SEC Regulation M

Regulation M is a set of rules created by the SEC to prevent price manipulation during securities offerings. These rules apply when companies or other parties are selling securities to the public. The regulation creates specific restrictions on trading activities that could artificially inflate or manipulate a security's price during the offering process.

For hedge funds, Regulation M becomes important when they participate in , , or other distribution activities. This is especially true when a hedge fund might play multiple roles in a transaction or have conflicting interests.

The regulation prohibits certain parties from buying, bidding for, or encouraging others to buy securities during specific "restricted periods." These parties include the company issuing the securities, existing shareholders who are selling shares, and other participants in the distribution process.

The goal is to prevent artificial price support during the offering. Without these rules, participants could manipulate the market price to make their offering more attractive or profitable.

The length of the restricted period depends on several factors. For securities with higher trading volumes and larger , the restricted period typically begins one business day before pricing. For securities with lower volumes or smaller public floats, the restricted period starts five business days before pricing.

Rule 105 is a particularly important part of Regulation M that focuses on . This rule prohibits a specific manipulative strategy where someone might short sell a security during the restricted period and then purchase shares in the offering to cover their .

Here's why this matters: without Rule 105, someone could artificially depress a security's price by short selling it right before or during an offering. Then, they could cover their short position by buying shares at the lower . This would give them an unfair profit while manipulating the market.

When the SEC discovers Rule 105 violations, they can impose both civil and criminal penalties. These penalties often include monetary fines and requiring violators to give up any profits they made from the prohibited conduct. The SEC typically calculates penalties based on the economic benefit gained from the manipulation, often focusing on the price difference between the market price and offering price multiplied by the number of shares involved.

Hedge funds must be especially careful when they have positions in securities that are subject to Regulation M restrictions. This becomes complex when funds deal with , , or when they serve as both an investor and a participant in the distribution process.

Successful compliance requires close coordination between a fund's trading desk and compliance team. They must ensure that all trading activities follow the restricted period limitations. Even accidental violations can result in significant regulatory penalties and damage to the fund's reputation.

Hedge funds should establish clear procedures for identifying when securities in their portfolios become subject to Regulation M restrictions. They should also implement systems to prevent inadvertent trading violations during restricted periods.