Rule 105

Rule 105 of Regulation M under the Securities Exchange Act of 1934 generally prohibits buying shares in a secondary offering if the buyer has shorted the securities within the restricted period (usually the 5 days before the pricing of the offering). It is designed to prevent people from manipulating the price of secondary offerings by shorting the securities being offered shortly before the secondary offering is priced.

It seeks to prevent this activity by making it illegal to buy shares in the offering if the buyer has sold the securities short during the shorter of either:

1. the five days preceding the pricing of the offering, or
2. the time between the prospectus being declared effective and the pricing. This period is called the restricted period. Because of the way most offerings happen, the five day period is usually the most relevant.

Note the change from the previous version of the rule, which prohibited using the shares bought in the offering to cover a short established during the restricted period. The current version goes farther than this, flatly prohibiting the short seller from participating in a secondary offering.

The Rule does, however, provide three separate and distinct exceptions that permit participation in the offering, even if the buyer had shorted during the restricted period:

• The “bona fide” purchase exception, perhaps the most relevant, allows for participation in a secondary offering, provided the short seller makes a purchase equivalent in quantity to the amount of the restricted period short sale(s) and this purchase occurred no later than the day prior to pricing, was printed on the tape, AND happened after the last restricted period short sale.

• The “separate accounts” exception allows a buyer to purchase shares in a secondary offering in one account if the short sales occurred in a separate account and decisions regarding securities transactions for each account were independently made, without coordination of trading or cooperation among the accounts.

• The “investment companies” exception states that an individual fund within a fund complex, or a series of a fund, is permitted to purchase shares in a secondary offering if another fund within the same complex or a different series of the fund sold short during the restricted period.

Additional information relating at the SEC’s website and at the Securities Industry and Financial Markets Association’s website.