We wrote last Wednesday about the rules adopted by the SEC governing short sales (not the complete ban but the rules imposing consequences for failed delivery and making it an antifraud provision to lie about having arranged for shares to cover a short position) and suggested that they may have violated the APA. This view was incorrect.

The interpretation came from reading the SEC's press release (the adopting release hadn't been published) and the belief that the SEC was adopting the rules through traditional rulemaking authority. The press release, for example, noted that at the end of 30 days, the “Commission expects to follow further rulemaking procedures at the expiration of the comment period."

But in fact we have come to learn from Broc Romanek at TheCorporateCounsel.net Blog (and a comment from the former Secretary of the SEC) that the rules were adopted not under the APA but under the emergency authority in Section 12(k)(2), something made clear by the implementing release. As Broc notes:

• I think the discrepancy can be explained - there likely was a shift in the SEC's thinking between the time of issuance of the press release and the later issuance of the emergency order, when the SEC decided to issue its new rules in the form of an emergency order from interim final rules, probably due to the fact that they just didn't have the time to crank out a full-blown release. The whole thing happened very quickly.

The APA does not apply to orders issued under Section 12(k)(2). As a result, the order would not be subject to the requirement of notice and comment. See 15 USCS § 78l(k)(2)(E)(exempting orders from requirements of 5 USC 553). Adoption of the rules could not, therefore, violate the APA.

The very decision to sidestep the APA, however, raises questions. The provisions adopted by the Commission were adopted pursuant to emergency authority. But the provisions were routine in nature and unlikely to have had a significant impact on activities in the market. The adopting release provided little immediate justification for the rules (a concern that naked short selling can harm the markets) or much of an explanation of how the rule would have improved market stability. In other words, while there may have been genuine concern over naked short selling (as there has been since at least the summer), there was no immediate reason to act, no immediate reason to sidestep the traditional rulemaking process in the APA. The APA allows for immediate implementation of a rule, without notice and comment, for good cause but requires an explanation of good cause in the release. By using Section 12(k)(2) rather than the APA, the SEC sidestepped the need to provide this explanation.

The order suggests that these same requirements will eventually be subject to rulemaking under the APA. The press release states that the SEC is seeking comment and intends to follow "further rulemaking procedures" with respect to the rules. In other words, the SEC appears to have used its authority in Section 12(k)(2) not to quell an emergency but to advance a substantive rulemaking agenda while avoiding the APA.

The authority in Section 12(k)(2) is quite broad. But there is nothing in the legislative history of Section 12(k)(2) that suggests that it was meant as a substitute for the APA. The authority was meant to be used to provide short term solutions to unusual market congressional examination.