Amendments to Regulation SHO, 61706-61731 [E8-24785]
Download as PDF
61706
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
further clarify, consolidate or simplify
the amendments for small entities. The
Commission also believes that using
performance standards to specify
different requirements for small entities
or exempting small entities from having
to comply with the amendment would
not accomplish the regulatory goal of
adopting a consistent approach to
persistent fails to deliver.
X. Statutory Authority
Pursuant to the Exchange Act and,
particularly, Sections 2, 3(b), 9(h), 10,
11A, 15, 17(a), 17A, and 23(a) thereof,
15 U.S.C. 78b, 78c(b), 78i(h), 78j, 78k–
1, 78o, 78q(a), 78q–1, 78w(a), the
Commission is adopting an amendment
to § 242.203.
List of Subjects
17 CFR Part 241
Securities.
17 CFR Part 242
Brokers, Fraud, Reporting and
recordkeeping requirements, Securities.
Text of the Amendments to Regulation
SHO
For the reasons set out in the
preamble, Title 17, Chapter II, of the
Code of Federal Regulations is amended
as follows.
■
PART 241—INTERPRETATIVE
RELEASES RELATING TO THE
SECURITIES EXCHANGE ACT OF 1934
AND GENERAL RULES AND
REGULATIONS THEREUNDER
1. Part 241 is amended by adding
Release No. 34–58775 and the release
date of October 14, 2008 to the list of
interpretative releases.
■
PART 242—REGULATIONS M, SHO,
ATS, AC, AND NMS, AND CUSTOMER
MARGIN REQUIREMENTS FOR
SECURITY FUTURES
2. The authority citation for part 242
continues to read as follows:
■
Authority: 15 U.S.C. 77g, 77q(a), 77s(a),
78b, 78c, 78g(c)(2), 78i(a), 78j, 78k–1(c), 78l,
78m, 78n, 78o(b), 78o(c), 78o(g), 78q(a),
78q(b), 78q(h), 78w(a), 78dd–1, 78mm, 80a–
23, 80a–29, and 80a–37.
agency that has a fail to deliver position
at a registered clearing agency in a
threshold security on the effective date
of this amendment and which, prior to
the effective date of this amendment,
had been previously excepted from the
close-out requirement in paragraph
(b)(3) of this section (i.e., because the
participant of a registered clearing
agency had a fail to deliver position in
the threshold security that is attributed
to short sales effected by a registered
options market maker to establish or
maintain a hedge on options positions
that were created before the security
became a threshold security), shall
immediately close out that fail to deliver
position, including any adjustments to
the fail to deliver position, within 35
consecutive settlement days of the
effective date of this amendment by
purchasing securities of like kind and
quantity;
*
*
*
*
*
(v) If a participant of a registered
clearing agency entitled to rely on the
35 consecutive settlement day close-out
requirement contained in paragraph
(b)(3)(i), (b)(3)(ii), or (b)(3)(iii) of this
section has a fail to deliver position at
a registered clearing agency in the
threshold security for 35 consecutive
settlement days, the participant and any
broker or dealer for which it clears
transactions, including any market
maker, that would otherwise be entitled
to rely on the exception provided in
paragraph (b)(2)(ii) of this section, 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;
By the Commission.
Dated: October 14, 2008.
Florence E. Harmon,
Acting Secretary.
[FR Doc. E8–24742 Filed 10–16–08; 8:45 am]
BILLING CODE 8011–01–P
*
*
*
*
3. Section 242.203 is amended by:
a. Revising paragraph (b)(3)(iii) and
paragraph (b)(3)(v) to read as follows:
SECURITIES AND EXCHANGE
COMMISSION
§ 242.203 Borrowing and delivery
requirements.
[Release No. 34–58773; File No. S7–30–08]
*
jlentini on PROD1PC65 with RULES
■
■
*
*
*
*
*
(b) * * *
(3) * * *
(iii) Provided, however, that a
participant of a registered clearing
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
17 CFR Part 242
RIN 3235–AK22
Amendments to Regulation SHO
Securities and Exchange
Commission.
AGENCY:
PO 00000
Frm 00050
Fmt 4700
Sfmt 4700
Interim final temporary rule;
request for comments.
ACTION:
SUMMARY: The Securities and Exchange
Commission (‘‘Commission’’) is
adopting an interim final temporary rule
under the Securities Exchange Act of
1934 (‘‘Exchange Act’’) to address
abusive ‘‘naked’’ short selling in all
equity securities by requiring that
participants of a clearing agency
registered with the Commission deliver
securities by settlement date, or if the
participants have not delivered shares
by settlement date, immediately
purchase or borrow securities to close
out the fail to deliver position by no
later than the beginning of regular
trading hours on the settlement day
following the day the participant
incurred the fail to deliver position.
Failure to comply with the close-out
requirement of the temporary rule is a
violation of the temporary rule. In
addition, a participant that does not
comply with this close-out requirement,
and any broker-dealer from which it
receives trades for clearance and
settlement, will not be able to short sell
the security either for itself or for the
account of another, unless it has
previously arranged to borrow or
borrowed the security, until the fail to
deliver position is closed out.
DATES: Effective Date: October 17, 2008
until July 31, 2009. Comment Date:
Comments should be received on or
before December 16, 2008.
ADDRESSES: Comments may be
submitted by any of the following
methods:
Electronic Comments
• Use the Commission’s Internet
comment form (https://www.sec.gov/
rules/final.shtml); or
• Send an e-mail to rulecomments@sec.gov. Please include File
Number S7–30–08 on the subject line;
or
• Use the Federal eRulemaking Portal
(https://www.regulations.gov). Follow the
instructions for submitting comments.
Paper Comments
• Send paper comments in triplicate
to Florence E. Harmon, Acting
Secretary, Securities and Exchange
Commission, 100 F Street, NE.,
Washington, DC 20549–1090.
All submissions should refer to File
Number S7–30–08. This file number
should be included on the subject line
if e-mail is used. To help us process and
review your comments more efficiently,
please use only one method. The
Commission will post all comments on
the Commission’s Internet Web site
(https://www.sec.gov/rules/final.shtml).
E:\FR\FM\17OCR1.SGM
17OCR1
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
Comments are also available for public
inspection and copying in the
Commission’s Public Reference Room,
100 F Street, NE., Washington, DC
20549 on official business days between
the hours of 10 a.m. and 3 p.m. All
comments received will be posted
without change; we do not edit personal
identifying information from
submissions. You should submit only
information that you wish to make
available publicly.
FOR FURTHER INFORMATION CONTACT:
James A. Brigagliano, Associate
Director, Josephine J. Tao, Assistant
Director, Victoria L. Crane, Branch
Chief, Joan M. Collopy, Special Counsel,
Christina M. Adams and Matthew
Sparkes, Staff Attorneys, Office of
Trading Practices and Processing,
Division of Trading and Markets, at
(202) 551–5720, at the Commission, 100
F Street, NE., Washington, DC 20549–
6628.
SUPPLEMENTARY INFORMATION: We are
adopting temporary Rule 204T of
Regulation SHO [17 CFR 242.204T] as
an interim final temporary rule. We are
soliciting comments on all aspects of the
rule. We will carefully consider the
comments that we receive and intend to
respond to them in a subsequent release.
jlentini on PROD1PC65 with RULES
I. Introduction
Recently, we have become concerned
that there is a substantial threat of
sudden and excessive fluctuations of
securities prices and disruption in the
functioning of the securities markets
that could threaten fair and orderly
markets. These concerns with respect to
financial institutions are evidenced by
our recent publication of emergency
orders under section 12(k) of the
Exchange Act in July (the ‘‘July
Emergency Order’’) 1 and September of
this year (the ‘‘Short Sale Ban
Emergency Order’’).2 In these orders we
noted our concerns about the possible
use of unfounded rumors regarding the
stability of financial institutions by
short sellers for the purpose of
manipulating the prices of securities
issued by the financial institutions to
increase profits through ‘‘naked’’ short
selling.3
1 See Exchange Act Release No. 58166 (July 15,
2008), 73 FR 42379 (July 21, 2008) (imposing
borrowing and delivery requirements on short sales
of the equity securities of certain financial
institutions).
2 See Exchange Act Release No. 58592 (Sept. 18,
2008), 73 FR 55169 (Sept. 24, 2008) (temporarily
prohibiting short selling in the publicly traded
securities of certain financial institutions); see also
Exchange Act Release No. 58611 (Sept. 21, 2008),
73 FR 55556 (Sept. 25, 2008) (amending the Short
Sale Ban Emergency Order).
3 ’’Naked’’ short selling generally refers to selling
short without having borrowed the securities to
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
Our concerns, however, are not
limited to just the financial institutions
that were the subject of the July
Emergency Order and the Short Sale
Ban Emergency Order. Given the
importance of confidence in our
financial markets as a whole, we have
become concerned about sudden and
unexplained declines in the prices of
equity securities generally. Such price
declines can give rise to questions about
the underlying financial condition of an
institution, which in turn can create a
crisis of confidence even without a
fundamental underlying basis. This
crisis of confidence can impair the
liquidity and ultimate viability of an
institution, with potentially broad
market consequences. These concerns
resulted in our issuance on September
17 of this year of an emergency order
under section 12(k) of the Exchange Act
(the ‘‘September Emergency Order’’).4
Pursuant to that emergency order we
imposed enhanced delivery
requirements on sales of all equity
securities by adding and making
immediately effective a temporary rule
to Regulation SHO, Rule 204T.5
To further our goal of preventing
substantial disruption in the securities
markets, we are adopting Rule 204T as
an interim final temporary rule, with
some modifications to address
operational and technical concerns
resulting from the requirements of the
temporary rule as adopted in the
September Emergency Order. We intend
that the temporary rule will address
potentially abusive ‘‘naked’’ short
make delivery. See Exchange Act Release No. 50103
(July 28, 2004), 69 FR 48008, 48009 n.10 (Aug. 6,
2004) (‘‘2004 Regulation SHO Adopting Release’’);
see also Commission press release, dated July 13,
2008, announcing that the Commission’s Office of
Compliance Inspections and Examinations, as well
as the Financial Industry Regulatory Authority
(‘‘FINRA’’) and New York Stock Exchange
Regulation, Inc., (‘‘NYSE’’) will immediately
conduct examinations aimed at the prevention of
the intentional spreading of false information
intended to manipulate securities prices. See
https://www.sec.gov/news/press/2008/2008-140.htm.
In addition, in April of this year, the Commission
charged Paul S. Berliner, a trader, with securities
fraud and market manipulation for intentionally
disseminating a false rumor concerning The
Blackstone Group’s acquisition of Alliance Data
Systems Corp (‘‘ADS’’). The Commission alleged
that this false rumor caused the price of ADS stock
to plummet, and that Berliner profited by short
selling ADS stock and covering those sales as the
false rumor caused the price of ADS stock to fall.
See https://www.sec.gov/litigation/litreleases/2008/
lr20537.htm.
4 See Exchange Act Release No. 58572 (Sept. 17,
2008), 73 FR 54875 (Sept. 23, 2008).
5 See id. The September Emergency Order also
made immediately effective amendments to Rule
203(b)(3) of Regulation SHO that eliminate the
options market maker exception from Regulation
SHO’s close-out requirement. It also made
immediately effective Rule 10b–21, a ‘‘naked’’ short
selling antifraud rule.
PO 00000
Frm 00051
Fmt 4700
Sfmt 4700
61707
selling by requiring that securities be
purchased or borrowed to close out any
fail to deliver position in an equity
security by no later than the beginning
of regular trading hours on the
settlement day following the date on
which the fail to deliver position
occurred. This temporary rule should
provide a powerful disincentive to those
who might otherwise engage in
potentially abusive ‘‘naked’’ short
selling.
II. Background
Short selling involves a sale of a
security that the seller does not own or
a sale which is consummated by the
delivery of a security borrowed by, or
for the account of, the seller.6 Short
sales normally are settled by the
delivery of a security borrowed by or on
behalf of the seller. In a ‘‘naked’’ short
sale, however, the short seller does not
borrow securities in time to make
delivery to the buyer within the
standard three-day settlement period.7
As a result, the seller fails to deliver
securities to the buyer when delivery is
due (known as a ‘‘fail’’ or ‘‘fail to
deliver’’).8 Sellers sometimes
intentionally fail to deliver securities as
part of a scheme to manipulate the price
of a security,9 or possibly to avoid
6 17
CFR 242.200(a).
2004 Regulation SHO Adopting Release, 69
FR at 48009 n.10.
8 Generally, investors complete or settle their
security transactions within three settlement days.
This settlement cycle is known as T+3 (or ‘‘trade
date plus three days’’). T+3 means that when a trade
occurs, the participants to the trade deliver and pay
for the security at a clearing agency three settlement
days after the trade is executed so the brokerage
firm can exchange those funds for the securities on
that third settlement day. The three-day settlement
period applies to most security transactions,
including stocks, bonds, municipal securities,
mutual funds traded through a brokerage firm, and
limited partnerships that trade on an exchange.
Government securities and stock options settle on
the next settlement day following the trade (or T+1).
In addition, Rule 15c6–1 prohibits broker-dealers
from effecting or entering into a contract for the
purchase or sale of a security that provides for
payment of funds and delivery of securities later
than the third business day after the date of the
contract unless otherwise expressly agreed to by the
parties at the time of the transaction. 17 CFR
240.15c6–1; Exchange Act Release No. 33023 (Oct.
7, 1993), 58 FR 52891 (Oct. 13, 1993). However,
failure to deliver securities on T+3 does not violate
Rule 15c6–1; see also Exchange Act Release No.
56212 (Aug. 7, 2007), 72 FR 45544, n. 2 (Aug. 14,
2007) (‘‘2007 Regulation SHO Final Amendments’’).
9 In 2003, the Commission settled a case against
certain parties relating to allegations of
manipulative short selling in the stock of a
corporation. The Commission alleged that the
defendants profited from engaging in massive
‘‘naked’’ short selling that flooded the market with
the stock, and depressed its price. See Rhino
Advisors, Inc. and Thomas Badian, Lit. Rel. No.
18003 (Feb. 27, 2003); see also SEC v. Rhino
Advisors, Inc. and Thomas Badian, Civ. Action No.
03 civ 1310 (RO) (S.D.N.Y); see also Exchange Act
7 See
E:\FR\FM\17OCR1.SGM
Continued
17OCR1
61708
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
jlentini on PROD1PC65 with RULES
borrowing costs associated with short
sales, especially when the costs of
borrowing stock are high.
Although the majority of trades settle
within the standard three-day
settlement cycle (‘‘T+3’’),10 we adopted
Regulation SHO 11 on July 28, 2004, in
part to address problems associated
with persistent fails to deliver securities
and potentially abusive ‘‘naked’’ short
selling. For example, Regulation SHO
requires broker-dealers to ‘‘locate’’
securities that the broker-dealer
reasonably believes can be delivered
within the standard three-day
settlement period.12
Another requirement of Regulation
SHO aimed at potentially abusive
‘‘naked’’ short selling and reducing fails
to deliver in certain equity securities is
the rule’s ‘‘close-out’’ requirement.
Specifically, Rule 203(b)(3) requires
participants 13 of a registered clearing
agency,14 which includes brokerRelease No. 48709 (Oct. 28, 2003), 68 FR 62972,
62975 (Nov. 6, 2003) (‘‘2003 Regulation SHO
Proposing Release’’) (describing the alleged activity
in the case involving stock of Sedona Corporation);
2004 Regulation SHO Adopting Release, 69 FR at
48016, n.76.
10 According to the National Securities Clearing
Corporation (‘‘NSCC’’), 99% (by dollar value) of all
trades settle within T+3. Thus, on an average day,
approximately 1% (by dollar value) of all trades,
including equity, debt, and municipal securities fail
to settle on time.
11 17 CFR 242.200. Regulation SHO became
effective on January 3, 2005.
12 17 CFR 242.203(b)(1). Rule 203(b)(1) of
Regulation SHO requires 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).’’ This is known as the ‘‘locate’’ requirement.
Market makers engaged in bona fide market making
in the security at the time they effect the short sale
are excepted from this requirement.
13 For purposes of Regulation SHO, the term
‘‘participant’’ has the same meaning as in section
3(a)(24) of the Exchange Act. See 15 U.S.C.
78c(a)(24).
14 The term ‘‘registered clearing agency’’ means a
clearing agency, as defined in Section 3(a)(23)(A) of
the Exchange Act, that is registered as such
pursuant to Section 17A of the Exchange Act. See
15 U.S.C. 78c(a)(23)(A) and 78q–1, respectively; see
also 2004 Regulation SHO Adopting Release, 69 FR
at 48031. The majority of equity trades in the
United States are cleared and settled through
systems administered by clearing agencies
registered with the Commission. The National
Securities Clearing Corporation (‘‘NSCC’’) clears
and settles the majority of equity securities trades
conducted on the exchanges and in the over-thecounter market. NSCC clears and settles trades
through the Continuous Net Settlement (‘‘CNS’’)
system, which nets the securities delivery and
payment obligations of all of its members. NSCC
notifies its members of their securities delivery and
payment obligations daily. In addition, NSCC
guarantees the completion of all transactions and
interposes itself as the contraparty to both sides of
the transaction.
