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SEC Proposes New Short Position Reporting Rules For Investment Managers – Finance and Banking – United States – Mondaq News Alerts

Highlights

The SEC has proposed monthly short position reporting by
institutional investment managers; public comment period is open
until the later of April 26 and 30 days after publication in the
Federal Register

Managers would report confidentially on new Form SHO, following
which the SEC would publish aggregated monthly short data

Proposed amendment to Regulation SHO would add
“buy-to-cover” order-marking requirement for
broker-dealers

The U.S. Securities and Exchange Commission (SEC) continues its
rollout of proposals to collect more data from hedge funds and
other asset managers about their trading and portfolio-management
activities. The latest initiative focuses on short-selling disclosure.

The SEC has proposed adding new Rule 13f-2 under the Securities
Exchange Act of 1934. Rule 13f-2 and its associated Form SHO would
require “institutional investment managers” to report
monthly to the SEC specified data concerning their short positions
above a certain threshold in individual equity securities. Managers
would submit this information confidentially. The SEC would use the
information received from reporting managers to publish monthly
aggregate data about large short positions with respect to
individual securities. 

SEC Chair Gary Gensler has stated that the proposed rules would
give the investing public “more visibility into the behavior
of large short sellers” and improve the SEC’s ability to
“understand the role short selling may play in market
events.”

Relatedly, the SEC has proposed adding new Rule 205 to
Regulation SHO under the Exchange Act. The rule would require a
broker-dealer to mark a purchase order as “buy-to-cover”
if the purchaser had a short position in the security when the
purchase order was entered. 

The SEC’s proposed rules are subject to a public comment
period ending on the later of April 26 and 30 days after
publication in the Federal Register.

Background

Congress added Section 13(f)(2) to the Exchange Act in 2011 as
part of its Dodd-Frank legislation. Section 13(f)(2) instructs the
SEC to prescribe rules providing for at least monthly public
disclosure of the aggregate amount of short sales in particular
issuers’ equity securities.

Proposed Rule 13f-2 and Form SHO are the SEC’s response
– admittedly a rather belated one – to that statutory
directive. The SEC’s decision to take up its rulemaking now
appears at least in part motivated by the view that recent
instances of market volatility indicate a lack of transparency into
the behavior of short-sellers. 1

Scope of Proposed Rule 13f-2

A useful way to look at proposed Rule 13f-2 and Form SHO is as
the short-side analog to the current long-focused Form 13F
reporting system. 2

Investment Managers Potentially Subject to Proposed
Reporting Requirement

An “institutional investment manager” is the type of
asset manager that potentially would be subject to Rule 13f-2 and
thus to reporting on Form SHO. The term would have the same meaning
as in the Form 13F context: either (i) an entity that invests in or
buys and sells securities for its own account or (ii) an entity or
a natural person that exercises investment discretion with respect
to the account of any other entity or natural person. A private
fund manager typically is an institutional investment manager due
to the second prong of that definition. A manager need not be a
registered investment adviser to have institutional investment
manager status.

Size of Short Position That Would Trigger Reporting
Obligation

An institutional investment manager would be subject to proposed
Rule 13f-2 and Form SHO if the manager (including all accounts over
which the manager or any person under its control has investment
discretion) met either of two “gross short position”
thresholds on any settlement date in a given calendar month:

  • Threshold A – Short Position in Shares of
    Reporting Issuer.
    The first reporting threshold –
    which the SEC calls “Threshold A” – relates to any
    equity security that the issuer has registered under Section 12 of
    the Exchange Act, or for which the issuer is required to file
    reports pursuant to Section 15(d) of the Exchange Act. This
    primarily means an equity security that the issuer has listed for
    trading on a U.S. securities exchange. 3 For an equity
    security of such a reporting issuer, an institutional investment
    manager would be subject to reporting for a given calendar month if
    it had either:
    • A gross short position in the security of at least $10 million
      at the close of regular trading on any settlement date during the
      calendar month; 4 or

    • An average gross short position for the calendar month equal to
      at least 2.5 percent of the outstanding class of equity security.
      5

The two-pronged approach of Threshold A therefore would measure
the size of the short position in question relative to both dollar
value and shares outstanding. The SEC explains that this approach
is intended to ensure that a substantial short position in either a
large-cap or a small-cap equity security could trigger a reporting
obligation.

