Short Sale Pilot Program

By: Cydney Posner

Further to the SEC's pilot program suspending short sale price tests for selected companies, click here for the order establishing the pilot. The SEC is establishing this pilot for a one-year period commencing on January 3, 2005.

The pilot will apply to

• short sales in the stocks identified in Appendix A to the Order;
• short sales in any security included in the Russell 1000 index effected between 4:15 p.m. EST and the open of the consolidated tape on the following day; and
• short sales in any security not included in the first and second bullets above effected in the period between the close of the consolidated tape and the open of the consolidated tape the following day (i.e., after-hours trading).

The SEC selected a subset of stocks from the Russell 3000 index for inclusion in the pilot, taking into account the liquidity, volatility, market depth and trading market of these securities. For those interested in the SEC's methodology, the securities were selected by excluding

• the 32 securities in the Russell 3000 index that, as of June 25, 2004, were not Nasdaq national market securities, listed on the Amex or listed on the NYSE (because short sales in these securities are currently not subject to a price test); and
• issuers that went public after April 30, 2004.

The SEC then sorted the remaining securities into three groups -- Amex, Nasdaq NNM and NYSE -- and ranked the securities in each group by average daily dollar volume over the period of the preceding year. The SEC then selected every third stock in each group. The pilot stocks are listed 50% on the NYSE, 2.2% on the Amex and 47.8% on the NNM. The remaining stocks in the Russell 3000 index will function as the control group.

The pilot program is designed to help the SEC assess whether to remove or extend short sale regulation. The SEC will examine, among other things, the impact of price tests on market quality (including volatility and liquidity), whether any price changes are caused by short selling, costs imposed by a price test and the use of alternative means to establish short positions. The SEC does not believe that any variations in prices and trading activity between the pilot and non--pilot stocks will be problematic and expects the risk of any adverse impact on the pilot securities "to be small." The SEC and the SROs will monitor trading activity during the pilot and watch for manipulative short selling.

The portion of the pilot applicable to the Russell 1000 is designed to allow the SEC to examine whether removing a price test after the close of regular trading in securities included in the Russell 1000 index would benefit investors and the markets by increasing liquidity and pricing efficiency in these securities in the after-hours market. The other portion of the study is designed to allow the SEC to study the effect on a broader segment of the market of removal of a price test during after-hours trading.

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