As part of their commitment to transparency, the SEC adopted new rules in 2023 regarding short sales. As a reminder, a short sale is when an investor attempts to make money from a stock, they expect to sell by borrowing shares in advance. They sell the borrowed shares, wait for the price to fall, buy shares at the new low price and return what they borrowed, netting a profit. This strategy can be risky. However, it does have a place in the market. There are two key parts to the SEC short sale role — Rule 13f-2 and Form SHO. Keep reading to learn more about these new SEC short selling rules and their impact on investors.
What Is SEC Form SHO?
Form SHO is a form that managers must file with the SEC if they meet certain requirements around short selling. Let's look at what type of information the SHO requires and how it maintains fair trading markets.
The SHO form was first introduced by the SEC in 2005 to curtail short sale abuses such as naked shorting. In a naked shorting trade, an investor attempts to short shares they may not have, without any confirmation of possession required to trade.
A naked short is problematic because it attempts to manipulate the stock market. By pretending to trade shares, they may not own, naked short sellers distort the true picture of supply and demand in a market that is responding in real time. Stock prices could tumble or soar in response to what may in fact be false information, which is a form of manipulation.
In a scenario where prices act counter to the short seller's expectations, there could be a ripple effect throughout the market. Consider the level of volatility meme stocks brought to the market for one example of the potential harm that could ensue when a short position gets out of hand, or the market does not respond as the short seller anticipated.
For these reasons, the SHO Regulation — for which the form is named — was developed to protect market integrity. SHO set specific "locate" and "close-out" requirements to stop naked shorting, which requires:
- Brokers to have a belief that they can obtain and deliver the stock they're shorting ("locate") in advance of the short
- Brokers to follow all delivery requirements when closing out a position ("close out")
- If certain conditions occur for five consecutive days, the broker must report them to the SEC
Firms have until the 14th day of the following month to file a SHO for the preceding month.
What Is SEC Rule 13f-2?
SEC Rule 13f-2 requires investment managers to report short positions taken using Form SHO, provided they meet a threshold. The threshold for reporting short positions is at least $100 million — meaning $100 million in short positions, not $100 million in assets under management.
Rule 13f-2 runs on a calendar month time frame. So, if the manager reaches $10 million or greater in average gross short position over the calendar month, they will be required to file a SHO. They will also be required to file a SHO if their average gross short position for the month as a percentage of outstanding shares in a given equity is greater than 2.5 percent.
Managers don't just report this activity for themselves, they are required to report on any person under their control who handles investments. This information is given to the SEC, which then publishes some information in aggregate, making it available to investors.
Because the data is aggregated, investors cannot see which investment manager had which positions. However, the data will help them to understand the total of short activity and which equities are being shorted. This is in addition to data investors can already access on the exchanges.
The SEC also tracks trends, with the goal of monitoring potential market risks associated with holding large short positions. The risks of shorting stocks are discussed in the following section for those who may be unaware of the possible downsides of this type of trade.
Why These Regulations Matter for Market Transparency
The SEC developed these new rules for short selling to protect against price manipulations, such as the naked shorting strategy discussed above, and to protect investors.
Rules like these target large institutional short sellers that specialize in shorting stocks, not individual traders who have a hunch that a stock is due for a correction.
From a transparent perspective, a short sale disclosure helps everyday investors better understand short sale activity in the market. It aims to prevent the sort of heavy losses seen in the meme stock trend.
The 13f-2 final rule makes the market more stable and balanced, while potentially hedging off volatility and acting as a stabilizing force.
Challenges and Criticisms of Form SHO and Rule 13f-2
Critics of the SEC short selling disclosure point to the regulatory burden of institutional investors on complying. They believe it takes too much time and effort to file the required number of reports, particularly under Rule 13f-2.
Hedge fund managers have suggested the 13f-2 final rule penalizes them by potentially revealing their strategies to competitors when they're forced to file a SHO form. They worry that legitimate short selling activity will be curbed out of a disinterest in keeping up with the paperwork. They believe the market could become less liquid, meaning that it would take longer for shares to trade.
Were the market to become less liquid, investors could be harmed by not being able to open or close a position at the correct time. However, the hedge fund managers' concerns seem overblown for now. Traders are still able to buy, sell and even short with ease.
For the naysayers pointing to the administrative burden of SHO compliance, SEC filing software that streamlines financial reporting can reduce the workload and improve efficiency.
Best Practices for Compliance with Form SHO and Rule 13f-2
Criticisms notwithstanding, neither Form SHO nor Rule 13f-2 is going anywhere. Those who don't like it have no choice but to comply — or change their trading strategy to reduce shorting activity below the threshold that triggers the SHO regulation.
Regulatory experts can help advisors track information, manage compliance proactively and avoid penalties associated with missing a filing deadline.
They can walk firms through the nuts and bolts associated with these filings. For example, if a stock is dual listed, the institution may hold the stock across different markets. A stock that appears to be under the threshold could in fact be over it, were the dual listing aspect overlooked. Knowing ahead of time where curveballs lie, experts can help firms understand their obligations and set up reporting systems that work for them — not make their jobs more challenging.
Experts can also help when it comes to preparing filings. Streamlining processes as much as possible will reduce the amount of time it takes to file and ease the burden of compliance.
The Future of Short Selling Regulations
As the market continues to evolve, the SEC may well expand the short selling regulations to ensure market fairness is maintained. The SEC may be willing to make use of blockchain and other emergent technologies to track and report on short sales and maintain transparency. While the future of short selling will continue to evolve, right now firms need to understand how Form SHO and Rule 13f-2 impact them and implement solutions for filing.
As a leader in proxy statement solutions, DFIN is poised to help with the preparation and filing of all SEC forms, including the SHO. DFIN's signature software uses artificial intelligence to gather, sort and organize information, verify completion and check for errors before filing.
Secure, encrypted transmission makes it simple to keep up with filing deadlines, while spending more time focusing on mission-critical tasks.
