Question 1

What is Regulation M, and what does it govern?

Accepted Answer

Regulation M (17 CFR 242.100 through 242.105) is the SEC's anti-manipulation rule set governing the activities of underwriters, issuers, selling security holders, and other distribution participants during a securities distribution, including an initial public offering. Its purpose is to prevent those with an interest in a distribution from artificially influencing the market price of the security being offered. Regulation M was adopted by the SEC in its release 'Anti-Manipulation Rules Concerning Securities Offerings,' 62 FR 520 (January 3, 1997). The preliminary note to Rule 100 (17 CFR 242.100(a)) states that any transaction or series of transactions, whether or not effected pursuant to Regulation M, remains subject to the antifraud and antimanipulation provisions of the securities laws, including Section 17(a) of the Securities Act of 1933 (15 U.S.C. 77q(a)) and Sections 9, 10(b), and 15(c) of the Securities Exchange Act of 1934 (15 U.S.C. 78i, 78j(b), and 78o(c)). Regulation M contains six rules: Rule 100 (definitions), Rule 101 (distribution participants), Rule 102 (issuers and selling security holders), Rule 103 (Nasdaq passive market making), Rule 104 (stabilizing and other activities), and Rule 105 (short selling in connection with a public offering).

Question 2

What is 'stabilizing' under Regulation M, and is it permitted?

Accepted Answer

Rule 100 (17 CFR 242.100) defines 'stabilize' or 'stabilizing' as the placing of any bid, or the effecting of any purchase, for the purpose of pegging, fixing, or maintaining the price of a security. Under Rule 104(b) (17 CFR 242.104(b)), stabilizing is prohibited except for the purpose of preventing or retarding a decline in the market price of a security. Stabilizing is the single, narrowly defined circumstance in which Regulation M permits a person with an interest in a distribution to enter a bid intended to affect the security's price. Rule 104(a) makes it unlawful to stabilize, to effect any syndicate covering transaction, or to impose a penalty bid in connection with an offering in contravention of the section, and provides that no stabilizing shall be effected at a price the person stabilizing knows or has reason to know is in contravention of the rule or is the result of activity that is fraudulent, manipulative, or deceptive under the securities laws. Regulation M was adopted in 62 FR 520 (January 3, 1997), and Rule 104 has since been amended, most recently in 2013 (per the section's source credit, 78 FR 44805, July 24, 2013).

Question 3

What price limits apply to a stabilizing bid?

Accepted Answer

Rule 104(f)(1) (17 CFR 242.104(f)(1)) provides that no stabilizing shall be made at a price higher than the lower of the offering price or the stabilizing bid for the security in the principal market (or, if the principal market is closed, the stabilizing bid in the principal market at its previous close). Additional limits govern the price at which stabilizing may be initiated, tied to the last independent transaction price or the highest current independent bid in the principal market. Under Rule 104(f)(2), when the principal market is open, stabilizing may be initiated at a price no higher than the last independent transaction price if the security has traded that day or on the most recent prior trading day and the current asked price is at least the last independent transaction price; otherwise, stabilizing may be initiated at a price no higher than the highest current independent bid. Rule 104(c) requires a person stabilizing to grant priority to any independent bid at the same price. Rule 104(d) provides that no sole distributor or syndicate stabilizing a price may maintain more than one stabilizing bid in any one market at the same price at the same time. Rule 104(e) prohibits stabilizing in an at-the-market offering, which Rule 100 defines as an offering of securities at other than a fixed price.

Question 4

How does stabilizing differ from unlawful manipulation?

Accepted Answer

Stabilizing is a bid or purchase made for the single permitted purpose of preventing or retarding a decline in the market price, at or below the offering price, subject to price caps, disclosure, and notification requirements under Rule 104. Manipulation is the artificial influencing of a security's price outside those limits and remains prohibited under the antifraud and antimanipulation provisions of the securities laws. Rule 104(a) (17 CFR 242.104(a)) provides that no stabilizing shall be effected at a price the person stabilizing knows or has reason to know is in contravention of the rule, or is the result of activity that is fraudulent, manipulative, or deceptive. The preliminary note to Rule 100 (17 CFR 242.100(a)) confirms that any transaction, whether or not effected pursuant to Regulation M, remains subject to Section 17(a) of the Securities Act and Sections 9, 10(b), and 15(c) of the Securities Exchange Act. The distinction is one of purpose and constraint: stabilizing may only prevent or retard a decline (Rule 104(b)), may not exceed the lower of the offering price or the principal-market stabilizing bid (Rule 104(f)(1)), and must be disclosed and notified (Rule 104(h)); activity outside those bounds is not stabilizing but manipulation.

