Don’t Short Before The Deal, SEC Reminds Hedge Funds And Buyside Firms

by Pepper Hamilton LLP

On September 17, 2013, the Securities and Exchange Commission (SEC) announced enforcement actions against 23 investment firms for violations of Rule 105 of SEC Regulation M.1 Rule 105 generally prohibits short selling securities during the five-day trading period leading up to the pricing of an offering and purchasing those same securities from an underwriter, broker or dealer participating in that same offering.

Rule 105 originally only prohibited short selling that was “covered” by the securities being offered publicly. In June 2007, however, the SEC adopted amendments to Rule 105 that have since prohibited all short selling prior to a public offering regardless of whether the position is “covered” by the securities being offered publicly or “covered” at all.

Rule 105 is designed to prevent short selling securities as a way of creating downward pressure on the market price of the securities being offered publicly before the issuer prices its public offering. These shorts are viewed as manipulative because they can artificially create value for the investment firm at the expense of the issuer in a public offering.

There are a few exceptions to the short-selling prohibitions in Rule 105, including:

  • reported purchases after the short sale of at least the same number of securities as the short sale
  • short selling by a separate account from the account purchasing in the distribution and with no coordination or cooperation between the two, and
  • short selling activity by registered investment companies, subject to certain procedural guidelines.

The restriction does not apply to non-firm commitment offerings, and the SEC can also grant exemptive relief.

Rule 105 applies to all short selling activities in violation of the rule regardless of intent. Investment firms should have surveillance systems in place to detect Rule 105 short selling violations and must report suspected violations to the Financial Industry Regulatory Authority (FINRA) on a suspicious activity report (SAR).

Pepper Points

Intentional violations aside, there are a handful of ways that an investment firm might potentially violate Rule 105, including “compliance breaks,” a “plow through” and a “short selling restriction failure.”

  • A “compliance break” would involve a failure in the investment firm’s surveillance system such that the syndicate desk and compliance personnel did not properly screen for the investment firm’s short selling positions over the past five trading days before agreeing to accept an allocation in the public offering. It is important that trading accounts are properly aggregated to minimize the risk of a compliance break.
  • A “plow through” can occur if the syndicate desk and the compliance personnel identified a short selling position but simply did not know or did not care about the Rule 105 prohibition.
  • A “short selling restriction failure” can occur when the investment firm knew about the public offering and failed to put the securities on principal trading restriction. Compliance with Rule 105 has become more difficult with the growing prominence of block trades and other overnight and one-day offerings.

Look for the SEC to bundle Rule 105 cases as it continues its enforcement efforts with the assistance of FINRA.


1 A copy of the press release can be found at:

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Pepper Hamilton LLP | Attorney Advertising

Written by:

Pepper Hamilton LLP

Pepper Hamilton LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.