Stabilization

The underwriters can close out a covered short position by exercising the over-allotment option, in whole or in part, or by purchasing shares in the open market. A bid or purchase on behalf of the syndicate to reduce a short position created in connection with the offering is a syndicate covering transaction. Stabilizing bids, syndicate covering transactions and penalty bids may have the effect of raising or maintaining the market price of a security, or of preventing or retarding a decline in the market price. Rule 104 controls all three activities and allows stabilizing only for the purpose of preventing or retarding a decline.

Where Stabilization Fits in Regulation M

Regulation M contains six sections: Rule 100, Preliminary note and definitions; Rule 101, Activities by distribution participants; Rule 102, Activities by issuers and selling security holders during a distribution; Rule 103, Nasdaq passive market making; Rule 104, Stabilizing and other activities in connection with an offering; and Rule 105, Short selling in connection with a public offering.

Rule 101 provides the general prohibition. In connection with a distribution of securities, it is unlawful for a distribution participant or an affiliated purchaser of such person, 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 that is also the issuer or selling security holder of the securities subject to the distribution is subject to Rule 102 rather than Rule 101. Rule 102 applies the same prohibition to an issuer or selling security holder, and to an affiliated purchaser of such person, in connection with a distribution effected by or on behalf of the issuer or selling security holder.

Rule 101 contains a list of excepted activity. One item on that list is titled Transactions complying with certain other sections, and it covers transactions complying with Rule 103 or Rule 104. Rule 101 refers to a distribution, and Rule 104 refers to an offering of any security.

A distribution is an offering of securities, whether or not subject to registration under the Securities Act of 1933, that is distinguished from ordinary trading transactions by the magnitude of the offering and the presence of special selling efforts and selling methods. A distribution participant is an underwriter, prospective underwriter, broker, dealer, or other person who has agreed to participate or is participating in a distribution. An underwriter is a person who has agreed with an issuer or selling security holder to purchase securities for distribution; to distribute securities for or on behalf of the issuer or selling security holder; or to manage or supervise a distribution of securities for or on behalf of the issuer or selling security holder.

Regulation M does not replace the antifraud and antimanipulation provisions of the securities laws. Any transaction or series of transactions, whether or not effected pursuant to the provisions of Regulation M, remains subject to those provisions, including, without limitation, Section 17(a) of the Securities Act of 1933 and Sections 9, 10(b), and 15(c) of the Securities Exchange Act of 1934.

The Three Activities Rule 104 Controls

Rule 100 sets out the meanings of three related terms. Stabilize or stabilizing means the placing of any bid, or the effecting of any purchase, for the purpose of pegging, fixing, or maintaining the price of a security. A syndicate covering transaction means 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 means an arrangement that permits the managing underwriter to reclaim a selling concession from a syndicate member in connection with an offering when the securities originally sold by the syndicate member are purchased in syndicate covering transactions.

Rule 104 applies to all three. It is unlawful for any person, directly or indirectly, to stabilize, to effect any syndicate covering transaction, or to impose a penalty bid, in connection with an offering of any security, in contravention of the provisions of Rule 104.

Rule 100 also sets out the meanings of terms that Rule 104 uses to set bid prices. The offering price means the price at which the security is to be or is being distributed. The principal market means the single securities market with the largest aggregate reported trading volume for the class of securities during the twelve full calendar months immediately preceding the filing of the registration statement. An independent bid means a bid by a person who is not a distribution participant, issuer, selling security holder, or affiliated purchaser.

The Permitted Purpose

Rule 104(b) limits stabilizing to one purpose. Stabilizing is prohibited except for the purpose of preventing or retarding a decline in the market price of a security. The rule does not permit stabilizing to push a price upward, and it does not permit stabilizing for any other purpose.

Rule 104(a) adds a second limit. No stabilizing shall be effected at a price that the person stabilizing knows or has reason to know is in contravention of Rule 104, or is the result of activity that is fraudulent, manipulative, or deceptive under the securities laws, or any rule or regulation thereunder.

Priority of Independent Bids

Under Rule 104(c), to the extent permitted or required by the market where stabilizing occurs, any person stabilizing must grant priority to any independent bid at the same price, irrespective of the size of the independent bid at the time that it is entered.

Control of Stabilizing

Under Rule 104(d), no sole distributor or syndicate or group stabilizing the price of a security, or any member or members of the syndicate or group, may maintain more than one stabilizing bid in any one market at the same price at the same time.

At-the-Market Offerings

Under Rule 104(e), stabilizing is prohibited in an at-the-market offering.

