Federal Securities Law Blog : Federal Securities Lawyer & Attorney : Porter Wright Law Firm : Securities Exchange Law : Serving Ohio, Washington DC, Florida

The list of 799 “financial companies” that cannot be subject to short sales by order of the SEC is growing. The SEC has authorized major stock exchanges to identify additional companies that should be added to the list, and the NYSE and NASDAQ have added at least 299 and 71 companies, respectively.

To identify companies, the SEC provided the exchanges with 7 criteria; if at least one criteria is met, the company goes on the list. The NYSE has confirmed that a company need only certify to NYSE that it meets the criteria to be put on the list.

NYSE reports that to be on the list a company must be a bank, savings association, registered broker or dealer, or insurance company (as defined at various points in the U.S. Code). However, this has not stopped some surprising companies from being added to the list, including CVS Caremark, General Motors, and IBM, all of which are tangentially related to lending/financing or insurance but are not traditionally thought of as a “financial company.”

Some commentators are criticizing that the goal of the no-sale list is to protect banks because they are particularly susceptible to a crisis of confidence, not to protect any company that might experience a decline in stock value. The SEC has long supported short selling as an important market tool against inflated prices.

Interestingly, two financial firms, JMP Securities and Diamond Hill Investment, asked to be taken off the no-short list because their managers support short selling activities in the market.
 

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Click here to see Porter Wright attorney Thomas Gorman discuss the recent naked short selling rules on CNBC.

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An emergency SEC rule that went into effect today prohibits short selling of the publicly traded securities of 799 financial firms. This rule coincides with a similar rule adopted by the U.K. Financial Services Authority yesterday.

As the SEC explains in its press release:

“Under normal market conditions, short selling contributes to price efficiency and adds liquidity to the markets. At present, it appears that unbridled short selling is contributing to the recent, sudden price declines in the securities of financial institutions unrelated to true price valuation. Financial institutions are particularly vulnerable to this crisis of confidence and panic selling because they depend on the confidence of their trading counterparties in the conduct of their core business.”

The rule will remain in place through October 2, 2008.

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An emergency SEC rule that went into effect today prohibits naked short selling of any equity security. This rule expands on the emergency rule issued by the SEC in July, which prohibited naked short selling of 19 financial company securities.

Naked short selling occurs when short sellers and the entities loaning the shares (market makers and brokerages) do not identify whether shares are available to be borrowed. Because actual share certificates do not necessarily change hands, and transactions are settled days after the sale occurs, shares can be shorted without ever being borrowed in the first place. This practice creates opportunities for abuse, and there have been allegations of the same shares being lent to different short sellers resulting in shares being sold that do not exist and more shares shorted than are available in the public float.

The rule will remain in place through October 1, 2008.

Is the rule enough to curb these abusive and manipulative selling activities? Or should the SEC reinstate the “uptick rule,” which was abandoned by the SEC only a year ago after having stood for 70 years? The uptick rule mandated that, subject to certain exceptions, a security could only be sold short at a price above its last sales price. Perhaps a reinstatement of the uptick rule would more effectively protect against naked short selling abuses. After all, by the time the SEC’s emergency rule could be enforced with regard to a particular security, that security may already be in a downward spiral.
 

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Financial institutions and businesses that extend credit to consumers will soon need to comply with new rules effective November 1, 2008 designed to protect against identity theft. The Federal Trade Commission, Federal Reserve, and other financial regulators have developed the Red Flag Rules under the Fair and Accurate Credit Transactions Act of 2003.

The Red Flag Rules apply to “financial institutions” and “creditors” with “covered accounts.” A financial institution is essentially a bank or credit union that holds a deposit or other type of account on behalf of consumers. “Creditor” has a much broader definition that includes any entity that regularly extends credit or is an assignee of an original creditor and is involved in the decision to extend credit. A “covered account” is an account used for personal, family, or household purposes that involves multiple payments or any account for which there is a reasonable foreseeable risk of identity theft.

The Rules are designed to make sure creditors are investigating the identity of the individuals to whom they extend credit. The broad definition of “creditor” includes finance companies, car dealers, mortgage brokers, utility companies, telecommunications companies, and non-profit and government entities that defer payment for goods and services.

The Rules are flexible depending on the size and nature of the financial institution or creditor and include 26 possible “red flags” to be identified in a written identity theft prevention program, including:

• Forged applications
• Suspicious documents, personal identifying information, or addresses
• Change of address followed by a request for a new credit card
• Consumer reporting agency alerts or warnings
• Identical social security numbers supplied by different customers
• Customers not receiving account statements; and
• Inactive accounts

Financial institutions and creditors must have a written program that detects red flags in connection with a covered account by November 1, 2008. Failure to comply could result in monetary fines and enforcement actions. Furthermore, companies that unwittingly facilitate identity theft are often subject to significant negative media attention. Some commentators suspect that the Red Flag Rules will eventually become the standard of care for determining whether a company has negligently contributed to identity theft.
 

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The U.S. Department of Justice will no longer allow its prosecutors to pressure corporate executives to disclose privileged documents. The much-criticized current policy had been to label companies uncooperative if they failed to reveal documents and communications that fall under the attorney-client privilege. The DOJ has revised the policy effective immediately.

Furthermore, the DOJ can no longer demand “non-factual” attorney work product and is not permitted to consider whether a company pays its attorney fees in advance or how a company disciplines employees when deciding whether the company is cooperating with an investigation. The DOJ has described the new policy by saying that refusal to cooperate by a corporation with an investigation is not evidence of guilt.

The SEC is not bound by the new rules; however, a bill being considered by the U.S. Senate would change that. Currently, the SEC recommends that companies under investigation share the results of internal investigations with the SEC even if such reports are privileged.
 

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