Read the full alert here.

If you have questions regarding this alert, please contact—

• Gemma L. Descoteaux, 214.969.4783, Dallas
• Russell W. Parks Jr., 202.887.4092, Washington, D.C.
• C.N. Franklin Reddick III, 310.728.3204, Los Angeles
• Adam K. Weinstein, 212.872.8112, New York

On October 3, 2008, new Section 457A was added to the Internal Revenue Code by the Emergency Economic Stabilization Act of 2008. As discussed in our client alert, “New Section 457A, Which Limits Deferral of Offshore Compensation, Is Signed into Law,” Section 457A imposes significant restrictions on the ability of U.S. taxpayers to defer compensation earned from certain tax indifferent parties, including managers of offshore hedge funds. Generally, under Section 457A, taxpayers are required to include in income compensation that is deferred under a “nonqualified deferred compensation plan” of an entity (including both domestic and foreign partnerships and foreign corporations) that is not subject to a general income tax regime (a “nonqualified entity”), provided that the compensation is not subject to a “substantial risk of forfeiture.”

On January 8, 2009, the IRS released Notice 2009-8, which provides interim guidance to assist taxpayers in complying with Section 457A while the Treasury Department and the IRS consider further guidance. The Notice states that any future guidance that would expand the coverage of Section 457A will be prospective.

If you have any questions regarding this alert, please contact—

• Patrick B. Fenn, pfenn@akingump.com, 212.872.1040, New York
• Stuart E. Leblang, sleblang@akingump.com, 212.872.1017, New York
• Bruce E. Simonetti, bsimonetti@akingump.com, 212.872.8023, New York
• Jessica Cherry, jcherry@akingump.com, 212.872.7437, New York
• Joshua R. Williams, jrwilliams@akingump.com, 212.872.8014, New York

Chairman Cox stated that, based on recent roundtables with market participants, investors benefited from transparent financial reporting of mark-to-market assets and that, to insure a healthy market, “the content provided to investors should not be compromised to meet other needs.” However, he recognized that fair value measurements of securities traded in inactive or illiquid markets pose a particular challenge to the financial institutions holding them, and that the SEC was investigating more robust guidelines for auditors and statement preparers to apply these rules.

Furthermore, on December 15, the Financial Accounting Standards Board announced that it is examining the possibility of broadly applying mark-to-market rules beyond securities to loans, bonds, derivatives and stocks to create more uniform accounting procedures.

The debate over mark-to-market has, on one side, critics who say this accounting approach ignores long-term values and creates write-down losses that deplete bank capital, while, on the other side, supporters say sufficient and clear information is necessary for investor confidence. In the nearly overnight collapse of insurance giant AIG, many critics faulted mark-to-market rules for quickly exaggerating the company’s unrealized losses and creating market volatility.  Rather than create balance sheets based on mark-to-market assets, financial institutions might value gains and losses over a multi-year period, a historical approach currently taken by pension funds and other conservative investment instruments.

• Jim Benjamin, 212.872.8091, New York

The lawsuit volume related to the current market crisis has already surpassed the savings-and-loan cases of the early 1990s. An estimated 98 subprime and credit crisis related securities lawsuits were filed in 2008. We believe that securities litigation will continue to increase, as the successes of civil suits or government investigations and suits, coupled with subsequent public disclosure of financial services practices, spur further claims. With a stagnant economic climate, we believe that market participants will more actively seek to recoup their losses and regain profitability through litigation.

Similarly, the U.S. government could aggressively pursue securities litigation to recoup the taxpayer dollars put towards the Wall Street “bailout,” targeting companies whose investment practices or public statements may be seen as having contributed to the market crisis.

While shareholder suits against directors and officers made up the bulk of subprime litigation in the immediate wake of the collapse of Fannie Mae and Freddie Mac, Lehman Brothers, Merrill Lynch and AIG, a newer “wave” of credit crisis litigation may target companies outside the financial services sector. Investors have begun and may continue to sue companies that placed wrong-way bets on commodities futures or companies that have been undermined by their exposure to these failed financial institutions and to auction rate securities.

Several major lawsuits have already emerged against a diverse array of companies, including a chicken producer, a solar cell manufacturer, a wireless network and an energy holding group, all of which suffered significant losses after Lehman’s collapse; allegations include failure to disclose their heavy exposure to failed financial institutions, lack of diversification or high risk-taking practices, and issuance of materially false or misleading financial statements about their economic outlooks.