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
dealers, to purchase shares to close out
fails to deliver in securities with large
and persistent fails to deliver, i.e.,
‘‘threshold securities.’’ 15 Until the
position is closed out, the participant
responsible for the fail to deliver
position and any broker-dealer from
which it receives trades for clearance
and settlement may not effect further
short sales in that threshold security
without first borrowing or arranging to
borrow the securities.16
As adopted, Regulation SHO included
two major exceptions to the close-out
requirement: The ‘‘grandfather’’
provision and the ‘‘options market
maker’’ exception. The ‘‘grandfather’’
provision had provided that fails to
deliver established prior to a security
becoming a threshold security did not
have to be closed out in accordance
with Regulation SHO’s thirteen
consecutive settlement day close-out
requirement.
Due to our concerns about the
potentially negative market impact of
large and persistent fails to deliver, and
the fact that we continued to observe
threshold securities with fail to deliver
positions that are not being closed out
under existing delivery and settlement
requirements, effective on October 15,
2007, we adopted an amendment to
Regulation SHO that eliminated the
‘‘grandfather’’ exception to Regulation
SHO’s close-out requirement.17
The options market maker exception
excepted any fail to deliver position in
a threshold security resulting from short
sales effected by a registered options
market maker to establish or maintain a
hedge on options positions that were
created before the underlying security
became a threshold security. On
September 17, 2008, as part of the
September Emergency Order, we
adopted and made immediately
effective an amendment to Rule
203(b)(3) of Regulation SHO to
eliminate the options market maker
exception to the rule’s close-out
requirement.18 Following the issuance
of the September Emergency Order, we
adopted amendments making
permanent the elimination of the
options market maker exception.19 As
we discussed in the 2008 Regulation
SHO Final Amendments, we believe it
was appropriate to eliminate the options
market maker exception in part because
substantial levels of fails to deliver
continue to persist in threshold
securities and it appears that a
significant number of these fails to
deliver are as a result of the options
market maker exception.20
In addition to the actions we have
taken aimed at reducing fails to deliver
and addressing potentially abusive
‘‘naked’’ short selling in threshold
securities, we have also taken action
targeting potentially abusive ‘‘naked’’
short selling in both threshold and nonthreshold securities. For example, in the
September Emergency Order we
adopted and made immediately
effective a ‘‘naked’’ short selling antifraud rule, Rule 10b–21, aimed at
sellers, including broker-dealers acting
for their own accounts, who deceive
certain specified persons about their
intention or ability to deliver securities
in time for settlement and that fail to
deliver securities by settlement date.21
Following the issuance of the September
Emergency Order, we adopted final
amendments making Rule 10b–21
permanent.22
Also, as mentioned above, in the July
Emergency Order and the Short Sale
Ban Emergency Order, we took
emergency action targeting ‘‘naked’’
short selling in the securities of certain
financial firms that included nonthreshold securities. Specifically, on
July 15, 2008, we published the July
18 See
15 Rule
203(c)(6) of Regulation SHO defines a
‘‘threshold security’’ as any equity security of an
issuer that is registered pursuant to Section 12 of
the Exchange Act (15 U.S.C. 78l) or for which the
issuer is required to file reports pursuant to Section
15(d) of the Exchange Act (15 U.S.C. 78o(d)) for
which there is an aggregate fail to deliver position
for five consecutive settlement days at a registered
clearing agency of 10,000 shares or more, and that
is equal to at least 0.5% of the issue’s total shares
outstanding; and is included on a list disseminated
to its members by a self-regulatory organization
(‘‘SRO’’). See 17 CFR 242.203(c)(6).
16 See 17 CFR 242.203(b)(3)(iv).
17 See 2007 Regulation SHO Final Amendments,
72 FR 45544. This amendment also contained a
one-time phase-in period that provided that
previously-grandfathered fails to deliver in a
security that was a threshold security on the
effective date of the amendment must be closed out
within 35 consecutive settlement days from the
effective date of the amendment. The phase-in
period ended on December 5, 2007.
PO 00000
Frm 00052
Fmt 4700
Sfmt 4700
September Emergency Order, supra note 4.
Exchange Act Release No. 58775 (Oct. 14,
2008) (adopting final amendments to Rule 203(b)(3)
of Regulation SHO to eliminate the options market
maker exception from the rule’s close-out
requirement) (‘‘2008 Regulation SHO Final
Amendments’’); see also Exchange Act Release No.
56213 (Aug. 7, 2007), 72 FR 45558 (Aug. 14. 2007)
(‘‘2007 Regulation SHO Proposed Amendments);
Exchange Act Release No. 54154 (July 14, 2006), 71
FR 41710 (July 21, 2006) (‘‘2006 Regulation SHO
Proposed Amendments’’); Exchange Act Release
No. 58107 (July 7, 2008), 73 FR 40201 (July 14,
2008) (‘‘2008 Regulation SHO Re-Opening
Release’’).
20 See 2008 Regulation SHO Final Amendments,
supra note 19; see also 2008 Regulation SHO ReOpening Release, 73 FR 40201.
21 See September Emergency Order, supra note 4.
22 See Exchange Act Release No. 58774 (Oct. 14,
2008) (‘‘Anti-Fraud Rule Adopting Release’’); see
also Exchange Act Release No. 57511 (March 17,
2008), 73 FR 15376 (March 21, 2008) (‘‘Anti-Fraud
Rule Proposing Release’’).
19 See
E:\FR\FM\17OCR1.SGM
17OCR1
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
Emergency Order 23 that temporarily
imposed enhanced requirements on
short sales in the publicly traded
securities of certain substantial financial
firms. The July Emergency Order
required that, in connection with
transactions in the publicly traded
securities of the substantial financial
firms identified in Appendix A to the
Emergency Order (‘‘Appendix A
Securities’’), no person could effect a
short sale in the Appendix A Securities
using the means or instrumentalities of
interstate commerce unless such person
or its agent had borrowed, or arranged
to borrow, the security or otherwise had
the security available to borrow in its
inventory, prior to effecting such short
sale. The July Emergency Order also
required that the short seller deliver the
security on settlement date, prohibiting
any fails to deliver in the Appendix A
Securities.24
We issued the July Emergency Order
because we were concerned that false
rumors regarding financial institutions
of significance in the U.S. may have
fueled market volatility in the securities
of some of these institutions. As we
noted in the July Emergency Order, false
rumors can lead to a loss of confidence
in our markets. Such loss of confidence
can lead to panic selling, which may be
further exacerbated by ‘‘naked’’ short
selling. As a result, the prices of
securities may artificially and
unnecessarily decline below the price
level that would have resulted from the
normal price discovery process. If
significant financial institutions are
involved, this chain of events can
threaten disruption of our markets.25
On July 29, 2008, we extended the
July Emergency Order after carefully
reevaluating the current state of the
markets in consultation with officials of
the Board of Governors of the Federal
Reserve System, the Department of the
Treasury, and the Federal Reserve Bank
of New York and remaining concerned
about the ongoing threat of market
disruption and effects on investor
23 See
supra note 1.
id.
25 We delayed the effective date of the July
Emergency Order to July 21, 2008 to create the
opportunity to address, and to allow sufficient time
for market participants to make, adjustments to
their operations to implement the enhanced
requirements. Moreover, in addressing anticipated
operational accommodations necessary for
implementation of the July Emergency Order, we
issued an amendment to the July Emergency Order
on July 18, 2008. See Exchange Act Release No.
58190 (July 18, 2008) (excepting from the July
Emergency Order bona fide market makers, short
sales in Appendix A Securities sold pursuant to
Rule 144 of the Securities Act of 1933, and certain
short sales by underwriters, or members of a
syndicate or group participating in distributions of
Appendix A Securities).
jlentini on PROD1PC65 with RULES
24 See
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
confidence.26 Pursuant to the extension,
the July Emergency Order terminated at
11:59 p.m. EDT on August 12, 2008.
Due to our continued concerns
regarding recent market conditions and
that short selling in the securities of a
wider range of financial institutions
than those subject to the July Emergency
Order may be causing sudden and
excessive fluctuations of the prices of
such securities that could threaten fair
and orderly markets, on September 18,
2008, we issued the Short Sale Ban
Emergency Order.27 The Short Sale Ban
Emergency Order temporarily
prohibited any person from effecting a
short sale in the publicly traded
securities of certain financial
institutions. On October 2, 2008, we
extended the Short Sale Ban Emergency
Order due to our continued concerns
regarding the ongoing threat of market
disruption and investor confidence in
the financial markets.28 Pursuant to the
extension, the Short Sale Ban
Emergency Order terminated at 11:59
p.m. EDT on October 8, 2008.
Our concerns are no longer limited to
just the financial institutions that were
the subject of the July Emergency Order
and the Short Sale Ban Emergency
Order. Given the importance of
confidence in our financial markets as a
whole, we have become concerned
about sudden and unexplained declines
in the prices of equity securities
generally. These concerns resulted in
our adopting and making immediately
effective in the September Emergency
Order the enhanced delivery
requirements contained in temporary
Rule 204T.29 For the reasons explained
in detail herein, today we are adopting
the temporary rule as set forth in the
September Emergency Order, with
modifications to address technical and
operational concerns resulting from the
requirements of the temporary rule.
III. Concerns About ‘‘Naked’’ Short
Selling
We have been concerned about
‘‘naked’’ short selling and, in particular,
abusive ‘‘naked’’ short selling, for some
time. As discussed above, such concerns
were a primary reason for our adoption
of Regulation SHO in 2004, the
elimination of the ‘‘grandfather’’ and
options market maker exceptions to
26 See Exchange Act Release No. 58248 (July 29,
2008), 73 FR 45257 (Aug. 4, 2008).
27 See supra note 2.
28 See Exchange Act Release No. 58723 (Oct. 2,
2008) (stating that the Short Sale Ban Emergency
Order would terminate the earlier of (i) three
business days from the President’s signing of the
Emergency Economic Stabilization Act of 2008
(H.R. 1424), or (ii) 11:59 p.m. E.D.T. on Friday,
October 17, 2008).
29 See September Emergency Order, supra note 4.
PO 00000
Frm 00053
Fmt 4700
Sfmt 4700
61709
Regulation SHO’s close-out
requirement, the adoption of a ‘‘naked’’
short selling antifraud rule, and our
recent issuance of the July Emergency
Order, Short Sale Ban Emergency Order,
and the September Emergency Order.
Despite these Commission actions,
due to our continuing concerns about
the potential impact of ‘‘naked’’ short
selling on the weakened financial
markets, we believe it is necessary to
immediately adopt as an interim final
temporary rule, temporary rule 204T,
with some modifications to address
technical and operational concerns
resulting from the rule’s requirements as
set forth in the September Emergency
Order. We believe that adoption of
temporary rule 204T as an interim final
temporary rule is necessary to further
address abusive ‘‘naked’’ short selling
and, therefore, fails to deliver resulting
from such short sales, in all equity
securities. As we have stated on several
prior occasions, we believe that all
sellers of securities should promptly
deliver, or arrange for delivery of,
securities to the respective buyer and all
buyers of securities have a right to
expect prompt delivery of securities
purchased.30 In addition, as we have
stated on several prior occasions, we are
concerned about the negative effect that
fails to deliver may have on the markets
and shareholders.31
For example, large and persistent fails
to deliver may deprive shareholders of
the benefits of ownership, such as
voting and lending.32 In addition, where
a seller of securities fails to deliver
securities on settlement date, in effect
the seller unilaterally converts a
securities contract (which is expected to
settle within the standard three-day
settlement period) into an undated
futures-type contract, to which the
buyer might not have agreed, or that
might have been priced differently.33
Moreover, 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. For example, by not borrowing
securities and, therefore, not making
delivery within the standard three-day
settlement period, the seller does not
incur the costs of borrowing.
30 See, e.g., Anti-Fraud Rule Proposing Release,
73 FR at 15376.
31 See, e.g., 2007 Regulation SHO Final
Amendments, 72 FR at 45544; 2006 Regulation SHO
Proposed Amendments, 71 FR at 41712; 2007
Regulation SHO Proposed Amendments, 72 FR at
45558–45559; Anti-Fraud Rule Proposing Release,
73 FR at 15378.
32 See id.
33 See id.
E:\FR\FM\17OCR1.SGM
17OCR1
61710
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
jlentini on PROD1PC65 with RULES
In addition, issuers and investors
have repeatedly expressed concerns
about fails to deliver in connection with
manipulative ‘‘naked’’ short selling. For
example, in response to proposed
amendments to Regulation SHO in
2006 34 designed to further reduce the
number of persistent fails to deliver in
certain equity securities by eliminating
Regulation SHO’s ‘‘grandfather’’
exception, and limiting the duration of
the rule’s options market maker
exception, we received a number of
comments that expressed concerns
about ‘‘naked’’ short selling and
extended delivery failures.35
Commenters continued to express these
concerns in response to proposed
amendments to eliminate the options
market maker exception to the close-out
requirement of Regulation SHO in
2007.36
To the extent that fails to deliver
might be part of manipulative ‘‘naked’’
short selling, which could be used as a
tool to drive down a company’s stock
price,37 such fails to deliver may
undermine the confidence of
investors.38 These investors, in turn,
may be reluctant to commit capital to an
34 See 2006 Regulation SHO Proposed
Amendments, 71 FR 41710.
35 See, e.g., letter from Patrick M. Byrne,
Chairman and Chief Executive Officer,
Overstock.com, Inc., dated Sept. 11, 2006; letter
from Daniel Behrendt, Chief Financial Officer, and
Douglas Klint, General Counsel, TASER
International, dated Sept. 18, 2006; letter from John
Royce, dated April 30, 2007; letter from Michael
Read, dated April 29, 2007; letter from Robert
DeVivo, dated April 26, 2007; letter from Ahmed
Akhtar, dated April 26, 2007.
36 See, e.g., letter from Jack M. Wedam, dated Oct.
16, 2007; letter from Michael J. Ryan, Executive
Director and Senior Vice President, Center for
Capital Markets Competitiveness, U.S. Chamber of
Commerce, dated Sept. 13, 2007 (‘‘U.S. Chamber of
Commerce’’); letter from Robert W. Raybould, CEO
Enteleke Capital Corp., dated Sept. 12, 2007
(‘‘Raybould’’); letter from Mary Helburn, Executive
Director, National Coalition Against Naked
Shorting, dated Sept. 11, 2007 (‘‘NCANS’’).
37 See supra note 9 (discussing a case in which
we alleged that the defendants profited from
engaging in massive ‘‘naked’’ short selling that
flooded the market with the company’s stock, and
depressed its price); see also S.E.C. v. Gardiner, 48
S.E.C. Docket 811, No. 91 Civ. 2091 (S.D.N.Y.
March 27, 1991) (alleged manipulation by sales
representative by directing or inducing customers to
sell stock short in order to depress its price); U.S.
v. Russo, 74 F.3d 1383, 1392 (2d Cir. 1996) (short
sales were sufficiently connected to the
manipulation scheme as to constitute a violation of
Exchange Act Section 10(b) and Rule 10b–5).
38 In response to the 2007 Regulation SHO
Proposed Amendments, we received comment
letters discussing the impact of fails to deliver on
investor confidence. See, e.g., letter from NCANS.
Commenters expressed similar concerns in
response to the 2006 Regulation SHO Proposed
Amendments. See, e.g., letter from Mary Helburn,
Executive Director, National Coalition Against
Naked Shorting, dated Sept. 30, 2006 (‘‘NCANS
(2006)’’); letter from Richard Blumenthal, Attorney
General, State of Connecticut, dated Sept. 19, 2006
(‘‘Blumenthal’’).
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
issuer they believe to be subject to such
manipulative conduct.39 In addition,
issuers may believe that they have
suffered unwarranted reputational
damage due to investors’ negative
perceptions regarding fails to deliver in
the issuer’s security.40 Unwarranted
reputational damage caused by fails to
deliver might have an adverse impact on
the security’s price.41
IV. Discussion of Temporary Rule 204T
A. Rule 204T’s Close-Out Requirement
In these unusual and extraordinary
times and in an effort to prevent
substantial disruption to the securities
markets, we have concluded that it is
necessary to immediately adopt as an
39 In response to the 2007 Regulation SHO
Proposed Amendments, we received comment
letters expressing concern about the impact of
potential ‘‘naked’’ short selling on capital
formation, claiming that ‘‘naked’’ short selling
causes a drop in an issuer’s stock price and may
limit the issuer’s ability to access the capital
markets. See, e.g., letter from Robert K. Lifton,
Chairman and CEO, Medis Technologies, Inc., dated
Sept. 12, 2007 (‘‘Medis’’); letter from NCANS.
Commenters expressed similar concerns in
response to the 2006 Regulation SHO Proposed
Amendments. See, e.g., letter from Congressman
Tom Feeney—Florida, U.S. House of
Representatives, dated Sept. 25, 2006 (‘‘Feeney’’);
see also letter from Zix Corporation, dated Sept. 19,
2006 (‘‘Zix’’) (stating that ‘‘[m]any investors
attribute the Company’s frequent re-appearances on
the Regulation SHO list to manipulative short
selling and frequently demand that the Company
‘‘do something’’ about the perceived manipulative
short selling. This perception that manipulative
short selling of the Company’s securities is
continually occurring has undermined the
confidence of many of the Company’s investors in
the integrity of the market for the Company’s
securities.’’).
40 Due in part to such concerns, some issuers have
taken actions to attempt to make transfer of their
securities ‘‘custody only,’’ (i.e., certificating the
securities and prohibiting ownership by a securities
intermediary) thus preventing transfer of their stock
to or from securities intermediaries such as the
Depository Trust Company (‘‘DTC’’) or brokerdealers. See Exchange Act Release No. 48709 (Oct.
28, 2003), 68 FR 62972, at 62975 (Nov. 6, 2003).
