Cashless Option Exercises Through a Broker by Employees of Financial Institutions Must Be Suspended Under Last Week's SEC Order Prohibiting Short Sales of Stocks of Financial Institutions

24 September 2008 Publication
Author(s): Patrick D. Daugherty Michael B. Kirwan

Legal News Alert: Transactional & Securities

One of the unintended consequences of last week’s emergency order prohibiting short sales of stocks of financial institutions is to prevent employees and other participants in stock option plans of these financial institutions from exercising stock options in cashless exercises through a broker. Unless the emergency order is amended, participants in stock option plans of financial institutions designated by the securities exchanges may not effect cashless option exercises in the open market through the end of the day on October 2, 2008, when the order will expire (unless the U.S. Securities and Exchange Commission (SEC) decides to extend it).

To help restore investor confidence, the SEC issued an emergency order on September 18, 2008 prohibiting short sales of the stocks of 799 financial institutions.1 Three days later, the SEC amended the order to make the securities exchanges responsible for designating the financial institutions whose stock is subject to the short-sale prohibitions.2 None of the limited exceptions in the original order or the September 21, 2008 amendment permits cashless option exercises.

In a cashless exercise through a broker, the issuer agrees to deliver the stock issuable upon exercise of the employee stock option to the broker, and the broker agrees to deliver the exercise price and withholding taxes to the issuer out of the proceeds from the short sale of the shares. The employee borrows shares for the short sale, and the issuer delivers the shares underlying the exercised option to enable the employee to close out the short position.

A short sale within the emergency order’s prohibitions is defined as a sale of a security that the seller does not own, or a sale that is consummated by the delivery of a security borrowed by or for the account of the seller.3 Short sales effected as part of a cashless option exercise fall within this definition.

The NYSE’s list of financial institutions whose stock may not be shorted while the SEC order is in effect may be found at NASDAQ’s list of financial institutions whose stock is subject to the prohibition may be found at

Provided that their stock option plans so permit, financial institutions on these lists may facilitate the exercise of employee stock options by accepting pre-existing shares in payment of the option exercise price, or by permitting net exercises in which the number of shares issued on exercise of the options is reduced to take account of the exercise price and withholding taxes.

The SEC adopted the emergency order prohibiting short sales of financial institution stock under statutory authority that permits emergency restrictions for up to 10 business days without prior notice and a public comment period. We understand that the SEC is looking at the issue of cashless option exercises for financial institution stock. Foley is participating in an American Bar Association subcommittee initiative that will submit comments on the emergency order. Please contact us if you have any comments or data that you would like the subcommittee to consider in its submission to the SEC.


Legal News Alert is part of our ongoing commitment to providing up-to-the-minute information about pressing concerns or industry issues affecting our clients and colleagues.

If you have any questions about this alert or would like to discuss the topic further, please contact your Foley attorney or the following individuals:

George T. Simon
Chicago, Illinois

Linda Y. Kelso
Jacksonville, Florida

Patrick D. Daugherty
Detroit, Michigan

Michael B. Kirwan
Jacksonville, Florida

2 The order also permits the securities exchanges to allow financial institutions to opt out of the prohibition upon their request.

3 at note 3 and Rule 200(a) of Regulation SHO.

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