Division of Market Regulation:
Responses to Frequently Asked Questions Concerning Regulation SHO
The following answers to frequently asked questions were prepared by and represent the views of the staff of the Securities and Exchange Commission’s (“Commission”) Division of Trading and Markets (“staff”). They are not rules, regulations, or statements of the Commission, and do not have the approval or disapproval of the Commission.
The staff may update these questions and answers periodically. In each update, the questions added after publication of the last version will be marked with “UPDATED!” or “NEW!” and may be marked “MOVED!”
For Further Information Contact: Any of the following attorneys in the Office of Trading Practices, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street, N. E., Washington, D.C. 20549-1001, at (202) 551-5777: Josephine Tao, Assistant Director, Valerie Dahiya, Branch Chief, Andrea Orr, Timothy (Mick) Riley, and Thankam Varghese, Special Counsels.
I. Introduction
A short sale is the sale of a security that the seller does not own and any sale that is consummated by the delivery of a security borrowed by, or for the account of, the seller. In order to deliver the security to the purchaser, the short seller will borrow the security, usually from a broker-dealer or an institutional investor. Typically, the short seller later closes out the position by purchasing equivalent securities on the open market and returning the borrowed security to the lender. In general, short selling is used to profit from an expected downward price movement, to provide liquidity in response to unanticipated demand, or to hedge the risk of an economic long position in the same security or in a related security.
The Commission has plenary authority under Section 10(a) of the Securities Exchange Act of 1934 to regulate short sales of securities registered on a national securities exchange, as necessary or appropriate in the public interest or for the protection of investors. Current regulatory requirements applicable to short sales of equity securities are generally found in Regulation SHO, which the Commission adopted to address its concerns regarding persistent fails to deliver and potentially abusive “naked” short selling. A “naked” short sale generally refers to selling short without having borrowed the securities to make delivery. All sellers of securities should promptly deliver, or arrange for delivery of, securities and all buyers of securities have a right to expect prompt delivery of securities purchased. The Commission was concerned about the negative effect that fails to deliver may have on the markets and shareholders. For example, large and persistent fails to deliver may deprive shareholders of the benefits of ownership, such as voting and lending, and sellers that fail to deliver securities on settlement date may attempt to use this additional freedom to engage in trading activities to improperly depress the price of a security.
Regulation SHO imposes four general requirements with respect to short sales of equity securities: a marking requirement, a short sale price test circuit breaker, a locate requirement, and a close-out requirement. Due to continued concerns about fails to deliver, and to promote market stability and preserve investor confidence, the Commission has amended Regulation SHO several times to eliminate certain exceptions, strengthen certain requirements and reintroduce a price test restriction.
As initially adopted, Regulation SHO included two major exceptions to the close-out requirement: the ‘‘grandfather’’ provision and the ‘‘options market maker’’ exception. Due to continued concerns about fails to deliver, and the fact that the Commission continued to observe certain securities with fail to deliver positions that were not being closed out under then existing requirements, in 2007 the Commission eliminated the ‘‘grandfather’’ provision and in 2008 the Commission eliminated the options market maker exception.
In 2008, the Commission adopted temporary Rule 204T, and in 2009 adopted final Rule 204, which strengthened further the close-out requirements of Regulation SHO by applying close-out requirements to fails to deliver resulting from sales of all equity securities and reducing the time-frame within which fails to deliver must be closed out.
The Commission adopted Rule 201 of Regulation SHO in 2010. Rule 201 restricts the price at which short sales may be effected when a stock has experienced significant downward price pressure. Rule 201 is designed to prevent short selling, including potentially manipulative or abusive short selling, from driving down further the price of a security that has already experienced a significant intra-day price decline, and to facilitate the ability of long sellers to sell first upon such a decline.
Regulation SHO’s four general requirements are summarized below:
- Rule 200 — Marking Requirements. Rule 200(g) requires that a broker-dealer must mark all sell orders of any equity security as “long,” “short” or “short exempt.” A sell order may only be marked “long” if the seller is “deemed to own” the security being sold and either: (i) the security to be delivered is in the physical possession or control of the broker or dealer; or (ii) it is reasonably expected that the security will be in the physical possession or control of the broker or dealer no later than the settlement of the transaction. The “short exempt” marking requirement applies only with respect to the short sale price test restriction.
- Rule 201 — Short Sale Price Test Circuit Breaker. Rule 201 generally requires trading centers to have policies and procedures in place to restrict short selling when a covered security has triggered a circuit breaker by experiencing a price decline of at least 10 percent in one day. Once the circuit breaker in Rule 201 has been triggered, the price test restriction will apply to short sale orders in that security for the remainder of the day and the following day, unless an exception applies.
- Rule 203(b)(1) and (2) — Locate Requirements. Rule 203(b)(1) generally prohibits a broker-dealer from accepting a short sale order in any equity security from another person, or effecting a short sale order in an equity security for the broker-dealer’s own account, unless the broker-dealer has: borrowed the security, entered into a bona-fide arrangement to borrow the security, or reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due. Rule 203(b)(2) provides an exception to the locate requirement for short sales effected by a market maker in connection with bona-fide market making activities.
- Rule 204 — Close-out Requirements. Under Rule 204, participants of a registered clearing agency (as defined in section 3(a)(24) of the Exchange Act) must deliver securities to a registered clearing agency for clearance and settlement on a long or short sale transaction in any equity security by settlement date, or must close out a fail to deliver in any equity security for a long or short sale transaction in that equity security generally by the times described as follows: the participant must close out a fail to deliver for a short sale transaction by no later than the beginning of regular trading hours on the settlement day following the settlement date, referred to as T+4; if a participant has a fail to deliver that the participant can demonstrate on its books and records resulted from a long sale, or that is attributable to bona-fide market making activities, the participant must close out the fail to deliver by no later than the beginning of regular trading hours on the third consecutive settlement day following the settlement date, referred to as T+6. In addition, Rule 203(b)(3) of Regulation SHO requires that participants of a registered clearing agency must immediately purchase shares to close out fails to deliver in “threshold securities” if the fails to deliver persist for 13 consecutive settlement days. Threshold securities, as defined by Rule 203(c)(6), are generally equity securities with large and persistent fails to deliver.
The Adopting Releases for Regulation SHO and the subsequent amendments to Regulation SHO may be found on the Commission’s web site:
Exchange Act Release No. 50103 (Jul. 28, 2004), 69 FR 48008 (Aug. 6, 2004), available at http://www.sec.gov/rules/final/34-50103.pdf (“Adopting Release”);
Exchange Act Release No. 56212 (Aug. 7, 2007), 72 FR 45544 (Aug. 14, 2007), available at http://www.sec.gov/rules/final/2007/34-56212fr.pdf (eliminating the “grandfather” exception to Regulation SHO’s close-out requirement);
Exchange Act Release No. 58775 (Oct. 14, 2008), 73 FR 61690 (Oct. 17, 2008), available at http://www.sec.gov/rules/final/2008/34-58775fr.pdf (eliminating the options market maker exception to Regulation SHO’s close-out requirement);
Exchange Act Release No. 60388 (July 27, 2009), 74 FR 38266 (July 31, 2009), available at http://www.sec.gov/rules/final/2009/34-60388fr.pdf (“Rule 204 Adopting Release”); and
Exchange Act Release No. 61595 (Feb. 26, 2010), 75 FR 11232 (Mar. 10, 2010), available at http://www.sec.gov/rules/final/2010/34-61595fr.pdf (“Rule 201 Adopting Release”).
Responses to Frequently Asked Questions Concerning Rule 201 of Regulation SHO may also be found on the Commission’s web site at http://www.sec.gov/divisions/marketreg/rule201faq.htm.
II. Responses to Frequently Asked Questions
1. General
(UPDATED! 10/15/15)
Question 1.1: When should market participants comply with Regulation SHO?
Answer: Rules 200 and 203 of Regulation SHO became effective on September 7, 2004 and market participants were required to begin complying with Rules 200 and 203 on January 3, 2005. Rule 204 of Regulation SHO was implemented by Emergency Order as temporary Rule 204T, effective September 18, 2008 and was adopted as final Rule 204, with no lapse in effectiveness, in 2009. Rule 201 of Regulation SHO became effective on March 10, 2010 and market participants were required to begin complying with Rule 201 on February 28, 2011.
(UPDATED! 10/15/15)
Question 1.2: When does Regulation SHO supplant existing Self-Regulatory Organization (“SRO”) Rules?
Answer: Regulation SHO supplants any conflicting SRO short sale rule and related guidance, including SRO guidance preceding its adoption. Further, Rule 201(e) of Regulation SHO specifically prohibits any SRO from having any rule that is not in conformity with, or conflicts with, the Commission’s short sale price test circuit breaker rule.
Question 1.3: How does Regulation SHO apply to overseas transactions?
Answer: Any broker-dealer using the United States jurisdictional means to effect short sales in securities traded in the United States are subject to Regulation SHO, regardless of whether the broker-dealer is registered with the Commission or relying on an exemption from registration. Adopting Release, 69 FR at 48014 n.54. Short sale regulation applies to trades in reported securities when the trades are agreed to in the United States, even if the trades are booked overseas. Securities Exchange Act Release No. 48709 (Oct. 28, 2003), 68 FR 62972, 62997, 62998 (Nov. 6, 2003). Whether a short sale is executed or agreed to in the United States will depend on the particular facts and circumstances of the transaction. See id. at 62997-98 (providing some examples of when the staff would consider a short sale to have been agreed to in the United States).
For further information about how the provisions of Regulation SHO may apply to overseas transactions, please refer to Question 4.6.
