UNITED STATES OF AMERICA
BEFORE THE
SECURITIES AND EXCHANGE COMMISSION

Securities Exchange Act of 1934
Release No. 50104 / July 28, 2004

ORDER SUSPENDING THE OPERATION OF SHORT SALE PRICE PROVISIONS FOR DESIGNATED SECURITIES AND TIME PERIODS

The Securities and Exchange Commission ("Commission"), by this Order, is establishing a Pilot ("Pilot") suspending the provisions of Rule 10a-1(a) under the Securities Exchange Act of 1934 (the "Act")¹ and any short sale price test of any exchange or national securities association for: (1) short sales² in the stocks identified in Appendix A to this Order; (2) short sales in any security included in the Russell 1000 index effected between 4:15 p.m. EST and the open of the consolidated tape³ on the following day; and (3) short sales in any security not included in paragraphs (1) and (2) above effected in the period between the close of the consolidated tape and the open of the consolidated tape the following day. The Commission is establishing this Pilot for a one-year period commencing on January 3, 2005. The Commission may issue subsequent orders that affect the operation of the Pilot. The Commission finds that the Pilot is necessary and appropriate in the public interest and consistent with the protection of investors.⁴

I. Short Selling In Designated Securities

During the term of the Pilot, all short selling in the securities identified in Appendix A to this Order shall be effected without regard to the provisions of Rule 10a-1(a) and any short sale price test of any exchange or national securities association. As discussed below, the Commission has selected a subset of stocks from the Russell 3000 index for inclusion in the Pilot, after giving due consideration to the liquidity, volatility, market depth and trading market of these securities.

A pilot that includes a subset of securities from the Russell 3000 provides a balanced and targeted approach to assessing the efficacy of a price test for short sales for a broad range of securities. The average daily dollar volume for the securities in the Russell 3000 index in 2003 was $22.9 million dollars.

We selected the securities to be included in the Pilot by first excluding the 32 securities in the Russell 3000 index as of June 25, 2004 that are not Nasdaq national market securities ("NNM"), listed on the American Stock Exchange ("Amex"), or listed on the New York Stock Exchange ("NYSE") because short sales in these securities are currently not subject to a price test. We also excluded issuers whose initial public offerings commenced after April 30, 2004.⁵ We then sorted the remaining securities into three groups -- Amex, Nasdaq NNM and NYSE -- and ranked the securities in each group by average daily dollar volume over the one year prior to the issuance of this order from highest to lowest for the period.⁶ In each group, we then selected every third stock from the remaining stocks.⁷

The Pilot stocks consist of 50% NYSE listed securities, 2.2% Amex listed securities, and 47.8% Nasdaq NNM securities. The Pilot stocks include stocks that have associated options trading on a registered options exchange or Nasdaq (63.7% of Pilot stocks) and associated securities futures (2.8% of Pilot stocks).⁸

The Pilot includes securities with varying levels of liquidity, which will enable us to examine whether the absence of a short sale price test affects less liquid and more liquid securities differently. We do not believe that there is sufficient volatility in these securities so as to make them inappropriate for inclusion in the Pilot. In addition, these securities have significant market depth, and are traded on exchanges or other organized markets with high levels of transparency and surveillance, which will enhance the ability of the Commission and self-regulatory organizations ("SROs") to monitor trading behavior during the Pilot and surveil for manipulative short selling.

The remaining stocks in the Russell 3000 index will function as the control group.⁹ The securities in the control group are similar to the stocks in the Pilot group in terms of the percentage of NYSE, Amex, and Nasdaq securities, as well as securities for which there are associated options and single stock futures.¹⁰

We are establishing the Pilot as part of the Commission's review of short sale regulation.¹¹ The Pilot is in the public interest because it will assist us in assessing whether changes to short sale regulation are necessary in light of current market practices and the purposes underlying short sale regulation.¹² The Pilot will enable us to obtain empirical data to help assess whether short sale regulation should be removed, in part or in whole, for actively-traded securities, or if retained, should be applied to additional securities. The Pilot will allow us to study trading behavior in the absence of a short sale price test on the stocks selected by comparing the trading behavior of the control group stocks to that of the Pilot stocks through empirical analysis. We will examine, among other things, the impact of price tests on market quality (including volatility and liquidity), whether any price changes are caused by short selling, costs imposed by a price test, and the use of alternative means to establish short positions.

We do not believe that any variations in prices and trading activity between the Pilot stocks and similar securities not subject to the price test will be problematic. The risk of any adverse impact on the Pilot securities is expected to be small, particularly relative to the benefits of obtaining empirical data regarding trading behavior in the absence of a short sale price test.¹³ A large number of Pilot stocks are actively traded, and as we have previously stated, we believe that actively traded securities are less susceptible to manipulation. ¹⁴ In addition, the Commission and the SROs will monitor trading activity during the Pilot and surveil for manipulative short selling.