Some issuers have attempted to withdraw their
issued securities on deposit at DTC in order to make
the securities ineligible for book-entry transfer at a
securities depository. See id. Withdrawing
securities from DTC or requiring custody-only
transfers would undermine the goal of a national
clearance and settlement system designed to reduce
the physical movement of certificates in the trading
markets. See id. We note, however, that in 2003 the
Commission approved a DTC rule change clarifying
that its rules provide that only its participants may
withdraw securities from their accounts at DTC,
and establishing a procedure to process issuer
withdrawal requests. See Exchange Act Release No.
47978 (June 4, 2003), 68 FR 35037 (June 11, 2003).
41 See 2006 Regulation SHO Proposed
Amendments, 71 FR at 41712; 2007 Regulation SHO
Amendments, 72 FR at 45544; 2007 Regulation SHO
Proposed Amendments, 72 FR at 45558–45559;
Anti-Fraud Rule Proposing Release, 73 FR at 15378
(providing additional discussion of the impact of
fails to deliver on the market); see also Exchange
Act Release No. 48709 (Oct. 28, 2003), 68 FR 62972,
62975 (Nov. 6, 2003) (discussing the impact of
‘‘naked’’ short selling on the market).
PO 00000
Frm 00054
Fmt 4700
Sfmt 4700
interim final temporary rule, temporary
rule Rule 204T, with some
modifications to address technical and
operational concerns resulting from the
rule’s requirements as set forth in the
September Emergency Order. We
believe that adoption of the temporary
rule will substantially restrict the
practice of potentially abusive ‘‘naked’’
short selling in all equity securities by
strengthening the delivery requirements
for such securities.42
Specifically, temporary Rule 204T(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 that equity
security, the participant shall, by no
later than the beginning of regular
trading hours 43 on the settlement day 44
following the settlement date,
immediately close out the fail to deliver
position by borrowing or purchasing
securities of like kind and quantity.45
Temporary Rule 204T(a)’s close-out
requirement requires a participant of a
registered clearing agency that has a fail
to deliver position at a registered
clearing agency on the settlement date
for a transaction to immediately borrow
or purchase securities to close out the
amount of the fail to deliver position by
no later than the beginning of regular
trading hours on the settlement day
following the settlement date (the
‘‘Close-Out Date’’). This close-out
requirement requires that the
participant take affirmative action to
purchase or borrow securities. Thus, a
participant may not offset the amount of
its settlement date fail to deliver
position with shares that the participant
receives or will receive on the Close-Out
42 As noted above, in a ‘‘naked’’ short sale, the
short seller does not borrow or arrange to borrow
securities in time to make delivery to the buyer
within the standard three-day settlement period. As
a result, the seller fails to deliver securities to the
buyer when delivery is due. See supra note 7 and
supporting text.
43 ‘‘Regular trading hours’’ has the same meaning
as in Rule 600(b)(64) of Regulation NMS. Rule
600(b)(64) provides that ‘‘Regular trading hours
means the time between 9:30 a.m. and 4 p.m.
Eastern Time, or such other time as is set forth in
the procedures established pursuant to
§ 242.605(a)(2).’’
44 The term ‘‘settlement day’’ is defined in Rule
203(c)(5) of Regulation SHO as: ‘‘* * * any
business day on which deliveries of securities and
payments of money may be made through the
facilities of a registered clearing agency.’’ 17 CFR
242.203(c)(5).
45 See temporary Rule 204T(a).
E:\FR\FM\17OCR1.SGM
17OCR1
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
jlentini on PROD1PC65 with RULES
Date.46 To meet its close-out obligation
a participant also must be able to
demonstrate on its books and records
that on the Close-Out Date it purchased
or borrowed shares in the full quantity
of its settlement date fail to deliver
position and, therefore, that the
participant has a net flat or net long
position on its books and records in that
equity security on the Close-Out Date.
The temporary rule defines a
‘‘settlement date’’ as ‘‘the business day
on which delivery of a security and
payment of money is to be made
through the facilities of a registered
clearing agency in connection with the
sale of a security.’’ 47 This definition is
consistent with Rule 15c6–1 that
prohibits broker-dealers from effecting
or entering into a contract for the
purchase or sale of a security that
provides for payment of funds and
delivery of securities later than the third
business day after the date of the
contract unless otherwise expressly
agreed to by the parties at the time of
the transaction.48
Because most transactions settle by
T+3 and because delivery on all sales
should be made by settlement date,
participants should consider having in
place policies and procedures to help
ensure that delivery is being made by
settlement date. We intend to examine
participants’ policies and procedures to
determine whether such policies and
procedures monitor for delivery by
settlement date.49
Similar to the existing close-out
requirement of Rule 203(b)(3) of
Regulation SHO, the temporary rule is
based on a participant’s fail to deliver
position at a registered clearing agency.
As noted above, the NSCC clears and
settles the majority of equity securities
trades conducted on the exchanges and
in the over-the-counter markets. NSCC
clears and settles trades through the
CNS system, which nets the securities
delivery and payment obligations of all
of its members. NSCC notifies its
members of their securities delivery and
payment obligations daily. Because the
temporary rule is based on a
participant’s fail to deliver position at a
registered clearing agency, the
46 In determining its close-out obligation, a
participant may rely on its net delivery obligation
as reflected in its notification from NSCC regarding
its securities delivery and payment obligations,
provided such notification is received prior to the
beginning of regular trading hours on the Close-Out
Date.
47 See temporary Rule 204T(f)(1).
48 See 17 CFR 240.15c6–1.
49 Of course, broker-dealers must comply with
any applicable SRO policies and procedures
requirements. For example, NASD Rule 3010
contains, among other things, written procedures
requirements for member firms.
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
temporary rule is consistent with
current settlement practices and
procedures and with the Regulation
SHO framework regarding delivery of
securities.50
In addition, similar to Rule
203(b)(3)(vi) of Regulation SHO, the
temporary rule provides that a
participant may reasonably allocate its
responsibility to close out a fail to
deliver position to another broker-dealer
from which the participant receives
trades for clearance or settlement.51
Specifically, temporary Rule 204T(d)
provides that if a participant of a
registered clearing agency reasonably
allocates a portion of a fail to deliver
position to another registered broker or
dealer for which it clears trades or from
which it receives trades for settlement,
based on such broker’s or dealer’s short
position, the provisions of Rule 204T(a)
and (b) relating to such fail to deliver
position shall apply to such registered
broker or dealer that was allocated the
fail to deliver position, and not to the
participant.52
Thus, participants that are able to
identify the accounts of broker-dealers
for which they clear or from which they
receive trades for settlement, could
allocate the responsibility to close out
the fail to deliver position to the
particular broker-dealer account(s)
whose trading activities have caused the
fail to deliver position provided the
allocation is reasonable (e.g., the
allocation must be timely). Absent such
identification, however, the participant
would remain subject to the close-out
requirement.
Unlike Rule 203(b)(3)(vi) of
Regulation SHO, temporary Rule
204T(d) imposes an additional
notification requirement on a broker50 See 17 CFR 242.203(b)(3) (Regulation SHO’s
close-out requirement). Consistent with current
industry practice under Regulation SHO, with
respect to a net syndicate short position created in
connection with a distribution of a security that is
part of a fail to deliver position at a registered
clearing agency, the requirements of temporary Rule
204T shall not apply provided action is taken to
close out the net syndicate short position by no
later than the beginning of regular trading hours on
the thirtieth day after commencement of sales in the
distribution. See e.g., Exchange Act Release No.
58190 (July 18, 2008) (amending the July
Emergency Order to provide an exception from its
requirements for fails to deliver in connection with
syndicate offerings).
51 See 17 CFR 242.203(b)(3)(vi). Rule 203(b)(3)(vi)
provides that ‘‘[i]f a participant of a registered
clearing agency reasonably allocates 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
or dealer’s short position, then the provisions of
this paragraph (b)(3) relating to such fail to deliver
position shall apply to the portion of such
registered broker or dealer that was allocated the
fail to deliver position, and not to the participant.’’
52 See temporary Rule 204T(d).
PO 00000
Frm 00055
Fmt 4700
Sfmt 4700
61711
dealer that has been allocated
responsibility for complying with the
rule’s requirements. Specifically,
temporary Rule 204T(d) provides that a
broker or dealer that has been allocated
a portion of a fail to deliver position that
does not comply with the provisions of
temporary Rule 204T(a) must
immediately notify the participant that
it has become subject to the borrowing
requirements of temporary Rule
204T(b).53 We are adopting this
notification requirement so that
participants will know when a brokerdealer for which they clear and settle
trades has become subject to the
temporary rule’s borrowing
requirements.
The temporary rule also differs from
the current close-out requirement of
Regulation SHO in that it applies to fails
to deliver in all equity securities rather
than only to those securities with a large
and persistent level of fails to deliver,
i.e., threshold securities. A primary
purpose of the temporary rule is to
prevent the use of ‘‘naked’’ short selling
as part of a manipulative scheme. To
achieve this purpose, the rule must
apply to all equity securities, regardless
of the level or persistence of any fails to
deliver in such securities. In addition,
as discussed above, we believe that all
sellers of securities should promptly
deliver, or arrange for delivery of,
securities to the respective buyer and all
buyers of securities have a right to
expect prompt delivery of securities
purchased. We believe this should be
the case for sales in all equity securities
and are adopting this temporary rule to
further that goal.
Regulation SHO, as adopted in 2004,
was a first step in trying to reduce
persistent fails to deliver and address
abusive ‘‘naked’’ short selling. In
Regulation SHO, we took a targeted
approach, imposing additional delivery
requirements on securities with a
substantial and persistent amount of
fails to deliver. As we stated in the 2004
Regulation SHO Adopting Release, we
took this targeted approach at that time
in an effort not to burden the vast
majority of securities where there are
not similar concerns regarding
settlement.54 In addition, Regulation
SHO’s close-out requirement was
adopted to address potential abuses that
may occur with large, extended fails to
deliver.55 We also noted in the 2004
Regulation SHO Adopting Release,
however, that we would pay close
attention to the operation and efficacy of
53 See
id.
2004 Regulation SHO Adopting Release, 69
FR at 48016.
55 See id. at 48017.
54 See
E:\FR\FM\17OCR1.SGM
17OCR1
61712
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
the provisions we were adopting at that
time and would consider whether any
further action was warranted.56
Because of continued concerns about
the potentially negative market impact
of fails to deliver, and the fact that
through our monitoring of the efficacy
of Regulation SHO’s close-out
requirement we continued to observe
threshold securities with fail to deliver
positions that are not being closed out
under existing delivery and settlement
requirements, we eliminated the
‘‘grandfather’’ and options market maker
exceptions to Regulation SHO’s closeout requirements.57
However, we are concerned that
Regulation SHO’s current provisions
have not gone far enough in reducing
fails to deliver and addressing
potentially abusive ‘‘naked’’ short
selling.58 More is needed to reduce fails
to deliver and to address potentially
abusive ‘‘naked’’ short selling,
especially in light of the current
instability and lack of investor
confidence in the financial markets.59 In
addition, because Regulation SHO’s
close-out requirement applies only to
threshold securities, fails to deliver in
non-threshold securities never have to
be closed out.60 We believe that
adoption of temporary rule 204T as an
interim final temporary rule is necessary
to curtail fails to deliver in both
threshold and non-threshold securities
to further address abusive ‘‘naked’’ short
selling in such securities.
As discussed above, due to our
concerns about potentially abusive
56 See
id. at 48018.
June 13, 2007, we adopted amendments to
eliminate the ‘‘grandfather’’ exception to Regulation
SHO’s close-out requirement. On September 17,
2008, in the September Emergency Order, we
adopted amendments to eliminate the options
market maker exception, which amendments were
subsequently made permanent. See supra notes 17,
18 and 19.
58 See, e.g., 2007 Regulation SHO Final
Amendments, 72 FR 45544 (eliminating the
‘‘grandfather’’ exception to Regulation SHO’s closeout requirement due to our observing continued
fails to deliver in threshold securities); 2008
Regulation SHO Final Amendments, supra note 19
(eliminating the options market maker exception to
Regulation SHO’s close-out requirement due to
substantial levels of fails to deliver continuing to
persist in optionable threshold securities).
59 See, e.g., letter from Leland Chan, General
Counsel, California Bankers Association, dated Aug.
21, 2008; letter from Eric C. Jensen, Esq., Cooley
Godward Kronish L.P., dated Aug. 21, 2008; letter
from Steven B. Boehm and Cynthia M. Krus,
Sutherland Asbill Brennan LLP, dated July 31,
2008; letter from James J. Angel, Professor of
Finance, Georgetown University, McDonough
School of Business, dated Aug. 20, 2008; letter from
Tuan Nguyen, dated Aug. 8, 2008.
60 OEA estimates that fails to deliver in nonthreshold securities averaged approximately 624
million shares or $4.6 billion in value per day from
January to July 2008. These fails account for
approximately 54.5% (56.6%) of all fail to deliver
shares (by dollar value).
jlentini on PROD1PC65 with RULES
57 On
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
‘‘naked’’ short selling in certain nonthreshold securities, we recently issued
the July Emergency Order to temporarily
impose enhanced requirements on short
sales in the Appendix A Securities.
Following our issuance of the July
Emergency Order, we issued the Short
Sale Ban Emergency Order in which we
took the additional step of prohibiting
short selling in the securities of a wider
range of financial institutions than those
subject to the July Emergency Order. In
addition, we issued the September
Emergency Order which, in part,
imposed enhanced delivery
requirements for transactions in all
equity securities and made effective
immediately a ‘‘naked’’ short selling
antifraud rule. We took these emergency
actions because we were concerned
about panic selling in securities due to
a loss of confidence that could be
further exacerbated by ‘‘naked’’ short
selling.
Following the issuance of the July
Emergency Order, members of the
public have repeatedly expressed their
concerns about a loss of confidence in
the financial markets.61 In addition,
since the termination of the July
Emergency Order and the issuance of
the Short Sale Ban Emergency Order
and the September Emergency Order,
we have continued our evaluation of the
markets and our discussions with the
Federal Reserve, Treasury, and the
Federal Reserve Bank of New York
regarding the state of the financial
markets. In light of these processes, we
have determined that we must take
action to adopt as an interim final
temporary rule, temporary Rule 204T, to
substantially restrict ‘‘naked’’ short
selling in all equity securities. As with
the July Emergency Order, the Short
Sale Ban Emergency Order, and the
September Emergency Order, we are
adopting this temporary rule as a
preventative step to help restore market
confidence.
In addition to applying the temporary
rule to fails to deliver in all equity
securities, rather than just threshold
securities, the temporary rule also
differs from the close-out requirement of
Rule 203(b)(3) of Regulation SHO in that
61 See, e.g., letter from Tom Donohue, President,
U.S. Chamber of Commerce, dated July 15, 2008;
letter from Ron Heller, dated July 21, 2008; letter
from Ronald L. Rourk, dated July 21, 2008; letter
from Wayne Jett, Managing Principal and Chief
Economist at Classical Capital, LLC, dated July 24,
2008; letter from Edward Herlilhy and Theodore
Levine, Wachtell, Lipton, Rosen and Katz, LLP,
dated Sept. 16, 2008; letter from Sen. Hillary
Rodham Clinton, dated Sept. 17, 2008; letter from
Representative D. Burton, dated Sept. 18, 2008;
letter from Elliott Bossen, Chief Investment Officer
at Silverback Asset Management, dated Sept. 24,
2008.
PO 00000
Frm 00056
Fmt 4700
Sfmt 4700
it shortens the close-out period for such
fails to deliver.62 For the reasons
discussed below, rather than requiring
close out of a fail to deliver position
within thirteen consecutive settlement
days (or 10 days after settlement date),
temporary Rule 204T requires a
participant to immediately purchase or
borrow shares to close out a fail to
deliver position by no later than the
beginning of regular trading hours on
the settlement day following the day on
which the fail to deliver position occurs.
As noted above, trades in most
securities generally settle within a threeday settlement cycle, known as T+3 (or
‘‘trade date plus three days’’). T+3
means that when a trade occurs, the
participants to the trade are expected to
deliver and pay for the security at a
clearing agency three settlement days
after the trade is executed so the
brokerage firm can exchange those
funds for the securities on that third
business day. The three-day settlement
period applies to most security
transactions, including stocks, bonds,
municipal securities, mutual funds
traded through a brokerage firm, and
limited partnerships that trade on an
exchange. Government securities and
stock options typically settle on the next
business day following the trade (or
T+1).63 We believe that delivery on all
sales should be made by settlement date
and, therefore, in temporary Rule 204T
we are requiring that fails to deliver in
all equity securities be closed out by no
later than the beginning of regular
trading hours on the Close-Out Date.
In the 2004 Regulation SHO Adopting
Release we stated we were adopting a
thirteen consecutive settlement day
close-out requirement in part because
the close-out requirement applied to
fails to deliver resulting from long and
short sales in threshold securities, and
extending the time period to ten days
after settlement date for a transaction
would make the close-out requirement
consistent with Rule 15c3–3(m).64 In
addition, we noted in that release that
ten days after settlement was also the
timeframe used at that time in NASD
Rule 11830.65 We also acknowledged
that a shorter timeframe, such as two
days after settlement, may capture many
62 Rule 203(b)(3) of Regulation SHO provides: ‘‘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, the participant shall
immediately thereafter close out the fail to deliver
position by purchasing securities of like kind and
quantity.’’ See 17 CFR 242.203(b)(3).
63 See supra note 8.
64 See 17 CFR 240.15c3–3(m).
65 See 2004 Regulation SHO Adopting Release, 69
FR at 48017, n.93.