Question 5

What is the 'restricted period,' and who is subject to it?

Accepted Answer

The restricted period is the window, defined in Rule 100 (17 CFR 242.100), during which Rules 101 and 102 prohibit specified persons from bidding for or purchasing the security being distributed. Rule 101 applies to distribution participants and their affiliated purchasers; Rule 102 applies to the issuer, selling security holders, and their affiliated purchasers. Rule 100 defines the restricted period in two tiers: for a security with an ADTV (average daily trading volume) value of $100,000 or more of an issuer whose common equity securities have a public float value of $25 million or more, the period begins on the later of one business day before the determination of the offering price or the time a person becomes a distribution participant, and ends upon completion of participation in the distribution; for all other securities, it begins five business days before pricing (or when the person becomes a participant, whichever is later). In a distribution involving a merger, acquisition, or exchange offer, the period begins when proxy solicitation or offering materials are first disseminated. Because a company conducting its IPO has no established ADTV or public float in the security before the offering, an IPO of common stock falls in the five-business-day tier.

Question 6

What does Rule 101 prohibit for distribution participants?

Accepted Answer

Rule 101(a) (17 CFR 242.101(a)) makes it unlawful for a distribution participant or an affiliated purchaser, directly or indirectly, to bid for, purchase, or attempt to induce any person to bid for or purchase, a covered security during the applicable restricted period. A distribution participant is defined in Rule 100 as an underwriter, prospective underwriter, broker, dealer, or other person who has agreed to participate or is participating in a distribution. Rule 101(b) sets out excepted activities that are not prohibited, including: the publication of research meeting Rules 138, 139, or 139b; transactions complying with Rule 103 (passive market making) or Rule 104 (stabilizing); odd-lot transactions; exercises of options, warrants, rights, or conversion privileges; unsolicited brokerage transactions and certain unsolicited purchases; qualifying basket transactions involving 20 or more securities where the covered security is no more than 5% of the basket's value; de minimis purchases totaling less than 2% of the security's ADTV by a participant that maintains and enforces written compliance policies; and certain transactions among distribution participants. If a distribution participant or affiliated purchaser is itself the issuer or a selling security holder, it is subject to Rule 102 rather than Rule 101.

Question 7

What does Rule 102 prohibit for issuers and selling security holders?

Accepted Answer

Rule 102(a) (17 CFR 242.102(a)) makes it unlawful, in connection with a distribution effected by or on behalf of an issuer or selling security holder, for that person or any affiliated purchaser, directly or indirectly, to bid for, purchase, or attempt to induce any person to bid for or purchase, a covered security during the applicable restricted period. Rule 102 mirrors the core prohibition of Rule 101 but applies to the parties on whose behalf the distribution is made rather than to the underwriters and dealers marketing it. Its excepted activities are narrower: Rule 102(b) covers odd-lot transactions; certain transactions by closed-end investment companies; redemptions by commodity pools or limited partnerships at net asset value; exercises of options, warrants, rights, or conversion privileges; offers to sell or solicitations to buy the securities being distributed; unsolicited purchases not effected through a broker, dealer, exchange, inter-dealer quotation system, or electronic communications network; and certain Rule 144A transactions. Separately, Rule 102(c) exempts distributions of securities under a plan effected by an agent independent of the issuer, as defined in Rule 100. Rule 102 does not include Rule 101's research and de minimis exceptions.

Question 8

Which securities are exempt from Rule 101 — the 'actively-traded' and ADTV exceptions?

Accepted Answer

Rule 101(c)(1) (17 CFR 242.101(c)(1)) excepts 'actively-traded securities' from Rule 101 — securities with an ADTV value of at least $1 million that are issued by an issuer whose common equity securities have a public float value of at least $150 million, provided the securities are not issued by the distribution participant or an affiliate. Rule 101(c)(2) separately excepts certain nonconvertible debt and nonconvertible preferred securities — of issuers whose probability of default is 0.055% or less over the following 12 full calendar months, as determined and documented in writing by the lead-manager distribution participant from a structural credit risk model — and asset-backed securities offered on an effective Form SF-3 shelf registration statement. Rule 100 defines ADTV as the worldwide average daily trading volume during the two full calendar months (or any 60 consecutive calendar days ending within the 10 calendar days) preceding the filing of the registration statement or the determination of the offering price. Because these thresholds require an established trading market and public float, a company's common stock in its initial public offering does not qualify as an actively-traded security, so the Rule 101 and 102 restricted-period prohibitions apply to an IPO. A 'covered security' is defined in Rule 100 as any security that is the subject of a distribution or any reference security; the exceptions turn on the characteristics of the security actually being distributed.