Question 1.4: Does Regulation SHO apply to bonds?
Answer: Regulation SHO applies to short sales of equity securities. The term “equity security” is defined in Section 3(a)(11) of the Exchange Act and Rule 3a11-1 thereunder. 17 CFR 240.3a11-1. A security convertible into an equity security is an equity security. Therefore, short sales of bonds that are convertible into equity would be subject to Regulation SHO. The staff will consider on a case-by-case basis securities, including structured products, to which the “equity” status may not be clear.
(UPDATED! 10/15/15)
Question 1.5: Do the requirements of Rules 201, 203 and 204 of Regulation SHO apply to short sales made in connection with underwritten offerings?
Answer: Syndicate activity is not expressly addressed in Rule 203(b) of Regulation SHO. However, the staff will not recommend enforcement action for violation of Rule 203(b)(1) of Regulation SHO (locate requirement) with regard to any sale by an underwriter, or any member of a syndicate or group participating in the distribution of a security, in connection with an over-allotment of securities, or any lay-off sale by such a person in connection with a distribution of securities through rights or a standby underwriting commitment. However, depending on the facts and circumstances, such activity is subject to the antifraud and anti-manipulation provisions of the Exchange Act, including Sections 9(a), 10(b), 15(c), and Rule 10b-5, and may be subject to Regulation M.
In addition, the staff notes that Rule 204 and Rule 203(b)(3) of Regulation SHO would not apply to any fail to deliver position directly resulting from a syndicate short position that is part of a distribution because the distribution does not clear through the Continuous Net Settlement System (“CNS”) operated by the National Securities Clearing Corporation (“NSCC”). However, purchasers in the distribution would be “deemed to own” any securities they purchased that are part of the syndicate short position, pursuant to Rule 200(b)(2). A fail to deliver position at a registered clearing agency resulting from secondary sales of such securities, where the seller intends to deliver the security as soon as all restrictions on delivery have been removed, may qualify, under Rule 204(a)(2), for close-out by no later than the beginning of regular trading hours on the thirty fifth consecutive calendar day following trade date. See also supra Questions 2.3(A), 4.5, 4.5(A), 5.6(A).
Under Rule 201(d)(5), a broker-dealer may mark a short sale order of a covered security ‘‘short exempt’’ if the broker-dealer has a reasonable basis to believe that the short sale order is by an underwriter or member of a syndicate or group participating in the distribution of a security in connection with an over-allotment of securities; or the short sale order is for purposes of a lay-off sale by an underwriter or member of a syndicate or group in connection with a distribution of securities through a rights or standby underwriting commitment.
2. Order Marking Requirements — Rule 200(g)
(UPDATED! 10/15/15)
Question 2.1: Should a broker or dealer mark a short sale order “short exempt” if the order involves an OTCBB stock?
Answer: This question pertained to “short exempt” marking under former Rule 10a-1 and former SRO price tests and is no longer applicable. See Exchange Act Release No. 55970 (Jun. 28, 2007), 72 FR 36348 (Jul. 3, 2007). For further information about “short exempt” marking under Rule 201, please refer to Division of Trading and Markets: Responses to Frequently Asked Questions Concerning Rule 201 of Regulation SHO.
(UPDATED! 10/15/15)
Question 2.2: May market participants presume that an “S” designation on an order indicates that an order is “sell long” and an “SS” designation on an order indicates that an order is “sell short?” Do these designations satisfy the new marking requirements under Regulation SHO?
Answer: Under Rule 200(g), brokers and dealers must mark all sell orders of any equity security as “long,” “short,” or “short exempt.” The primary objective is to make sure that orders are marked and executed properly and that accurate data on those orders is available for surveillance and compliance purposes. For this reason, the staff will not recommend enforcement action for violation of Rule 200(g) of Regulation SHO if firms use shortened forms or other designations to identify long, short and short exempt trades, and to process the orders properly, provided the designations follow a clear and consistent methodology for marking orders, and clear and accurate records are maintained to demonstrate compliance.
Question 2.3: May a seller mark an order “long” if the seller owns the security pursuant to Rule 200(b) but is not “net long” in the security?
Answer: Rule 200(c) provides that a person shall be deemed to “own” securities only to the extent that the person has a “net long” position in such securities. Therefore, a seller must be net long in a security in order to mark “long” an order for that security. Rule 200(c) does not change the “net long” requirement of former Rule 3b-3.
(UPDATED! 10/15/15)
Question 2.3(A): May a broker-dealer, under Rule 200, mark an order to sell an equity security “long” if the seller is deemed to own the security or the seller owns a security that is convertible into or exchangeable for that security?
Answer: Under Rule 200(g)(1) of Regulation SHO, an order to sell shall be marked “long” only if the seller is deemed to own the security being sold pursuant to Rule 200(a) through (f) and either: (i) the security to be delivered is in the physical possession or control of the broker-dealer; or (ii) it is reasonably expected that the security will be in the physical possession or control of the broker-dealer no later than the settlement of the transaction. Rule 200(b)(3) provides that a person shall be deemed to own a security if the person owns a security convertible into or exchangeable for it and has tendered such security for conversion or exchange.
The “reasonably expected” language in Rule 200(g)(1)(ii) was added in recognition of the fact that it may be difficult for a person to know with certainty at the time of a sale that a security will be in the possession or control of the broker-dealer prior to settlement. Adopting Release, 69 FR at 48015. In particular, there may be situations where, through no fault of the customer or the broker-dealer, it is not reasonably expected that the security will be in the physical possession or control of the broker-dealer by settlement date. These situations could include delivery delays related to processing a convertible security, option, or warrant that has been tendered for conversion or exchange, or delivery delays related to processing to remove a restricted legend from stock that was formerly restricted, but which, pursuant to Rule 144 under the Securities Act of 1933, may be sold without restriction. An order to sell a security, where the seller owns a security convertible into or exchangeable for that security, should not be marked “long” unless the convertible or exchangeable security has been tendered for conversion or exchange prior to the submission of the sale order and it is reasonably expected that the security sold will be in the broker-dealer’s possession or control by settlement date. In the above circumstances, and in any other circumstances where it is not reasonably expected that the security will be in the broker-dealer’s possession or control by settlement date, the sell order of the deemed to own securities should not be marked “long” and should be marked “short”.
(UPDATED! 08/28/09)
Question 2.4: How should a broker-dealer mark an order where the seller is net long for only part of the order?
Answer: A seller may be net long a security but wish to sell additional shares of that security in excess of the seller's net long position. For example, a seller may be net long 500 shares of a security but may wish to sell a total of 600 shares of that security. Under such circumstances, only 500 shares can be sold long, and the remaining 100 shares must be sold short.
Rule 200(g) of Regulation SHO requires a broker-dealer to mark sell orders in any equity security as "long" or "short." Rule 200(a) defines a short sale as "any sale of a security which the seller does not own or any sale which is consummated by the delivery of a security borrowed by, or for the account of, the seller." Rule 200(g)(1) provides that "[a]n order to sell shall be marked "long" only if the seller is deemed to own the security being sold pursuant to paragraphs (a) through (f) of this section and either: (i) The security to be delivered is in the physical possession or control of the broker or dealer; or (ii) It is reasonably expected that the security will be in the physical possession or control of the broker or dealer no later than the settlement of the transaction." Rule 200(c) of Regulation SHO provides that a person shall be deemed to own securities only to the extent that he has a net long position in such securities. In addition, to determine its own net position, Rule 200(f) requires a broker-dealer to aggregate all of its positions in a security unless it qualifies for independent trading unit aggregation.
Thus, under the above-mentioned scenario, if the seller is long 500 shares, the sell order for the sale of such 500 long shares must be marked "long" and the sell order for the sale of the additional 100 shares must be marked "short."
Furthermore, Rule 17a-3 requires, in part, that "[e]very member of a national securities exchange who transacts a business in securities …. shall make and keep current…books and records relating to its business" including a memorandum of each order which shall show the terms and conditions of the order or instructions. The memorandum must include accurate terms and conditions of the order. Thus, the order must be marked to accurately reflect that part of the order is long and part of the order is short.
(UPDATED! 04/10/12)
Question 2.4(A): As an alternative, when the seller is net long for only part of the order, may the broker-dealer mark the entire order "short" if the broker-dealer maintains books and records that identify the portion of the order that was a long sale and the portion of the order that was a short sale?
Answer: Yes. As an alternative, the entire order may be marked "short" when the seller is net long for only part of the order as long as the broker-dealer's books and records under Rules 17a-3 and 17a-4 identify the portion of the order that was a long sale and the portion of the order that was a short sale. For example, if a seller is net long 500 shares and wants to sell 600 shares, the broker-dealer may mark the sell order for 600 shares "short" if the broker-dealer's books and records identify that the seller sold 500 shares "long" and 100 shares "short." In addition, broker-dealers are reminded that, as a result of marking the entire order "short," all of Regulation SHO's requirements for short sale orders will apply to the full order (i.e., all 600 shares). Further, a broker-dealer may not mark the entire sell order "long."
(UPDATED! 08/28/09)
Question 2.5: How should a broker-dealer mark an order where the seller is net long 1,000 shares and wants to simultaneously enter multiple orders to sell 1,000 shares each?
Answer: Rule 200(g)(1) of Regulation SHO states that "[a]n order to sell shall be marked "long" only if the seller is deemed to own the security being sold pursuant to paragraphs (a) through (f) of this section and either: (i) The security to be delivered is in the physical possession or control of the broker or dealer; or (ii) It is reasonably expected that the security will be in the physical possession or control of the broker or dealer no later than the settlement of the transaction." Further, Rule 200(c) of Regulation SHO provides that a person shall be deemed to own securities only to the extent that he has a net long position in such securities.