E:\FR\FM\17OCR1.SGM
17OCR1
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
instances of ordinary course settlement
delays.66
In addition, we have stated previously
that the vast majority of fails to deliver
are closed out within five days after
T+3.67 In addition, a recent analysis by
our Office of Economic Analysis found
that more than half of all fails to deliver
and more than 70% of all fail to deliver
positions are closed out within two
settlement days after T+3.68 Although
this information shows that delivery is
being made, it demonstrates that often
delivery is not being made until several
days following the standard three-day
settlement cycle. In addition, the
current close-out requirement for
threshold securities under Regulation
SHO and the lack of any close-out
requirement for non-threshold securities
under Regulation SHO enables fails to
deliver to persist for many days beyond
settlement date. We believe that
allowing fails to deliver to extend out
beyond settlement date for a transaction
is too long.
We have continuously monitored the
extent of fails to deliver and abusive
‘‘naked’’ short selling in the markets.
We believe that allowing fails to deliver
in all equity securities to persist for
thirteen consecutive settlement days (10
days after settlement date) if such
securities are threshold securities, or
indefinitely if such securities are not
threshold securities, is too long. As
discussed above, fails to deliver may be
indicative of a scheme to manipulate the
price of a security. In addition, we are
concerned about the negative effect that
fails to deliver and potentially abusive
‘‘naked’’ short selling may have on the
market and the broader economy,
including on investor confidence.
Temporary Rule 204T addresses these
concerns by requiring a participant to
immediately close out a fail to deliver
position by purchasing or borrowing
securities by no later than the beginning
of regular trading hours on the CloseOut Date.
We believe we should act to require
earlier close out so that more sales settle
by settlement date. Indeed, we believe
that delivery on all sales should be
made by settlement date. As we discuss
above, and as we have stated on several
66 See
id.
e.g., 2007 Regulation SHO Final
Amendments, 72 FR at 45544, n.5.
68 OEA’s analysis examined the period from
January to July 2008 and used the age of the fail
to deliver position as reported by the NSCC. The
NSCC data included only securities with at least
10,000 shares in fails to deliver. We note that these
numbers included securities that were not subject
to the close-out requirement in Rule 203(b)(3) of
Regulation SHO, which applies only to ‘‘threshold
securities’’ as defined in Rule 203(c)(6) of
Regulation SHO.
jlentini on PROD1PC65 with RULES
67 See,
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
prior occasions, we believe that all
sellers of securities should promptly
deliver, or arrange for delivery of,
securities to the respective buyer and all
buyers of securities have a right to
expect prompt delivery of securities
purchased.69 Although the temporary
rule’s close-out requirement may
capture some instances of ordinary
course settlement delays, we believe
that the temporary rule’s close-out
requirement is necessary to help ensure
that fails to deliver in all equity
securities settle by settlement date. In
addition, as discussed above, due to our
belief that delivery should be made by
settlement date, participants should
consider having policies and procedures
in place to monitor for the delivery of
securities by settlement date.
We understand, however, that fails to
deliver may occur from long sales
within the first two settlement days after
settlement date for legitimate reasons.
For example, human or mechanical
errors or processing delays can result
from transferring securities in custodial
or other form rather than book-entry
form, thereby causing a fail to deliver on
a long sale within the normal three-day
settlement period.
Thus, temporary Rule 204T(a)(1)
includes an exception from the
temporary rule’s close-out requirement
for fail to deliver positions resulting
from long sales of all equity securities.
Specifically, temporary Rule 204T(a)(1)
provides that if a participant of a
registered clearing agency has a fail to
deliver position at a registered clearing
agency in any equity security and the
participant can demonstrate on its books
and records that such fail to deliver
position resulted from a long sale, the
participant shall by no later than the
beginning of regular trading hours on
the third consecutive settlement day
following the settlement date,
immediately close out the fail to deliver
position by purchasing securities of like
kind and quantity.70
B. Borrowing Requirements
If a participant does not purchase or
borrow shares, as applicable, to close
out a fail to deliver position in
69 See
supra note 30.
temporary Rule 204T(a)(1). We note that if
a person that has loaned a security to another
person sells the security and a bona fide recall of
the security is initiated within two business days
after trade date, the person that has loaned the
security will be ‘‘deemed to own’’ the security for
purposes of Rule 200(g)(1) of Regulation SHO, and
such sale will not be treated as a short sale for
purposes of temporary Rule 204T. In addition, a
broker-dealer may mark such orders as ‘‘long’’ sales
provided such marking is also in compliance with
Rule 200(c) of Regulation SHO. Thus, the close-out
requirement of temporary Rule 204T(a)(1) applies to
sales of such securities.
70 See
PO 00000
Frm 00057
Fmt 4700
Sfmt 4700
61713
accordance with temporary Rule 204T,
the participant violates the close-out
requirement of the temporary rule. In
addition, the temporary rule imposes on
the participant for its own trades and on
all broker-dealers from which that
participant receives trades for clearance
and settlement (including introducing
and executing brokers), a requirement to
borrow or arrange to borrow securities
prior to accepting or effecting further
short sales in that security.
Specifically, temporary Rule 204T(b)
provides that the participant and any
broker or dealer from which it receives
trades for clearance and settlement,
including any market maker that is
otherwise entitled to rely on the
exception provided in Rule 203(b)(2)(iii)
of Regulation SHO,71 may not accept a
short sale order in an equity security
from another person, or effect a short
sale order in such equity security for its
own account, to the extent that the
broker or dealer submits its short sales
to that participant for clearance and
settlement, 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.72
The borrow requirements of
temporary Rule 204T(b) are consistent
with the requirements of Rule
203(b)(3)(iv) of Regulation SHO for a
participant that has not closed out a fail
to deliver position in a threshold
security that has persisted for thirteen
consecutive settlement days.73 Similar
to Regulation SHO, the temporary rule
is aimed at addressing potentially
abusive ‘‘naked’’ short selling. To that
end, we believe it is appropriate to
include in the temporary rule borrow
requirements for broker-dealers,
71 See 17 CFR 242.203(b)(2)(iii) (providing an
exception from Regulation SHO’s ‘‘locate’’
requirement for short sales effected by a market
maker in connection with bona fide market making
activities in the securities for which the exception
is claimed).
72 See temporary Rule 204T(b).
73 See 17 CFR 242.203(b)(3)(iv). Rule 203(b)(3)(iv)
of Regulation SHO provides that ‘‘[i]f 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, the participant and any broker or
dealer for which it clears transactions, including
any market maker that would otherwise be entitled
to rely on the exception provided in paragraph
(b)(2)(iii) of this section, many 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.’’
E:\FR\FM\17OCR1.SGM
17OCR1
61714
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
jlentini on PROD1PC65 with RULES
including participants, that sell short a
security that has a fail to deliver
position that has not been closed out in
accordance with the requirements of the
temporary rule. We believe that the
borrow requirements of temporary Rule
204T(b) will further our goal of limiting
fails to deliver and addressing abusive
‘‘naked’’ short selling by promoting the
prompt and accurate clearance and
settlement of securities transactions. By
requiring that participants and brokerdealers from which they receive trades
for clearance and settlement borrow or
arrange to borrow securities prior to
accepting or effecting short sales in the
security that has a fail to deliver
position that has not been closed out,
the temporary rule will help to ensure
that shares will be available for delivery
on the short sale by settlement date and,
thereby, help to avoid additional fails to
deliver occurring in the security.
Unlike the borrow requirements of
Rule 203(b)(3)(iv) of Regulation SHO,
however, the borrow requirements of
the temporary rule specify that
participants must notify all brokerdealers from which they receive trades
for clearance and settlement that a fail
to deliver position has not been closed
out in accordance with temporary Rule
204T. Specifically, temporary Rule
204T(c) provides that the participant
must notify any broker or dealer from
which it receives trades for clearance
and settlement, including any market
maker that is otherwise entitled to rely
on the exception provided in Rule
203(b)(2)(iii) of Regulation SHO,74 (a)
that the participant has a fail to deliver
position in an equity security at a
registered clearing agency that has not
been closed out in accordance with the
requirements of temporary Rule 204T,
and (b) when the purchase that the
participant has made to close out the
fail to deliver position has cleared and
settled at a registered clearing agency.75
We are including this notification
requirement in temporary Rule 204T(c)
so that all broker-dealers that submit
trades for clearance and settlement to a
participant that has a fail to deliver
position in a security that has not been
closed out in accordance with
temporary Rule 204T will be on notice
that short sales in that security to be
cleared or settled through that
participant will be subject to the borrow
requirements of temporary Rule 204T(b)
until the fail to deliver position has
been closed out.
74 See 17 CFR 203(b)(2)(iii) (providing for an
exception from the ‘‘locate’’ requirement for market
makers engaged in bona fide market making in that
security at the time of the short sale).
75 See temporary Rule 204T(c).
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
The temporary rule, however,
includes an exception from the
borrowing requirements for any brokerdealer that can demonstrate that it was
not responsible for any part of the fail
to deliver position of the participant.
Specifically, temporary Rule 204T(b)(1)
provides that a broker or dealer shall not
be subject to the requirements of
temporary Rule 204T(b) if the broker or
dealer timely certifies to the participant
that it has not incurred a fail to deliver
position on settlement date for a long or
short sale in an equity security for
which the participant has a fail to
deliver position at a registered clearing
agency or that the broker or dealer is in
compliance with the requirements of
temporary Rule 204T(e).76 We have
included this exception because we do
not believe that a broker-dealer should
be subject to the borrowing
requirements of the temporary rule if
the broker-dealer can demonstrate that it
did not incur a fail to deliver position
in the security on settlement date.
In addition, as noted above, the
temporary rule provides that a
participant may reasonably allocate
(e.g., the allocation must be timely) its
responsibility to close out a fail to
deliver position to another broker-dealer
for which the participant clears or from
which the participant receives trades for
settlement. Thus, to the extent that the
participant can identify the brokerdealer(s) that have contributed to the
fail to deliver position, and the
participant has reasonably allocated the
close-out obligation to the brokerdealer(s), the requirement to borrow or
arrange to borrow prior to effecting
further short sales in that security will
apply to only those particular brokerdealer(s).
C. Pre-Fail Credit
To avoid the borrow or arrangement
to borrow requirement of temporary
Rule 204T(a), a participant could closeout the fail by borrowing and delivering
securities sufficient to close-out the fail
to deliver position prior to the
beginning of regular trading hours on
the Close-Out Date. If, however, the
participant does not succeed in
eliminating the fail to deliver position
the participant can only close out that
position by immediately borrowing or
purchasing securities to close out the
fail to deliver position by no later than
the beginning of regular trading hours
on the Close-Out Date in accordance
with temporary Rule 204T.
76 See temporary Rule 204T(b)(1). Temporary
Rule 204T(e) is discussed in detail below in Section
IV.C.
PO 00000
Frm 00058
Fmt 4700
Sfmt 4700
To encourage close outs of fail to
deliver positions prior to the Close-Out
Date, similar to the September
Emergency Order,77 temporary Rule
204T(e) provides that a broker-dealer
can satisfy the temporary rule’s closeout requirement by purchasing
securities in accordance with the
conditions of that provision (i.e., brokerdealers will receive ‘‘pre-fail credit’’ for
the purchase). Specifically, temporary
Rule 204T(e) provides that even if a
participant of a registered clearing
agency has not closed out a fail to
deliver position at a registered clearing
agency in accordance with temporary
Rule 204T(a), or has not allocated a fail
to deliver position to a broker or dealer
in accordance with temporary Rule
204T(d), a broker or dealer shall not be
subject to the requirements of
paragraphs (a) or (b) of the temporary
rule if the broker or dealer purchases
securities prior to the beginning of
regular trading hours on the Close-Out
Date for a long or short sale to close out
an open short position, and if:
(1) The purchase is bona fide;
(2) The purchase is executed on, or
after, trade date but by no later than the
end of regular trading hours on
settlement date for the transaction;
(3) The purchase is of a quantity of
securities sufficient to cover the entire
amount of the open short position; and
(4) The broker or dealer can
demonstrate that it has a net long
position or net flat position on its books
and records on the settlement day for
which the broker or dealer is seeking to
demonstrate that it has purchased
shares to close out its open short
position.
To receive pre-fail credit under
temporary Rule 204T(e), the purchase
must be ‘‘bona fide.’’ Thus, where a
broker-dealer enters into an arrangement
with another person to purchase
securities, and the broker-dealer knows
or has reason to know that the other
person will not deliver securities in
settlement of the transaction, the
purchase will not be considered to be
‘‘bona fide.’’ 78 In addition, the purchase
77 See Exchange Act Release No. 58711 (Oct. 1,
2008) (stating that in connection with extending the
September Emergency Order, the Commission
incorporates and adopts the Division of Trading and
Markets: Guidance Regarding the Commission’s
Emergency Order Concerning Rules to Protect
Investors Against ‘‘Naked’’ Short Selling Abuses
and the Division of Trading and Markets Guidance
Regarding Sale of Loaned but Recalled Securities).
78 See 17 CFR 203(b)(3)(vii) (discussing bona fide
purchases for purposes of Regulation SHO). It is
possible under Regulation SHO that a close out by
a participant of a registered clearing agency may
result in a fail to deliver position at another
participant if the counterparty from which the
participant purchases securities fails to deliver.
However, Regulation SHO prohibits a participant of
E:\FR\FM\17OCR1.SGM
17OCR1
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
must be of a quantity of securities
sufficient to cover the entire amount of
the open short position.79
Temporary Rule 204T(e) also requires
that to receive pre-fail credit, the
purchase must be executed on, or after,
trade date but by no later than the end
of regular trading hours on the
settlement date of the transaction that
resulted in the fail to deliver position at
a registered clearing agency.80 The
purpose of this provision is to
encourage broker-dealers to close out
fail to deliver positions prior to the
beginning of regular trading hours on
the Close-Out Date.
In addition, to help ensure that
broker-dealers purchase sufficient
shares to close out their fail to deliver
positions, temporary Rule 204T(e)
requires that the broker-dealer claiming
pre-fail credit be net long or net flat on
the settlement day on which the brokerdealer is claiming pre-fail credit.81 In
addition, the temporary Rule 204T(e)
requires that the broker-dealer be able to
demonstrate that it has complied with
this requirement.82 This requirement
will enable the Commission and SROs
to monitor more effectively whether or
not a broker-dealer has complied with
the requirements of temporary Rule
204T(e).
jlentini on PROD1PC65 with RULES
D. Market Makers
To allow market makers to facilitate
customer orders in a fast moving
market, similar to the September
Emergency Order,83 temporary rule
includes a limited exception from the
rule’s close-out and borrowing
requirements for fails to deliver
attributable to bona fide market making
activities by registered market makers,
options market makers, or other market
makers obligated to quote in the overthe-counter market. Specifically,
a registered clearing agency, or a broker-dealer for
which it clears transactions, from engaging in
‘‘sham close outs’’ by entering into an arrangement
with a counterparty to purchase securities for
purposes of closing out a fail to deliver position and
the purchaser knows or has reason to know that the
counterparty will not deliver the securities, and
which thus creates another fail to deliver position.
See id. at (b)(3)(vii); 2004 Regulation SHO Adopting
Release, 69 FR at 48018 n.96. In addition, we note
that borrowing securities, or otherwise entering into
an arrangement with another person to create the
appearance of a purchase would not satisfy the
close-out requirement of Regulation SHO. For
example, the purchase of paired positions of stock
and options that are designed to create the
appearance of a bona fide purchase of securities but
that are nothing more than a temporary stock
lending arrangement would not satisfy Regulation
SHO’s close-out requirement.
79 See temporary Rule 204T(e)(3).
80 See temporary Rule 204T(e)(2).
81 See temporary Rule 204T(e)(4).
82 See id.
83 See supra note 77.
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
temporary Rule 204T(a)(3) provides that
if a participant of a registered clearing
agency has a fail to deliver position at
a registered clearing agency in any
equity security that is attributable to
bona fide market making activities by a
registered market maker, options market
maker, or other market maker obligated
to quote in the over-the-counter market
(individually a ‘‘Market Maker,’’
collectively ‘‘Market Makers’’), the
participant shall by no later than the
beginning of regular trading hours on
the third consecutive settlement day
following the settlement date,
immediately close out the fail to deliver
position by purchasing securities of like
kind and quantity.84
In addition, similar to the September
Emergency Order,85 the temporary rule
excepts Market Makers from the
borrowing requirements of temporary
Rule 204T(b) if the Market Maker can
demonstrate that it does not have an
open fail to deliver position at the time
of any additional short sales. The
borrowing requirements of the
temporary rule apply to all brokerdealers from which a participant of a
registered clearing agency receives
trades for clearance and settlement. To
allow Market Makers to facilitate
customer orders, we do not believe that
a Market Maker should be subject to the
temporary rule’s borrowing
requirements if the Market Maker does
not have an open fail to deliver at the
time of any additional short sales.
E. Sales Pursuant to Rule 144
The temporary rule includes an
exception for sales of all equity
securities pursuant to Rule 144 under
the Securities Act of 1933 (‘‘Securities
Act’’).86 Specifically, temporary Rule
204T(a)(2) provides that if a participant
of a registered clearing agency has a fail
to deliver position at a registered
clearing agency in an equity security
sold pursuant to Rule 144 for thirty-five
consecutive settlement days after the
settlement date for a sale in that equity
security, the participant shall, by no
84 See temporary Rule 204T(a)(3). Unlike the
September Emergency Order, however, the
temporary rule does not require a Market Maker to
which a fail to deliver position at a registered
clearing agency is attributable to attest in writing to
the market on which it is registered that the fail to
deliver position at issue was established solely for
the purpose of meeting its bona fide market making
obligations and the steps the Market Maker has
taken in an effort to deliver securities to its
registered clearing agency. We believe the costs of
such a requirement would outweigh the benefits.