We believe that a one-year Pilot will allow the Commission sufficient time to gather and analyze data necessary to reach conclusions regarding trading behavior in the absence of short sale price restrictions. The Commission, however, may, by further order, terminate, extend the period of, or modify the Pilot as it determines necessary or appropriate in the public interest or for the protection of investors. In addition, the Pilot will suspend only the operation of short sale price tests. All other short sale rules, including the other provisions of Rule 10a-1,¹⁵ the marking, locate and delivery requirements adopted under Regulation SHO,¹⁶ and applicable SRO rules, will remain in effect.

II. Short Selling During After-Hours Trading

During the Pilot, short sales: (1) in any security included in the Russell 1000 index effected after 4:15 p.m. EST and the open of the consolidated tape on the following day; and (2) in any security not included either in paragraph (1) or in the designated securities described in Section I above effected between the close of the consolidated tape and the open of the consolidated tape on the following day, shall be effected without regard to the provisions of Rule 10a-1(a) and any short sale price test of any exchange or national securities association.

Securities in the Russell 1000 index are appropriate for inclusion in a Pilot examining short sales between 4:15 p.m. and the close of the consolidated tape.¹⁷ The Russell 1000 index represents a broad range of securities; it comprises 1,000 of the largest companies in the Russell 3000 index (approximately 92% of the total market capitalization of the Russell 3000 index).¹⁸ Although there is limited trading volume in these securities after 4:15 p.m., we believe the liquidity is sufficient to allow us to examine the impact of removing short sale price tests.

Moreover, we believe securities in the Russell 1000 index are less susceptible to manipulative short selling in the absence of a price test after 4:15 p.m. than securities of issuers with a lower market capitalization. A subset of the Russell 3000, the Russell 1000 securities generally trade on exchanges or other organized market centers, and we believe that as a result, the investment community widely follows Russell 1000 index securities. Any aberrations in price are likely to be observed and addressed quickly. In addition, while after-hours trading has grown in recent years, the volume is relatively small compared to the volume of trading occurring during regular trading hours when liquidity is greatest and prices reflect active market interest.¹⁹ Thus, the impact of any manipulative short selling after hours would be less than the effect of such activity during regular market hours because after-hours prices are not widely viewed as indicative of normal market prices. Further, we do not believe that there is sufficient volatility in these securities after hours so as to make them inappropriate for inclusion in the Pilot. The lack of significant market depth in these securities after hours will allow us to examine what effect, if any, removing a short sale price test has where information on buy and sell orders is not as readily available.

This portion of the Pilot will allow us to examine whether removing a price test after the close of regular trading in securities included in the Russell 1000 index would benefit investors and the markets by increasing liquidity and pricing efficiency in these securities in the after-hours market. We will also be able to study whether the absence of a short sale price test enhances a broker-dealer's ability to facilitate customer orders in a security at a specific reference price, such as the closing price or volume weighted average price, that are often executed in the after-market.

For these reasons, we believe that it is appropriate that the Pilot include the suspension of all price tests for all securities included in the Russell 1000 index for short sales effected between 4:15 p.m. and the open of the consolidated tape the following day.²⁰

We are also removing the price tests during the one-year Pilot period for short sales in any other security effected when the consolidated tape is not operating. This portion of the Pilot is important because it will allow us to study the effect of removal of a price test on a broader segment of the market than the other parts of the Pilot while the consolidated tape is not operating. It will also allow us to study whether, and to what extent, removal of the price test after hours will affect regular trading in the security on the following day. Moreover, we do not believe this portion of the Pilot will pose any threat to liquidity or increase volatility in these securities after-hours. Historically, the Commission has found that there is little evidence that significant trading activity occurs when the consolidated tape is not operating,²¹ and there is little transparency or market depth. Nevertheless, the Commission and the SROs will monitor the trading and our analysis of data obtained from the Pilot will also focus on the impact of after-hours short selling.

III. Conclusion

The Commission finds that establishing the Pilot for the reasons stated above is necessary and appropriate in the public interest and consistent with the protection of investors. The Pilot will allow the Commission to obtain empirical data and study the effects of short selling in the absence of price test restrictions.

Accordingly,

A. IT IS HEREBY ORDERED that the suspension of the short sale price tests described below in Paragraph B shall commence on January 3, 2005 and shall terminate on December 31, 2005. The Commission from time to time may issue further orders affecting the operation of this Order.

B. IT IS FURTHER ORDERED that the provisions of Rule 10a-1(a) and any short sale price test of any exchange or national securities association are suspended with respect to:

(1) short sales in the securities set forth in Appendix A to this Order;

(2) short sales in any security included in the Russell 1000 index effected between 4:15 p.m. EST and the open of the consolidated tape on the following day; and

(3) short sales in any security not included in paragraphs (1) and (2) above effected between the close of the consolidated tape and the open of the consolidated tape on the following day.

