Short Sales Around a Public Offering

This rule binds any person, not only distribution participants, and it does not make the short sale itself unlawful. What it forbids is the purchase in the offering by someone who shorted during the restricted period.

Which Offerings and Which Trades Does the Rule Reach?

The rule applies in connection with an offering of equity securities for cash made pursuant to a registration statement, or a notification on Form 1-A or Form 1-E filed under the Securities Act. Those are the "offered securities".

Against that backdrop it is unlawful for any person to do both of the following:

• Sell short the security that is the subject of the offering, where short sale takes its meaning from Regulation SHO's definition and order marking rule.
• Purchase the offered securities from an underwriter or broker or dealer participating in the offering.

The prohibition attaches only where the short sale was effected during the rule's restricted period. Marking and close-out obligations for short sales generally are covered in the unit on handling and executing short sales.

Exam Tip: Gotchas

• The rule is about equity securities sold for cash. An offering that is not for cash, or that is not of equity securities, is outside it before any timing question arises.
• Buying in the open market is not the prohibited purchase. The ban reaches a purchase of the offered securities from a participating underwriter, broker or dealer, not a secondary-market buy of the subject security, whoever the seller is.

How Is the Restricted Period Measured?

The restricted period is the shorter of two periods:

• The period beginning five business days before the pricing of the offered securities and ending with that pricing.
• The period beginning with the initial filing of the registration statement or the notification on Form 1-A or Form 1-E, and ending with the pricing.

Because the rule takes the shorter of the two, a deal priced three business days after its initial filing has a three-business-day restricted period, not a five-day one.

Exam Tip: Gotchas

• Both periods end at pricing, so only the start dates compete. The shorter period wins, which means a filing made fewer than five business days before pricing shortens the window.
• The five-day count is in business days and runs backward from pricing. It is not measured from the effective date or from the start of the offering.

What Are the Three Exceptions?

The rule states three excepted situations.

Bona fide purchase. A person may still purchase the offered securities if that person makes a bona fide purchase or purchases of the subject security that meets all four of these conditions:

• At least equivalent in quantity to the entire amount of the restricted period short sale or sales.
• Effected during regular trading hours.
• Reported to an effective transaction reporting plan.
• Effected after the last restricted period short sale, and no later than the business day prior to the day of pricing.

That branch also carries a separate negative condition: the person must not have effected a short sale, reported to an effective transaction reporting plan, within the 30 minutes prior to the close of regular trading hours on the business day prior to the day of pricing.

Separate accounts. The prohibition does not reach the purchase of the offered security in an account of a person who sold short during the restricted period in a separate account, if decisions regarding securities transactions for each account are made separately and without coordination of trading or cooperation among or between the accounts.

Investment companies. The prohibition does not stop a registered investment company, or a series of such a company, from purchasing an offered security where the restricted period short sale of it was effected by an affiliated investment company, or any series of such a company, or by a separate series of the investment company itself.

Exam Tip: Gotchas

• The bona fide purchase must be at least equivalent in quantity to the entire amount of the restricted period short sale or sales. A partial buy-back does not restore eligibility, however early it is made.
• The bona fide purchase has both a deadline and a floor. It must come after the last restricted period short sale and no later than the business day prior to pricing, which leaves no room for a same-day cure on pricing day.
• The separate accounts exception needs real separation, not separate account numbers. Decisions must be made separately and without coordination of trading or cooperation among or between the accounts.

Which Offerings Are Outside the Rule Entirely?

The rule does not apply to offerings that are not conducted on a firm commitment basis. A best efforts offering is therefore outside it, and no restricted period analysis is needed.

Separately, the Commission may grant an exemption from the rule, on written application or on its own motion, either unconditionally or on specified terms and conditions, to any transaction or security, or any class of them.

Exam Tip: Gotchas

• The firm commitment carve-out is written as an exception to the whole section. It removes the offering from the rule rather than excusing one trade inside it.

What Should You Check on Exam Day?

• Confirm the offering is of equity securities for cash under a registration statement or a Form 1-A or Form 1-E notification.
• Compute both candidate periods and use the shorter one; a late filing can shorten the window below five business days.
• Check that the prohibited purchase came from an underwriter, broker or dealer participating in the offering.
• For a bona fide purchase, test quantity, regular trading hours, reporting, timing after the last short sale, and the pricing-eve deadline.
• Confirm the offering is on a firm commitment basis before applying the rule at all.