We note, however, that as with any exception, a
broker-dealer would have to evidence eligibility for,
and compliance with, the requirements of the
exception.
85 See supra note 77.
86 See 17 CFR 230.144.
PO 00000
Frm 00059
Fmt 4700
Sfmt 4700
61715
later than the beginning of regular
trading hours on the thirty-sixth
consecutive settlement day following
the settlement date for the transaction,
immediately close out the fail to deliver
position by purchasing securities of like
kind and quantity.87
Regulation SHO provides an
exception from the ‘‘locate’’ requirement
of Rule 203(b)(1) for situations where a
broker-dealer effects a short sale on
behalf of a customer that is deemed to
own the security pursuant to Rule 200
of Regulation SHO, although, through
no fault of the customer or brokerdealer, it is not reasonably expected that
the security will be in the physical
possession or control of the brokerdealer by settlement date and, therefore,
is a ‘‘short’’ sale under the marking
requirements of Rule 200(g).88 Rule
203(b)(2)(ii) of Regulation SHO provides
that in such circumstances, delivery
must be made on the sale as soon as all
restrictions on delivery have been
removed, and in any event no later than
35 days after trade date, at which time
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.89 In addition, recently we
adopted amendments to the close-out
requirement of Regulation SHO to allow
fails to deliver resulting from sales of
threshold securities pursuant to Rule
144 to be closed out within 35 rather
than 13 consecutive settlement days.90
Securities sold pursuant to Rule 144
under the Securities Act are formerly
restricted securities that a seller is
‘‘deemed to own,’’ as defined by Rule
200(a) of Regulation SHO.91 The
securities, however, may not be capable
of being delivered on the settlement
date due to processing delays related to
removal of the restricted legend and,
therefore, sales of these securities
frequently result in fails to deliver.
87 See
temporary Rule 204T(a)(2).
to Rule 200(g)(2) of Regulation SHO,
as adopted in August 2004, generally these sales
were marked ‘‘short exempt.’’ See 2004 Regulation
SHO Adopting Release, 69 FR at 48030–48031; but
cf. Exchange Act Release No. 55970 (June 28, 2007),
72 FR 36348 (July 3, 2007) (removing the ‘‘short
exempt’’ marking requirement).
89 See 17 CFR 242.203(b)(2)(ii). In the 2004
Regulation SHO Adopting Release, the Commission
stated that it believed that 35 calendar days is a
reasonable outer limit to allow for restrictions on
a security to be removed if ownership is certain. In
addition, the Commission noted that Section
220.8(b)(2) of Regulation T of the Federal Reserve
Board allows 35 calendar days to pay for securities
delivered against payment if the delivery delay is
due to the mechanics of the transactions. See 2004
Regulation SHO Adopting Release, 69 FR at 48015,
n.72.
90 See 2007 Regulation SHO Final Amendments,
72 FR at 45550–45551.
91 See 17 CFR 242.200(a).
88 Pursuant
E:\FR\FM\17OCR1.SGM
17OCR1
61716
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
jlentini on PROD1PC65 with RULES
Consistent with our statements in
connection with our recent amendments
to Regulation SHO in connection with
closing out fails to deliver in threshold
securities sold pursuant to Rule 144, we
believe that a close-out requirement of
35 consecutive settlement days from
settlement date for fails to deliver
resulting from sales of all equity
securities sold pursuant to Rule 144,
will permit the orderly settlement of
such sales without the risk of causing
market disruption due to unnecessary
purchasing activity (particularly if the
purchases are for sizable quantities of
stock). Because the security being sold
will be received as soon as all
processing delays have been removed,
this additional time will allow
participants to close out fails to deliver
resulting from the sale of the security
with the security sold, rather than
having to close out such fail to deliver
position by purchasing securities in the
market.92
If, however, a fail to deliver position
resulting from the sale of an equity
security pursuant to Rule 144 is not
closed out in accordance with
temporary Rule 204T(a)(2), the
borrowing requirements of temporary
Rule 204T(b) will apply. Thus, if a
participant does not close out a fail to
deliver position at a registered clearing
agency in accordance with temporary
Rule 204T(a)(2), the temporary rule
prohibits the participant, and any
broker-dealer from which it receives
trades for clearance and settlement,
including market makers, from
accepting any short sale orders or
effecting further short sales in the
particular security without borrowing,
or entering into a bona-fide arrangement
to borrow, the security until the
participant closes out the entire fail to
deliver position by purchasing
securities of like kind and quantity and
that purchase has cleared and settled at
a registered clearing agency.93
92 We understand that sellers that own restricted
equity securities that wish to sell pursuant to an
effective resale registration statement under Rule
415 under the Securities Act experience similar
types of potential settlement delays as sales of
securities pursuant to Rule 144 under the Securities
Act. Thus, fails to deliver in such securities may be
closed out in accordance with temporary Rule
204T(a)(2) if the fails to deliver resulted from sales
of securities that were outstanding at the time they
were sold and the sale occurred after a registration
has become effective. In addition, we understand
that sales pursuant to broker-assisted cashless
exercises of compensatory options to purchase a
company’s stock, may result in potential settlement
delays and, therefore, fails to deliver. Such fails to
deliver may be closed out in accordance with
temporary Rule 204T(a)(2).
93 See temporary Rule 204T(b).
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
V. Other Matters
The Administrative Procedure Act
generally requires an agency to publish
notice of a proposed rulemaking in the
Federal Register.94 This requirement
does not apply, however, if the agency
‘‘for good cause finds * * * that notice
and public procedure are impracticable,
unnecessary, or contrary to the public
interest.’’ 95 Further, the Administrative
Procedure Act also generally requires
that an agency publish an adopted rule
in the Federal Register 30 days before
it becomes effective.96 This
requirement, however, does not apply if
the agency finds good cause for making
the rule effective sooner.97
For the reasons discussed throughout
this release, we believe that we have
good cause to act immediately to adopt
this rule on an interim final temporary
basis. The September Emergency Order,
in which we adopted and made
immediately effective temporary Rule
204T expires at 11:59 p.m. EDT on
October 17, 2008. As discussed
throughout this release, we have
determined it is necessary to act
immediately and adopt this rule on an
interim final temporary basis so that
temporary rule 204T remains in effect in
the form set forth herein following the
expiration of the September Emergency
Order.
This temporary rule takes effect on
October 17, 2008. For the reasons
discussed above, we have acted on an
interim final temporary basis. We
emphasize that we are requesting
comments on the temporary rule and
will carefully consider the comments
we receive and respond to them in a
subsequent release. Moreover, this is a
temporary rule, and will expire on July
31, 2009. Setting a termination date for
the rule will necessitate further
Commission action no later than the end
of that period if the Commission intends
to continue the same, or similar,
requirements contained in the
temporary rule.
The sunset provision will enable the
Commission to assess the operation of
the temporary rule and intervening
developments, including a restoration of
stability to the financial markets, as well
as public comments, and consider
whether to continue the rule with or
without modification or not at all.
We find that there is good cause to
have the temporary rule take effect on
October 17, 2008 and that notice and
public procedure in advance of
effectiveness of the rule are
94 See
5 U.S.C. § 553(b).
95 Id.
96 See
5 U.S.C. § 553(d).
97 Id.
PO 00000
Frm 00060
Fmt 4700
Sfmt 4700
impracticable, unnecessary, and
contrary to the public interest.98
VI. Request for Comment
We are requesting comments from all
members of the public. We will
carefully consider the comments that we
receive and intend to respond to them
in a subsequent release. We seek
comment generally on all aspects of the
temporary rule. In addition, we seek
comment on the following:
Æ The temporary rule requires
participants to immediately close out a
fail to deliver position by no later than
the beginning of regular trading hours
on the Close-Out Date. Should we
narrow the close-out requirement
further? Should we allow a longer or
shorter period of time within which to
close out a fail to deliver position? What
would be the justifications for allowing
a shorter or longer close-out period?
Æ Are there any operational or
compliance issues related to complying
with the requirement in temporary Rule
204T(a) to immediately purchase or
borrow securities ‘‘by no later than the
beginning of regular trading hours’’?
Should we allow a participant to take
steps to purchase or borrow securities
after the beginning of regular trading
hours on the Close-Out Date to satisfy
temporary Rule 204T(a)? If so, how
much time after the beginning of regular
trading hours should we provide? For
example, should we allow trading
during an opening auction that
commences after the beginning of
regular trading hours or should we
provide until noon? Alternatively,
should we allow participants to
purchase or borrow securities at any
time on the Close-Out Date to satisfy the
temporary rule’s close-out requirement?
What would be the costs and benefits of
allowing additional time beyond the
beginning of regular trading hours on
the Close-Out Date for the participant to
purchase or borrow securities to close
out a fail to deliver position?
Æ Temporary Rule 204T(f)(1) defines
‘‘settlement date’’ as ‘‘the business day
on which delivery of a security and
payment of money is to be made
through the facilities of a registered
clearing agency in connection with the
sale of a security.’’ Is this an appropriate
definition of ‘‘settlement date’’?
Æ Due to our expectation that delivery
of securities on all sales should be made
98 This finding also satisfies the requirements of
5 U.S.C. 808(2), allowing the rules to become
immediately effective notwithstanding the
requirements of 5 U.S.C. 801 (if a Federal agency
finds that notice and public comment are
‘‘impractical, unnecessary, or contrary to the public
interest,’’ a rule ‘‘shall take effect at such time as
the Federal agency promulgating the rule
determines.’’).
E:\FR\FM\17OCR1.SGM
17OCR1
jlentini on PROD1PC65 with RULES
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
by settlement date, we state in the
release that participants should consider
having in place policies and procedures
to monitor for the delivery of securities
by settlement date. Should we adopt a
rule requiring that participants have in
place such policies and procedures?
Æ Should a de minimus amount of
fails to deliver be excepted from the
close-out requirements of the temporary
rule? If so, what should be the de
minimus amount?
Æ Should the temporary rule be
expanded to apply to debt as well as
equity securities? Please explain.
Æ The temporary rule requires that a
participant purchase securities by no
later than the beginning of regular
trading hours on the third settlement
day after the settlement date for a fail to
deliver position resulting from a long
sale transaction. What are the costs
associated with purchasing versus
borrowing securities to close out a fail
to deliver position? Should we permit
participants to close out a fail to deliver
position for long sale transactions by
borrowing as well as purchasing
securities? Please explain.
Æ The temporary rule allows a
participant to close out a fail to deliver
position attributable to bona fide market
making activity by a registered market
maker, options market maker, or other
market maker obligated to quote in the
over-the-counter market by purchasing
securities of like kind and quantity by
no later than the beginning of regular
trading hours on the third settlement
day after the settlement date. Should
this close-out period be a shorter or
longer time-frame? Please explain. What
would be the costs and benefits of a
longer or shorter close-out period for
such fails to deliver?
Æ The temporary rule does not
include a complete exception from its
close-out requirement for options
market makers with fails to deliver
resulting from short sales effected to
establish or maintain a hedge on options
positions. We seek comment regarding
the impact of the temporary rule on
options market makers that are subject
to the close-out requirement of the
temporary rule. For example, we seek
comment regarding the impact of the
temporary rule, if any, on liquidity,
spread widths, and quote depth in the
securities that are subject to the
temporary rule.
Æ The temporary rule allows a
participant to close out a fail to deliver
position resulting from a sale of an
equity security pursuant to Rule 144 of
the Securities Act by no later than the
beginning of regular trading hours on
the thirty-sixth consecutive settlement
day after the settlement date. Are there
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
other types of sales that encounter
settlement delays due to processing
requirements similar to sales of Rule
144 securities that should have an
exception from the close-out
requirements of temporary Rule
204T(a)? Please explain.
Æ What impact will the temporary
rule have on borrowing costs? Please
explain. What impact will the
temporary rule have on legitimate short
selling and market efficiency?
Æ An arrangement to borrow means a
bona fide agreement to borrow the
security such that the security being
borrowed is set aside at the time of the
arrangement solely for the person
requesting the security. Should we
define ‘‘arrangement to borrow’’ as
requiring a contract between the brokerdealer and the lending source?
Æ Should temporary Rule 204T(b)
require that participants and brokerdealers from which participants receive
trades for clearance and settlement
borrow securities prior to effecting
further short sales, rather than allowing
for either an arrangement to borrow or
a borrow? If a fail to deliver position has
not been closed out in accordance with
temporary Rule 204T, should we
prohibit the participant, and any brokerdealer from which it receives trades for
clearance and settlement, from effecting
any further short sales until the fail to
deliver position has been closed out?
Æ If a participant becomes subject to
the requirements of temporary Rule
204T(b), the participant will be required
to borrow or arrange to borrow
securities prior to settlement at a
registered clearing agency of the
purchase to close out the fail to deliver
position. What are the costs associated
with this requirement?
Æ Temporary Rule 204T(c) imposes a
notification requirement on
participants. Will such a notification
requirement impose operational or
systems costs on participants? What
types of communication mechanisms
will participants use to comply with
this requirement of the temporary rule?
What will be the costs and benefits of
this notification requirement?
Æ The temporary rule allows a brokerdealer to obtain pre-fail credit if it
purchases securities in accordance with
the conditions specified in temporary
Rule 204T(e). Are there any operational
or compliance concerns associated with
the conditions of temporary Rule
204T(e)? To what extent, if any, will
temporary Rule 204T(e) encourage
broker-dealers to close out a fail to
deliver position prior to the Close-Out
Date?
Æ The temporary rule does not
propose amendments to the ‘‘locate’’
PO 00000
Frm 00061
Fmt 4700
Sfmt 4700
61717
requirement of Rule 203(b)(1) of
Regulation SHO. In addition to the
temporary rule, should we also require
that broker-dealers arrange to borrow, or
borrow, equity securities prior to
effecting short sales in those equity
securities? How would this impact the
liquidity and availability of such equity
securities overall? How would this
affect lending rates for such equity
securities?
Æ The temporary rule imposes a
close-out requirement on fails to deliver
for all equity securities. Due to this hard
delivery requirement is it necessary to
retain the ‘‘locate’’ requirement of
Regulation SHO for short sales? What
are the benefits of continuing to require
that broker-dealers have a reasonable
grounds to believe that a security can be
borrowed so that it can be delivered by
settlement date if a participant is
required to immediately close out a fail
to deliver position by no later than the
beginning of regular trading hours on
the Close-Out Date?
Æ The temporary rule does not allow
any exceptions for fails to deliver due to
mechanical aspects of corporate events,
such as equity offers, including initial
public offerings (‘‘IPOs’’),99 and tender
offers. Will the temporary rule cause
any disruption to these corporate
events? For example, will the temporary
rule interfere with the ability of
underwriters to provide price support?
Would any disruption warrant an
exception for certain corporate events?
If so, should the exception focus on
particular corporate events and why?
How much time is needed for securities
subject to such corporate events to be
delivered? Would providing exceptions
for such securities create opportunities
for price manipulation?
VII. Paperwork Reduction Act
A. Background
Temporary Rule 204T contains
‘‘collection of information’’
requirements within the meaning of the
Paperwork Reduction Act of 1995
(‘‘Paperwork Reduction Act’’).100 We
submitted these requirements to the
99 See Amy Edwards and Kathleen Weiss Hanley,
Short Selling in Initial Public Offerings (2008)
https://ssrn.com/abstract=981242 showing that fails
to deliver in IPOs are not from ‘‘naked’’ short
selling but instead seem to be related to fails to
deliver resulting from long sales that result from
underwriter price support. The aggregate fails to
deliver in these stocks seem to persist for the
typical price support period. Thus, the temporary
rule’s close-out requirement could apply to a high
proportion of such fails to deliver, potentially as
much as 2.5% of the shares offered on average.
Edwards and Hanley believe that such a result
could have a substantial impact on the aftermarket
of IPOs.
100 44 U.S.C. 3501 et seq.
E:\FR\FM\17OCR1.SGM
17OCR1
61718
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
jlentini on PROD1PC65 with RULES
Office of Management and Budget
(‘‘OMB’’) for review and approval in
accordance with 44 U.S.C. 3507(j) and 5
CFR 1320.13. Separately, we have
submitted the collection of information
to OMB for review and approval in
accordance with 44 U.S.C. 3507(d) and
5 CFR 1320.11. The OMB has approved
the collection of information on an
emergency basis with an expiration date
of April 30, 2009. An agency may not
conduct or sponsor, and a person is not
required to respond to, a collection of
information unless it displays a
currently valid OMB control number.
The title for the collection of
information is: ‘‘Temporary Rule 204T’’
and the OMB control number for the
collection of information is 3235–0647.
Temporary Rule 204T will
substantially restrict the practice of
‘‘naked’’ short selling in all equity
securities by strengthening the delivery
requirements for such securities.101
Temporary Rule 204T(a) amends
Regulation SHO to require that
participants of a clearing agency
registered with the Commission deliver
securities by settlement date, or if the
participants have not delivered shares
by settlement date, the participants
must, by no later than the beginning of
regular trading hours on the settlement
day following the settlement date (the
‘‘Close-Out Date’’), immediately close
out the fail to deliver position by
borrowing or purchasing securities of
like kind and quantity.
