UNITED STATES OF AMERICA
BEFORE THE SECURITIES AND EXCHANGE COMMISSION

Securities Exchange Act of 1934
Release No. 50747 / November 29, 2004

ORDER DELAYING PILOT PERIOD FOR SUSPENSION OF THE OPERATION OF SHORT SALE PRICE PROVISIONS

On July 28, 2004, we issued an order (“Pilot Order”) establishing a one year Pilot (“Pilot”) suspending the provisions of Rule 10a-1(a) under the Securities Exchange Act of 1934 (the “Act”)¹ and any short sale price test of any exchange or national securities association for short sales² of certain securities.³ The Pilot Order provided that the Pilot would commence on January 3, 2005 and terminate on December 31, 2005, and that we may issue further orders affecting the operation of the Pilot Order.⁴ In response to information that we have received from market participants, we are issuing this Order (“Second Pilot Order”) to reset the Pilot to commence on May 2, 2005 and end on April 28, 2006. All other terms of the Pilot Order remain unchanged. We may issue further orders affecting the operation of the Pilot. We find that the delay of the commencement of the Pilot is necessary and appropriate in the public interest and consistent with the protection of investors.⁵

I. New Pilot Period

We established the Pilot as part of our review of short sale regulation in conjunction with the adoption of Regulation SHO.⁶ The Pilot is designed to assist us in assessing whether changes to short sale regulation are necessary in light of current market practices and the purposes underlying short sale regulation.⁷ In order to achieve this goal, it is critical that the data we receive on short sales of Pilot securities during the term of the Pilot is accurate and comprehensive. This is possible only if market participants execute all short sales of Pilot stocks without regard to any short sale price test.

Pursuant to Regulation SHO, brokers and dealers are required to mark short sale orders of Pilot stocks effected during any Pilot period as “short exempt” so that such orders are not subject to price tests.⁸ Since the adoption of Regulation SHO and the order establishing the Pilot, our staff has communicated extensively with self-regulatory organizations and brokers and dealers in order to facilitate the implementation of Regulation SHO and the Pilot. During the course of this process, our staff was informed that a large number of brokers and dealers believe it would be inefficient and very costly for them to comply with this marking requirement for Pilot stocks under the time frame established by the Pilot Order. According to these brokers and dealers, they and their customers would need to make significant systems changes to be sure that short sale orders for Pilot stocks are marked properly and that the marking is maintained at each stage of processing the order. They also assert that these systems changes will be more extensive, costly and time-consuming to implement than they had anticipated during the comment period for Regulation SHO.

The order processing systems of brokers and dealers and their customers are predominantly electronic. Currently, many of these systems are not programmed to automatically identify and mark Pilot stocks as “short exempt” or to recognize a “short exempt” marking. A broker-dealer may have many different internal systems that are linked together, and each of its customers may have different systems through which the customer communicates orders to the broker-dealer. According to the market participants, modifying these systems and their interconnections presents significant programming challenges.

For example, market participants state that these systems currently are not equipped to change orders marked “short” to “short exempt.” Broker-dealer firms have advised our staff that it will be difficult to implement systems changes under the time frame established by the Pilot Order to identify and change all orders marked short so that all short sales of Pilot stocks are processed as intended by Regulation SHO and the Pilot, i.e., without regard to any short sale price test.

Finally, broker-dealer firms have asked us to consider the possibility that the systems changes may be in effect only for the one-year duration of the Pilot. Even if the brokers and dealers and their customers were able to make the necessary systems changes with reasonable expenditure of time and money, at the conclusion of the Pilot, brokers and dealers and their customers may be required to change their systems again, which would result in additional costs.

In this context, we have been informed that a number of market centers have offered to assist their broker-dealer members in executing short sales in Pilot stocks in a manner consistent with Regulation SHO. According to these market centers, they would process all short sale orders of Pilot stocks without any short sale price test, regardless of whether the broker-dealers had marked the orders as “short exempt.” The market centers would do this by “masking” short sale instructions on Pilot stocks and executing the short sales as “short exempt.” Therefore, brokers and dealers and their customers would not be required to make extensive, and possibly temporary, systems changes, and short sales of Pilot stocks would be executed appropriately.

