— Segregated account managers may participate for accounts other than an account that has been sold short during the limited period. There must be real accounting segregation. Advisors must be willing to demonstrate that the accounts have: separate investment and trading strategies and objectives, separate staff who do not coordinate transactions, information barriers between accounts, separate profit and loss accounts for each account, and no allocation of securities between accounts. Advisors must train all investment professionals and inform them of the rule. Investors may purchase an amount of shares at least equal to the total amount of the restricted short sale. Purchases must be made after the investor`s last restricted short sale during normal trading hours and no later than the business day preceding the pricing of the offer. (2) Segregated accounts. Subparagraph (a) of this Article shall not prohibit the purchase of collateral offered in an account of a person if that person has been sold overdrawn in a segregated account during the blocking period provided for in Rule 105, if decisions relating to investment transactions are taken separately for each account and without coordination of operations or cooperation between accounts. Rule 105 prohibits the sale of such a security within five business days “preceding the price” of an offer and the subsequent purchase of securities by means of that offer.
The practical result of the rule is that a fund can sell or participate in the offer shortly before the offer (during the lock-up period), but cannot do both, with some exceptions. The rule prohibits the purchase of tracked and secondary securities if the buyer has made a short sale on the same security. The time window covered by the rule is the lesser of the five trading days or, less frequently, the number of days between the first submission of the registration statement and the bid price. A violation of Rule 105 does not require any intention on the part of the short seller to engage in a prohibited transaction. The violation occurs if the short sale is carried out within the restricted five-day window and the investor then buys shares of the same security in the offer. If, for any reason, a short sale that is the subject of an offer is made, the investor need only refrain from purchasing shares of the offer or invoke an exemption to comply with the rule. Short selling alone safely during the window is not a violation. (3) Investment companies. Paragraph (a) of this Section shall not prohibit an investment company (within the meaning of Article 3 of the Law on Investment Companies) registered under Article 8 of the Law on Investment Companies or such a company (investment company) from purchasing an offered security if one of the following persons sold the security offered short during the lock-up period under Rule 105: (a) Unlawful acts. In connection with an offer of equity securities in cash pursuant to a registration statement or notification on Form 1-A (Section 239.90 of this Chapter) or Form 1-E (Section 239.200 of this Chapter) filed under the Securities Act of 1933 (“Offered Securities”), it is unlawful for any person to sell the security being offered and purchase the securities offered from a underwriter.
or dealer participating in the offer if such a short sale was made during the shorter period (“Rule 105 Lock-up Period”): The court rejected the SEC`s argument that the previous short sale of NYSE-listed stocks meant that the rule applied (here). Rather, the Court concluded that the “primary purpose” of Rule 105 is “the purchase of offered shares,” which in this case occurred in Canada, such that the offer was “entirely foreign.” The SEC implemented Rule 105 to protect the “pricing mechanism independent of the securities market so that bid prices result from natural forces of supply and demand” and not from market manipulation.  Prior to 2007, the rule prohibited investors from using shares purchased in a public offering to cover a short sale during the lock-up period. In 2007, the SEC amended the rule to create a general prohibition on buying securities in an offering that were short-sold during the lockout period. This clear rule was intended to prevent attempts to conceal business structures that circumvented the previous version of the rule. Rule 105 prohibits the purchase of securities in a binding take-over bid if a short sale of those securities has been made for a limited period of time (whether or not the company holds a long-term economic position), generally defined as five business days before the offer price.  A short sale is defined as “any sale of a security not owned by the seller, or any sale made by the delivery of a security borrowed by or on behalf of the seller.  In the enforcement actions announced last week, the SEC asserted that each company violated Rule 105 by first short selling securities during the lock-up period between 2008 and 2013 and then purchasing the same securities from an underwriter, broker or dealer in a subsequent public offering.
 Enforcement actions apply to registered investment advisers, asset managers, registered dealers and trading firms. All but one of the companies have reached a settlement with the SEC. (A) a quantity at least equivalent to the total amount of the short sale under Rule 105 for short selling; Risk and hedging account management staff “had the ability to review the portfolio holdings and trading activities of each PM group through Millennium`s proprietary order entry and portfolio management system, and also had the authority to determine the trading strategies executed in corporate accounts,” the SEC said. As a result, the corporation`s accounts were not covered by the segregated accounts exception in Rule 105. Thus, if one of the company`s accounts short-circuited a security during the Rule 105 lock-up period, the rule prohibited any PM group from purchasing that security as part of the secondary offer. (D) made after the last short sale in accordance with Rule 105 and no later than the business day preceding the date of price fixing; and Rule 105 aims to curb market manipulation that can artificially reduce the value of a repeat or secondary offer. The rule prohibits investors from buying a security from underwriters and other participants in an offer if they have short-sold the shares for a limited period of time. The lock-up period is the shorter of the following two periods: The final chapter of our practical guide to regulating hedge fund trading activities has been published. Chapter 5: Rule 105 of Regulation M and the Takeover bid Rules summarizes how the rule works, past enforcement actions, and provides a forecast of the SEC`s current approach. The ways in which hedge fund investments may inadvertently violate Rule 105 are discussed and what a hedge fund should do if this happens. The rule applies only to subscribed offers of equity securities registered with the SEC.
It does not apply to offers exempt from registration, i.e. Reg D (here), Rule 144A (here), registered direct offers or PIPE offers, which often contain their own specific trading prohibitions that are unique to each individual offer. Exceptions may also apply to international offers. How does Regulation 105 of Regulation M work? The SEC adopted Rule 105 to prevent manipulation in the pricing of a registered public offering of equity securities. The concern is that short selling just before the price could artificially lower the asking price. Therefore, the rule focuses on limiting short selling during a period of “lock-in” before pricing. Specifically, the rule only applies in the following circumstances: some advisors have taken note and put safeguards in place, and the number of violations appears to be decreasing each year since the risk warning. Yet some consultants continue to stumble upon the rule. Since launching its Rule 105 sweeps in 2013, the SEC has launched dozens of enforcement actions for alleged rule violations. The vast majority have settled.
Very few have chosen to challenge Rule 105 applications in the Federal Court. One such case, filed by the SEC in January 2014, was recently dismissed in the Southern District of New York. What connects these two unrelated sets of rules? Both are known to unknowingly pour funds into technical violations, and both are practice areas where the SEC is known to act on unintentional technical violations. Rule 105 of Regulation M (here) is an anti-fraud provision contained in Regulation M pursuant to Section 10(b) of the Securities Exchange Act of 1934 (here). The rule is intended to restrict trading activities that pay on an issuer`s share price and cause a company to receive fewer offers than normal market conditions would dictate.