A participant that does not comply
with the temporary rule’s close-out
requirements will have violated
temporary Rule 204T. In addition, the
participant and any broker-dealer from
which it receives trades for clearance
and settlement, will not be able to short
sell the security either for itself or for
the account of another, unless it has
previously arranged to borrow or has
borrowed 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.102
Several provisions under temporary
Rule 204T will impose a new
‘‘collection of information’’ within the
meaning of the Paperwork Reduction
Act. These collections of information
are mandatory for broker-dealers relying
on the rule. The information collected
will be retained and/or provided to
101 As noted above, in a ‘‘naked’’ short sale, the
short seller does not borrow or arrange to borrow
securities in time to make delivery to the buyer
within the standard three-day settlement period. As
a result, the seller fails to deliver securities to the
buyer when delivery is due.
102 See temporary Rule 204T(b).
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
other entities pursuant to the specific
rule provisions and will be available to
the Commission and SRO examiners
upon request. The information collected
will aid the Commission and SROs in
monitoring compliance with the rule’s
requirements.
1. Allocation Notification Requirement
Similar to Rule 203(b)(3)(vi) of
Regulation SHO, temporary Rule
204T(d) provides that a participant may
reasonably allocate its responsibility to
close out a fail to deliver position to
another broker-dealer for which the
participant clears or from which the
participant receives trades for
settlement.103 Unlike Rule 203(b)(3)(vi)
of Regulation SHO, however, temporary
Rule 204T(d) imposes an additional
notification requirement on a brokerdealer that has been allocated
responsibility for complying with the
rule’s requirements (the ‘‘allocation
notification requirement’’).104
Specifically, temporary Rule 204T(d)
provides that a broker or dealer that has
been allocated a portion of a fail to
deliver position that does not comply
with the provisions of temporary Rule
204T(a) must immediately notify the
participant that it has become subject to
the borrowing requirements of
temporary Rule 204T(b).105 This
allocation notification requirement is
designed to help ensure that
participants that receive trades for
clearance and settlement from brokerdealers will be on notice that the brokerdealer is subject to the borrow
requirements of temporary Rule 204T(b)
until the fail to deliver position has
been closed out.
Such notification will require a
broker-dealer to determine that it has a
fail to deliver that does not comply with
the provisions of temporary Rule
204T(a) and, therefore, has become
subject to the requirements of temporary
Rule 204T(b). After making such
determination, the temporary rule
requires that the broker-dealer notify
such participant regarding this
information.
We estimate that such procedures will
take a broker-dealer no more than
103 See 17 CFR 242.203(b)(3)(vi). Rule
203(b)(3)(vi) provides that ‘‘[i]f a participant of a
registered clearing agency reasonably allocates 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 or dealer’s short position, then the
provisions of this paragraph (b)(3) relating to such
fail to deliver position shall apply to the portion of
such registered broker or dealer that was allocated
the fail to deliver position, and not to the
participant.’’
104 See temporary Rule 204T(d).
105 See id.
PO 00000
Frm 00062
Fmt 4700
Sfmt 4700
approximately 0.16 hours (10 minutes)
to complete. We base this estimate in
part on the fact that, in accordance with
Rule 203(b)(3)(vi) of Regulation SHO,
participants are permitted to allocate
responsibility to close out a portion of
a fail to deliver position to a brokerdealer that is responsible for the fail to
deliver position; the fact that most
broker-dealers already have the
necessary communication mechanisms
in place and are already familiar with
notification processes and procedures to
comply with the borrowing
requirements of Rule 203(b)(3)(iv) of
Regulation SHO for threshold securities;
and the fact that broker-dealers will be
able to continue to use the same
communication mechanisms, processes
and procedures to comply with the
notification requirement of temporary
Rule 204T(b). On average, participants
estimate that currently it takes
approximately 0.16 hours (10 minutes)
to notify broker-dealers pursuant to Rule
203(b)(3)(iv) of Regulation SHO.106
If a broker-dealer has been allocated a
portion of a fail to deliver position in an
equity security and after the beginning
of regular trading hours on the CloseOut Date, the broker-dealer has to
determine whether or not that portion of
the fail to deliver position was not
closed out in accordance with
temporary Rule 204T(a), we estimate
that a broker-dealer will have to make
such determination with respect to
approximately 1.76 equity securities per
day.107
As of December 31, 2007, there were
5,561 registered broker-dealers. Each of
these broker-dealers could clear trades
through a participant of a registered
clearing agency and, therefore, become
subject to the notification requirements
of temporary Rule 204T(b). We estimate
a total of 2,466,415 notifications in
accordance with temporary Rule
204T(b) across all broker-dealers (that
were allocated responsibility to close
out a fail to deliver position) per year
106 We base this estimate on information provided
to our staff by three small, three medium, and three
large registered clearing agency participants.
107 OEA estimates that there are approximately
9,809 fail to deliver positions per settlement day.
Across 5,561 broker-dealers, the number of
securities per broker-dealer per day is
approximately 1.76 equity securities. During the
period from January to July 2008, approximately
4,321 new fail to deliver positions occurred per day.
The NSCC data for this period includes only
securities with at least 10,000 shares in fails to
deliver. To account for securities with fails to
deliver below 10,000 shares, the figure is multiplied
by a factor of 2.27. The factor is estimated from a
more complete data set obtained from NSCC during
the period from September 16, 2008 to September
22, 2008. It should be noted that these numbers
include securities that were not subject to the closeout requirement of Rule 203(b)(3) of Regulation
SHO.
E:\FR\FM\17OCR1.SGM
17OCR1
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
(5,561 broker-dealers notifying
participants once per day 108 on 1.76
securities, multiplied by 252 trading
days in a year). The total estimated
annual burden hours per year will be
approximately 394,626 burden hours
(2,466,415 multiplied by 0.16 hours/
notification). We estimate that the
paperwork compliance for the allocation
notification requirement for each
broker-dealer will be approximately
71.0 burden hours per year.
2. Demonstration Requirement for Fails
To Deliver on Long Sales
Temporary Rule 204T(a)(1) includes
an exception from temporary rule’s
close-out requirement for fail to deliver
positions resulting from long sales of all
equity securities. Under this exception,
if a participant has a fail to deliver
position at a registered clearing agency
in an equity security and can
demonstrate on its books and records
that such fail to deliver position
resulted from a long sale (the
‘‘demonstration requirement for fails to
deliver on long sales’’), such participant
will have until no later than the
beginning of regular trading hours on
the third consecutive settlement day
following the settlement date to
immediately close out the fail to deliver
position by purchasing securities of like
kind and quantity.109
This provision allows a participant an
additional two settlement days in which
to close out the fail to deliver position
that resulted from a long sale, provided
that the participant’s books and records
reflect the fact that the fail to deliver
resulted from a long sale.110
The demonstration requirement will
require a participant of a registered
clearing agency to determine whether it
has a fail to deliver position at a
registered clearing agency in an equity
security that resulted from a long sale.
After making such determination, the
temporary rule requires that the
participant demonstrate or reflect this
information in its books and records.
We estimate that such procedures will
take a participant of a registered clearing
agency no more than approximately
0.16 hours (10 minutes) to complete.
We base this estimate on the fact that,
to comply with Regulation SHO’s
marking requirements, broker-dealers
are already required to ascertain
jlentini on PROD1PC65 with RULES
108 Because
failure to comply with the close-out
requirements of temporary Rule 204T(a) is a
violation of the temporary rule, we believe that a
broker-dealer would make the notification to a
participant that it is subject to the borrowing
requirements of temporary Rule 204T(b) at most
once per day.
109 See temporary Rule 204T(a)(1).
110 See id.
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
whether a customer is ‘‘deemed to own’’
the securities being sold before marking
a sell order ‘‘long’’ and, if the securities
are not in the broker-dealer’s physical
possession or control, whether the
broker-dealer reasonably expects that
the shares will be in the broker-dealer’s
physical possession or control by
settlement date.111 This reasonableness
determination includes consideration of
whether or not a prior sale resulted in
a fail to deliver position. In addition,
broker-dealers already must comply
with the documentation requirement
contained in the ‘‘locate’’ requirement of
Rule 203(b)(1) of Regulation SHO.
Participants will be able to use similar
mechanisms, processes and procedures
to demonstrate compliance with the
temporary rule’s close-out requirement
for fails to deliver resulting from long
sales as they use for compliance with
the current requirements of Regulation
SHO.
If a participant of a registered clearing
agency has a fail to deliver position in
an equity security at a registered
clearing agency and determined that
such fail to deliver position resulted
from a long sale, we estimate that a
participant of a registered clearing
agency will have to make such
determination with respect to
approximately 34 securities per day.112
As of July 31, 2008, there were 197
participants of NSCC, the primary
registered clearing agency responsible
for clearing U.S. transactions that were
registered as broker-dealers. We
estimate a total of 1,687,896
demonstrations in accordance with
temporary Rule 204T(a)(1) across all
participants per year (197 participants
checking for compliance once per day
on 34 securities, multiplied by 252
trading days in a year). The total
approximate estimated annual burden
hour per year will be approximately
270,063 burden hours (1,687,896
multiplied by 0.16 hours/
documentation). We estimate that the
paperwork burden for the temporary
demonstration provision for each
participant will be approximately 1,371
burden hours per year.
3. Pre-Borrow Notification Requirement
The borrowing requirements of
temporary Rule 204T(b) are similar to
the requirements of Rule 203(b)(3)(iv) of
111 See
17 CFR 242.200(g)(1).
estimates approximately 68% of trades
are long sales and applies this percentage to the
number of fail to deliver positions per day. 68% of
50 securities per day is 34 securities per day. The
68% figure is estimated as 100% minus the
proportion of short sale trades found in the
Regulation SHO Pilot Study. See https://
www.sec.gov/news/studies/2007/
regshopilot020607.pdf.
112 OEA
PO 00000
Frm 00063
Fmt 4700
Sfmt 4700
61719
Regulation SHO for a participant that
has failed to close out a fail to deliver
position in a threshold security that has
persisted for thirteen consecutive
settlement days.113 Unlike the current
borrow requirements of Rule
203(b)(3)(iv) of Regulation SHO,
however, temporary Rule 204T(c)
specifies that participants must notify
all broker-dealers from which they
receive trades for clearance and
settlement that a fail to deliver position
has not been closed out in accordance
with temporary Rule 204T(a) (the ‘‘preborrow notification requirement’’).
Specifically, temporary Rule 204T(c)
provides that the participant must notify
any broker or dealer from which it
receives trades for clearance and
settlement, including any market maker
that would otherwise be entitled to rely
on the exception provided in Rule
203(b)(2)(iii) of Regulation SHO,114 (1)
that the participant has a fail to deliver
position in an equity security at a
registered clearing agency that has not
been closed out in accordance with the
requirements of temporary Rule 204T(a),
and (2) when the purchase that the
participant has made to close out the
fail to deliver position has cleared and
settled at a registered clearing agency.115
The notification requirement will
involve a participant of a registered
clearing agency determining whether it
has a fail to deliver position in an equity
security at a registered clearing agency
that has not been closed out in
accordance with the requirements of
temporary Rule 204T(a), and when the
purchase that the participant has made
to close out the fail to deliver position
has cleared and settled at a registered
clearing agency. After making such
determinations, the temporary rule
requires that the participant notify such
broker-dealer regarding this
information.
We estimate that such procedures will
take a participant of a registered clearing
113 See 17 CFR 242.203(b)(3)(iv). Rule
203(b)(3)(iv) of Regulation SHO provides that ‘‘[i]f
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, the participant and
any broker or dealer for which it clears transactions,
including any market maker that would otherwise
be entitled to rely on the exception provided in
paragraph (b)(2)(iii) of this section, 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.’’
114 See 17 CFR 203(b)(2)(iii) (providing for an
exception from the ‘‘locate’’ requirement for market
makers engaged in bona fide market making in that
security at the time of the short sale).
115 See temporary Rule 204T(c).
E:\FR\FM\17OCR1.SGM
17OCR1
61720
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
jlentini on PROD1PC65 with RULES
agency no more than approximately
0.16 hours (10 minutes) to complete.116
We base this estimate in part on the fact
that most participants already notify
broker-dealers for which they receive
orders for clearance and settlement that
the participant has a fail to deliver
position in a threshold security that has
not been closed out in order to comply
with the borrow requirements of Rule
203(b)(3)(iv) of Regulation SHO for
threshold securities; the fact that most
participants already have the necessary
communication mechanisms in place
and are already familiar with
notification processes and procedures to
comply with the borrow requirements of
Rule 203(b)(3)(iv) of Regulation SHO for
threshold securities; and the fact that
participants will be able to continue to
use the same communication
mechanisms, processes and procedures
to notify any broker-dealers from which
they receive trades for clearance and
settlement of the information required
by the temporary rule’s notification
requirement as they use for compliance
with Regulation SHO.
If a participant of a registered clearing
agency has a fail to deliver position in
an equity security and after the
beginning of regular trading hours on
the Close-Out Date (or, in the case of a
fail to deliver that resulted from a long
sale, on the third consecutive settlement
day following the settlement date), the
participant has to determine whether or
not the fail to deliver position was
closed out in accordance with
temporary Rule 204T(a), we estimate
that a participant of a registered clearing
agency will have to make such
determination with respect to
approximately 50 equity securities per
day.117
As of July 31, 2008, there were 197
participants of NSCC, the primary
registered clearing agency responsible
for clearing U.S. transactions that were
116 We base this estimate on information provided
to our staff by three small, three medium, and three
large registered clearing agency participants.
117 OEA estimates that there are approximately
9,809 fail to deliver positions per day. Across 197
broker-dealer participants of the NSCC, the number
of securities per participant per day is
approximately 50 equity securities. During the
period from January to July 2008, approximately
4,321 new fail to deliver positions occurred per day.
The NSCC data for this period includes only
securities with at least 10,000 shares in fails to
deliver. To account for securities with fails to
deliver below 10,000 shares, the figure is grossedup by a factor of 2.27. The factor is estimated from
a more complete data set obtained from NSCC
during the period from September 16, 2008 to
September 22, 2008. It should be noted that these
numbers include securities that were not subject to
the close-out requirement of Rule 203(b)(3) of
Regulation SHO.
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
registered as broker-dealers.118 We
estimate a total of 2,482,200
notifications in accordance with
temporary Rule 204T(c) across all
participants per year (197 participants
notifying broker-dealers once per day on
50 securities, multiplied by 252 trading
days in a year). The total estimated
annual burden hours per year will be
approximately 397,152 burden hours
(2,482,200 @ 0.16 hours/
documentation). We estimate that the
paperwork burden for the notification
requirement for each participant will be
approximately 2,016 burden hours per
year.
4. Certification Requirement
The temporary rule includes an
exception from the borrowing
requirements for any broker-dealer that
can demonstrate that it was not
responsible for any part of the fail to
deliver position of the participant.
Specifically, temporary Rule 204T(b)(1)
provides that a broker or dealer shall not
be subject to the requirements of
temporary Rule 204T(b) if the broker or
dealer timely certifies to the participant
that it has not incurred a fail to deliver
position on settlement date for a long or
short sale in an equity security for
which the participant has a fail to
deliver position at a registered clearing
agency or that the broker or dealer is in
compliance with the requirements of
temporary Rule 204T(e) (the
‘‘certification requirement’’).119
This certification requirement will
allow a broker-dealer to avoid being
subject to the temporary rule’s
borrowing requirements if it can
demonstrate that it did not incur a fail
to deliver position in the security on
settlement date. Also, by requiring the
broker-dealer to demonstrate that it was
not responsible for any part of the fail
to deliver position of the participant, the
information collected will help ensure
that broker-dealers are complying with
the requirements of the temporary rule.
This certification requirement will
require a broker-dealer to determine that
118 Those participants not registered as brokerdealers include such entities as banks, U.S.registered exchanges, and clearing agencies.
Although these entities are participants of a
registered clearing agency, generally these entities
do not engage in the types of activities that will
implicate the close-out requirements of the
temporary rule. Such activities of these entities
include creating and redeeming Exchange Traded
Funds, trading in municipal securities, and using
NSCC’s Envelope Settlement Service or Inter-city
Envelope Settlement Service. These activities rarely
lead to fails to deliver and, if fails to deliver do
occur, they are small in number and are usually
closed out within a day. Thus, such fails to deliver
will not trigger the close-out requirement of the
temporary rule.
119 See temporary Rule 204T(b)(1).
PO 00000
Frm 00064
Fmt 4700
Sfmt 4700
it has not incurred a fail to deliver
position on settlement date in an equity
security for which the participant has a
fail to deliver position at a registered
clearing agency or that the broker-dealer
is in compliance with the requirements
set forth in the Pre-Fail Credit provision
of temporary Rule 204T(e). After making
such determinations, the broker-dealer
will have to certify this information to
the participant. We estimate that such
procedures will take a broker-dealer no
more than approximately 0.16 hours (10
minutes) to complete.
We base this estimate, in part, on the
fact that, to comply with the close-out
requirements of Rule 203(b) of
Regulation SHO, current industry
practice for some participants that are
registered broker-dealers is to document
purchases made on settlement days 11,
12, and 13 to demonstrate that such
participants do not have a close-out
obligation under Regulation SHO. On
average, participants informed us that
such documentation takes
approximately 0.16 hours (10
minutes).120
If the broker-dealer determines that it
has not incurred a fail to deliver
position on settlement date in an equity
security for which the participant has a
fail to deliver position at a registered
clearing agency or has purchased
securities in accordance with the
conditions specified in temporary Rule
204T(e), we estimate that a brokerdealer will have to make such
determinations with respect to
approximately 1.76 securities per day.
