No. S7-24-99

SUMMARY INDEX

I. LIST OF COMMENTERS¹

II. INTRODUCTION

III. SUMMARY OF COMMENTS¹⁰

A. Introduction

B. Specific Comments Concerning the Eight Concepts

1. Threshold Approach

2. Exception for Actively Traded Securities

3. Short Sale Restrictions for Certain Events and Strategies

4. Excepting Hedging Transactions

5. Revise Short Sale Regulation in Response to Market Developments

a. After-hours Trading Sessions

b. Decimalization

6. Revise Definition of Short Sale

a. Aggregation Issue

b. Manipulative Strategies

7. Extend Short Sale Rule to Non-Exchange Listed Securities

a. Industry Comments

b. Individual Comments

8. Eliminate Rule 10a-1

a. In Favor of Eliminating the Rule

b. Opposed to Elimination of the Rule

c. Eliminate the Tick Test

Endnotes

Modified: 09/22/2003

Summary of Comments SEC Concept Release: Short Sales

Release No. 34-42037 (October 20, 1999) File No. S7-24-99

SUMMARY INDEX

I. LIST OF COMMENTERS1

II. INTRODUCTION

III. SUMMARY OF COMMENTS10

A. Introduction

B. Specific Comments Concerning the Eight Concepts

1. Threshold Approach

2. Exception for Actively Traded Securities

3. Short Sale Restrictions for Certain Events and Strategies

4. Excepting Hedging Transactions

5. Revise Short Sale Regulation in Response to Market Developments

a. After-hours Trading Sessions

b. Decimalization

6. Revise Definition of Short Sale

a. Aggregation Issue

b. Manipulative Strategies

7. Extend Short Sale Rule to Non-Exchange Listed Securities

a. Industry Comments

b. Individual Comments

8. Eliminate Rule 10a-1

a. In Favor of Eliminating the Rule

b. Opposed to Elimination of the Rule

c. Eliminate the Tick Test

Endnotes

Modified: 09/22/2003

Summary of Comments
SEC Concept Release: Short Sales

Release No. 34-42037 (October 20, 1999)
File No. S7-24-99

I. LIST OF COMMENTERS¹

III. SUMMARY OF COMMENTS¹⁰