Stabilizing Levels

Rule 104(f) controls the price of a stabilizing bid. It has eight parts, covering the maximum bid, the start of stabilizing, maintaining or carrying over a bid, increasing or reducing a bid, currency, adjustments, components of units, and special prices.

Maximum Stabilizing Bid

Under Rule 104(f)(1), notwithstanding the other provisions of paragraph (f), no stabilizing may be made at a price higher than the lower of the offering price or the stabilizing bid for the security in the principal market. If the principal market is closed, the limit is the lower of the offering price or the stabilizing bid in the principal market at its previous close.

Initiating Stabilizing

Rule 104(f)(2) ties the price at which stabilizing may start to independent bids and transactions, with a separate rule where no bona fide market exists. It sets out how stabilizing may be initiated in three situations.

When the principal market is open, then after the opening of quotations for the security in the principal market, stabilizing may be initiated in any market at a price no higher than the last independent transaction price for the security in the principal market. That level applies if the security has traded in the principal market on the day stabilizing is initiated or on the most recent prior day of trading in the principal market, and the current asked price in the principal market is equal to or greater than the last independent transaction price. If both conditions are not satisfied, stabilizing may be initiated in any market after the opening of quotations in the principal market at a price no higher than the highest current independent bid for the security in the principal market.

When the principal market is closed, Rule 104(f)(2)(ii) separates two cases. If the principal market is closed but it is immediately before the opening of quotations for the security in the market where stabilizing will be initiated, stabilizing may be initiated at a price no higher than the lower of the price at which stabilizing could have been initiated in the principal market at its previous close, or the most recent price at which an independent transaction in the security has been effected in any market since the close of the principal market, if the person stabilizing knows or has reason to know of the transaction. 

If the principal market is closed but it is after the opening of quotations in the market where stabilizing will be initiated, stabilizing may be initiated at a price no higher than the lower of the price at which stabilization could have been initiated in the principal market at its previous close, or the last independent transaction price for the security in that market if the security has traded in that market on the day stabilizing is initiated or on the last preceding business day and the current asked price in that market is equal to or greater than the last independent transaction price. If both of those conditions are not satisfied, stabilizing may be initiated at a price no higher than the highest current independent bid for the security in that market.

When there is no market for the security, or the offering price has not yet been determined, Rule 104(f)(2)(iii) applies. If no bona fide market for the security being distributed exists at the time stabilizing is initiated, no stabilizing may be initiated at a price in excess of the offering price. If stabilizing is initiated before the offering price is determined, stabilizing may be continued after determination of the offering price at the price at which stabilizing then could be initiated.

Maintaining, Increasing and Reducing a Bid

Under Rule 104(f)(3), a stabilizing bid initiated under paragraph (f)(2) that has not been discontinued may be maintained, or carried over into another market, irrespective of changes in the independent bids or transaction prices for the security.

Under Rule 104(f)(4), a stabilizing bid may be increased to a price no higher than the highest current independent bid for the security in the principal market if the principal market is open. If the principal market is closed, a stabilizing bid may be increased to a price no higher than the highest independent bid in the principal market at the previous close of that market. A stabilizing bid may be reduced, or carried over into another market at a reduced price, irrespective of changes in the independent bids or transaction prices for the security. If stabilizing is discontinued, it may not be resumed at a price higher than the price at which stabilizing then could be initiated.

Currency, Adjustments, Units and Special Prices

Rule 104(f)(5) covers a stabilizing bid expressed in a currency other than the currency of the principal market for the security. That bid may be initiated, maintained, or adjusted to reflect the current exchange rate, consistent with the provisions of Rule 104. If, in initiating, maintaining, or adjusting the bid, the bid would be at or below the midpoint between two trading differentials, the stabilizing bid must be adjusted downward to the lower differential.

Under Rule 104(f)(6), if a security goes ex-dividend, ex-rights, or ex-distribution, the stabilizing bid must be reduced by an amount equal to the value of the dividend, right, or distribution. The same downward adjustment applies if the reduced bid would be at or below the midpoint between two trading differentials.

Under Rule 104(f)(7), when two or more securities are being offered as a unit, the component securities may not be stabilized at prices the sum of which exceeds the then permissible stabilizing price for the unit.

Under Rule 104(f)(8), any stabilizing price that otherwise meets the requirements of Rule 104 need not be adjusted to reflect special prices available to any group or class of persons, including employees or holders of warrants or rights.