As of December 31, 2007, there were
5,561 registered broker-dealers. Each of
these broker-dealers may clear trades
through a participant of a registered
clearing agency. We estimate that on
average, a broker-dealer will have to
certify to the participant that it has not
incurred a fail to deliver position on
settlement date in an equity security for
which the participant has a fail to
deliver position at a registered clearing
agency or, alternatively, that it is in
compliance with the requirements set
forth in the Pre-Fail Credit provision of
the temporary Rule 204T(e), 2,466,415
times per year (5,561 broker-dealers
certifying once per day on 1.76
securities, multiplied by 252 trading
days in a year). The total approximate
estimated annual burden hour per year
will be approximately 394,626 burden
hours (2,466,415 multiplied by 0.16
hours/certification). We estimate that
the paperwork burden for the
certification provision for each broker120 We base this estimate on information provided
to our staff by three small, three medium, and three
large registered clearing agency participants.
E:\FR\FM\17OCR1.SGM
17OCR1
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
jlentini on PROD1PC65 with RULES
dealer will be approximately 71.0
burden hours per year.
5. Pre-Fail Credit Demonstration
Requirement
To encourage close outs of fail to
deliver positions prior to the Close-Out
Date, temporary Rule 204T(e) provides
that a broker-dealer can satisfy the
temporary rule’s close-out requirement
by purchasing securities in accordance
with the conditions of that provision
(i.e., broker-dealers will receive ‘‘pre-fail
credit’’ for the purchase), including a
condition that the broker-dealer
demonstrate that it has a net long
position or net flat position on its books
and records on the settlement day for
which the broker or dealer is claiming
credit (the ‘‘Pre-Fail Credit
demonstration requirement’’).
Temporary Rule 204T(e) provides that
even if a participant of a registered
clearing agency has not closed out a fail
to deliver position at a registered
clearing agency in accordance with
temporary Rule 204T(a), or has not
allocated a fail to deliver position to a
broker-dealer in accordance with
temporary Rule 204T(d), a broker or
dealer may receive credit for purchasing
securities prior to the beginning of
regular trading hours on the Close-Out
Date if, among other things, the
purchase is executed on, or after, trade
date but by no later than the end of
regular trading hours on settlement date
and the broker or dealer can
demonstrate that it has a net long
position or net flat position on its books
and records on the settlement day for
which the broker or dealer is claiming
credit.121
The Pre-Fail Credit provision is
intended to encourage broker-dealers to
close out fail to deliver positions prior
to the beginning of regular trading hours
on the Close-Out Date. By requiring,
among other things, that the brokerdealer demonstrate that it has a net long
position or net flat position on its books
and records on the settlement day for
which the broker-dealer is claiming
credit, the information collected will
help ensure that broker-dealers
purchase sufficient shares to close out
their fail to deliver position prior to the
beginning of regular trading hours on
the Close-Out Date.
Such demonstration requirement will
require a broker-dealer that purchased
securities in accordance with the
conditions specified in temporary Rule
204T(e) to determine that it has a net
long position or net flat position on the
settlement day for which the brokerdealer is claiming credit. After making
121 See
temporary Rule 204T(e).
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
such determination, the temporary rule
requires that the broker-dealer
demonstrate such information on its
books and records. We estimate that
such procedures will take a brokerdealer no more than approximately 0.16
hours (10 minutes) to complete.
We base this estimate on the fact that,
to comply with the close-out
requirement of Rule 203(b)(3) of
Regulation SHO, current industry
practice for some participants that are
registered broker-dealers is to document
purchases made on settlement days 11,
12, and 13 to demonstrate that such
participants do not have a close-out
obligation under Regulation SHO. On
average, participants informed us that
such documentation takes
approximately 0.16 hours (10
minutes).122
If a broker-dealer purchased securities
in accordance with the conditions
specified in temporary Rule 204T(e) and
determined that it has a net long
position or net flat position on the
settlement day for which the brokerdealer is claiming credit, we estimate
that a broker-dealer will have to make
such determination with respect to
approximately 1.76 securities per
day.123
As of December 31, 2007, there were
5,561 registered broker-dealers. We
estimate that on average, a broker-dealer
will have to demonstrate in its books
and records that it has a net long
position or net flat position on the
settlement day for which the brokerdealer is claiming credit, 2,466,415
times per year (5,561 broker-dealers
checking for compliance once per day
on 1.76 securities, multiplied by 252
trading days in a year). The total
approximate estimated annual burden
hour per year will be approximately
394,626 burden hours (2,466,415
multiplied by 0.16 hours/
demonstration). We estimate that the
paperwork burden for the temporary
Pre-Fail Credit provision for each
broker-dealer will be approximately
71.0 burden hours per year.
6. Market Maker Demonstration
Requirement
To allow market makers to facilitate
customer orders in a fast moving
market, the temporary rule includes a
limited exception from the rule’s closeout requirement for fails to deliver
attributable to bona fide market making
activities by registered market makers,
options market makers, or other market
122 We base this estimate on information provided
to our staff by three small, three medium, and three
large registered clearing agency participants.
123 See supra, note 107.
PO 00000
Frm 00065
Fmt 4700
Sfmt 4700
61721
makers obligated to quote in the overthe-counter market (collectively,
‘‘Market Makers’’). Under this
exception, a participant must close out
the fail to deliver position attributable to
a Market Maker by no later than the
beginning of regular trading hours on
the morning of the third settlement day
after the settlement date for the
transaction that resulted in the fail to
deliver position. The borrowing
requirements of the temporary rule do
not apply to Market Makers provided
the Market Maker can demonstrate that
it does not have an open fail to deliver
position at the time of any additional
short sales (the ‘‘Market Maker
demonstration requirement’’).
By requiring a Market Maker to
demonstrate that it does not have an
open fail to deliver position at the time
of any additional short sales and, thus,
avoid being subject to the temporary
rule’s pre-borrow requirements, the
information collected will help ensure
that Market Makers are complying with
the requirements of temporary Rule
204T(b)(2).
This requirement will require a
Market Maker to determine whether it
has an open fail to deliver position at
the time of any additional short sales in
the particular equity security in which
there is a fail to deliver position at a
registered clearing agency. After making
such a determination, the temporary
rule requires that the Market Maker
demonstrate that it does not have an
open fail to deliver position in that
equity security. We estimate that such
procedures will take a Market Maker no
more than approximately 0.16 hours (10
minutes) to complete.124
If a participant of a registered clearing
agency has a fail to deliver position in
an equity security at a registered
clearing agency that is attributable to a
Market Maker and the Market Maker, in
seeking to avoid the borrowing
requirements of temporary Rule
204T(b), has determined that it does not
have an open fail to deliver position, we
estimate that such Market Maker will
have to make such determination with
respect to approximately 15 securities
per day.125
124 We base this estimate on information provided
to our staff by three large, three medium, and three
small firms that engage in market making activities
currently complying with temporary Rule 204T,
pursuant to the September Emergency Order, which
has similar requirements to temporary Rule
204(T)(b)(2) of this release.
125 OEA estimates that there are approximately
9,809 fail to deliver positions per day. An upper
bound on the number of fail to deliver positions per
day due to market makers is 9,809. Across 656
market makers, the number of securities per market
maker per day is approximately 15 equity
E:\FR\FM\17OCR1.SGM
Continued
17OCR1
61722
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
with regard to this collection of
information should be in writing, with
reference to File No. S7–30–08, and be
submitted to the Securities and
Exchange Commission, Records
Management, Office of Filings and
Information Services, 100 F Street, NE.,
Washington, DC 20549–1090. As OMB
is required to make a decision
concerning the collections of
information between 30 and 60 days
after publication, a comment to OMB is
best assured of having its full effect if
OMB receives it within 30 days of
publication.
B. Request for Comment
We invite comment on these estimates
and assumptions. Pursuant to 44 U.S.C.
3506(c)(2)(B), we request comment in
order to: (a) Evaluate whether the
collection of information is necessary
for the proper performance of our
functions, including whether the
information will have practical utility;
(b) evaluate the accuracy of our estimate
of the burden of the collection of
information; (c) determine whether
there are ways to enhance the quality,
utility and clarity of the information to
be collected; and (d) evaluate whether
there are ways to minimize the burden
of the collection of information on those
who respond, including through the use
of automated collection techniques or
other forms of information technology.
Persons submitting comments on the
collection of information requirements
should direct them to the Office of
Management and Budget, Attention:
Desk Officer for the Securities and
Exchange Commission, Office of
Information and Regulatory Affairs,
Washington, DC 20503, and should also
send a copy of their comments to
Florence E. Harmon, Acting Secretary,
Securities and Exchange Commission,
100 F Street, NE., Washington, DC
20549–1090, with reference to File No.
S7–30–08. Requests for materials
submitted to OMB by the Commission
jlentini on PROD1PC65 with RULES
As of December 31, 2007, there were
656 Market Makers.126 We estimate a
total of 2,479,680 written
demonstrations in accordance with
temporary Rule 204T(b)(1) across all
Market Makers per year (656 Market
Makers demonstrating once per day on
15 securities, multiplied by 252 trading
days in a year). The total estimated
annual burden hour per year will be
approximately 396,749 burden hours
(2,479,680 multiplied by 0.16 hours/
demonstration). We estimate that the
paperwork burden for the Market Maker
demonstration requirements for each
Market Maker will be approximately
604.8 burden hours per year.
A. Summary
securities. During the period from January to July
2008, approximately 4,321 new fail to deliver
positions occurred per day. The NSCC data for this
period includes only securities with at least 10,000
shares in fails to deliver. To account for securities
with fails to deliver below 10,000 shares, the figure
is grossed-up by a factor of 2.27. The factor is
estimated from a more complete data set obtained
from NSCC during the period from September 16,
2008 to September 22, 2008. It should be noted that
these numbers include securities that were not
subject to the close-out requirement of Rule
203(b)(3) of Regulation SHO.
126 These numbers are based on OEA’s review of
2007 FOCUS Report filings reflecting registered
broker-dealers. This number does not include
broker-dealers that are delinquent on FOCUS
Report filings.
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
VIII. Cost-Benefit Analysis
The Commission is sensitive to the
costs and benefits of its rules.
Commenters should provide analysis
and data to support their views on the
costs and benefits associated with the
temporary rule.
We are adopting, as an interim final
temporary rule, Rule 204T, under the
Exchange Act. The temporary rule is
intended to address abusive ‘‘naked’’
short selling in all equity securities by
requiring that participants of a
registered clearing agency deliver
securities by settlement date, or if the
participants have not delivered shares
by settlement date, the participants
must, by no later than the beginning of
regular trading hours on the Close-Out
Date, immediately close out the fail to
deliver position by borrowing or
purchasing securities of like kind and
quantity.
If a participant does not purchase or
borrow shares, as applicable, to close
out a fail to deliver position in
accordance with temporary Rule
204T(a), the participant will have
violated the temporary rule. In addition,
the temporary rule imposes on the
participant for its own trades and on all
broker-dealers from which that
participant receives trades for clearance
and settlement (including introducing
and executing brokers), a requirement to
borrow or arrange to borrow securities
prior to accepting or effecting further
short sales in that security.127
To the extent that a participant
becomes subject to the borrowing
requirements of temporary Rule
204T(b), a broker-dealer that clears
through the participant can avoid being
subject to the borrowing requirements of
temporary Rule 204T(b) if the brokerdealer can demonstrate that it was not
responsible for any part of the fail to
deliver position of the participant.
Moreover, to allow Market Makers to
127 See
PO 00000
temporary Rule 204T(b).
Frm 00066
Fmt 4700
Sfmt 4700
facilitate customer orders in a fast
moving market without possible delays
associated with complying with the preborrow penalty provision of temporary
Rule 204T(b), the borrowing
requirements of the temporary rule do
not apply to Market Makers provided
the Market Maker can show that it does
not have an open fail to deliver position
at the time of any additional short
sales.128
Similar to Rule 203(b)(3)(vi) of
Regulation SHO, temporary Rule 204(d)
provides that a participant may
reasonably allocate its responsibility to
close out a fail to deliver position to
another broker-dealer for which the
participant clears trades, or from which
it receives trades for settlement.129
Unlike Rule 203(b)(3)(vi) of Regulation
SHO, however, temporary Rule 204T(d)
imposes a notification requirement on a
broker-dealer that has been allocated
responsibility for complying with the
rule’s requirements.130
In addition, the temporary rule
provides that if a participant has a fail
to deliver position at registered clearing
agency in an equity security and can
demonstrate on its books and records
that such fail to deliver position
resulted from a long sale, such
participant has until no later than the
beginning of regular trading hours on
the third consecutive settlement day
following the settlement date to
immediately close out the fail to deliver
position by purchasing securities of like
kind and quantity.
The temporary rule also extends the
close-out requirement for fails to deliver
attributable to bona fide market making
activities by Market Makers by requiring
a participant to close out the fail to
deliver position attributable to a Market
Maker by no later than the beginning of
regular trading hours on the third
settlement day after the settlement date
for the transaction that resulted in the
fail to deliver position.
In addition, consistent with Rule
203(b)(3)(ii) of Regulation SHO, the
temporary rule includes an exception
for sales of securities pursuant to Rule
144 of the Securities Act.131
128 See
temporary Rule 204T(b)(2).
17 CFR 242.203(b)(3)(vi). Rule
203(b)(3)(vi) provides that ‘‘[i]f a participant of a
registered clearing agency reasonably allocates 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 or dealer’s short position, then the
provisions of this paragraph (b)(3) relating to such
fail to deliver position shall apply to the portion of
such registered broker or dealer that was allocated
the fail to deliver position, and not to the
participant.’’
130 See temporary Rule 204T(d).
131 See 17 CFR 242.203(b)(3)(ii).
129 See
E:\FR\FM\17OCR1.SGM
17OCR1
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
jlentini on PROD1PC65 with RULES
Specifically, temporary Rule 204T(a)(2)
provides that if a participant of a
registered clearing agency has a fail to
deliver position at a registered clearing
agency in any equity security sold
pursuant to Rule 144 for thirty-five
consecutive settlement days after the
settlement date for a sale in that equity
security, the participant shall, by no
later than the beginning of regular
trading hours on the thirty-sixth
consecutive settlement day following
the settlement date for the transaction,
immediately close out the fail to deliver
position by purchasing securities of like
kind and quantity.132
If, however, a fail to deliver position
resulting from the sale of an equity
security pursuant to Rule 144 is not
closed out in accordance with
temporary Rule 204T(a)(2), the
participant is subject to the borrow
requirements in temporary Rule
204T(b). Thus, if the fail to deliver
position persists beyond thirty-five
consecutive settlement days, the
temporary rule prohibits a participant of
a registered clearing agency, and any
broker-dealer from which it receives
trades for clearance and settlement,
from accepting any short sale orders or
effecting further short sales in the
particular security without borrowing,
or entering into a bona-fide arrangement
to borrow, the security until the
participant closes out the entire fail to
deliver position by purchasing
securities of like kind and quantity and
that purchase has cleared and settled at
a registered clearing agency.133
Although we recognize the temporary
rule may impose increased borrowing
costs to assure settlement in accordance
with the requirements of the temporary
rule, which may increase the costs of
legitimate short selling, we believe that
the requirements of the temporary rule
are necessary to achieve our goal of
further reducing fails to deliver and
addressing abusive ‘‘naked’’ short
selling.
B. Benefits
The temporary rule will substantially
restrict the practice of ‘‘naked’’ short
selling in all equity securities by
strengthening the delivery requirements
for such securities. By requiring that
participants of a registered clearing
agency deliver securities by settlement
date, or if the participants have not
delivered shares by settlement date,
immediately close out the fail to deliver
position by borrowing or purchasing
securities of like kind and quantity, the
temporary rule also furthers our goals of
132 See
133 See
temporary Rule 204T(a)(2).
temporary Rule 204T(b).
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
limiting fails to deliver and helping to
reduce the possibility that abusive
‘‘naked’’ short selling may contribute to
disruption in the securities markets.
This, in turn, will help to ensure that
investors remain confident that trading
can be conducted without the influence
of illegal manipulation. The temporary
rule also furthers the goals of helping to
maintain fair and orderly markets
against the threat of sudden and
excessive fluctuations of securities
prices and substantial disruption in the
functioning of the securities markets.
The temporary rule also promotes the
prompt and accurate clearance and
settlement of transactions in equity
securities.
In addition, the temporary rule will
help to further reduce the number of
fails to deliver. These fails may create a
misleading impression of the market for
these securities. Large and persistent
fails to deliver may have a negative
effect on shareholders, potentially
depriving them of the benefits of
ownership, such as voting and lending.
Thus, by facilitating the prompt receipt
of shares, the temporary rule will help
enable investors to receive the benefits
associated with share ownership.
Persistent fails to deliver in a security
may also be perceived by potential
investors negatively and may affect their
decision about making a capital
commitment. Thus, by providing greater
assurance that securities will be
delivered and, thereby, alleviating
investor apprehension as they make
investment decisions, the temporary
rule will benefit issuers in that an
increase in investor confidence in the
market for their securities will facilitate
investment in their securities.
1. Close-Out Requirements
By requiring that participants of a
registered clearing agency deliver
securities by settlement date, or if the
participants have not delivered shares
by settlement date, immediately close
out the fail to deliver position by
borrowing or purchasing securities of
like kind and quantity, the temporary
rule will help restore, maintain, and
enhance investor confidence in the
securities markets. It will also help
reduce manipulative schemes involving
‘‘naked’’ short selling in equity
securities. Sellers that fail to deliver
securities on settlement date may enjoy
fewer restrictions than if they were
required to deliver the securities within
a reasonable period of time, and such
sellers may attempt to use this
additional freedom to engage in trading
activities that deliberately depress the
price of a security. Thus, the temporary
rule’s close-out requirements are
PO 00000
Frm 00067
Fmt 4700
Sfmt 4700
61723
expected to remove a potential means of
manipulation, thereby decreasing the
possibility of artificial market influences
and contributing to price efficiency.
