SEC Unanimously Approves Amendments to Rule 105 of Regulation M

At its open meeting held June 20, 2007 (the “Open Meeting”), the Securities and Exchange Commission (the “Commission” or “SEC”) voted unanimously to adopt previously proposed amendments to Rule 105 of Regulation M. Once the amendments are effective, Rule 105 will prohibit any person who sells short during the Rule 105 pre-pricing period for an offering from purchasing any securities in that offering, subject to two new exceptions adopted in response to the comments received on the proposal.

Under Rule 105 of Regulation M, it is presently unlawful (subject to limited exceptions) for any person to cover a short sale with offered securities purchased from an underwriter or broker-dealer participating in a firm commitment offering of securities for cash pursuant to a registration statement or notification on Form 1-A, if the short sale occurred during the period ending with the pricing of the offering and beginning on the later of (1) the fifth business day before pricing, or (2) the initial filing of the registration statement or notification on Form 1-A (the “pre-pricing period”). The amendments approved at the Open Meeting will eliminate the “covering” component of the current prohibition and make it unlawful for a person who sold short during the pre-pricing period to purchase securities in the offering -- even if the securities purchased in the offering are not used to cover the short sale -- unless an exception is available. This “bright-line rule” is intended to put an end to the progression of schemes that have been engineered to camouflage covering activity that is already prohibited by Rule 105, to streamline compliance with Rule 105 and to facilitate enforcement of Rule 105.

New Exceptions. In the Commission’s original proposal, there were no exceptions to this bright-line rule. See Short Selling in Connection with a Public Offering, SEC Release 34-54888 (Dec. 6, 2006), 71 Fed. Reg. 75002 (Dec. 13, 2006). In response to comments, however, exceptions will be incorporated into the Rule for (i) bona fide pre-pricing purchases, and (ii) purchases by investment companies and other related, but separately managed, accounts.

(i) Bona fide Pre-Pricing Purchases. Rule 105, as amended, will incorporate an exception allowing the purchase of securities in the offering by persons who established short positions in the offered securities during the pre-pricing period but then entered a bona fide transaction that closed out their short positions prior to the pricing of the offering. To be eligible for the exception, the covering transaction will be subject to certain conditions (not detailed during the Open Meeting) intended to assure transparency, provide time for the effects of the pre-pricing period short sale to dissipate and provide an opportunity for the market to react to the covering purchase. Division of Market Regulation Director Erik Sirri noted at the Open Meeting that the exception for bona fide pre-pricing purchases will provide an opportunity for persons to participate in the offering if they sold short before becoming aware of the offering or as a part of normal trading strategies. Because the SEC release detailing this new exception is not yet available, it is unclear how the exception will be crafted to accomplish its intended purpose or to address timing issues associated with certain types of transactions, such as “overnight” or “bought” deals where investors may not have sufficient time after becoming aware of the transaction to engage in qualifying covering purchases.

(ii) Purchases by Investment Companies and Related, But Separately Managed, Accounts. Rule 105, as amended, will incorporate exceptions for certain types of accounts that are related (such as separate funds within a fund family) but that are separately managed and do not engage in coordinated trading activity. In particular, an exception will be available for investment companies registered under Section 8 of the Investment Company Act of 1940 to allow a registered investment company to purchase securities in the offering even if an affiliated investment company (or another fund in the same fund family) sold the offered security short during the pre-pricing period. Similarly, an exception will be incorporated into Rule 105 to allow a person to purchase offered securities in an account even if there was a short sale of the offered securities during the pre-pricing period in a related, but separately managed, account, provided investment decisions for the related accounts are made independently and without coordination among the managers or trading among or between the accounts. James Brigagliano, Associate Director for Trading Practices and Processing in the SEC’s Division of Market Regulation, noted at the Open Meeting that the exception for separate accounts is activity-based and intended to afford considerable structural flexibility. Moreover, it will be available to any entity that satisfies the exception’s requirements and thus is much more expansive than the “aggregation unit” provision of Regulation SHO (Rule 200(f)), which by its terms is available only to broker-dealers.

Other Amendments to Rule 105. Rule 105 will also be amended to provide expressly that it applies only to equity securities and only to short sales of the security that is the subject of the distribution.

Effective Date. The amendments to Rule 105 will become effective 60 days following their publication in the Federal Register.

Other Matters Acted on at the Open Meeting. At the Open Meeting, the SEC also:

• Unanimously adopted amendments to extend its interactive data voluntary reporting program on the EDGAR system to permit mutual funds to submit as exhibits to their registration statements supplemental, tagged information contained in the risk/return summary section of their prospectuses. The risk/return summary section contains key mutual fund information, including investment objectives and strategies, risks, and costs.
• Unanimously voted to propose amendments to Form 20-F, Rules 3-10 and 4-01 of Regulation S-X, Forms F-4 and S-4, and Rule 701 under the Securities Act of 1933, to accept financial statements prepared in accordance with International Financial Reporting Standards (“IFRS”) as published by the International Accounting Standards Board (“IASB”) without reconciliation to generally accepted accounting principles as used in the United States (“US GAAP”) when contained in the filings of foreign private issuers with the Commission. Please refer to our Firm’s separate alert memo on this matter issued on June 20, 2007: SEC Proposes to Eliminate US GAAP Reconciliation for IFRS Financial Statements.
• Unanimously voted to adopt amendments to the proxy rules under the Securities Exchange Act of 1934 to require issuers and other soliciting persons to post their proxy materials on an Internet website and provide shareholders with a notice of the Internet availability of the materials. The issuer or soliciting person may also choose to furnish paper copies of the proxy materials along with the notice. If the issuer or soliciting person chooses not to furnish a paper copy of the proxy materials along with the notice, a shareholder may request delivery of a copy at no charge to the shareholder. Please refer to our Firm’s separate alert memo on this matter issued on June 21, 2007: SEC Adopts Mandatory E-Proxy Rules; Phase-In Starts with Large Accelerated Filers.

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The summary above is based on remarks at the Open Meeting; the Commission’s full release, including the text of the proposed amendments to Rule 105, is not yet available. The webcast of the Open Meeting may be found at http://sec.gov/news/openmeetings.shtml.

Please feel free to contact any of your regular contacts at the firm or any of our partners and counsel listed under Capital Markets in the “Our Practice” section of this website if you have any questions.

CLEARY GOTTLIEB STEEN & HAMILTON LLP