Thus, we remind sellers that where a seller is net long 1,000 shares and simultaneously enters multiple orders to sell 1,000 shares owned, only one such order would constitute a long sale. After the long sale order is entered to sell the 1,000 shares, it is no longer reasonable to expect that delivery can be made by settlement date on additional orders to sell the same shares. In addition, under Rule 200(g)(1) of Regulation SHO, a broker-dealer must mark only one order as "long" and any additional orders as "short."
(UPDATED! 3/18/15)
Question 2.5(A): Is the guidance on marking multiple orders to sell 1,000 shares owned, set forth in Question 2.5 above, limited to simultaneous order entry?
Answer: No. Simultaneous order entry is one example of a scenario where, after one or more long sale orders are entered to sell an amount of shares equal to the seller’s net long position, any additional orders to sell the same shares must be marked “short.” Thus, we remind sellers that where a seller is net long 1,000 shares and simultaneously, or in rapid succession, enters multiple orders to sell 1,000 shares owned, only one such order would constitute a long sale and any additional orders must be marked as “short.”
(UPDATED! 3/18/15)
Question 2.5(B): Does the guidance on marking multiple orders to sell 1,000 shares owned, set forth in Question 2.5 above, apply where some of the sale orders are non-marketable and thus less likely to be executed?
Answer: Rule 200(f) provides that, in order to determine its net position, a broker or dealer shall aggregate all of its positions in a security.[1] In addition, under Rule 200(c) and Rule 200(g)(1) of Regulation SHO, sale orders may only be marked “long” to the extent of the seller’s net long position. After one or more long sale orders are entered to sell an amount of shares equal to the seller’s net long position, any additional orders to sell the same shares must be marked “short.” When determining a seller’s net position and marking a sale order, it is not known whether or when pending unexecuted sale orders[2] will be executed. Unexecuted orders to sell a security are presumed to decrease a seller’s net long position, unless there is no realistic possibility that such sale orders will be executed. For example, if a market maker peg offer is set at the maximum allowable price away from the inside market, such that it is significantly higher than the inside offer and will likely never, or very rarely, be executed, a seller could calculate its net position without decrementing for that open market maker peg offer.[3] Broker-dealers not decrementing for such open market maker peg offers should be prepared to demonstrate, upon request of SRO or Commission staff, that such sale orders are never, or very rarely, executed (e.g., evidenced by order tickets and other relevant records maintained as a part of books and records as required by the federal securities laws).
(UPDATED! 10/15/15)
Question 2.5(C): Is the guidance that an unexecuted order to sell a security is presumed to decrease a seller’s net long position, unless there is no realistic possibility that such sale order will be executed, limited to the specific scenario of market maker peg offers set at the maximum allowable price away from the inside market?
Answer: Depending on the facts and circumstances, a market maker peg offer set at the maximum allowable price away from the inside market may be one of the rare scenarios that falls within the parameters of sell orders with no realistic possibility of execution such that a seller could calculate its net position without decrementing for an open unexecuted order to sell a security. In order to demonstrate that there is no realistic possibility of execution, a broker or dealer should be prepared to demonstrate that such sale orders are never, or very rarely, executed (e.g., evidenced by order tickets and other relevant records maintained as a part of books and records as required by the federal securities laws). Thus, orders that are less likely to be executed, such as non-marketable orders at prices above the current national best bid, but which may nonetheless occasionally or sometimes be executed, would not be considered sell orders with no realistic possibility of execution. SRO or Commission staff may consider, on a case-by-case basis, whether any other scenarios are applicable based on the facts and circumstances.
(UPDATED! 3/18/15)
Question 2.6: Is a broker-dealer required to re-mark a pending sell order if, although the order was correctly marked based on the seller’s net position at the time of order entry, the seller’s net position in the security has changed prior to execution such that the original marking is no longer consistent with the seller’s net position? Is a broker-dealer required to re-mark a pending sell order if the seller increases the quantity or changes the price of the order?
Answer: Rule 200(f) provides that, in order to determine its net position, a broker-dealer shall aggregate all of its positions in a security. In addition, if a broker-dealer is using independent trading units for net position calculation, each unit is required under Rule 200(f)(2) to determine, at the time of each sale, its net position for every security that it trades.[4] As long as a broker-dealer marked a sell order accurately based on the seller’s net position in the security at the time of order entry, an unchanged, pending sell order does not have to be re-marked to reflect a change in the seller’s net position in the security after order entry but prior to its execution. However, if the pending sell order is cancelled and replaced, any new sell order in the security must reflect the seller’s net position in the security at the time the new order is entered. A broker-dealer must not mark a new sell order based on the seller’s net position at the time the previous, cancelled sell order was entered.
In addition, if a seller increases the quantity of a pending sell order, the resulting modified order will be considered to be a new sell order that must be marked by the broker-dealer to reflect the seller’s net position at the time of order modification. Thus, the broker-dealer may not rely on the initial marking of the sell order, prior to the increase in the quantity of the order, and must re-mark the order at the time of entry of the new sell order reflecting the increased order quantity. A broker-dealer is not required to re-mark a pending sell order if the seller decreases the quantity of the order.
Any modification to the price of an order to sell a covered security, including displayed orders, marked “short” or “short exempt” under Rule 201(c), while the short sale price test restriction of Rule 201 is in effect with respect to that covered security, should be considered a new order. As a result, a trading center’s reasonably designed policies and procedures should prevent the execution or display of the new sale order marked “short” at a price that is less than or equal to the current national best bid. In addition, a broker-dealer would need to identify, pursuant to its reasonably designed policies and procedures, that the new order is at a price above the current national best bid at the time of submission of the new order to a trading center in order to mark the new order “short exempt” under Rule 201(c). See 17 CFR 242.201(b); 17 CFR 242.201(c).
3. Trade Execution
(UPDATED! 10/15/15)
Question 3.1: How should brokers and dealers process orders when the normal closing time for a regular trading day has changed (e.g., early closing of markets for holidays)?
Answer: This question pertained to the 2004/2005 pilot to study the removal of short sale price tests and is no longer applicable. See Exchange Act Release No. 50104 (July 28, 2004), 69 FR 48032 (Aug. 6, 2004). For further information about regular trading hours and the short sale price test circuit breaker under Rule 201, please refer to Division of Trading and Markets: Responses to Frequently Asked Questions Concerning Rule 201 of Regulation SHO, Questions 1.2 and 2.1.
4. Locate and Delivery Requirement — Rules 203(b)(1) and (2)
Question 4.1: How should broker-dealers determine “reasonableness” to satisfy the locate requirement of Regulation SHO?
Answer: Rule 203(b)(1)(ii) permits a broker or dealer to accept a short sale order in an equity security if the broker-dealer has reasonable grounds to believe that the security can be borrowed so that it can be delivered on the settlement date. “Reasonableness” is determined based on the facts and circumstances of the particular transaction. What is reasonable in one context may not be reasonable in another context. See, e.g., Adopting Release, 69 FR at 48014 (providing some examples of reasonableness); see also id. at 48014 n.58, 61, 62.
(UPDATED! 10/15/15)
Question 4.2: How may broker-dealers use Easy to Borrow lists?
Answer: Easy to Borrow lists generally may be used to establish a reasonable basis for a locate. Adopting Release, 69 FR at 48014. Easy to Borrow lists are prepared by a firm to indicate that firm’s ability to supply the identified securities. Therefore, for example, introducing firms may rely on Easy to Borrow lists of the clearing firms through which they clear and settle transactions unless circumstances indicate that it would not be reasonable to rely on such lists. For example, if the securities on the Easy to Borrow list have experienced delivery failures, it would not be reasonable to rely on the list. Securities that are ‘‘threshold securities’’ pursuant to Rule 203(c) should generally not be included on ‘‘Easy to Borrow’’ lists. Furthermore, if the Easy to Borrow list is prepared by a clearing firm through which the introducing firm does not clear or settle transactions, or otherwise does not maintain a relationship in which the clearing firm agrees to make securities on its Easy to Borrow lists available to the introducing firm, then it would not be reasonable to rely on the list.
Question 4.3: May an executing broker rely on customer representations that a short sale is supported by a locate from the stock loan department of the executing broker, then execute the order, and then confirm the locate later in the same day or the next morning?
Answer: The executing broker has the responsibility to perform the locate prior to effecting a short sale, and must have a reasonable basis to believe that the security can be delivered on the settlement date. Footnote 58 of the Adopting Release explains that a broker-dealer may obtain an assurance from a customer that the customer can obtain securities from another identified source in time to settle the trade. The executing broker may rely on a customer’s representation that an order to sell short a security is supported by a locate obtained by the customer from the stock loan department of the executing broker, or any other identified entity that is authorized to loan stock, as long as reliance on such representation is reasonable. However, where a broker-dealer knows or has reason to know that a customer’s prior assurances resulted in failures to deliver, assurances from such customer would not provide the reasonable grounds required for a locate.
Rule 203(b)(1) requires that the executing broker document the locate. Documentation should include the source of the securities cited by the customer. Documentation should also include support for the reasonable grounds to rely on customer assurances. For example, an executing broker may provide information showing that previous borrowings arranged by the customer resulted in timely deliveries of securities to settle the customer’s transactions.
After the executing broker executes a short sale, the executing broker may take steps to confirm the locate information provided by the customer. Confirmation of the locate after the execution of a short sale may provide information on whether the locate based on customer representations was reasonable. However, confirmation after the fact is not a substitute for a locate that is required to be performed before a short sale may be executed.
