Series 14: 6.1.7.5. Restrictions On Short Selling Prior To Pricing

6.1.7.5. Restrictions on Short Selling Prior to Pricing

Recall from Chapter 2’s discussion of short selling that in a typical short sale, the short seller borrows shares and then sells them, hoping that the price drops before he must buy shares on the secondary market to return to the lender. In the case of a follow-on offering for a class of securities already in circulation, it is possible for a short seller to borrow and sell existing shares, but then purchase and return the newly offered shares.

The SEC became concerned that short selling shortly before a follow-on offering could depress the market for the offered securities. The share prices of follow-on offerings are typically set at a discount to the market price. If a short seller aggressively shorts the security right before the offering, it can depress the market price, causing the offering price to be even lower. A short seller who covers her short position with securities bought in the follow-on offering could then benefit from this artificial price depression. Regulation M, Rule 105, was put into place to restrict this strategy of ma