Plaintiffs, other than shareholders, may include securities issuers and underwriters, mortgage insurers, monoline insurers, credit default counter parties and collateralized debt obligations (CDO) service providers. Defendants to these cases may be CDO sponsors, mortgage lenders and brokers, asset managers, institutional trustees, credit default swap counterparties, insurers and rating agencies.

Rating agencies, such as Moody’s and Standard and Poor’s, could face a barrage of claims from both private financial entities and government regulators. Several securities class action cases by public retirement fund investors brought under the Securities Act of 1933 have included ratings agencies in their complaints, holding them liable for underwriting or appraising toxic mortgage-backed securities (MBS). Additionally, in a first-of-its-kind case, several community organizations in Los Angeles have brought a civil rights complaint against rating agencies for inflating ratings of mortgage bonds “designed to fail,” which, they claim, caused a disproportionate number of foreclosures in minority and low-income communities.

Investors in CDOs or MBS may bring claims against investment advisors for recommending unsuitable investments. Likewise, Employee Retirement Income Security Act (ERISA) claims against retirement fund managers who made allegedly risky investments with subprime exposure could create substantial litigation over fiduciary duties.

Read the full article from the American Lawyer here.

For more information regarding this alert, please contact—

• Mark Botti, 202.887.4202, Washington, DC
• Anthony Swisher, 202.887.4263, Washington, DC

Will the current distressed economic environment make securing antitrust approval for mergers or acquisitions easier than it otherwise might be?  We deal here with mergers between historically significant competitors that, under normal circumstances, might raise more than passing antitrust concern.  The short answer, as discussed below, is that antitrust principles will take into account the weakened financial condition of a merging party.  There is some precedent, in the form of the Depression-era Appalachian Coals[1] case, which supports the proposition that overall economic malaise might help a deal get through that would not otherwise pass muster.  A more predictable analysis, however, would focus on the condition of the individual firms involved in the merger or acquisition, as well as on the impact of the financial crisis on competition in the relevant market, not merely on the overall state of the economy.  The latter might perhaps make the enforcement agencies less skeptical in reviewing a claim that one of the companies is so distressed or the market so dysfunctional that a merger or acquisition cannot be anticompetitive.  However, the acknowledgment by the Federal Trade Commission or the Justice Department’s Antitrust Division that the country is in an overall economic crisis will not be a “get out of jail free” card for any particular merger.  Rather, economic distress will be taken into account (if at all) on an individualized basis under one of three related sets of principles:  (1) the failing firm defense, (2) the General Dynamics defense and (3) the flailing firm defense.

Failing Firm Defense. The financial distress of one party to a transaction most readily factors into the antitrust analysis under what is called the “failing firm” doctrine.  The Supreme Court’s decision in Citizen Publishing Co. v. United States, 394 U.S. 131, 136-38 (1969) provides a leading example of its application.  The court in Citizen held that a merger (through creation of a monopoly joint selling arrangement) between the only two daily newspapers in Tucson, Arizona would not be unlawful if one of the companies was “failing,” and satisfied the following criteria: (1) the company was in imminent danger of failure, (2) the failing company had no realistic prospect for a successful reorganization and (3) there was no viable alternative purchaser that posed a less anticompetitive risk.  The antitrust enforcement agencies have incorporated these considerations directly into their merger enforcement guidelines.  See U.S. Dept. of Justice and Federal Trade Commission, Horizontal Merger Guidelines ¶ 5-5.2 (1997 rev.).  The basic point of the failing firm analysis is that, if a company would exit the market but for its acquisition, stopping the acquisition will not protect any future competition.

General Dynamics Defense. What of the case where a firm is struggling but does not meet the strict requirements of the “failing firm” defense?  Merging parties have, with varying degrees of success, attempted to rely on the financial distress of a company, under what is known as the General Dynamics defense, relying on the Supreme Court’s decision in United States v. General Dynamics Corp., 415 U.S. 486 (1974).  In that case, the court concluded that, even if a company was not going to exit the market, if the company lacked resources to be able to engage in new competition in the future (as opposed to merely fulfilling existing contractual commitments), acquisition of that company would not be unlawful.  The court in General Dynamics found that one of two merging coal producers was unlikely to play a significant competitive role in the future because future competition “would depend on uncommitted [coal] reserves, and one of the acquired firms had no uncommitted reserves.”  Id. at 503-04.  In short, without any uncommitted reserves, the acquired firm had no ability to compete for new customers.

