Rapid Rulemaking: SEC Update
SEC Proposes New Short Sale Reporting Requirements
On February 25, 2022, the Securities and Exchange Commission (the “SEC”) proposed new regulations (the “Proposed Rules”) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Investment Advisers Act of 1940, as amended, which, among other things, would require “institutional investment managers”, as defined under Section 13(f)(6)(A) of the Exchange Act (“investment managers”), to report to the SEC on a monthly basis certain short sale related information. / The SEC would then publicly disclose the aggregated data by security, while maintaining the confidentiality of the reporting investment managers.
According to the SEC, the Proposed Rules seek to fulfill the mandate under Section 13(f)(2) of the Exchange Act, added under Section 929X of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”), to prescribe rules to make certain short sale data publicly available on a regular basis. The SEC also cited the market volatility around “meme stocks” in early 2021, and asserted that the Proposed Rules would have given it tools to better understand the role of short selling activity in it.
Overview of the Proposed Rules
The Proposed Rules would require investment managers to report to the SEC on proposed Form SHO certain short sale related information with respect to equity securities over which they have investment discretion meeting any of the following thresholds:
- for any equity security of a reporting issuer, either (i) a gross short position of $10 million or more at the close of regular trading hours on any settlement date occurring during the calendar month, or (ii) a monthly average gross short position as a percentage of the issuer’s total shares outstanding equaling 2.5% or more; and
- for any equity security of a non-reporting issuer, a gross short position of $500,000 or more at the close of regular trading on any settlement date occurring during the calendar month.
The above thresholds are calculated based only on gross short positions in the equity security itself, excluding short positions established through options or other derivatives or in ETFs that may include the equity security (but see below daily reporting requirements on related activity through derivatives and ETFs). Under the Proposed Rule, the SEC would define “gross short position” as the number of shares of the equity security that the manager holds short, excluding any potential offsetting economic positions like derivatives of the equity security or shares of the equity security held (i.e., no netting of the investment manager’s position in the equity security).
Proposed Form SHO would be due within 14 calendar days following the end of each calendar month, meaning that an investment manager’s compliance department would need to make a determination as to the manager’s filing obligations on a monthly basis.
Form SHO would require an investment manager to disclose detailed information regarding its short positions that meet any of the aforementioned thresholds, including, among other data, any monthly gross short positions by number of shares and dollar value, whether and to what extent such positions are hedged and certain daily activity related to each gross short position.
Significantly, proposed Form SHO expressly provides that all information that would reveal the identity of the filing investment manager would be automatically deemed subject to a confidential treatment request under Rule 24b-2 of the Exchange Act. The SEC stated that it “currently plans” to publish only aggregated data derived from information provided in filers’ Form SHO reports rather than providing the public with disclosure regarding which investment manager holds a certain short position. Such aggregated information would be disclosed within one month after the end of each reporting calendar month, and would include, among other data:
- aggregate gross short position across all reporting managers in the reported security at the close of the last settlement day of the reporting month;
- the percentage of the reported aggregate gross short position that is purported to be fully hedged, partially hedged, or not hedged; and
- net activity during the reporting period in the reported security.
Background and SEC Objectives
According to the SEC, the Proposed Rules would provide it and the public with valuable information on short sale activity that is not currently available, bolster its oversight of short selling, promote greater risk management among market participants, and facilitate capital formation to the extent that greater transparency bolsters confidence in the markets.
According to the SEC, the information collected under the Proposed Rules would be helpful to the SEC in reconstructing market events, including by distinguishing directional versus market neutral activity, as well as to investors in determining how broadly held short sentiment really is with respect to any given security or issuer. The SEC also asserted that the information would allow it to better detect “short and distort” activity, “bear raids”, large exposure of investment managers and systemic risk concerns regarding short selling.
The SEC acknowledged that the public release of the aggregated information may increase the risk of trading behavior harmful to short sellers, including “short squeezes”, as market participants may nonetheless be able to identify the relevant investment manager in some instances (for example, the SEC estimates that 32% of stocks reported on Proposed Form SHO would have only one investment manager within the reporting threshold). This in turn could have a chilling effect on short selling and thereby negatively impact price discovery and market efficiency. On the other hand, the SEC noted that the data available pursuant to the Proposed Rules may allow it to more quickly identify a short squeeze and the market participants involved.
The Proposed Rules, which are subject to further modification, would increase the regulatory burden on investment managers, including as follows:
- investment managers would need to establish procedures and systems to track their short sale related activity daily, with relatively low reporting thresholds; and
- some of the required reporting information could be subject to interpretation, such as to what extent a short position is hedged and what daily activity is relevant to the short position, which may be particularly complex determinations for multi-strategy funds and funds that use both internal and external advisors.
Once finalized and adopted, these rules will impose significant new reporting requirements on investment managers, including banks, hedge funds, family offices and broker-dealers.
 Note that the threshold of having investment discretion over at least $100 million in equity securities applicable to Form 13F filings by an institutional investment manager is not applicable to Proposed Rule 13f-2, and therefore an investment manager not required to file Form 13F would still need to file proposed Form SHO if they exceeded the above thresholds.
“Institutional investment managers” include any person, other than a natural person, investing in or buying and selling securities for its own account, and any person exercising investment discretion with respect to the account of any other person.
 Information regarding the investment manager’s gross short positions would be included in Information Table 1: Manager’s Gross Short Position Information and information regarding daily activity would be included in Information Table 2: Daily Activity Affecting Manager’s Gross Short Position During the Reporting Period.