(UPDATED! 11/04/05)
Question 4.3(B): How does a customer's history with respect to timely delivery of securities in settling short sale transactions affect a broker-dealer's "reasonable grounds" obligation under Rule 203(b)(1)?
Answer: Rule 203 requires that the executing broker has the responsibility to perform the locate prior to effecting a short sale, and must have a reasonable basis to believe that the security can be delivered on the settlement date. Reasonableness is based on the facts and circumstances of a particular transaction. In some instances, it may be reasonable for an executing broker to rely on assurances from a customer that the customer can obtain the securities from an identified source in time to settle the trade. If the executing broker knows or has reason to know that a customer's prior assurances resulted in failures to deliver, however, reliance on further assurances from that customer would not be reasonable.
Rule 203(b)(1) requires that the locate be made and documented prior to effecting any short sale, including the broker-dealer's reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due. Information important to assessing the broker-dealer's "reasonable grounds" includes information about whether securities were delivered on a timely basis for settlement in situations where the broker-dealer relied on representations from the customer to support its locate. Accordingly, the executing broker-dealer must consider information, either from its own records or from the records of its clearing firm, about settlement of the customer's trades. It would not be reasonable for an executing broker to assert that it did not know or have reason to know whether a customer's prior short sale trades resulted in delivery failures if the executing broker made no reasonable effort to obtain such information. See Footnote 58 of the Adopting Release.
If the executing broker discovered that the customer's prior assurances resulted in a single failure to deliver, the executing broker should consider the relevant facts and circumstances to determine whether it would be reasonable to rely on the customer's assurances for other transactions. For example, it may be reasonable for an executing broker to rely on the customer's assurances if the circumstances of the fail in a prior transaction were unusual, or if previous locates relying on the customer's assurances resulted in timely deliveries of securities to settle the customer's transactions and the fail in the prior transaction was an anomaly.
(UPDATED! 10/10/06)
Question 4.3(C): May firms rely on pre-existing agreements, such as standing instruction letters or blanket assurances, with customers when complying with the locate requirements of Rule 203(b)(1) of Regulation SHO?
Answer: Rule 203(b)(1) of Regulation SHO provides that a "broker or dealer may not accept a short sale order in an equity security from another person, or effect a short sale in an equity security for its own account, unless the broker or dealer has: (i) Borrowed the security, or entered into a bona-fide arrangement to borrow the security; or (ii) Reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due; and (iii) Documented compliance with this paragraph (b)(1)." Thus, the broker-dealer has the responsibility to perform the locate prior to effecting each short sale.
To comply with the rule, the broker-dealer must perform the locate prior to, and on the same day that, the broker-dealer effects each short sale. For example, the broker-dealer must perform a new locate when a Good Till Cancel ("GTC") short sale order requiring a locate cannot be effected on the same day that the locate was performed. Moreover, the broker-dealer may not rely on a pre-existing agreement with another source in lieu of this trade-by-trade determination.
In addition, the rule requires that broker-dealers document, at a minimum, the identity of the source, as well as the fact that the locate was performed prior to, and on the same day that, the broker-dealer effected the short sale. The rule also requires documentation of the number of shares located. We understand, however, that documenting the specific number of shares located may be problematic for systems reasons. In such circumstances, the broker-dealer must be able to demonstrate, upon request of SRO or Commission staff, that the locate: (1) was performed prior to, and on the same day that, the broker-dealer effected the short sale; (2) the short sale did not exceed the number of shares located, and (3) that there were reasonable grounds to rely on the locate.
Footnote 58 of the Adopting Release provides that a broker-dealer may obtain an assurance from a customer that such party can obtain securities from another identified source in time to settle the trade. As discussed in more detail in Question 4.3(B), that customer assurance may in some circumstances provide the "reasonable grounds" required by Rule 203(b)(1)(ii). Where the broker-dealer is relying on a customer assurance, the broker-dealer must demonstrate, upon request of SRO or Commission staff, that it confirmed that the customer performed the locate prior to, and on the same day that, the broker-dealer effected the short sale. The broker-dealer may not rely on a pre-existing agreement, such as a standing instruction letter or blanket assurance, with a customer when complying with the locate requirements of the rule, but must obtain the customer's individual assurance prior to, and for, each short sale.
Question 4.4: May an executing broker-dealer re-apply a locate for intra-day buy-to-cover trades?
Answer: A locate for a security may be re-applied for an intra-day buy-to-cover trade in the following scenario:
Prior to a customer’s short sale of 100 shares of XYZ stock, the executing broker-dealer obtains an appropriate locate for the securities. The short sale is then executed. Subsequently that day, the broker-dealer purchases 100 shares of XYZ stock for the customer, and the customer’s net trading position is flat. If the customer wants to then sell short another 100 shares of XYZ stock in the same trading day, the executing broker-dealer may apply the original locate to that sale, provided that such subsequent short sale is for an amount of securities that is no greater than the amount of securities obtained in the original locate, and provided further that the source of the located shares indicates that the original locate is good for the entire trading day.
For a "hard to borrow" security or a threshold security, a broker-dealer may not re-apply a locate for intra-day buy-to cover trades. Without obtaining locates prior to each short sale in such securities in the scenario described above, it is unlikely that the broker-dealer executing such trades would have reasonable grounds to believe that such securities can be borrowed so that they can be delivered on the date that delivery is due on each trade. A broker-dealer, however, may have reasonable grounds to believe that securities will be available when delivery is due on such short sales if the broker-dealer pre-borrows the securities.
Question 4.5: Does the locate requirement apply to convertible securities?
Answer: The locate requirement applies to all equity securities. The term “equity security” is defined in Section 3(a)(11) of the Exchange Act and Rule 3a11-1 thereunder (17 CFR 240.3a11-1). A security convertible into an equity security is an equity security; therefore, such convertibles would be subject to the locate requirement. The Staff will consider on a case-by-case basis securities, including structured products, to which the “equity” status may not be clear.
A convertible security that is subject to the locate requirement may qualify for an exception. Rule 203(b)(2)(ii) provides an exception from the uniform locate requirement for situations in which a broker-dealer effects a sale on behalf of a customer that is deemed to “own” the security although, through no fault of the customer or the broker-dealer, it is not reasonably expected that the security will be in the physical possession or control of the broker-dealer by the settlement date. The Adopting Release states that such circumstances could include the situation where a convertible security, option, or warrant has been tendered for conversion or exchange, but the underlying security is not reasonably expected to be received by the settlement date. (69 FR at 48015). In such situation, delivery should be made on the sale as soon as all restrictions on delivery have been removed, and in any event within 35 days after trade date. If delivery is not made within 35 days after the trade date, the broker-dealer that sold on behalf of the person must either borrow securities or close out the open position by purchasing securities of like kind and quantity.
(UPDATED! 10/15/15)
Question 4.5(A): If a seller owns a security convertible into or exchangeable for another security, must the broker-dealer obtain a “locate” on a sale of the underlying security? Can the convertible or exchangeable security serve as the “locate” source for a sale of the underlying security?
Answer: An order to sell a security, where the seller owns a security convertible into or exchangeable for that security, may be considered a “short” sale under the marking requirements of Rule 200(g). Such circumstances could include the situation where a convertible security, such as an ADR, option, or warrant has been tendered for conversion or exchange, but the underlying security is not reasonably expected to be received by settlement date. See Adopting Release, 69 FR at 48015; see also infra Question 2.3(A). Rule 203(b)(1) provides that a broker-dealer may not accept a short sale order in an equity security from another person, or effect a short sale in an equity security for its own account, unless the broker-dealer has borrowed the security, has entered into a bona-fide arrangement to borrow the security; or has reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due. Rule 203(b)(2)(ii) provides that the “locate” requirement does not apply to any sale of a security that a person is deemed to own pursuant to Rule 200, provided that the broker-dealer has been reasonably informed that the person intends to deliver such security as soon as all restrictions on delivery have been removed and further provides that if the person has not delivered such security within 35 days after the trade date, the broker-dealer that effected the sale must borrow securities or close out the short position by purchasing securities of like kind and quantity. Rule 200(b)(3) provides that a person shall be deemed to own a security if the person owns a security convertible into or exchangeable for it and has tendered such security for conversion or exchange.
Where the seller owns a security convertible into or exchangeable for the security being sold, the “locate” requirement does not apply to the sale, provided that the convertible or exchangeable security, such as an ADR, option, or warrant, has been tendered for conversion or exchange prior to the submission of the sale order, and the broker-dealer has been reasonably informed that the person intends to deliver the security being sold as soon as all restrictions on delivery have been removed (i.e., as soon as processing of the conversion or exchange is complete). If the convertible or exchangeable security has not been tendered for conversion or exchange prior to the submission of the sale order, the seller is not deemed to own the underlying security pursuant to Rule 200 and the “locate” requirement would apply to the sale. See also infra Question 2.3(A).
Ownership of a security convertible into, or exchangeable for, the security being sold, is not a borrow or arrangement to borrow the security being sold. Ownership of a security convertible into, or exchangeable for, the security being sold would also not provide reasonable grounds to believe the security being sold can be borrowed. In addition, where the convertible or exchangeable security has not been tendered for conversion or exchange prior to the sale order (such that the exception to the “locate” requirement under Rule 203(b)(2)(ii) is not available), the underlying security may not be available for delivery by settlement date. Therefore, the convertible or exchangeable security, such as an ADR, option, or warrant, may not serve as the “locate” source for a sale of the underlying security.