Flailing Firm Defense. The so-called “flailing firm” defense is often invoked as a General Dynamics variant, where a merging company is in financial distress, but it is not exiting the market (as required for the failing firm defense) and it would likely have some competitive influence going forward (unlike the factual situation in General Dynamics).  The argument is that the company is in such a weakened state that its competitive influence is reduced to the point that its elimination from the market will not have a significant impact.  The defense has met with some degree of skepticism and resistance from the antitrust enforcement agencies and is not incorporated explicitly into the Merger Guidelines.  Some courts, moreover, have failed to recognize the flailing firm defense as an appropriate expansion of the failing firm defense.  See United States v. UPM-Kymmene Oyj, 2003-2 Trade Cas. (CCH) ¶ 74,101 (N.D. Ill. 2003) (distinguishing “weakened competitor” argument from failing firm and failing division defenses and declining, on policy basis, to extend defenses where the division was “noncompetitive simply because its parent had not decided to compete.”).  Nonetheless, the weakened financial condition of a merging company can play a significant role in the evaluation of a merger, even where it is not a complete defense.  See, e.g. FTC v. Arch Coal, Inc., 329 F. Supp. 2d 109, 146-47 (D.D.C. 2004) (acquired firm’s financing obligations and high costs prevented it from competing aggressively on price).

We believe that, whatever views the agencies might hold generally regarding these defenses, the current economic crisis might cause them to be more receptive to the factual proposition that a merging company is possibly failing or flailing.  The economic crisis is not something the agencies are likely to question, and its very real impact on the financial viability of U.S. businesses is not open to debate.  Thus, merging parties who have well-grounded arguments that one of them is failing or flailing should have an open-minded audience in the agencies.  This is likely to remain true even in the upcoming Obama administration.  Moreover, if the merging parties are able to link the financial crisis to evidence that the market in which they compete is undergoing substantial change such that an anticompetitive effect from the merger is unlikely, they gain greater traction with these arguments.  Consider, for example, the Supreme Court’s Appalachian Coal decision.  Many modern-day observers attribute the outcome in that case to the backdrop of the Great Depression.  The court allowed competing coal producers who controlled 73 percent of the commercial production in their area of competition to form a joint sales agency, despite the fact that the trial court found that prices were likely to stabilize or rise as a result.  Important to the court’s decision was an analysis of the severe financial distress facing the industry as a whole, with capacity far outstripping demand, and the consolidating producers facing substantial competition for a large volume of their sales.

Despite Appalachian Coals and the judicial precedent involving failing and flailing firms, parties considering a merger of substantial current competitors should not think that the financial crisis will readily carry the day in the antitrust review of their merger.  Indeed, the Appalachian Coals decision is questioned today, and it is important to recall that the Justice Department in fact filed the challenge despite the economic crisis at the time.  We similarly expect a modern Justice Department not to accept the economic crisis as a sufficient basis to clear an otherwise anticompetitive merger, but instead would want to ground its decision in established antitrust doctrine as applied to the specific facts of the particular merger. 

So, what does all of this mean to parties considering a merger or acquisition in the current distressed economic environment?  While the distressed financial markets will not guarantee that a failing firm or flailing firm defense will work, and the parties still have to satisfy the factually specific inquiry and technical requirements of the law, we expect the antitrust agencies not to turn too jaundiced an eye on such claims, but rather be more receptive to them then they’ve been in a long time.  Parties in these circumstances should therefore consider these arguments as potentially viable components of the antitrust tool kit and marshal carefully the facts linking the financial crisis to an analysis of why a merger is positive for the market, not anticompetitive.  These are not one-size-fits-all solutions, but a failing or weakened firm argument in today’s tough economic environment may make a merger or acquisition more plausible from an antitrust point of view than it would have been before the financial crisis.