  • Threshold B – Short Position in Shares of
    Non-Reporting Issuer.
     The second reporting threshold,
    referred to by the SEC as “Threshold B,” relates to any
    equity security that the issuer has not registered under Section 12
    of the Exchange Act and for which the issuer is not required to
    file reports pursuant to Section 15(d) of the Exchange Act. This
    category essentially relates to over-the-counter (OTC) securities.
    For an equity security of such a non-reporting issuer, an
    institutional investment manager would be subject to reporting for
    a given calendar month if it had a gross short position in the
    security of at least $500,000 at the close of regular trading on
    any settlement date during the calendar month. 6

The SEC notes that Threshold B is designed to trigger reporting
by managers that have substantial short positions in a
non-reporting issuer, even if the position is relatively small
compared to the issuer’s market cap.

“Gross Short Exposure”

For purposes of the reporting thresholds, the term “gross
short position” means simply the number of shares of the
equity security that are held short. The manager would not net out
any offsetting economic positions such as shares held long or
derivative instruments providing synthetic long exposure.
7 Nor would synthetic short exposure count toward
calculation of the gross short position.

Proposed Form SHO

If an institutional investment manager determined that it met a
threshold degree of gross short exposure with respect to an equity
security of any issuer in a given calendar month, the manager would
have to file a Form SHO within 14 calendar days after the end of
that month. 8 The Form SHO would include information
about each equity security in which the manager had met a reporting
threshold for the month in question. (For example, if the manager
met a threshold gross short position in the common stock of both
issuer A and issuer B, the Form SHO would include information about
the manager’s gross short position in each issuer.)

Content of Form SHO

Form SHO would consist of a cover page and two information
tables. The cover page would indicate, among other things, the
manager’s name and the month for which the Form SHO was being
filed.

  • Information Table 1. Table 1 would relate to
    the manager’s end-of-month gross short position with respect to
    each reported equity security. It would identify each equity
    security for which information was being reported, and would
    disclose with respect to each equity security: (i) the
    manager’s end-of-month gross short position in terms of number
    of shares; (ii) the manager’s end-of-month gross short position
    in terms of dollar value; and (iii) the extent to which the
    end-of-month gross short position was fully hedged, partially
    hedged, or not hedged. 9

  • Information Table 2. If Table 1 provides a
    month-end snapshot, Table 2 would provide a moving picture of
    trading activity that affected the size of the manager’s gross
    short positions over the course of the month. Specifically, Table 2
    would indicate each date during the month on which the manager
    settled a trade in each reported equity security. With respect to
    each of those settlement dates, the manager would disclose the
    number of shares that were, among other things: (i) sold short;
    (ii) purchased to cover an existing short position; (iii) acquired
    in a call option exercise that reduced or closed a short position;
    (iv) sold in a put option exercise that created or increased a
    short position; (v) sold in a call option assignment that created
    or increased a short position; or (vi) acquired in a put option
    assignment that reduced or closed a short position.

The SEC states that the intra-month activity information
elicited by Table 2 would provide the SEC with “additional
context and transparency” into how and when short positions
are created, increased, closed out, or reduced.

Monthly Publication of Aggregate Data by
SEC

The SEC plans to publish aggregated information regarding each
equity security reported by managers on Form SHO for a given
calendar month. The SEC would publish this aggregated information
within one month following the end of the reporting calendar
month.

Confidential Treatment for Information Reported on
Form SHO

Proposed Form SHO provides that all information that would
reveal the manager’s identity is deemed subject to a
confidential treatment request. The SEC expects that manager
confidentiality also will be protected by the agency’s delayed
publication of aggregated data; the SEC therefore does not
anticipate granting confidential treatment requests regarding
information from which aggregated data will be derived.

Proposed Rule 205 of Regulation SHO

In conjunction with proposed Rule 13f-2 and Form SHO, the SEC
has proposed to revise broker-dealers’ order-marking
obligations under Regulation SHO. Broker-dealers currently are
required to mark only sell orders (in each case as long, short, or
short exempt.) Proposed Rule 205 of Regulation SHO would introduce
a new “buy-to-cover” marking requirement applicable to
purchase orders.

Proposed Rule 205 would require a broker-dealer to mark a
purchase order as buy-to-cover if, at the time of order entry, the
purchaser had a gross short position in the relevant security in
the specific account for which the purchase was being made at that
broker-dealer. An order would be marked buy-to-cover regardless of
the size of the order in relation to the size of the
purchaser’s gross short position in the account, and regardless
of whether the gross short position was offset by a long position
held in the purchaser’s account. 10

Broker-dealers also would be required to report buy-to-cover
orders to the Consolidated Audit Trail.

The SEC believes that having buy-to-cover records would be
useful “in reconstructing market events, and … in
identifying and investigating any potentially abusive trading
practices including any potential manipulative short
squeezes.”