(UPDATED! 8/28/09)
Question 4.6: May a U.S. broker-dealer that executes orders on behalf of a foreign broker-dealer rely on a locate provided by such foreign broker-dealer in the same way that the U.S. broker-dealer may rely on a locate provided by a U.S. broker-dealer?
Answer: Rule 203(b)(1)(ii) permits a broker-dealer to accept a short sale order in an equity security from another person if the broker-dealer has reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due. Subject to certain requirements, Rule 203(b)(2)(i) provides an exception to the locate requirement for short sale orders received by a registered broker-dealer from another registered broker-dealer. This "broker to broker" exception applies only to transactions undertaken between broker-dealers registered in the U.S. pursuant to the requirements of Rule 15(a) of the Securities Exchange Act of 1934.
U.S. broker-dealers must treat an assurance from a non-U.S. registered broker-dealer that it obtained a source of securities that can be delivered in time for settlement in the same manner as an assurance originating from a non-broker-dealer customer. For instance, the U.S. broker-dealer must have a reasonable belief that the securities will be available for delivery on the date delivery is due. Moreover, the U.S. broker-dealer must document this information. Consistent with Footnote 58 of the Regulation SHO Adopting Release (Release No. 50103), the documentation should include the source of the securities obtained by the foreign broker-dealer and support for the reasonableness of the U.S. broker-dealer's reliance on the foreign broker-dealer's assurances. See also FAQs 4.3(B) and 4.3(C). For further information about how the provisions of Regulation SHO may apply to overseas transactions, please refer to Question 1.3.
(UPDATED! 10/15/15)
Question 4.7: Market makers, as defined in Section 3(a)(38) of the Exchange Act, include block positioners. Regulation SHO provides an exception to the locate requirement for market makers. Are all block positioners excepted from the locate requirement?
Answer: Rule 203(b)(2)(iii) provides an exception from the locate requirement for short sales effected by market makers, but only in connection with bona-fide market making activities. Rule 203(c)(1) provides that the term “market maker” has the same meaning as in Section 3(a)(38) of the Exchange Act, which defines “market maker” as “any specialist permitted to act as a dealer, any dealer acting in the capacity of a block positioner, and any dealer that, with respect to a security, holds itself out (by entering quotations in an inter-dealer communications system or otherwise) as being willing to buy and sell such security for its own account on a regular or continuous basis.”
Block positioners, to the extent they engage in bona-fide block positioning activities, may also rely on this exception from the locate requirement in connection with such activities. Although the term “block positioner” is not defined in Regulation SHO or the Exchange Act, for purposes of Regulation SHO, “Rule 3b—8(c) of the Exchange Act (17 CFR 240.3b—8(c)) defines a ‘qualified block positioner’ as a dealer that: (1) is a broker or dealer registered pursuant to Section 15 of the Exchange Act; (2) is subject to and in compliance with Rule 15c3—1 of the Exchange Act (17 CFR 240.15c3—1); (3) has and maintains minimum net capital, as defined in Rule 15c3—1, of $1,000,000; and (4) except when such activity is unlawful, meets all of the following conditions: (i) engages in the activity of purchasing long or selling short, from time to time, from or to a customer (other than a partner or a joint venture or other entity in which a partner, the dealer, or a person associated with such dealer, as defined in Section 3(a)(18) of the Exchange Act, participates) a block of stock with a current market value of $200,000 or more in a single transaction, or in several transactions at approximately the same time, from a single source to facilitate a sale or purchase by such customer, (ii) has determined in the exercise of reasonable diligence that the block could not be sold to or purchased from others on equivalent or better terms, and (iii) sells the shares comprising the block as rapidly as possible commensurate with the circumstances.” See Exchange Act Release No. 58775, 73 FR at 61699 (eliminating the options market maker exception to Regulation SHO’s close-out requirement).
(UPDATED! 10/15/15)
Question 4.8: What constitutes “bona-fide market making activities?”
Answer: Rule 203(b)(2)(iii) provides that the “locate” requirement does not apply to short sales executed by market makers, as defined in Section 3(a)(38) of the Exchange Act, including specialists and options market makers, in the security for which the exception is claimed, but only in connection with bona-fide market making activities. The term “bona-fide market making” refers to bona-fide activities described in Section 3(a)(38) of the Exchange Act. Whether activity is “bona-fide” will depend on the facts and circumstances of the particular activity. But see Adopting Release, 69 FR at 48015 (setting forth examples of activities that would not be considered to be “bona-fide market making activities”); see also Exchange Act Release No. 58775, 73 FR at 61698-99 (providing additional guidance on what constitutes bona-fide market making for purposes of the market maker exception to the “locate” requirement of Rule 203(b)(1) of Regulation SHO).
Reliance on and compliance with an exchange’s market making designation and quoting requirements does not per se qualify a market maker for the bona-fide market making exception to the locate requirement under Regulation SHO. The Commission adopted a narrow exception to Regulation SHO’s “locate” requirement for market makers that may need to facilitate customer orders in a fast moving market without possible delays associated with complying with such requirement. Adopting Release, 69 FR at 48015. Only market makers engaged in bona-fide market making in the security at the time they effect the short sale are excepted from the “locate” requirement. Exchange Act Release No. 58775, 73 FR at 61699.
Indicia of bona-fide market making activity include where a market maker’s quotes are generally accessible to the public and the market maker holds itself out as being willing to buy and sell a security for its own account on a regular or continuous basis. See Id. Therefore, a market maker whose quotes are only accessible or provided to a restricted, limited or targeted audience would not be engaged in bona-fide market making for purposes of the exception to the “locate” requirement under Regulation SHO.
Question 4.9: How does the locate requirement apply to short sales of securities in a Rule 144 transaction?
Answer: Rule 203(b)(2)(ii) provides an exception from the uniform locate requirement for situations in which a broker-dealer effects a sale on behalf of a customer that is deemed to “own” the security although, through no fault of the customer or the broker-dealer, it is not reasonably expected that the security will be in the physical possession or control of the broker-dealer by the settlement date. One such situation is where a customer owns stock that was formerly restricted, but presently may be sold pursuant to the provisions of Rule 144 under the Securities Act of 1933. Adopting Release, 69 FR at 48015 n.71; 17 CFR 230.144. Rule 144 securities may not be capable of being delivered on settlement date due to processing to remove the restricted legend. In such situation, delivery should be made on the sale as soon as all restrictions on delivery have been removed, and in any event within 35 days after trade date. If delivery is not made within 35 days after the trade date, the broker-dealer that sold on behalf of the person must either borrow securities or close out the open position by purchasing securities of like kind and quantity.
(UPDATED! 10/15/15)
Question 4.10: A broker-dealer wishes to execute customer orders internally at a price that would trade through one or more protected quotations on other trading centers, but pursuant to Regulation NMS, is able to do so only if it simultaneously routes one or more ISOs to execute against the full displayed size of each of such better-priced quotations. Where the ISO is a short sale ISO, is the broker-dealer required to obtain a "locate" (i.e., have reasonable grounds to believe that the securities to be sold short are available for borrowing), as required by Rule 203(b)(1) of Regulation SHO?
Answer: In certain circumstances, a broker-dealer facilitating a customer order may be required under Regulation NMS to effect a ISO, while the broker-dealer is short the stock. Rule 203(b) of Regulation SHO provides that a broker or dealer may not accept a short sale order in an equity security from another person, or effect a short sale in an equity security for its own account, unless the broker or dealer has borrowed the security or entered into a bona-fide arrangement to borrow the security, or has reasonable grounds to believe the security can be borrowed so that it can be delivered on the date delivery is due. Regulation SHO includes an exception from the locate requirement, in Rule 203(b)(2)(iii), for short sales effected by market makers in connection with bona-fide market making activities.
The staff has previously indicated that because market makers, as defined in Section 3(a)(38) of the Exchange Act, include block positioners, the exception from the locate requirement also applies to short sales effected by block positioners in connection with bona-fide block positioning activities. See infra Question 4.7. The block positioner exception allows block positioners to facilitate customer orders in a fast moving market without possible delays associated with complying with the locate requirement.
A broker-dealer that submits a short sale ISO as a result of facilitating a customer order in the following circumstances would not be required to comply with the locate requirement in connection with the ISO, even if the customer order being facilitated was not necessarily of block size and the broker-dealer was not necessarily acting in the capacity of a block positioner or market maker:
- a broker-dealer that sells to facilitate a customer purchase at a price that would trade through one or more protected quotations on other trading centers and submits a principal sell short ISO to execute against the full displayed size of each such better-priced quotation pursuant to Rule 611;
- a broker-dealer that agrees to purchase from a customer at a price that would trade through one or more protected quotations on other trading centers and submits a principal sell short ISO to execute against the full displayed size of each such better-priced quotation pursuant to Rule 611.
In addition, a broker-dealer that agrees to facilitate two customers in an agency cross transaction at a price that would trade through one or more protected quotations on other trading centers may agree with the customers that the broker will send principal sell short ISOs to execute against the full displayed size of each such better-priced quotation pursuant to Rule 611. A short sale ISO submitted in such circumstances solely to comply with Rule 611 is also excepted from the locate requirement.
In all of the examples described above, the locate exception is limited to the short sale ISO only. There is no exemption from the locate requirement for any short sale executed to facilitate the customer order. For example, if the broker-dealer is routing a short sale ISO for its principal account but owes any executions it receives to customer orders, and the customer orders are short sales, the locate exception does not apply to the customer short sale. The broker-dealer must continue to comply with the locate requirements of Rule 203(b)(1) with regard to that order.