Offerings With No U.S. Stabilizing Activities

Rule 104(g) addresses an offering of a security in the United States that is supported by stabilizing outside the United States. Stabilizing to facilitate such an offering is not a violation of Rule 104 if three conditions are satisfied: no stabilizing is made in the United States; stabilizing outside the United States is made in a jurisdiction with statutory or regulatory provisions governing stabilizing that are comparable to the provisions of Rule 104; and no stabilizing is made at a price above the offering price in the United States, except as permitted by Rule 104(f)(5).

For this purpose, the Securities and Exchange Commission (SEC) by rule, regulation, or order may determine whether a foreign statute or regulation is comparable to Rule 104, considering, among other things, whether the foreign statute or regulation specifies appropriate purposes for which stabilizing is permitted; provides for disclosure and control of stabilizing activities; places limitations on stabilizing levels; requires appropriate recordkeeping; and provides other protections comparable to the provisions of Rule 104. The SEC also considers whether procedures exist to enable it to obtain information concerning any foreign stabilizing transactions.

Disclosure and Notification

Rule 104(h) contains three disclosure and notification requirements.

Under Rule 104(h)(1), any person displaying or transmitting a bid that the person knows is for the purpose of stabilizing must provide prior notice to the market on which the stabilizing will be effected, and must disclose its purpose to the person with whom the bid is entered.

Under Rule 104(h)(2), any person effecting a syndicate covering transaction or imposing a penalty bid must provide prior notice to the self-regulatory organization with direct authority over the principal market in the United States for the security for which the syndicate covering transaction is effected or the penalty bid is imposed.

Under Rule 104(h)(3), any person subject to Rule 104 who sells to, or purchases for the account of, any person any security where the price of the security may be or has been stabilized must send to the purchaser, at or before the completion of the transaction, a prospectus, offering circular, confirmation, or other document containing a statement similar to the statement provided for in Item 502(d) of Regulation S-B or Item 502(d) of Regulation S-K.

FINRA Rules That Support Regulation M

FINRA Rule 5190, Notification Requirements for Offering Participants, sets forth the notice requirements applicable to all members participating in offerings of securities for purposes of monitoring compliance with the provisions of SEC Regulation M. Rule 5190(e), titled Notice of Penalty Bids and Syndicate Covering Transactions in OTC Equity Securities, where OTC means over-the-counter, applies to a member imposing a penalty bid or engaging in a syndicate covering transaction in connection with an offering of an OTC Equity Security pursuant to Rule 104 of SEC Regulation M. 

Unless another member has assumed responsibility in writing, that member must provide written notice to FINRA, in the form FINRA specifies, of two things. The first is the member’s intention to conduct such activity, prior to imposing the penalty bid or engaging in the first syndicate covering transaction, including identification of the security and its symbol and the date such activity will occur. The second is confirmation that the member has imposed a penalty bid or engaged in a syndicate covering transaction, within one business day of completion of such activity, including identification of the security and its symbol, the total number of shares and the date or dates of such activity.

FINRA Rule 6435, Withdrawal of Quotations in an OTC Equity Security in Compliance with SEC Regulation M, applies to a member that is a distribution participant, affiliated purchaser, selling security holder or issuer in a distribution of an OTC Equity Security that is a covered security subject to Rule 101 or 102 of SEC Regulation M and that is entering quotations in the security. Unless another member has assumed responsibility in writing for compliance with the rule, that member must withdraw all quotations in the OTC Equity Security to comply with the applicable restricted period under Rule 101 or 102, and must not enter a stabilizing bid for the OTC Equity Security pursuant to Rule 104 of SEC Regulation M.

Recordkeeping and Notices to the Syndicate

Under Rule 104(i), a person subject to Rule 104 must keep the information and make the notification required by Rule 17a-2 under the Securities Exchange Act of 1934, titled Recordkeeping requirements relating to stabilizing activities.

Rule 17a-2 applies to any person who effects any purchase of a security subject to Rule 104 for the purpose of stabilizing, or who participates in a syndicate or group that engages in stabilizing, the price of any security, and to any person who effects a syndicate covering transaction or imposes a penalty bid. It applies to a security with respect to which a registration statement under the Securities Act of 1933 has been or is to be filed; a security that is being or is to be offered under an exemption from registration under Regulation A; or a security that is being or is to be otherwise offered if the aggregate offering price of the securities being offered exceeds five million dollars.

A person subject to Rule 17a-2 who acts as a manager and stabilizes or effects syndicate covering transactions or imposes a penalty bid must promptly record and maintain certain separately retrievable information for a period of not less than three years, the first two years in an easily accessible place. That information is the name and class of any security stabilized or any security in which syndicate covering transactions have been effected or a penalty bid has been imposed; the price, date, and time at which each stabilizing purchase or syndicate covering transaction was effected by the manager or by any participant in the syndicate or group, and whether any penalties were assessed; the names and addresses of the members of the syndicate or group; their respective commitments or, for a standby or contingent underwriting, the percentage participation of each member; and the dates when any penalty bid was in effect.