• Kerry Berchem, 212.872.1095, New York

The recent market downturn has forced some corporate insiders to involuntarily sell shares of their companies to satisfy margin calls or otherwise cover debts.  For example, the chairman and CEO of Chesapeake Energy was recently  forced to sell $569 million of Chesapeake securities to cover a margin call, while the co-founders of Boston Scientific were forced to sell $292 million of Boston Scientific securities that were pledged as collateral for a loan.   These forced sales have focused attention on whether or not companies should allow insiders to hold company securities in a margin account or to pledge company securities as collateral for a loan.  Recent forced sales have also highlighted the potential for insider trading and short swing profit liability resulting from such involuntary sales of company securities.  Each of these issues is discussed in more detail below.

Whether Pledging Company Securities Should be Allowed

Should a company allow its insiders to pledge company securities to secure a margin loan or to serve as collateral for another type of loan?  Some executives want this option because it allows them to borrow money to buy stock in the company.  Other executives may have significant holdings of company stock and want to use the shares as collateral for a loan.  On the one hand, the ability of an insider to use company securities to secure a margin loan may allow the insider to demonstrate his or her commitment to the company by buying company stock.  Most companies encourage their executives to buy stock in the company because such purchases by insiders can signal confidence in the company and possibly drive up the stock price.  On the other hand, particularly with the deflated stock prices in today’s market, these actions could subject the insider to insider trading or short swing profit liability if the insider is forced to make an involuntary sale.  Further, a major sale of company shares by an insider is likely to create a negative reaction by investors in the marketplace and drive down the company’s stock price.  Also, the board of directors could be placed in a difficult position if the insider asks the board for help to avoid a massive sell-off that could depress the company’s stock price.  Although companies are all over the map on whether or not to prohibit or allow insiders to pledge company stock, companies may want to revisit their corporate governance and insider trading policies in light of the current market situation in order to determine whether or not it is now prudent to prohibit their insiders from pledging company stock.

Insider Trading

An insider’s pledge of stock as security for a loan could subject the insider to insider trading liability.  For purposes of the antifraud provisions of the securities laws, the pledging of stock as collateral for a loan is equivalent to a “sale” of the stock to the pledgee.[1] Therefore, if the insider is in possession of material non-public information that is adverse to the company at the time the securities are pledged, the insider may be liable to the pledgee if the securities decline in value and the insider defaults on the loan.

Even if the shares were pledged at a time when the insider was not in possession of material non-public information, the insider risks insider trading liability if the insider is in possession of material non-public information at the time of the forced sale.  Although Rule 10b5-1 provides an affirmative defense to insider trading liability pursuant to certain written plans, forced sales by a broker or pledgee may not be eligible for this defense.  To be eligible, the margin agreement or pledge agreement cannot permit the insider to exercise any influence over the sale after entering into the agreement, and the agreement or pledgee cannot provide the insider with any discretion to substitute or provide additional collateral or cash, or to repay the loan before the pledged securities may be sold.[2] Because the insider can generally prevent such a sale of securities by repaying the loan or pledging additional collateral, the insider is typically deemed to control and have discretion over the sale.

In addition to the potential insider trading liability, an insider could also violate the company’s insider trading policy if the sale occurred during a blackout period.

Short Swing Profit Liability

An insider forced to sell off company shares may also be subject to short swing profit liability under Section 16 of the Exchange Act.  While the initial pledge of securities as collateral for a margin or other type of loan is not a reportable event under Section 16, an insider’s sale of pledged securities following a margin shortfall or loan default is a reportable and perhaps matchable transaction under Section 16.[3] Such a sale could, therefore, subject the insider to short swing profit liability if the insider has any matchable purchase within less than a six-month period before or after the sale.  In any event, the forced sale must be reported on Form 4.  Although no disclosure regarding the purpose of the sale is required, many recent filings include explanatory footnotes stating that the reported transaction was an involuntary sale made pursuant to a margin call or an involuntary sale of shares pledged as collateral for a loan.[4]

[2] See U.S. Securities and Exchange Commission, Division of Corporation Finance:  Manual of Publicly Available Telephone Interpretations, Fourth Supplement, Rule 10b5-1, Question 9 (October 2000).  A link to the material is available here.

[3] See Alloys Unlimited, Inc. v. Gilbert, 319 F. Supp.  617 (SDNY 1970).  Harrison ex rel. FPA Corp. v. Orleans, 755 F. Supp.  592 (SDNY 1991).  Although an insider may try to avoid liability under Section 16(b) by claiming the sale was an involuntary, forced transaction, courts have generally rejected this defense where the insider could have prevented the sale by, for example, substituting cash or other collateral, or where the insider otherwise has an opportunity for speculative abuse by influencing the timing of the transaction.

