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The Ban and the TARP

By Harvard Law School Program on Corporate Governance

(Editor’s Note: This post is based on a client memorandum by Edward D. Herlihy and Theodore A. Levine of Wachtell, Lipton, Rosen & Katz)

Late last week the SEC announced that its ban on short selling in financial company stocks would expire three (3) days after the enactment by Congress of the Troubled Asset Relief Program. It was an arbitrary decision to tie the expiration of the ban to the Congressional action and, even if it made sense when the SEC announced it, it does not make sense now for the SEC ban to be lifted at midnight on Wednesday, October 8, 2008, especially given the recent market turmoil and instability.

The worldwide credit and securities markets are experiencing a serious meltdown with significant disruptions and dislocations. A substantial number of market regulators have, in one fashion or another and for varying lengths of time, banned short selling in financial company stocks. The SEC should coordinate its efforts, including the length of the short selling ban with the major international regulators and marketplaces in order to have a consistent and coordinated approach. It makes no sense for the SEC to impose the shortest ban or to unilaterally lift it.

During the time while the ban continues in place, the SEC needs to develop, in conjunction with the other regulators, a market-wide solution.

The SEC plan must include the following elements:

? The re-imposition of an ?Uptick Rule? (see our memo of September 26, 2008) tailored to today?s marketplace.

? Necessary remedial measures to address abusive short selling, in addition to its final interim rule on ?naked? short sales, which requires delivery of securities by the settlement date and imposes penalties for failure to do so.

? We have repeatedly urged the SEC to respond to the public commentary and debate about the extent and nature of abusive short selling and manipulative conduct and the effectiveness of the ban, based on the results of the SEC investigative efforts. As we previously said (see our memo of September 26, 2008) the SEC needs to promptly issue a public report to answer these questions. It has been more than 6 months since the collapse of Bear Stearns. It is a disservice to the investing public for the SEC to delay in providing this information to the marketplace.

? The SEC must also complete its investigations into abusive and manipulative short selling and the spreading of false rumors quickly and bring enforcement actions against those who have engaged in these activities.

A long-term comprehensive approach to deal with the short selling issues and related activities also needs to be developed by the SEC. Any permanent market-wide solution should include, among other things, regulation of the credit default swap market, additional reporting requirements to the SEC for market oversight of institutional short selling, and the relationship of options, convertible securities and other financial instruments to short selling.

Full post as published by The Harvard Law School Corporate Governance Blog on October 12, 2008 (boomark / email).