SEC Amends Short Sale Ban

The SEC last night issued amendments (the “Amendments”) to its September 18 order (the “Original Order”) banning short selling in financial stocks. The text of the Amendments and the statement of the SEC Division of Trading and Markets can be found at the following link: http://www.sec.gov/news/press/2008/2008-218.htm

The following are the highlights of the Amendments:

* In addition to the original list of financial institutions published by the SEC on September 18, each national securities exchange will be required to publish a list that includes additional financial institutions covered by the ban on short sales. The SEC expects the lists to cover banks, savings associations, broker-dealers, investment advisers and insurance companies, both domestic and foreign, and the owners of those entities. Covered institutions will be permitted to opt out of the ban by notifying the relevant exchange. The NYSE list can be found by clicking here. The NASDAQ list can be found here.

* The Amendments extend for the duration of the ban (until October 2, 2008) the exception (the “Derivatives Market Making Exception”) for short sales of covered securities made as part of a bona fide market making and hedging activity related directly to bona fide market making in derivative securities based on covered securities. Under the Original Order, the Derivatives Market Making Exception expired at 11:59 p.m. on September 19, 2008.

* In order to rely on the Derivatives Market Making Exception, market makers in derivative securities may not effect a short sale in a covered security for customer positions in derivative securities established on or after September 22, 2008 if the market maker knows that the customer’s transaction will result in the customer establishing or increasing an economic net short position (through actual positions, derivatives, or otherwise). In order to rely on the Exception, market makers also must, as soon as practicable, publish a notice on their web site to that effect.

* The Derivatives Market Making Exception applies to bona fide market making in derivative securities. We have confirmed orally with the SEC staff that the Exception extends to activities in derivative products generally, including for example cash-settled swaps on covered securities.

* Since the Derivatives Market Making Exception is limited to short sales that are related to bona fide market making in derivative securities, the Exception by its terms would appear not to permit a market maker to effect short sales of covered securities on behalf of a customer, even if such short sales do not increase the economic net short position of the customer (for example, for a customer hedging a newly acquired convertible bond). Instead, a market maker would appear to be required to enter into a derivative security (which, as noted above, could include a cash settled swap) with the customer, in connection with which the market maker would then be permitted to hedge through a physical short sale, so long as the derivative security does not increase the customer’s economic net short position.

* The Derivatives Market Making Exception applies to short sales made as part of a bona fide market making and hedging activity related to market making in exchange traded funds.

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