[4] Examples of recently filed Form 4s with explanatory footnotes are available here, here, here and here.

Akin Gump Strauss Hauer & Feld LLP partners John M. Dowd and Andrew J. Rossman will be presenting a free webinar titled “Who’s Going to Court, Who’s Going to Jail?: Civil and Criminal Law Enforcement in the Wake of Financial Crisis.”  The program will address issues such as—

• assessing what laws, regulations and legal theories are available to federal and state law enforcement
• examining potential private litigation causes of action and the likely targets of such civil lawsuits
• evaluating the impact recent federal court rulings, such as Stoneridge, will have on civil litigation
• analyzing possible plaintiffs’ and defendants’ legal strategies in civil and criminal actions.

The live webinar takes place on Tuesday, from 10 a.m. to 11 a.m. EST.  To view the program, please go to the Washington Legal Foundation Web site at www.wlf.org.  The program will be recorded and available for later viewing on the Foundation’s Web site, as well.

Wednesday, October 29:

With credit tight, corporate managers are looking for other ways to grow their businesses.  Strategic partnerships fit the bill.  But corporate finance experts say such hook-ups—while often appealing—come with their own set of problems.

On Wednesday, October 29, Financial Week M&A reporter Tim Catts, along with Akin Gump Strauss Hauer & Feld LLP’s C.N. Franklin Reddick III and KPMG Corporate Finance LLC’s Cherie Smith Homa, will participate in a live Financial Week Webcast—”To Buy or Not to Buy? Why a Strategic Partnership May Be the Way to Go”-in which they will discuss the promise and perils of strategic partnering.

To register for this free webcast, visit the Financial Week Web site.

For more information on this alert, please contact—

• Mark Botti, 202.887.4202, Washington, DC
• Anthony Swisher, 202.887.4263, Washington, DC

Introduction and Background

The recent worldwide financial turmoil and the still-uncertain aftermath of the Emergency Economic Stabilization Act of 2008 have sparked major  mergers and acquisitions (M&A) that need very rapid antitrust regulatory approval in order to calm distressed markets and salvage shareholder value.  More such M&A deals are surely coming.  Despite the normal 30-day waiting period under the Hart-Scott-Rodino (HSR) Act, deals can be done much more quickly under the right circumstances.

The HSR Act, Section 7A of the Clayton Act, 15 U.S.C. § 18a. is a “file and wait” statute.  Parties to proposed transactions meeting certain size thresholds must file notification with both the Federal Trade Commission (FTC) and the U.S. Department of Justice, Antitrust Division (DOJ).  They must also observe a mandatory waiting period prior to closing, generally 30 days, but  15 days in the case of a bankruptcy or cash tender offer.  If a transaction raises substantive antitrust issues requiring thorough investigation,, a so-called “Second Request” for information may be issued, typically causing the waiting period to be extended by many months.   Critically, however, the mandatory HSR waiting period can also be shortened through the discretionary grant of an “early termination.”   § 7A(b)(2).

Obtaining “early termination” for large transactions often requires a proactive approach.  Many significant transactions bog down early in the regulatory process as a result of an obscure first step in the agency review process known as “clearance.”  During the clearance stage, the FTC and DOJ decide between them which of the two is going to review the transaction.  Weeks, and in some unfortunate instances, months are sometimes lost during this clearance process, particularly when the agencies dispute which of them is going to review a transaction.  Parties can help the agencies cut through the clearance issues by engaging them actively even prior to making their filing.  Where necessary to move the matter forward rapidly, merging parties make presentations to both agencies rather than wait for clearance.  Most important, companies need to educate antitrust agency staff regarding key issues and communicate specific reasons underlying the need for expeditious review and approval.  Lastly, companies need to develop proactive pre- and post-filing strategies to quickly marshal information for staff, with the goal of securing prompt antitrust clearance.  A sure prescription for delay is simply to file the necessary documents and just sit back while the agencies do their work.

