MFA Recommends Reforms to Short Selling Regulations
The Managed Funds Association ("MFA") urged the SEC to revise Rule 105 of Regulation M ("Short selling in connection with a public offering") to curb unintended barriers to capital formation.
In a follow-up letter to recommendations sent to SEC Chair Paul Atkins in May, the MFA explained that Rule 105 was designed to prevent manipulative short selling by barring investors who sell short during a "restricted period" from later buying in the offering. The MFA argued that while Rule 105 is meant to safeguard pricing integrity, its current application discourages participation by (i) disqualifying investors for short sales made even before an offering is announced, (ii) applying vague and inconsistently enforced exceptions such as the Bona Fide Purchase and Separate Account provisions, and (iii) imposing strict liability and expansive disgorgement penalties that can be disproportionate to the conduct. The MFA warned that these flaws have deterred institutional capital, reduced participation in offerings, and ultimately constrained issuers’ ability to raise funds.
The MFA recommended:
- Redefining the restricted period: The MFA urged the SEC to start the restricted period at the public announcement of an offering, rather than capturing short sales made days earlier when investors could not know a deal was imminent. The association argued that this change would align the rule with its original intent and avoid penalizing unrelated trading activity.
- Clarifying exceptions: The MFA requested clearer guidance on the Bona Fide Purchase and Separate Account exceptions, noting that vague standards and inconsistent enforcement have made it difficult for investment managers to rely on them. The association stressed that greater certainty is needed so that technical missteps do not disqualify legitimate participation in offerings.
- Reconsidering enforcement and disgorgement: The MFA criticized the SEC’s strict liability approach and expansive disgorgement calculations, which it said often exaggerate gains and impose penalties disproportionate to actual conduct. The association recommended tailoring enforcement to focus on intentional misconduct and recalibrating remedies to reflect genuine profits derived from violations.
The MFA said that revising Rule 105 would maintain safeguards against manipulative short selling while boosting investor participation, thereby strengthening efficiency, competition, and capital formation.