Question 9

What is a syndicate covering transaction, and what is a penalty bid?

Accepted Answer

Rule 100 (17 CFR 242.100) defines a syndicate covering transaction as the placing of any bid or the effecting of any purchase on behalf of the sole distributor or the underwriting syndicate or group to reduce a short position created in connection with the offering. A penalty bid is defined as an arrangement that permits the managing underwriter to reclaim a selling concession from a syndicate member when the securities the member originally sold are purchased in syndicate covering transactions. A syndicate short position typically arises when underwriters allocate more shares than the base offering (an over-allotment); Rule 100's definition of 'completion of participation in a distribution' addresses the case in which a syndicate over-allotment option is exercised in an amount that exceeds the net syndicate short position at the time of exercise. Rule 104(a) makes it unlawful to effect a syndicate covering transaction or to impose a penalty bid in contravention of the section, and Rule 104(h)(2) requires any person effecting a syndicate covering transaction or imposing a penalty bid to provide prior notice to the self-regulatory organization with direct authority over the principal market in the United States for the security.

Question 10

What is passive market making under Rule 103?

Accepted Answer

Rule 103 (17 CFR 242.103) permits a broker-dealer to make a market in a covered security that is a Nasdaq security during the restricted period, on stated conditions, without violating Rule 101. It does not apply to any security for which a stabilizing bid subject to Rule 104 is in effect, or during any at-the-market offering or best-efforts offering. Under Rule 103(b), a passive market maker must effect all transactions as a registered market maker on Nasdaq and may not bid for or purchase the covered security at a price exceeding the highest independent bid at the time of the transaction (subject to limited exceptions). On each day of the restricted period, a passive market maker's net purchases may not exceed the greater of its 30% ADTV limitation or 200 shares; if that limit is reached or exceeded, it must promptly withdraw its quotations and may not effect any further bid or purchase in the security that day. Rule 100 defines a passive market maker as a market maker that effects bids or purchases in accordance with Rule 103.

Question 11

What must the prospectus disclose about stabilization and syndicate activity?

Accepted Answer

Item 508(l) of Regulation S-K (17 CFR 229.508(l)) requires the plan of distribution to briefly describe any transaction the underwriter intends to conduct during the offering that stabilizes, maintains, or otherwise affects the market price of the offered securities — including stabilizing transactions, syndicate short covering transactions, and penalty bids — and to explain how those transactions affect the price and identify the exchange or market on which they may occur. Item 508(l) further requires that, if stabilizing began before the effective date of the registration statement, the prospectus disclose the amount of securities bought, the prices, and the period; and, if true, that the underwriter may discontinue the transactions at any time. Item 508(k) (17 CFR 229.508(k)) requires disclosure where underwriters or selling group members intend to engage in passive market making transactions permitted by Rule 103. Separately, Rule 104(h) (17 CFR 242.104(h)) imposes market and self-regulatory-organization notification duties: prior notice to the market on which stabilizing will be effected and disclosure of purpose to the counterparty (104(h)(1)); prior notice to the relevant SRO for syndicate covering transactions and penalty bids (104(h)(2)); and delivery to purchasers, at or before completion of a transaction where the price may be or has been stabilized, of a document containing a prescribed stabilization statement (104(h)(3)).

Question 12

What is Rule 105, and how does it relate to a public offering?

Accepted Answer

Rule 105 (17 CFR 242.105) addresses short selling in connection with a public offering. It makes it unlawful, in connection with an offering of equity securities for cash under a registration statement (or a Form 1-A or Form 1-E notification), to sell short the security that is the subject of the offering during the Rule 105 restricted period and then purchase the offered securities from an underwriter or a broker or dealer participating in the offering. The Rule 105 restricted period is the shorter of the period beginning five business days before the pricing of the offered securities and ending with the pricing, or the period beginning with the initial filing of the registration statement or notification and ending with the pricing. Rule 105(b) provides a bona fide purchase exception: the prohibition does not apply if the person makes a bona fide purchase of the subject security at least equal in quantity to the entire restricted-period short sale, effected during regular trading hours, reported to an effective transaction reporting plan, and completed after the last restricted-period short sale and no later than the business day before pricing, subject to the additional conditions in the rule. Rule 105 is a short-selling restriction and operates independently of the stabilizing, syndicate covering, and penalty bid provisions of Rule 104.

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Stabilization and Syndicate Activity