This interpretive guidance is strictly limited to a broker-dealer's submission of a short sale ISO under the facts presented above, and any other short sales by the broker-dealer or customer would be required to comply with the Regulation SHO locate requirement, unless the broker-dealer or customer is otherwise entitled to rely on another exception in Rule 203(b)(2) of Regulation SHO. In the event that the broker-dealer's short sale ISO resulted in a fail-to-deliver position at a registered clearing agency, such fail position would be subject to the close-out requirement of Rule 204 of Regulation SHO.
5. Close-Out Requirements — Rule 204
(UPDATED! 10/15/15)
Question 5.1: Does the close-out requirement apply to open fail positions in securities that exist prior to January 3, 2005?
Answer: This question pertained to the “grandfather provision” under Rule 203(b)(3) and is no longer applicable because the “grandfather provision” was eliminated in 2007. See Exchange Act Release No. 56212, 72 FR 45544. For further information about Rule 203(b)(3) and 203(c)(6), please refer to Section 6., below.
(MOVED! 10/15/15)
Question 5.2: Must an open fail position be closed out if a security is not a threshold security on the trade date but later appears on a threshold list? Must an open fail position be closed out if a security is a threshold security on the trade date but later does not appear on a threshold list?
Answer: This question pertained to Rule 203(b)(3) and has been moved to Section 6., below, addressing questions regarding threshold securities under Rule 203(b)(3) and 203(c)(6). See supra Question 6.3.
(UPDATED! 10/15/15)
Question 5.3: Does the close-out requirement apply to delivery failures that do not occur at a registered clearing agency?
Answer: The close-out requirement applies only to fail to deliver positions in an equity security at a registered clearing agency. We understand that transactions conducted outside CNS, operated by NSCC, are rare. If this historical pattern changes and a significant level of fails are not included in CNS, this position may be reconsidered.
(UPDATED! 10/15/15)
Question 5.4: When entering into an arrangement to pre-borrow an equity security under Rule 204(b), must a firm clean up the entire amount of the fail before accepting additional orders to sell short such security? Or, may the firm effect short sale orders up to the amount of shares of the security that is pre-borrowed?
Answer: Under Rule 204(b), if a participant of a registered clearing agency has a fail to deliver position in any equity security at a registered clearing agency and does not close out such fail to deliver position in accordance with the requirements of Rule 204(a), the participant and any broker or dealer from which it receives trades for clearance and settlement, to the extent that the broker or dealer submits its short sales to that participant for clearance and settlement, may not accept a short sale order in the equity security from another person, or effect a short sale in the equity security for its own account without first borrowing the security, or entering into a bona-fide arrangement to borrow the security, until the participant closes out the fail to deliver position by purchasing securities of like kind and quantity and that purchase has cleared and settled at a registered clearing agency. This pre-borrow requirement remains in place until the participant closes out the fail to deliver position by purchasing securities of like kind and quantity and that purchase has cleared and settled at a registered clearing agency. Therefore, a participant that has a close-out obligation for a security may effect short sale orders for such security up to the amount pre-borrowed.
Rule 204(d) permits the participant to reasonably allocate a portion of a fail to deliver position to another registered broker or dealer for which it clears trades or for which it is responsible for settlement, based on such broker’s or dealer’s short position. If the participant has reasonably allocated the fail to deliver position, the provisions of Rule 204 relating to such fail to deliver position, including the pre-borrow requirement, apply to such registered broker or dealer that was allocated the fail to deliver position, and not to the participant. See also supra Question 6.4 (addressing threshold securities under Rules 203(b)(3) and 203(c)(6)).
(UPDATED! 10/15/15)
Question 5.5: When must the close-out be initiated?
Answer: Rule 204(a) provides that a participant of a registered clearing agency must deliver securities to a registered clearing agency for clearance and settlement on a long or short sale in any equity security by settlement date, or if a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in any equity security for a long or short sale transaction in the equity security, the participant shall, by no later than the beginning of regular trading hours on the applicable close-out date, immediately close out its fail to deliver positions by borrowing or purchasing securities of like kind and quantity. “No later than the beginning of regular trading hours” includes market orders to purchase securities placed at the beginning of regular trading hours and executed within a reasonable time after placement, but does not include limit orders or other delayed orders, even if placed at the beginning of regular trading hours. However, the participant may satisfy the close-out requirement to purchase securities of like kind and quantity with a VWAP order provided the order to purchase the equity security on a VWAP basis is irrevocable and received by no later than the beginning of regular trading hours on the applicable close-out date; and the final execution price of any such transaction is not determined until after the close of regular trading hours when the VWAP value is calculated and the execution is on an agency basis. (74 FR at 38271 n.66). Placing a market or VWAP order to purchase securities at or before the beginning of regular trading hours, but cancelling or modifying the order prior to execution would not fulfill the close-out requirement. See also supra Question 6.5 (addressing threshold securities under Rules 203(b)(3) and 203(c)(6)).
(MOVED! 10/15/15)
Question 5.6: If a threshold security also qualifies as an “owned” security within the meaning of Rule 203(b)(2)(ii), when should the firm close out the short position: after the 13th consecutive settlement day; or the day that is 35 days after the trade date?
Answer: This question pertained to Rule 203(b)(3) and has been moved to Section 6., below, addressing questions regarding threshold securities under Rule 203(b)(3) and 203(c)(6). See supra Question 6.6.
(UPDATED! 10/15/15)
Question 5.6(A): How should a participant apply the thirty-five calendar day close out period to a fail to deliver position resulting from a sale of securities that a person is deemed to own under Rule 200?
Answer: Under Rule 204(a)(2), if a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in any equity security resulting from a sale of a security that a person is deemed to own pursuant to Rule 200 and that such person intends to deliver as soon as all restrictions on delivery have been removed, the participant shall, by no later than the beginning of regular trading hours on the thirty-fifth consecutive calendar day following the trade date for the transaction, immediately close out the fail to deliver position by purchasing securities of like kind and quantity. Additional time to close out fails to deliver resulting from sales of securities that a person is deemed to own is provided so that participants can close out such fails with the security sold, as soon as all processing delays have been removed, rather than having to close out such fails by purchasing securities in the market. See Exchange Act Release No. 60388, 74 FR at 38277-78.
The thirty-five calendar day close out period expires once the deemed to own security has actually been delivered. The participant may not treat the thirty-five calendar day close out period for a fail to deliver position resulting from the sale of a deemed to own security as a credit against close out obligations for fail to deliver positions unrelated to the sale of the deemed to own security. Therefore, participants should have in place a reasonable methodology to apply this exception, including a methodology to ensure that the participant is not claiming the thirty-five day close out period beyond the date of delivery of the deemed to own securities.
(MOVED! 10/15/15)
Question 5.7: If a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in a threshold security for 13 consecutive settlement days and immediately thereafter purchases securities of like kind and quantity to close out the fail to deliver position as required under Rule 203(b)(3), will the participant be deemed to have satisfied the close-out obligation on the day the purchase is executed, or on the day the purchase settles?
Answer: This question pertained to Rule 203(b)(3) and has been moved to Section 6., below, addressing questions regarding threshold securities under Rules 203(b)(3) and 203(c)(6). See supra Question 6.7.
(MOVED! 10/15/15)
Question 5.8: If a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in a threshold security at the end of each day for 13 consecutive settlement days, but during the 13-day period the participant experiences a reduction in its end of day fail to deliver position at NSCC, how should the participant apply that reduction to its open fail position(s)?
Answer: This question pertained to Rule 203(b)(3) and has been moved to Section 6., below, addressing questions regarding threshold securities under Rules 203(b)(3) and 203(c)(6). See supra Question 6.8.
6. Threshold Securities — Rule 203(b)(3) and Rule 203(c)(6)
Rule 203(b)(3) applies to fails to deliver in threshold securities, as defined by Rule 203(c)(6), if the fails to deliver persist for 13 consecutive settlement days. Although as a result of compliance with Rule 204, generally fail to deliver positions will not remain for 13 consecutive settlement days, if, for whatever reason, a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in a threshold security for 13 consecutive settlement days, the requirement to close-out such position under Rule 203(b)(3) remains in effect. The following questions address Rules 203(b)(3) and 203(c)(6) in the circumstances where they apply.
(UPDATED! 10/15/15)
Question 6.1: Who is responsible for providing lists of threshold securities? When are the threshold lists provided?
Answer: Staff understands that the SROs disseminate threshold lists that contain securities that are listed on their market systems and that exceed the specified fail level for at least five consecutive settlement days. A threshold security is expected to appear on one list. If a threshold security is listed on more than one market system, the SROs have agreed that the security will appear only on the threshold list of the SRO that maintains the primary listing.
Staff also understands that SROs disseminate their threshold lists before the commencement of each trading day. SROs make all their lists publicly available at or before midnight each trading day. Therefore, these threshold lists are in effect for the open of trading immediately following the posting of the threshold lists. SROs make threshold data available on their web sites in a downloadable, uniform, pipe-delimited ASCII format.
(UPDATED! 10/15/15)
Question 6.2: How will SROs determine which securities should be included on a threshold list?
Answer: Any equity security of an issuer that is registered under Section 12 or that is required to file reports pursuant to Section 15(d) of the Exchange Act could qualify as a threshold security. Therefore, threshold securities may include those equity securities that trade over the counter, as well as those that trade on an exchange.
At the conclusion of each settlement day, NSCC provides the SROs with data on securities that have aggregate fails to deliver at NSCC of 10,000 shares or more. For the securities for which it is the primary market, each SRO uses this data to calculate whether the level of fails is equal to at least 0.5% of the issuer’s total shares outstanding of the security. If, for five consecutive settlement days, such security satisfies these criteria, then such security is deemed a threshold security. Each SRO includes such security on its daily threshold list until the security no longer qualifies as a threshold security.