The Bigger Picture

The SEC maintains that the information generated by its proposed
short-reporting rules would benefit investors and boost the
SEC’s market-oversight ability by producing information that is
not captured by existing reporting requirements. This is the same
theme the SEC has sounded in other recent rule proposals
concerning, for example, expanding beneficial ownership
reporting under Section 13(d) of the Exchange Act,
creating new quarterly financial disclosure
obligations
 for private fund advisers, and
collecting additional information under Form PF.

It is at least an open question whether the proposed
short-position reporting rules would produce the benefits the SEC
expects. In particular, a substantial amount of short-position
information is already available, either free to the public or for
a modest fee to professional investors.

There is also the question of the potential cost associated with
the proposed new disclosure regime. Beyond direct financial and
logistical compliance costs, indirect costs to managers could
include copycat trading, exposure to retaliation by issuers who
reverse-engineer the SEC’s published aggregate data to identify
individual managers and, perhaps, the encouragement of short
squeezes. We expect that these and similar cost-benefit issues will
get a robust airing during the public comment period.

Footnotes

1. In particular, the SEC asserts that the data to be
made available under the proposed rules would help it identify and
respond to potential shorting-related market manipulation, such as
so-called “bear raids” and “short-and-distort”
schemes. Prior academic commentary is consistent with that view,
and also has suggested that the type of data collected under the
new rules would shed light on the role of short-covering in feeding
meme-stock price surges.

2. Section 13(f)(1) of the Exchange Act and Rule 13f-1
thereunder require an institutional investment manager that
exercises investment discretion with respect to at least $100
million of U.S. listed equity securities to report its portfolio
holdings on a security-by-security basis as of the last day of each
quarter. The manager effects that reporting by publicly filing Form
13F with the SEC within 45 calendar days after the
quarter-end.

3. An issuer registers a class of securities under
Section 12(b) of the Exchange Act to permit the class to be listed
for trading on a U.S. securities exchange. Absent a listing, an
issuer must register a class of equity securities under Section
12(g) of the Exchange Act if the class is widely enough held.
Either type of class registration under Section 12 subjects the
issuer to SEC reporting. An issuer also becomes subject to SEC
reporting pursuant to Section 15(d) of the Exchange Act if it files
a registration statement that becomes effective under the
Securities Act of 1933.

4. Proposed Rule 13f-2(a)(1)(A). To determine whether it
met the first prong of Threshold A – i.e., a gross short position
in an equity security of a reporting issuer with a value of at
least $10 million at the close of regular trading on any settlement
date during the calendar month – the manager would determine its
end-of-day gross short position in the security on each settlement
date during the month and multiply that figure by the closing price
on that settlement date. 

5. Proposed Rule 13f-2(a)(1)(B). To determine whether it
met the second prong of Threshold A – i.e., a 2.5 percent or
greater monthly average gross short position as a percentage of the
outstanding class of a reporting issuer’s equity security – the
manager would: (a) identify its gross short position in the
security at the close of each settlement date during the calendar
month and divide that figure by the number of shares outstanding on
that settlement date; and then (b) add together the daily
percentages during the month as determined in (a) and divide the
resulting total by the number of settlement dates in the
month. 

6. Proposed Rule 13f-2(a)(2). To determine whether it met
Threshold B – i.e., a gross short position in any equity security
of a non-reporting issuer with a value of at least $500,000 at the
close of regular trading on any settlement date during the calendar
month – the manager would determine its end-of-day gross short
position in the security on each settlement date during the month
and multiply that figure by the closing price on that settlement
date (or if a closing price were unavailable, the price at which
the manager last purchased or sold any share of the
security).

7. Proposed Rule 13f-2(b)(4).

8. Proposed Rule 13f-2(a). Proposed Form SHO has rules to
avoid duplicative reporting by affiliated managers, modeled on
those contained in Form 13F. 

9. The manager would categorize a reported gross short
position as “fully hedged” if the manager held an
offsetting position that reduced the risk of price fluctuations for
its entire position in that equity security, for example, through
delta hedging. The manager would report that it was “partially
hedged” if the manager held an offsetting position that was
less than the identified price risk associated with the gross short
position.

10. For example, assume a customer had a gross short
position of 100 shares in security ABC in Account No. 123 at Broker
X. If the customer placed a purchase order for 50 shares of ABC
through Broker X in Account No. 123, Broker X would mark the order
as buy-to-cover. A purchase order for 150 shares of ABC in Account
No. 123 likewise would be marked buy-to-cover.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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