The manager must also promptly furnish to each member of the syndicate or group the name and class of any security being stabilized, and the date and time at which the first stabilizing purchase was effected, and must promptly notify each member of the date and time when stabilizing was terminated.

A person who has a participation in a syndicate account but who is not a manager of the account, and who effects one or more stabilizing purchases or syndicate covering transactions for its sole account or for the account of a syndicate or group, must notify the manager within three business days following the purchase of the price, date, and time at which the purchase or transaction was effected. That person must also notify the manager of the date and time when the purchase or transaction was terminated. The manager maintains those notifications in a separate file, together with the information required by Rule 17a-2(c)(1), for a period of not less than three years, the first two years in an easily accessible place.

Securities Outside Rule 104

Under Rule 104(j), the provisions of Rule 104 do not apply to exempted securities, as defined in section 3(a)(12) of the Securities Exchange Act of 1934, or to transactions of Rule 144A securities. The second category covers transactions in securities eligible for resale under Rule 144A(d)(3) if the securities are sold in the United States solely to qualified institutional buyers, or to purchasers that the seller and any person acting on behalf of the seller reasonably believes are qualified institutional buyers, in a transaction exempt from registration, or to persons not deemed to be U.S. persons during a distribution qualifying under that paragraph. Rule 104(j) lists no other category.

Short Selling Before an Offering

Rule 105 of Regulation M is a separate rule. In connection with an offering of equity securities for cash pursuant to a registration statement or a notification on Form 1-A or Form 1-E filed under the Securities Act of 1933, it is unlawful for any person to sell short the security that is the subject of the offering and purchase the offered securities from an underwriter or broker or dealer participating in the offering, if the short sale was effected during the Rule 105 restricted period. That 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.

Exam Relevance

Stabilization appears at different depths across FINRA programmes, and candidates should check the current outline for their examination.

The Securities Industry Essentials (SIE) Exam content outline lists Regulation M in the SEC Rules and Regulations for Section 3, Understanding Trading, Customer Accounts and Prohibited Activities. Rule 104 is the Regulation M rule that governs stabilization. Topic 1.4, Offerings, covers the setting in which stabilizing takes place. It lists roles of participants, with investment bankers, underwriting syndicate, and municipal advisors named in parentheses; types of offerings, with public versus private securities offering, initial public offering (IPO), secondary offering and follow-on offering, and methods of distribution, with best efforts and firm commitment named in parentheses, listed beneath it; shelf registrations and distributions, with definition and purpose named in parentheses; types and purpose of offering documents and delivery requirements, with official statement, program disclosure document, and prospectus named in parentheses; and regulatory filing requirements and exemptions, with the SEC and blue-sky laws named in parentheses. A candidate preparing for the SIE should retain that stabilizing bids are an exception to the general Regulation M prohibition, that a stabilizing bid may not be placed above the offering price, and that a buyer receives a document with a statement that the price may be stabilized.

The Series 7 outline lists Regulation M in the SEC Rules and Regulations for Function 1, Section 1.2. The same section lists syndicate formation and operational procedures, with purpose of syndicate bid, roles and responsibilities of underwriters, and selling group concession and reallowance named in parentheses. The word stabilization also appears in a Series 7 technical analysis bullet in Function 3, Section 3.3, among chart pattern terms. That is chart analysis, and it is a different use of the word from Regulation M.

The Series 79 outline, Function 2, Underwriting/New Financing Transactions, Types of Offerings and Registration of Securities, names stabilization directly. Topic 2.3, Execution and Distribution, lists the education of the internal sales force and marketing of the offering; building the book; sizing, pricing and timing; allocation, syndicate short covering, stabilization and other market activities, with research and summarization of retail versus institutional demand and investor trading history, management of stabilizing activity and syndicate short positions, and billing and delivery listed beneath it; and listing requirements for the New York Stock Exchange and Nasdaq. Beneath management of stabilizing activity and syndicate short positions, the outline lists the structure and management of the over-allotment option, with the greenshoe given in parentheses, and the determination of whether to exercise the greenshoe. The rules listed for the topic include FINRA Rule 5190, FINRA Rule 6220(a)(17), titled Definition of Stabilizing Bid, SEC Rule 17a-2, and Regulation M Rules 100, 103, 104 and 105.