The agencies have historically attempted to respond to legitimate needs for speed and regularly grant early termination where antitrust problems are absent.  For example, in hostile tender offers or where financing is at risk due to delay, the agencies have commonly expedited their review. For small transactions that are not antitrust-sensitive, early termination is routinely granted in two to three weeks.  However, for large and complex transactions, even if early termination is granted because no antitrust problems are presented, termination often does not occur until very  late in the 30-day period, or may even not occur until late in a second 30-day period following a “pull and refile” procedure.  However, the agencies’ track record thus far in the current crisis indicates that they are working very diligently to clear even extremely large mergers.on an expedited-and sometimes extremely expedited-basis.  Recent examples of distressed market acquisitions illustrate this point:

1) After a hotly contested bidding war with Citigroup, Wells Fargo & Company’s acquisition of Wachovia Corporation was announced on October 9, 2008, and U.S. antitrust regulators approved the deal only one day later.

2) On September 29, 2008, Mitsubishi UFJ Financial Group (MUFG) and Morgan Stanley announced that the two companies had reached a definitive agreement under which MUFG invested $9 billion in equity in Morgan Stanley for a 21 percent interest in the company.  MUFG received early termination of the HSR waiting period on October. 3, 2008, four days later.

3) The acquisition of The Bear Stearns Companies Inc. by JP Morgan Chase & Co. was announced on March 16, 2008, and early termination of the waiting period was granted on April 1, 2008, just 16 days after filing.

The agencies’ rapid clearance of these matters does not signal that they are turning a blind eye to anticompetitive aspects of transactions.  Rather, the rapid clearance shows that the financial crisis is an important factor driving the agencies to prioritize their review of certain transactions.  Merging parties still need to marshal the facts and arguments-in as organized and rapid a fashion as humanly possible-to demonstrate why a merger between competitors is not anticompetitive.

NEXT: In our next antitrust posting, we will discuss the role that the financial distress of the merging firms can play in convincing the agencies there is no antitrust concern.

If you have questions regarding this alert, please contact-

• Mark H. Barth, 212.872.1065, New York
• David M. Billings, 44.20.7012.9620, London
• Jan-Paul Bruynes, 212.872.7457, New York
• James A. Deeken, 214.969.4788, Dallas
• Patrick J. Dooley, 212.872.1080, New York
• Christopher M. Gorman-Evans, 44.20.7012.9656, London
• Barry Y. Greenberg, 214.969.2707, Dallas
• Ira P. Kustin, 212.872.1021, New York
• Arina Lekhel, 212.872.8018, New York
• Burke A. McDavid, 7.495.783.7835, Moscow
• Prakash H. Mehta, 202.887.4248, Washington, D.C.
• Lisa A. Peterson, 817.886.5070, Dallas
• Eliot D. Raffkind, 214.969.4667, Dallas
• Fadi G. Samman, 202.887.4317, Washington, D.C.
• William L. Sturman, 212.872.1035, New York
• Ann E. Tadajweski, 212.872.1087, New York
• Simon Thomas, 44.20.7012.9627, London
• Stephen M. Vine, 212.872.1030, New York

On October 14, 2008, and October 15, 2008, the Securities and Exchange Commission (SEC) adopted rules that continue the effectiveness of certain emergency orders issued by the SEC on September 17, 2008, and September 18, 2008.  The SEC’s new rules include (1) an interim final temporary rule that continues the requirement of persons filing Form 13Fs to report their short sales and short positions (the “Short Sale Reporting Rule”), (2) an interim final temporary rule to require the closing out of “failures to deliver” securities (the “Close-Out Rule”), (3) a final rule targeting deception of market participants about a seller’s intention or ability to deliver securities at settlement (the “Anti-Fraud Rule”) and (4) a final amendment to Rule 203 of Regulation SHO that eliminates the option market maker exemption from the requirement to close out failures to deliver in threshold securities.  The Short Sale Reporting Rule and the Close-Out Rule contain significant changes from the previously published emergency orders, which changes are described in more detail below.  The Anti-Fraud Rule and the elimination of the market maker exception are substantially similar to the previously published emergency orders.

The Short Sale Reporting Rule will be effective from October 18, 2008, to August 1, 2009.  The Close-Out Rule will be effective from October 17, 2008, until July 31, 2009.  The Anti-Fraud Rule and the elimination of the market maker exception will be effective on October 17, 2008, and extend indefinitely.