We have been informed that both the brokers and dealers and the market centers agree that the market centers’ proposals to “mask” short sale orders in Pilot stocks for the duration of the Pilot would be more efficient than having the brokers and dealers and their customers make necessary systems changes. Some market centers, however, would be required to make significant changes to their systems, and we understand that some of the market centers would not be able to complete all the necessary systems changes by January 3, 2005. We have been informed that the market centers would be ready to “mask” orders on May 2, 2005.

Based on the forgoing, we believe that it is necessary and appropriate in the public interest and consistent with the protection of investors to delay the commencement of the Pilot until May 2, 2005. For the Commission to fully evaluate the effectiveness of short sale price restrictions, the data must be complete and accurate. The delay will provide an opportunity for systems to be modified in a manner that will help achieve the purposes of the Pilot. ⁹ Accordingly, the Pilot will now commence on May 2, 2005 and will end on April 28, 2006.

The compliance date for all other provisions of Regulation SHO remains January 3, 2005. This Second Pilot Order does not affect the responsibility of brokers and dealers to comply with the requirements of Regulation SHO, including the order marking requirements.¹⁰ By issuing this Second Pilot Order, we are providing an opportunity for firms to work with the market centers to develop cost effective means of executing trades of Pilot stocks. Brokers and dealers, however, retain the responsibility to appropriately mark the orders of Pilot stocks upon commencement of the Pilot on May 2, 2005.

II. Conclusion

We find that delaying implementation of the Pilot until May 2, 2005, for the reasons stated above, is necessary and appropriate in the public interest and consistent with the protection of investors.

Accordingly,

IT IS HEREBY ORDERED that the suspension of the provisions of Rule 10a-1(a)

and any short sale price test of any exchange or national securities association shall commence on May 2, 2005 and shall terminate on April 28, 2006. The Commission from time to time may issue further orders affecting the operation of the Second Pilot Order.

All other provisions of the Pilot Order shall remain in effect.

By the Commission.

¹ 17 CFR 240.10a-1.

² “Short sale” is defined in Rule 200 of Regulation SHO, 17 CFR 242.200.

³ Securities Exchange Act Release No. 50104 (July 28, 2004), 69 FR 48032 (August 6, 2004). Specifically, the Pilot Order suspended price tests for the following: (1) short sales in the securities identified in Appendix A to the Pilot Order; (2) short sales in the securities included in the Russell 1000 index effected between 4:15 p.m. EST and the open of the effective transaction reporting plan of the Consolidated Tape Association (“consolidated tape”) on the following day; and (3) short sales in any security not included in paragraphs (1) and (2) effected in the period between the close of the consolidated tape and the open of the consolidated tape on the following day.

⁴ 69 FR at 48033.

⁵ See Section 36 of the Act. In addition, pursuant to Section 3(f) of the Act, we considered the impact of these modifications on efficiency, competition, and capital formation. 15 U.S.C. 78c(f).

⁶ 69 FR at 48032; Securities Exchange Act Release No. 50103 (July 28, 2004), 69 FR 48008 (August 6, 2004) (the “Adopting Release”).

⁷ 69 FR at 48032.

⁸ Rule 200(g) of Regulation SHO requires that brokers and dealers mark all sell orders of any equity security as “long,” “short,” or “short exempt.” 17 CFR 242.200(g). The Adopting Release states that short sales of pilot securities effected during any pilot period should be marked “short exempt.” 69 FR at 48012.

⁹ In addition, resetting the commencement date of the Pilot would allow the market centers to continue implementation of systems to electronically record all short sale orders, including manual orders.

¹⁰ We believe that an exemption from the order marking requirements may be necessary and appropriate to allow broker-dealers to avail themselves of the order “masking” process described above for Pilot stocks, if implemented by the market centers. Accordingly, prior to the commencement of the Pilot, we will consider written requests for appropriate relief from the order marking requirements for Pilot stocks.

http://www.sec.gov/rules/final/34-50747.htm