Rule 105 of Regulation M: Restricted Period, Exceptions, and Penalties

Rule 105 of Regulation M prohibits anyone who sells a stock short during the five business days before a public offering is priced from buying shares in that same offering. The SEC wrote the rule to shut down a specific manipulation: shorting into an offering to push the price down, then covering with cheap shares bought from the underwriter. It is a strict liability rule. Intent doesn’t matter, and penalties routinely climb into the hundreds of thousands of dollars, even when the trader had no idea an offering was coming.¹

The Prohibited Trading Pattern

The rule targets a two-step sequence. First, a short sale of the stock during the restricted period. Second, a purchase of that same stock in a public offering from an underwriter or participating broker-dealer. If both happen, the rule has been violated, regardless of why the short was placed or whether the trader knew about the offering when the short went in.¹

This is where institutional investors get caught. A portfolio manager can short a stock for a legitimate hedge and later decide, on separate reasoning, to participate in that company’s follow-on offering. If the short fell inside the window, the rule has been broken. The SEC treats the trading pattern itself as the violation.²

How the Restricted Period Is Measured

The restricted period is the shorter of two windows: the five business days ending at pricing, or the period from the initial filing of the registration statement through pricing.¹ Because most registration statements are filed well ahead of pricing, the five-business-day window is almost always the operative one. The alternative matters when an offering runs from filing to pricing in fewer than five business days.

Counting matters. Weekends and market holidays don’t count. Timing within the pricing day also shifts the count. If underwriters set the price after the close, that day is the first day of the lookback. If pricing happens before the close, the lookback starts the prior business day. A one-day miscount can turn a lawful short into a violation.

Which Offerings Are Covered

Rule 105 applies to firm commitment offerings of equity securities for cash. In a firm commitment deal, the underwriters buy the entire block from the issuer and resell it to the public, taking the risk of unsold shares. Follow-on and secondary offerings both qualify.²

Best efforts offerings, private placements, and offerings that aren’t for cash are outside the rule.¹

Convertibles carry a nuance that catches people out. When a company offers a convertible bond or convertible preferred, a trader can short the underlying common stock and still purchase the convertible in the offering. The rule reaches the “subject” security being offered, not reference securities.³

The Two Exceptions

Rule 105 provides two ways to short during the restricted period and still participate in the offering. Both are narrow.

Bona Fide Purchase

A trader who shorted during the restricted period can preserve offering participation by making a curative purchase that closes out the short. Every condition below must be met:

The purchase must cover at least as many shares as were sold short during the restricted period.
The purchase must occur during regular trading hours, after the trader’s last restricted-period short sale, and no later than the business day before pricing.
The purchase must be reported to an effective transaction reporting plan.
The trader cannot short the stock during the final 30 minutes of regular trading on the business day before pricing.

That last condition is easy to miss. A qualifying curative purchase is wiped out by a single short sale in the last half-hour of the session on the day before pricing.¹

Separate Accounts

A firm running multiple accounts can have one account short a stock while another buys in the offering, but only when the accounts operate with genuine independence. The SEC looks for:⁴

Distinct investment objectives and strategies for each account.
No communication of trading decisions between the personnel managing each account.
Documented information barriers preventing the sharing of position data.
Separate profit and loss statements.
Compensation for decision-makers that isn’t tied to the performance of both accounts.

Thin information barriers won’t hold up. The SEC reviews whether these controls are documented, audited, and actually followed.²

Penalties

Violators typically face three layers of financial consequences: disgorgement of profits, prejudgment interest, and a civil monetary penalty.

In a 2024 settled action against Contrarian Capital Management, the SEC ordered roughly $352,000 in disgorgement, $30,000 in prejudgment interest, and a $140,000 civil penalty for buying stock in two public offerings after shorting during the restricted period. The firm had revised its compliance procedures before the settlement.⁵

Civil penalties follow the Exchange Act’s three-tier structure. Under the January 2025 inflation adjustment, Tier I reaches up to $11,823 per violation for an individual and $118,225 for a firm. Tier II, which applies when the conduct involves reckless disregard of a regulatory requirement, is $118,225 for individuals and $591,127 for entities. Tier III, reserved for violations causing substantial losses to others or substantial gains to the violator, tops out at $236,451 for individuals and $1,182,251 for entities.⁶ Real-world numbers run higher. The SEC’s largest Rule 105 sanction involved Worldwide Capital and its principal, who agreed to pay more than $7.2 million in combined disgorgement, interest, and penalties.⁷

What Compliance Has to Catch

Because the rule is strict liability, “we didn’t know” is not a defense. Programs have to prevent the trading pattern, not explain it later.

At a minimum, that means automated monitoring that flags any short position in a security where the firm may participate in an upcoming offering, tracks the restricted period for each offering under consideration using the business-day counting rules, and blocks offering purchases in any account that shorted during the window. Firms relying on the separate accounts exception need documented information barriers and regular audits confirming that trading personnel on different desks don’t share position information. Firms that want to keep the bona fide purchase option open also need to monitor the 30-minute pre-close restriction on the day before pricing, because a single short sale in that window, including one from an algorithm, ends the exception.

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eCFR. 17 CFR 242.105 – Short Selling in Connection With a Public Offering
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Securities and Exchange Commission. Rule 105 of Regulation M: Short Selling in Connection With a Public Offering
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Federal Register. Short Selling in Connection With a Public Offering
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Securities and Exchange Commission. Short Selling in Connection With a Public Offering: Amendments to Rule 105 of Regulation M
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Securities and Exchange Commission. SEC Charges Colorado-Based Investment Adviser With Violating Rule 105
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Securities and Exchange Commission. Inflation Adjustments to the Civil Monetary Penalties
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U.S. Securities and Exchange Commission. SEC Announces Largest Monetary Sanction for Rule 105 Short Selling Violations