SHORT SALE REPORTING RULE

The Short Sale Reporting Rule, or Rule 10a-3T under the Securities Exchange Act of 1934, requires any person that files a Form 13F for the relevant calendar quarter, to file a Form SH on a weekly basis reporting any daily short sales and changes in short positions.  The SEC revised the Short Sale Reporting Rule included in the previous emergency orders and Form SH by, among other things, (1) changing the due date of Form SH, (2) eliminating certain reporting requirements from Form SH, (3) changing the de minimis exception, (4) eliminating the grandfather provision for short positions entered into prior to September 22, 2008, and (5) requiring the filing of Form SH in XML format.

• Due Date of Form SH. The Form SH filing must be made on the last business day of each calendar week immediately following the calendar week in which any new short positions with respect to Section 13(f) securities (excluding options) were effected.
• Elimination of Categories on Form SH. Form SH no longer requires reporting (i) the value of securities sold short, (ii) the largest intraday stock position and (iii) the time of the largest intraday short position.
• De minimis Exception. The revised Short Sale Reporting Rule increases the “de minimis” exception for reporting short sales or short positions to $10 million in market value and 0.25 percent of the issued and outstanding Section 13(f) securities.
• Elimination of Grandfather Provision. Filing persons must now include short positions that existed prior to September 22, 2008. There is an optional two-week phase-in period for reporting pre-September 22 short positions. If a filing person takes advantage of the phase-in period by excluding pre-September 22 short positions from its Form SH report to be filed on October 24, 2008, and/or October 31, 2008, the lower de minimis exception threshold of $1 million in market value and 0.25 percent of the issued and outstanding class of the relevant 13(f) securities continues to apply for the phase-in period.
• XML Formatting. A Form SH must be filed electronically through EDGAR as an XML tagged data file.

Form SH will remain nonpublic to the extent permitted by law.  A manager must continue to label its Form SH as nonpublic by adding the phrase NONPUBLIC (in bold and capital letters) at the top and bottom of each page of the form, with the exception of the XML tagged data file containing transaction data.

The Close-Out Rule

The revised Close-Out Rule, or Rule 204T of Regulation SHO, is similar to the version of the Close-Out Rule included in the SEC’s emergency order issued on September 17, 2008, but contains certain modifications, including several exceptions, and allows clearing brokers or other participants of a registered clearing agency (each a “clearing firm”) to delegate some responsibilities to the firms for which they clear (each an “introducing firm”).

The revised Close-Out Rule requires a clearing firm or introducing firm to close out any sales of equity securities (including short sales and certain long sales that cannot be properly documented) for which the seller fails to deliver equity securities by the settlement date, by borrowing or purchasing securities of like kind and quantity by the beginning of trading on the business day following the original settlement date.  If the clearing firm or introducing firm fails to deliver securities and does not close out the failure to deliver by the next settlement day, such firm will not be able to accept any short sale order in that equity security from any person without first borrowing the security or arranging to borrow the security and closing out the original failure to deliver.  Under current SEC rules, the settlement date for the sale of securities must be no later than the third business day after entering into the trade (T+3).

The above requirements apply differently for certain long sales, for certain market making activities and for sales pursuant to Rule 144 under the Securities Act of 1933, as amended.  Transactions that a clearing firm can demonstrate on its books and records resulted from a long sale, or transactions that are attributable to bona fide market making activities by registered market makers, options market makers or other market makers obligated to quote in the over-the-counter market are required to be closed out by the beginning of trading hours on the third consecutive settlement day following the original settlement day.  Sales of equity securities pursuant to Rule 144 are required to be closed out by the 36^th consecutive settlement day following the original settlement date.

In addition, the borrowing requirements of the revised Close-Out Rule do not apply to market makers if they meet certain requirements or to clearing firms or introducing firms that have purchased securities prior to a failure to deliver.  Market makers are exempted from the borrowing requirements of the Close-Out Rule if they can demonstrate that they do not have any open short positions at the time of any additional short sales.  The revised Close-Out Rule also allows clearing firms and introducing firms to purchase securities prior to a failure to deliver, so long as (1) the purchase is bona fide, (2) the purchase is executed on or after the trade date but by no later than the end of regular trading hours on the settlement date for the transaction, (3) the purchase is of a quantity of securities sufficient to cover the entire amount of the open short position and (4) the clearing firm or introducing firm can demonstrate that it has a net long position or net flat position on its books and records on the settlement day for which the clearing firm or introducing firm is seeking to demonstrate that it has purchased shares to close out its open short position

Our previously published client alerts on the September Emergency Order and Form SH can be found here.