All other provisions of Rule 10a-1 shall remain in effect.

C. IT IS FURTHER ORDERED that no self-regulatory organization shall have a rule that is not in conformity with or conflicts with the provisions of Paragraph B. All other provisions of the rules of any self-regulatory organization shall remain in effect.

By the Commission.

APPENDIX A

The following securities are subject to this Order:

¹ 17 CFR 240.10a-1.

² "Short sale" is defined in Rule 200 of Regulation SHO, 17 CFR 242.200.

³ The term "consolidated tape" refers to the effective transaction reporting plan of the Consolidated Tape Association.

⁴ In addition, pursuant to Section 3(f) of the Act, the Commission has considered the Pilot's impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f).

⁵ Similarly, we excluded spin-offs commencing after April 30, 2004.

⁶ Securities selected for inclusion in the Pilot will remain in the Pilot even if during the term of the Pilot they cease being included in the Russell 3000 index.

⁷ In each group, we started our selection with the second stock in order to have a more representative daily dollar volume sample. The most representative stock in a group of three stocks ranked by volume would be the middle stock. Thus, to select the most representative sample for the pilot, we would select the second stock of every three stocks; in other words, every third stock starting with the second.

⁸ The percentage of the stocks selected for the Pilot that are NYSE or Amex listed, or Nasdaq NNM, or for which there are associated options or securities futures, are representational of the Russell 3000 index as a whole. Specifically, the Russell 3000 index is composed of 49.9% NYSE listed securities, 2.2% Amex listed securities, 47.9% Nasdaq NNM securities, 63% with associated options, and 3.4% with associated single stock futures.

⁹ Like the group of pilot stocks, the control group will exclude any securities as to which there is currently no price test (i.e., securities that are not exchange-listed or Nasdaq NNM).

¹⁰ Specifically, the control group is composed of 49.9% NYSE listed securities, 2.2% Amex listed securities, 47.9% Nasdaq securities, 62.7% with associated options, and 3.7% with associated single stock futures.

¹¹ See Securities Exchange Act Release No. 50103 (July 28, 2004) ("Adopting Release").

¹² Adopting Release.

¹³ The general anti-fraud and anti-manipulation provisions of the federal securities laws will continue to apply to trading in these securities, thus prohibiting trading activity designed to improperly influence the price of a security. See, e.g., Section 17(a) of the Securities Act of 1933, 15 USC 77q(a), and Sections 9(a), 10(b), and 15(c) of the Act, 15 USC 78i(a), 78j(b) and 78o(c), and Rules 10b-5 and 15c1-2 thereunder, 17 CFR 240.10b-5 and 240.15c1-2. Moreover, the Commission expects that SROs will actively monitor trading in the Pilot securities to identify any improper or abusive short selling during the course of the Pilot.

¹⁴ See Securities Exchange Act Release No. 38067, 62 FR 520 (Jan. 3, 1997) (adopting anti-manipulation rules including an exception to the rules for trading activity in securities with high average daily trading volume ("ADTV")).

¹⁵ 17 CFR 240.10a-1.

¹⁶ 17 CFR 242.200, 242.203.

¹⁷ Regular trading-hours are between 9:30 a.m. and 4:00 p.m. EST. See Electronic Communication Networks and After-Hours Trading, Report by the Division of Market Regulation, June 2000, at 4. However, trade reporting can be delayed and continue past 4:00 p.m. Therefore, for purposes of the Pilot we have set 4:15 p.m. as the end of regular trading activity.

¹⁸ Securities selected for inclusion in this portion of the after-hours Pilot will remain in the Pilot even if during the term of the Pilot they cease being included in the Russell 1000 index.

¹⁹ For example, based on a sample of a trading day in January of 2000, only 3% of the share volume in NYSE-listed securities was effected after 4:00 p.m. Similarly, share volume from post-4:00 p.m. trades in Nasdaq securities for the same date accounted for only 3% of the daily total. A vast majority of this after-hours trading volume in both markets was effected shortly after the regular session closed through market structured after-market execution opportunities, i.e., crossing-sessions. Electronic Communication Networks and After-Hours Trading Report at 12-13.

²⁰ The consolidated tape operates from 8:00 a.m. to 8:00 p.m. EST. See Securities Exchange Act Release No. 44983 (October 25, 2001), 66 FR 55225, 55227 (November 1, 2001). The NASD's short sale rule, Rule 3350, is currently not applicable beyond traditional market hours (9:30 a.m. to 4:00 p.m. Eastern Time). See NASD Notice to Members 94-68.

²¹ Electronic Communication Networks and After-Hours Trading Report at 13.

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