Threshold securities under Rule 203(c)(6), by definition, are limited to equity securities. The term “equity security” is defined in Section 3(a)(11) of the Exchange Act and Rule 3a11-1 thereunder. A security convertible into an equity security is an equity security. Therefore, a debt security would not be a threshold security unless such debt security is convertible into an equity security. Any debt securities that may inadvertently be included in published threshold lists are not subject to the Rule 203(b)(3) threshold security close-out requirement of Regulation SHO.
Question 6.3: Must an open fail position be closed out if a security is not a threshold security on the trade date but later appears on a threshold list? Must an open fail position be closed out if a security is a threshold security on the trade date but later does not appear on a threshold list?
Answer: The close-out and pre-borrow requirements of Rule 203(b)(3) of Regulation SHO are based on settlement days, not trade days. Under Rule 203(b)(3) of Regulation SHO, it is irrelevant whether a security is a threshold security on the date that it is sold short. The close-out and pre-borrow requirements of Rule 203(b)(3) apply if a security is a threshold security for 13 consecutive settlement days and a participant in a registered clearing agency has open delivery failures in that security on each of those days.
For example, if a participant sells short a security that is not a threshold security on the date of sale, the close-out and pre-borrow requirements of Rule 203(b)(3) would not apply to a fail to deliver position on the participant’s net short settlement obligation unless the security later becomes a threshold security and it maintains that status for 13 consecutive settlement days and the participant has delivery failures for all of those days. On the other hand, a participant must close out a fail to deliver position in a threshold security that has persisted for 13 consecutive settlement days irrespective of the dates of the participant’s trades in that security. If the security ceases to be a threshold security prior to the 13th consecutive settlement day that a participant has a fail position in the security, there would be no obligation under Rule 203(b)(3) of Regulation SHO to close out the fail position.
Question 6.4: When entering into an arrangement to pre-borrow a threshold security under Rule 203(b)(3) must a firm clean up the entire amount of the fail before accepting additional orders to sell short such security? Or, may the firm effect short sale orders up to the amount of shares of the security that is pre-borrowed?
Answer: Under Rule 203(b)(3), if a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in a threshold security for thirteen consecutive settlement days, two consequences follow: (1) the participant must immediately take steps to close out the fail to deliver position; and (2) the participant and any broker or dealer for which it clears transactions may not accept a short sale order in the threshold security from another person, or effect a short sale in the threshold security for its own account, without borrowing the security or entering into a bona-fide arrangement to borrow the security, until the participant closes out the fail to deliver position by purchasing securities of like kind and quantity. This pre-borrow requirement remains in place until the participant closes out the entire fail to deliver position. Therefore, a participant that has a close-out obligation for a security may effect short sale orders for such security up to the amount pre-borrowed.
Rule 203(b)(3)(iv) permits the participant to reasonably allocate a portion of a fail to deliver position to another registered broker or dealer for which it clears trades or for which it is responsible for settlement, based on such broker’s or dealer’s short position. If the participant has reasonably allocated the fail to deliver position, the provisions of Rule 203(b)(3) relating to such fail to deliver position, including the pre-borrow requirement, apply to such registered broker or dealer that was allocated the fail to deliver position, and not to the participant.
Question 6.5: When must the close-out be initiated?
Answer: Rule 203(b)(3) provides that a participant of a registered clearing agency that has a net settlement failure in a threshold security for 13 consecutive settlement days must immediately take steps to close out the fail to deliver position. The close-out process must be initiated no later than the beginning of trading on the trading day following the 13th consecutive settlement day with a net short settlement obligation.
Question 6.6: If a threshold security also qualifies as an “owned” security within the meaning of Rule 203(b)(2)(ii), when should the firm close out the short position: after the 13th consecutive settlement day; or the day that is 35 days after the trade date?
Answer: The close-out requirement that applies to threshold securities in Rule 203(b)(3)(iii) is based on net short positions, not trade dates. If a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in a threshold security for 13 consecutive settlement days, the participant must take action to close out the fail to deliver position after the 13th consecutive settlement day. See infra Question 6.5. Until the close-out obligation is satisfied, the participant must pre-borrow securities prior to effecting any subsequent short sales in such threshold security. See infra Question 6.4.
The close-out requirement that applies to “owned” securities in Rule 203(b)(2)(ii), however, is a sale-based provision that does not apply directly to net short positions and is not limited to sales of threshold securities. It provides an exception from the locate requirement for a short sale of an “owned” security, provided that the broker or dealer has been reasonably informed that the person intends to deliver such security as soon as all restrictions on delivery have been removed. If the person has not delivered such security within 35 days after the date of sale, the broker or dealer that effected the sale must borrow securities or close out the short position by purchasing securities of like kind and quantity.
These close-out requirements operate independently and concurrently. Therefore, if an “owned” security is a threshold security, the security must be delivered within 35 days of the trade date, and a fail to deliver position in that security must be closed out after 13 consecutive settlement days of delivery failures.
(05/24/05)
Question 6.7: If a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in a threshold security for 13 consecutive settlement days and immediately thereafter purchases securities of like kind and quantity to close out the fail to deliver position as required under Rule 203(b)(3), will the participant be deemed to have satisfied the close-out obligation on the day the purchase is executed, or on the day the purchase settles?
Answer: Rule 203(b)(3) provides that a participant of a registered clearing agency that has a fail to deliver position in a threshold security for 13 consecutive settlement days must immediately thereafter close out the fail to deliver position by purchasing securities of like kind and quantity. Until the close-out obligation is satisfied, a participant must pre-borrow securities to effect any new short sales in such threshold securities.
The staff interprets the phrase "purchasing securities of like kind and quantity" in Rule 203(b)(3) to mean that a participant satisfies the obligation to close out an open fail to deliver position in a threshold security that has persisted for 13 consecutive settlement days when such participant executes a purchase of securities, and where:
- the purchase is a bona-fide transaction;
- the purchase is executed on settlement day 11, 12 or 13;
- the purchase is submitted to a registered clearing agency for settlement;
- the purchase is of a quantity of securities sufficient to close out the entire amount of the open fail position that has persisted for 11, 12 or 13 consecutive settlement days, as applicable; and
- the net purchases of the threshold security effected by the participant on that day, as reflected in such participant's books and records, are at least equal to the amount of such participant's open fail to deliver position in such threshold security on that day.
Purchases to close out fail to deliver positions in threshold securities must be bona-fide purchases. Rule 203(b)(3)(v) provides that where a participant enters into an arrangement with another person to purchase securities to close out an open fail to deliver position in a threshold security, and the participant knows or has reason to know that the other person will not deliver securities in settlement of the purchase, the participant will not be deemed to have fulfilled the close-out requirements of Rule 203(b)(3).
The staff's interpretation that a participant satisfies the close-out obligation on the day when such participant executes a purchase of securities applies only to fail positions that are or are projected to be subject to the close-out requirements of Rule 203(b)(3); i.e., to purchases made on settlement day 11, 12, or 13. Therefore, this interpretation does not apply to purchases made on settlement day 10 or earlier, because there is no present or projected close-out requirement and such purchases would settle on or before 13 consecutive settlement days has elapsed.
(03/17/06)
Question 6.8: If a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in a threshold security at the end of each day for 13 consecutive settlement days, but during the 13-day period the participant experiences a reduction in its end of day fail to deliver position at NSCC, how should the participant apply that reduction to its open fail position(s)?
Answer: Rule 203(b)(3) of Regulation SHO requires a participant to close out a fail to deliver position in a threshold security that has persisted for 13 consecutive settlement days by purchasing securities of like kind and quantity. A participant's close-out requirement is determined by the change in the participant's end-of-day net fail to deliver position, in excess of any grandfathered amount, as recorded at NSCC that has remained open for 13 consecutive settlement days. In determining its close-out requirement, the participant must look to its total fails position at NSCC and not to fails positions at the customer account level.
If, prior to the 13th consecutive settlement day, the participant reduces its open fail to deliver position and such reduction is reflected in the participant's end-of-day net fail to deliver position at NSCC, the participant may first apply the reduction to the most recent increase in its fail to deliver position reflected at NSCC and then to any increase in its fails position that existed at NSCC on the day preceding that day and so forth until the entire amount of the reduction has been applied. If the participant wishes to apply any reduction reflected in its end-of-day net fail to deliver position at NSCC, the participant must do so in accordance with the methodology described in this Question 6.9.
Example
In this example, the participant has a fail to deliver position at NSCC of 5,000 shares in threshold security X that is subject to both increases and decreases during the 13 consecutive settlement day period.
| Settlement Day | Participant's End-of-Day Fail to Deliver Position | Increase/(Reduction) in Fail to Deliver Position from Previous Settlement Day | Participant's Close-out Requirement |
| 1 | 5,000 | 5,000 | 0 |
| 2 | 5,000 | 0 | 0 |
| 3 | 5,500 | 500 | 0 |
| 4 | 5,500 | 0 | 0 |
| 5 | 5,500 | 0 | 0 |
| 6 | 5,500 | 0 | 0 |
| 7 | 5,900 | 400 | 0 |
| 8 | 5,300 | (600) | 0 |
| 9 | 5,300 | 0 | 0 |
| 10 | 5,300 | 0 | 0 |
| 11 | 10,000 | 4,700 | 0 |
| 12 | 10,000 | 0 | 0 |
| 13 | 10,000 | 0 | 5,000 |
| 14 | 10,000 | 0 | 0 |
| 15 | 10,000 | 0 | 300 |
| 16 | 5,000 | (5,000) | 0 |
| 17 | 5,000 | 0 | 0 |
| 18 | 4,700 | (300) | 0 |
| 19 | 4,700 | 0 | 0 |
| 20 | 4,700 | 0 | 0 |
| 21 | 4,700 | 0 | 0 |
| 22 | 4,700 | 0 | 0 |
| 23 | 4,700 | 0 | 4,700 |
| 24 | 4,700 | 0 | 0 |
| 25 | 4,700 | 0 | 0 |
| 26 | 0 | (4,700) | 0 |
In the above example, the participant has three separate increases in its fail to deliver position at NSCC that persist for 13 consecutive settlement days and must be closed out by the participant at the end of the 13th settlement day following the day of the increase, or on the morning of the 14th settlement day following the day of the increase, by purchasing shares of like kind and quantity.