The Series 57 outline, Function 1, Trading Activities, Section 1.2.1, Initial Public Offerings (IPOs), Secondary Offerings and Safe Harbor, lists permitted and prohibited trading activities related to IPOs and secondary offerings; penalty bids; stabilizing bids; passive market making; required notification related to IPOs and secondary offerings; and trading within safe harbors. Its rules include FINRA Rule 5190(e), FINRA Rule 6435, and Regulation M Rules 101 through 105.

The Series 24 outline, in Function 5, Section 5.1, lists Nasdaq Rule 4614, Stabilizing Bids; SEC Rule 17a-2; Regulation M Rule 100, with the terms stabilization and stabilizing named in parentheses; and Regulation M Rule 104. In Function 4, Section 4.1, it lists SEC Regulation M and FINRA Rule 6435.

Common Misunderstandings

Stabilization is market manipulation that regulators ignore. Stabilizing is prohibited except for the purpose of preventing or retarding a decline in the market price of a security, and any transaction remains subject to the antifraud and antimanipulation provisions of the securities laws.

A stabilizing bid can be placed at any price. No stabilizing may be made at a price higher than the lower of the offering price or the stabilizing bid for the security in the principal market.

Stabilizing is meant to raise the price of a security. The only permitted purpose is preventing or retarding a decline in the market price of a security.

Over-allotment and stabilizing are the same thing. Over-allotment is a sale by the underwriters of shares in excess of the number they are obligated to purchase, which creates a syndicate short position. Stabilizing is the placing of a bid or the effecting of a purchase for the purpose of pegging, fixing, or maintaining the price of a security.

Rule 104 applies only to the underwriters. Rule 104 applies to any person who stabilizes, effects a syndicate covering transaction, or imposes a penalty bid in connection with an offering of any security.

A stabilizing bidder goes ahead of other bidders at the same price. A person stabilizing must grant priority to any independent bid at the same price, irrespective of the size of the independent bid at the time that it is entered.

A syndicate member may enter as many stabilizing bids as it chooses. No sole distributor or syndicate or group stabilizing the price of a security, or any member or members of the syndicate or group, may maintain more than one stabilizing bid in any one market at the same price at the same time.

Buyers are never told that a price may be stabilized. A person who sells a security whose price may be or has been stabilized must send the purchaser, at or before the completion of the transaction, a prospectus, offering circular, confirmation, or other document containing a statement similar to the one provided for in Item 502(d) of Regulation S-B or Regulation S-K.

Stabilizing is permitted in an at-the-market offering. Stabilizing is prohibited in an at-the-market offering.

Stabilization in Regulation M and stabilization in technical analysis are the same idea. Regulation M uses the word for a bid or purchase made to peg, fix, or maintain the price of a security in connection with an offering, while technical analysis uses it as a chart pattern term.

Key Points to Retain

Stabilizing means the placing of any bid, or the effecting of any purchase, for the purpose of pegging, fixing, or maintaining the price of a security.

Rule 104 of Regulation M prohibits stabilizing except for the purpose of preventing or retarding a decline in the market price of a security.

Rule 101 generally makes it unlawful for a distribution participant to bid for or purchase a covered security during the applicable restricted period, and transactions complying with Rule 103 or Rule 104 are among the excepted activity.

Over-allotment creates a syndicate short position. Underwriters can close out a covered short position by exercising the over-allotment option, in whole or in part, or by purchasing shares in the open market.

No stabilizing may be made at a price higher than the lower of the offering price or the stabilizing bid for the security in the principal market.

A person stabilizing must grant priority to any independent bid at the same price.

No sole distributor or syndicate or group, and no member of it, may maintain more than one stabilizing bid in any one market at the same price at the same time.

Stabilizing is prohibited in an at-the-market offering.

A person displaying or transmitting a stabilizing bid must provide prior notice to the market and disclose the purpose of the bid to the person with whom it is entered.

A seller of a security whose price may be or has been stabilized must send the purchaser a prospectus, offering circular, confirmation, or other document with a statement similar to the one provided for in Item 502(d) of Regulation S-B or Regulation S-K.

Rule 17a-2 requires records of stabilizing and notices to the syndicate, and records are kept for not less than three years, the first two years in an easily accessible place.

FINRA Rule 6435 bars a covered member from entering a stabilizing bid for an OTC Equity Security pursuant to Rule 104, and FINRA Rule 5190(e) requires notice of penalty bids and syndicate covering transactions in OTC equity securities.

Regulation M appears in the Section 3 SEC Rules and Regulations list of the SIE outline, and stabilization is named directly in the Series 24, Series 57 and Series 79 outlines.ilization?