The participant has an initial increase in its fail to deliver position of 5,000 shares that persists for 13 consecutive settlement days and must be closed out at the end of the 13th settlement day following the day of the increase, or on the morning of the 14th settlement day following the day of the increase.
In addition, the participant's fail to deliver position increases by 500 shares to 5,500 and then again by 400 shares to 5,900 shares on settlement days 3 and 7, respectively. On settlement day 8, however, the participant's end of day fail to deliver position reflects a 600 shares reduction from the prior day. This 600 shares reduction is applied first to the 400 shares increase on settlement day 7 and the excess amount of 200 shares is then applied to the 500 shares increase on settlement day 3. As a result of the 600 shares reduction at NSCC, the 400 shares increase in the participant's position that occurred on day 7 is reduced to 0 and the 500 shares increase in the participant's position that occurred on day 3 is reduced to 300. There are no further reductions in the participant's end-of-day net fail to deliver position. Thus, the 300 shares increase must be closed out at the end of the 13th settlement day following the day of the increase to 500 shares, or on the morning of the 14th settlement day following the day of the increase to 500 shares.
On settlement day 11, the participant's fail to deliver position is 10,000 shares, an increase of 4,700 shares from the prior settlement day. The participant's position then decreases by 5,000 shares on settlement day 16 as a result of the purchase to close out the 5,000 share open fail position that occurred on day 1 and that has persisted for 13 consecutive settlement days. On settlement day 18, the participant's fail to deliver position decreases to 4,700 shares, a 300 shares reduction from the prior settlement day, as a result of the purchase to close out the 300 shares open fail to deliver position that has persisted for 13 consecutive settlement days. On settlement day 26, the participant's fail to deliver position decreases to 0 shares, a 4,700 shares reduction from the prior settlement day, as a result of the purchase to close out the 4,700 shares increase in the participant's fail to deliver position that occurred on settlement day 11 and that has persisted for 13 consecutive settlement days.
Although there are reductions in the participant's fail to deliver position at NSCC on settlement days 16, 18 and 26, these reductions are as a result of the participant fulfilling its close out requirement of 5,000, 300 and 4,700 shares, respectively, at the end of the 13th settlement day and, therefore, are not allocated to prior increases in the participant's fail to deliver position.
To the extent that a reduction in a participant's fail to deliver position at NSCC is equal to, and results from, a prior close out requirement, the participant may not allocate the reduction to prior increases in its fail to deliver position because the participant has already received credit for such reduction due to the reduction being applied to the amount of the participant's close out requirement. If, however, the reduction in the participant's fail to deliver position at NSCC is greater than the amount of the participant's close out requirement, the participant may allocate any amount in excess of the close out requirement in accordance with this Question 6.9.
(UPDATED! 10/15/15)
7. Clearance and Settlement
Question 7.1: Do naked short sale transactions create "counterfeit shares?"
Answer: Some believe that naked short sale transactions cause the number of shares trading to exceed the number of shares outstanding, which in turn allows broker-dealers to trade shares that don't exist. Others believe that the U.S. clearance and settlement system, and specifically the NSCC’s CNS, produces "phantom" or "counterfeit" securities by accounting for fails to deliver.
Naked short selling has no effect on an issuer's total shares outstanding. There is significant confusion relating to the fact that the aggregate number of positions reflected in customer accounts at broker-dealers may in fact be greater than the number of securities issued and outstanding. This is due in part to the fact that securities intermediaries, such as broker-dealers and banks, credit customer accounts prior to delivery of the securities. For most securities trading in the U.S. market, delivery subsequently occurs as expected. However, fails to deliver can occur for a variety of legitimate reasons, and flexibility is necessary in order to ensure an orderly market and to facilitate liquidity. Regulation SHO is intended to address the limited situations where fails are a potential problem.
Similarly, CNS has no effect on an issuer's total shares outstanding. With regards to the contention that the U.S. clearance and settlement system, and specifically NSCC's CNS system, creates counterfeit shares, this is not the case. CNS is essentially an accounting system that indicates delivery and receive obligations among its members (i.e., broker-dealers and banks). These obligations do not reflect ownership positions until such time as delivery of shares are actually made. Ownership positions are reflected on the records of The Depository Trust Company ("DTC").
Question 7.2: Does NSCC's stock borrow program ("SBP") create "counterfeit shares"?
Answer: The SBP was implemented in the late 1970s to allow NSCC to satisfy its members' priority needs for stocks that they do not receive because of fails. It is governed by NSCC rules approved by the Commission. Under the SBP, NSCC uses shares voluntarily made available to the SBP by some of its members to complete deliveries to members that did not receive their securities on settlement day. The SBP moves securities that are actually on deposit at DTC from the lending member to the NSCC member who did not receive securities. NSCC then records the lender's right to receive the same amount of shares that it loaned just as if the lender had purchased securities but not received them (i.e., the member lending the securities replaces the member receiving the loaned securities in the CNS system). The lending and delivery of shares through the SBP, however, does not relieve the member that has failed to deliver from its obligation to deliver securities.
The shares loaned by NSCC members for use in the SBP must be on deposit at DTC and are debited from members' accounts when the securities are used to make delivery. Once a member's shares are used for delivery to another member, the lending member no longer has the right to sell or relend those shares until such time as the shares are returned to its DTC account. Accordingly, NSCC's SBP does not create "counterfeit shares." In fact, the program facilitates the delivery of securities to buyers while maintaining the obligation of the sellers to deliver securities to NSCC. This outcome is consistent with the NSCC's obligation to facilitate the prompt and accurate clearance and settlement of securities transactions and in general to protect investors and the public interest.
Question 7.3: Should NSCC buy-in all fails to deliver in CNS?
Answer: A "fail to deliver" in NSCC's CNS occurs when an NSCC member (e.g., a broker-dealer or a bank) fails to deliver securities on settlement date. There are many reasons why NSCC members do not or cannot deliver securities to NSCC on the settlement date. Many times the member will experience a problem that is either unanticipated or is out of its control, such as (1) delays in customer delivery of shares to the broker-dealer; (2) an inability to borrow shares in time for settlement; (3) delays in obtaining transfer of title; (4) an inability to obtain transfer of title; and (5) deliberate failure to produce stock at settlement which may result in a broker-dealer not receiving shares it had purchased to fulfill its deliver obligations. In addition, market makers may maintain temporary short positions in CNS until such time as there is sufficient trading to flatten out their position.
NSCC does not have the authority to execute buy-ins on behalf of its members. Moreover, forcing close-outs of all fails can increase risk in clearing and settling transactions as well as potentially interfering with the trading and pricing of securities.
[1] Aggregation must be based on a listing of securities positions in all proprietary accounts. See Exchange Act Release No. 50103 (July 28, 2004), 69 FR 48008, 48010 n.22 (Aug. 6, 2004).
[2] Such orders may be referred to as in flight, open, resting, live, open interest, etc.
[3] For example, NASDAQ offers a market maker peg order type that market makers may use to meet their quoting obligations under NASDAQ Rule 4613(a). The use of market maker peg orders is not sufficient to demonstrate eligibility for bona fide market making under Regulation SHO. The use of market maker peg orders may be one indicator, among other necessary indicators, for a market maker to demonstrate that it may be engaged in bona-fide market making activities for purposes of Regulation SHO, depending on the facts and circumstances. A market maker entering such an order must consider the factors set forth by the Commission in determining whether reliance on the exception from the “locate” requirement of Rule 203 for bona-fide market making is appropriate. See Exchange Act Release No. 67584 (August 2, 2012).
[4] The Adopting Release for Regulation SHO notes that, “[a]ggregation of the unit’s net position prior to each sale limits the potential for abuse associated with coordination among units.” See Exchange Act Release No. 50103 (July 28, 2004), 69 FR 48008, 48011 (Aug. 6, 2004); see also Exchange Act Release No. 48795 (Nov. 17, 2003), 68 FR 65820 (Nov. 21, 2003) (“[i]f the seller has a ‘net long’ position in the security after this aggregation process, then the sale may be effected as a ‘long’ sale to the extent of the ‘net long’ position”). If a firm that is aggregating on a firm-wide basis is unable to accomplish real-time aggregation on a firm-wide basis, the firm should be able to demonstrate why such aggregation is impracticable and that the alternative method employed (e.g., on a daily basis) accurately reflects firm ownership positions. Exchange Act Release No. 50103 (July 28, 2004), 69 FR 48008, 48010 n.24 (Aug. 6, 2004). There is no allowance for the use of alternative aggregation methods by broker-dealers aggregating positions by independent trading unit. 17 CFR 242.200(f)(2).
Last Reviewed or Updated: Oct. 15, 2015