Under temporary Rule 204T(a)(1), a
participant that has a fail to deliver
position at a registered clearing agency
in an equity security and can
demonstrate on its books and records
that such fail to deliver position
resulted from a long sale, will have until
no later than the beginning of regular
trading hours on the third consecutive
settlement day following the settlement
date to immediately close out the fail to
deliver position by purchasing
securities of like kind and quantity. This
provision allows participants an
additional two settlement days to close
out fail to deliver positions that result
from long sales, provided that the
participant’s books and records reflect
the fact that the fail to deliver resulted
from a long sale.134 We believe this
exception to temporary Rule 204T(a)’s
close-out requirement benefits
participants because the two additional
days to close-out these fail to deliver
positions may reduce close-out costs for
such participants.
The temporary rule also extends
temporary Rule 204T(a)’s close-out
requirement for fails to deliver
attributable to bona fide market making
activities by Market Makers by requiring
a participant to close out the fail to
deliver position attributable to a Market
Maker by no later than the beginning of
regular trading hours on the third
settlement day after the settlement date.
We believe this exception to temporary
Rule 204T(a)’s close-out requirement
benefits participants because the two
additional days to close-out these fail to
deliver positions may reduce close-out
costs for such participants.
Similar to Rule 203(b)(3)(vi) of
Regulation SHO, temporary Rule 204(d)
allows a participant to reasonably
allocate its responsibility to close out a
fail to deliver position to another
broker-dealer for which the participant
clears trades, or from which it receives
trades for settlement. This allocation
provision benefits participants because
if a participant can identify the accounts
of broker-dealers for which they clear or
from which they receive trades for
settlement, the participant can allocate
the responsibility to close out the fail to
deliver position to the particular brokerdealer account(s) whose trading
activities caused the fail to deliver
position provided the allocation is
reasonable and, therefore, the allocated
broker-dealer rather than the participant
134 See
E:\FR\FM\17OCR1.SGM
temporary Rule 204T(a)(1).
17OCR1
61724
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
jlentini on PROD1PC65 with RULES
will incur any costs associated with the
temporary rule’s close-out requirement.
In addition, temporary Rule 204T(d)
imposes a notification requirement on a
broker-dealer that has been allocated
responsibility for complying with the
rule’s requirements. Thus, under the
temporary rule’s allocation provision, if
the broker-dealer does not comply with
the provisions of temporary Rule
204T(a), it must immediately notify the
participant that it has become subject to
the borrowing requirements of
temporary Rule 204T(b).135 This
allocation notification requirement is
intended to let participants know when
a broker-dealer from which the
participant receives trades for clearance
and settlement has become subject to
the temporary rule’s borrowing
requirements. The notification
requirement furthers the Commission’s
goals of limiting fails to deliver and
addressing abusive ‘‘naked’’ short
selling by promoting the prompt and
accurate clearance and settlement of
transactions involving equity securities.
The notification requirement will also
help ensure that participants that
receive trades for clearance and
settlement from broker-dealers will be
on notice that the broker-dealer is
subject to the borrow requirements of
temporary Rule 204T(b) until the fail to
deliver position has been closed out.
Moreover, under the temporary rule’s
Pre-Fail Credit provision, a broker or
dealer may receive credit for purchasing
securities prior to the beginning of
regular trading hours on the Close-Out
Date if, among other things, the
purchase is executed on, or after, trade
date but by no later than the end of
regular trading hours on settlement date
and the broker or dealer can
demonstrate that it has a net long
position or net flat position on its books
and records on the settlement day for
which the broker or dealer is claiming
credit. The Pre-Fail Credit provision is
intended to encourage earlier close out
of fails to deliver in all equity securities
and, therefore, to the extent used could
result in a reduction of persistent fails
to deliver.
2. Borrowing Requirements
The borrowing requirements of
temporary Rule 204T(b) are similar to
the requirements of Rule 203(b)(3)(iv) of
Regulation SHO for a participant that
has not closed out a fail to deliver
position in a threshold security that has
persisted for thirteen consecutive
settlement days.136 Similar to
Regulation SHO, the temporary rule is
135 See
136 See
temporary Rule 204T(d).
17 CFR 242.203(b)(3)(iv).
VerDate Aug<31>2005
17:16 Oct 16, 2008
aimed in part at addressing potentially
abusive ‘‘naked’’ short selling in equity
securities. To that end, we believe it is
appropriate to include in the temporary
rule borrowing requirements for brokerdealers, including participants, that sell
short a security that has a fail to deliver
position that has not been closed out in
accordance with the requirements of the
temporary rule. We believe that the
borrowing requirements of temporary
Rule 204T(b) will further our goal of
limiting fails to deliver and addressing
abusive ‘‘naked’’ short selling by
promoting the prompt and accurate
clearance and settlement of transactions
in equity securities. By requiring that
participants and broker-dealers from
which they receive trades for clearance
and settlement borrow or arrange to
borrow securities prior to accepting or
effecting short sales in the security that
has a fail to deliver position that has not
been closed out, the temporary rule will
help to ensure that shares will be
available for delivery on the short sale
by settlement date and, thereby, help to
avoid additional fails to deliver
occurring in the security.
Unlike the current borrow
requirements of Rule 203(b)(3)(iv) of
Regulation SHO, however, the borrow
requirements of the temporary rule
specify that participants must notify all
broker-dealers from which they receive
trades for clearance and settlement that
a fail to deliver position in an equity
security has not been closed out in
accordance with temporary Rule
204T(a).137 This notification
requirement in temporary Rule 204T(c)
is intended to ensure that all brokerdealers that submit trades for clearance
and settlement to a participant that has
a fail to deliver position in an equity
security that has not been closed out in
accordance with temporary Rule
204T(a) are on notice that all short sales
in that security will be subject to the
borrowing requirements of temporary
Rule 204T(b) until the fail to deliver
position has been closed out.
However, if a participant becomes
subject to the borrowing requirements of
temporary Rule 204T(b) because it did
not close out a fail to deliver position
by no later than the beginning of regular
trading hours on the settlement date for
the transaction, a broker-dealer that
clears through the participant will not
also be subject to the borrowing
requirements of temporary Rule 204T(b)
if the broker-dealer can demonstrate that
it was not responsible for any part of the
fail to deliver position of the
participant.138 This exception allows a
137 See
138 See
Jkt 217001
PO 00000
temporary Rule 204T(c).
temporary Rule 204T(b)(1).
Frm 00068
Fmt 4700
Sfmt 4700
broker-dealer to avoid being subject to
the borrowing requirements of the
temporary rule if the broker-dealer can
demonstrate that it did not incur a fail
to deliver position in the security on
settlement date.
Moreover, the borrowing
requirements of the temporary rule will
not apply to Market Makers, provided
that the Market Maker can show that it
does not have an open fail to deliver
position at the time of any additional
short sales.139 This provision is
intended to allow Market Makers to
facilitate customer orders in a fast
moving market without possible delays
associated with complying with the preborrow penalty provision of temporary
Rule 204T(b).
3. Sales of Securities Pursuant to Rule
144
Securities sold pursuant to Rule 144
of the Securities Act are formerly
restricted securities that a seller is
‘‘deemed to own,’’ as defined by Rule
200(a) of Regulation SHO.140 The
securities, however, may not be capable
of being delivered on the settlement
date due to processing delays related to
removal of the restricted legend and,
therefore, sales of these securities
frequently result in fails to deliver.
Consistent with our statements in
connection with our recent amendments
to Regulation SHO in connection with
closing out fails to deliver in threshold
securities sold pursuant to Rule 144,141
we believe that a close-out requirement
of thirty-five consecutive settlement
days from settlement date for fails to
deliver resulting from sales of equity
securities sold pursuant to Rule 144,
will permit the orderly settlement of
such sales without the risk of causing
market disruption due to unnecessary
purchasing activity (particularly if the
purchases are for sizable quantities of
stock). Because the Rule 144 security
sold will be received as soon as all
processing delays have been removed,
this additional time will allow
participants to close out fails to deliver
resulting from the sale of the security
with the security sold, rather than
having to close out such fail to deliver
position by purchasing securities in the
market. Thus, the amendments will
139 See
temporary Rule 204T(b)(2).
17 CFR 242.200(a).
141 As mentioned above, we recently adopted
amendments to the close-out requirement of
Regulation SHO to allow fails to deliver resulting
from sales of threshold securities pursuant to Rule
144 to be closed out within 35 rather 13 consecutive
settlement days. See 2007 Regulation SHO Final
Amendments, 72 FR at 45550–45551.
140 See
E:\FR\FM\17OCR1.SGM
17OCR1
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
jlentini on PROD1PC65 with RULES
reduce costs to participants and, in turn,
investors.
Although the temporary rule allows
fails to deliver resulting from sales of
equity securities sold pursuant to Rule
144 of the Securities Act thirty-five
consecutive settlement days after the
settlement date before a participant
must take action to close out the fail to
deliver position, these fails to deliver
must be closed out by no later than the
beginning of regular trading hours on
the thirty-sixth settlement day and,
therefore, these fails to deliver cannot
continue indefinitely. Thus, we believe
that the temporary rule is consistent
with our goal of further reducing fails to
deliver in equity securities, while
balancing the concerns associated with
closing out fails to deliver resulting
from sales of securities pursuant to Rule
144 of the Securities Act.
C. Costs
We recognize that the temporary rule
may result in increased short selling
costs for participants that may impact
legitimate short selling activities;
however, we believe such costs will be
limited. For example, it might result in
participants incurring borrowing costs
where they borrow securities to close
out a fail to deliver position that might
have been closed out soon thereafter
with shares received from the customer.
Such actions might result in added
demand in the lending market which in
turn might exert upward pressure on
securities lending rates, potentially
making short selling more expensive for
all market participants. For example, it
is estimated that about $700 billion in
U.S. equity securities are lent out per
year. Preliminary input from industry
participants suggests that lending rates
increased significantly after the
September Emergency Order for stocks
not covered by the ban on short selling.
While results from the period after the
September Emergency Order may be
confounded by the unusual
circumstances of the continued credit
crisis, an increase of 10 basis points in
lending rates would result in an annual
cost increase to securities borrowers of
$700 million and the new revenue for
securities lenders increasing by the
corresponding amount of $700 million.
Therefore, if lending increased by 10
basis points, the annual impact on the
securities lending market would be
about $1,400 million (or $1,050 million
for nine months).
To the extent that the requirements of
the temporary rule will result in
increased costs to short selling in equity
securities, it may lessen some of the
benefits of legitimate short selling and,
thereby, result in a reduction in short
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
selling generally. Such a reduction may
lead to a decrease in market efficiency
and price discovery, less protection
against upward stock price
manipulations, a less efficient allocation
of capital, an increase in trading costs,
and a decrease in liquidity. We also
recognize that requiring that
participants purchase securities to close
out fails to deliver in equity securities
in accordance with the temporary rule,
may potentially impact the willingness
of participants to provide liquidity.
As a likely result of the temporary
rule as contained in the September
Emergency Order, bid-ask spreads on
equity securities have increased.
Preliminary input from industry
participants suggests that bid-ask
spreads have increased after the
September Emergency Order for stocks
not covered by the ban on short selling.
While results from the period after the
September Emergency Order may be
confounded by the unusual
circumstances of the continued credit
crisis, an increase of 1 basis point in
bid-ask spreads would result in an
annual cost to investors of about $6,048
million. To calculate the annual cost,
we assume that 12 billion shares trade
on a daily basis. At an average share
price of approximately $20, this
constitutes $240 billion in dollar
volume per day. Based on this total, an
increase in transaction costs of one basis
point would result in a daily increase in
realized transaction costs of
approximately $24 million a day. At this
rate, investors would experience
increased total transaction costs of over
$100 million within the first five trading
days of the rule or about $6,048 million
annually ($24 million times 252 trading
days) (or $4,536 million for nine
months).
We believe, however, that
strengthening rules against potentially
abusive ‘‘naked’’ short selling will
provide increased confidence in the
securities markets. Thus, although we
recognize that the temporary rule may
result in increased short selling costs,
we believe such costs are justified by
the fact that the temporary rule may
help restore, maintain, and enhance
investor confidence in the markets by
preventing potentially abusive ‘‘naked’’
short selling.
1. Close-Out Requirements
We also recognize that requiring that
participants purchase securities to
close-out fails to deliver in any equity
security in accordance with the
temporary rule, may potentially impact
the willingness of participants to
provide liquidity. However, we believe
that any such potential effect will be
PO 00000
Frm 00069
Fmt 4700
Sfmt 4700
61725
minimal because participants will still
have some flexibility by having two
additional settlement days in which to
purchase securities to close-out their fail
to deliver positions that either result
from long sales or are attributable to
bona fide market making activities by
Market Makers.
In addition, we recognize that the
temporary rule’s close-out requirement
may result in some additional costs for
participants of a registered clearing
agency in terms of systems and
surveillance modifications, as well as
changes to processes and procedures.
However, we believe any additional
costs incurred in implementing
temporary Rule 204T’s close-out
requirement in terms of these
modifications will be minimal. The
close-out requirement of the temporary
rule is consistent with the current
settlement practices and procedures and
with the close-out requirement of
Regulation SHO. For example, because
most transactions settle by T+3,
participants should already have in
place policies and procedures to help
ensure that delivery is being made by
settlement date. Nevertheless,
participants will incur costs for each
close-out and these costs could
accumulate to significant amounts over
time and across participants.
Moreover, similar to the existing
close-out requirement of Rule 203(b)(3)
of Regulation SHO, the temporary rule
is based on a participant’s fail to deliver
position at a registered clearing agency.
As noted above, the NSCC clears and
settles the majority of equity securities
trades conducted on the exchanges and
in the over-the-counter markets. The
NSCC clears and settles trades through
the CNS system, which nets the
securities delivery and payment
obligations of all of its members. The
NSCC notifies its members of their
securities delivery and payment
obligations daily. Thus, because the
temporary rule is based on a
participant’s fail to deliver position at a
registered clearing agency, it is
consistent with current settlement
practices and procedures and with the
Regulation SHO framework regarding
delivery of securities.142 As such, we
anticipate that most participants will
already have systems, processes and
procedures in place in order to comply
with the temporary rule’s close-out
requirements and, therefore, that any
additional implementation costs
associated with the temporary rule will
be minimal.
In addition, to comply with
Regulation SHO’s close-out requirement
142 See
E:\FR\FM\17OCR1.SGM
17 CFR 242.203(b)(3).
17OCR1
jlentini on PROD1PC65 with RULES
61726
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
when it became effective in January
2005, participants needed to modify
their recordkeeping systems and
surveillance mechanisms. Participants
also should have retained and trained
the necessary personnel to ensure
compliance with the rule’s close-out
requirements. Thus, most of the
infrastructure necessary to comply with
the temporary rule’s close-out
requirement should already be in place.
Thus, we believe that any changes to
personnel, computer hardware and
software, recordkeeping or surveillance
costs will be minimal.
We recognize that the requirements of
temporary Rule 204T(a)(1) may also
impose additional costs on participants
of a registered clearing agency. As
discussed above, under temporary Rule
204T(a)(1), a participant of a registered
clearing agency that has a fail to deliver
position at a registered clearing agency
in an equity security and can
demonstrate on its books and records
that the fail to deliver position resulted
from a long sale, will have until no later
than the beginning of regular trading
hours on the third consecutive
settlement day following the settlement
date to immediately close out the fail to
deliver position by purchasing
securities of like kind and quantity.
Thus, to qualify for this additional time
to close out a fail to deliver position, the
temporary rule requires the participant
to demonstrate on their books and
records that the fail to deliver position
resulted from a long sale.
This demonstration requirement may
result in participants incurring costs
related to personnel, recordkeeping,
systems, and surveillance mechanisms.
For example, as discussed in detail in
section VII above, for purposes of the
Paperwork Reduction Act, we estimate
that it will take each participant of a
registered clearing agency no more than
approximately 0.16 hours (10 minutes)
to comply with the demonstration
requirement of the temporary Rule
204T(a)(1). In addition, we estimate that
the total annual hour burden per year
for each participant subject to the
documentation requirement will be
1,371 hours.
The allocation notification
requirement of temporary Rule 204T(d)
will impose costs on broker-dealers that
have been allocated responsibility for
the close-out requirement under the
temporary rule. As discussed above,
temporary Rule 204T(d) requires a
broker or dealer that has been allocated
a portion of a fail to deliver position that
has not complied with the close-out
provisions under the temporary rule to
notify the participant that it has become
subject to the borrowing requirements of
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
temporary Rule 204T(b). This
notification requirement may result in
broker-dealers incurring costs related to
personnel, recordkeeping, systems, and
surveillance mechanisms. For example,
as discussed in detail in section VII,
above, for purposes of the Paperwork
Reduction Act, we estimate that it will
take each broker-dealer no more than
approximately 0.16 hours (10 minutes)
to comply with the notification
requirements of temporary Rule
204T(d). In addition, we estimate that
the total annual hour burden per year
for each broker-dealer subject to the
notification requirement will be 71.0
hours.
We also recognize that the
requirements of temporary Rule 204T(e)
may impose additional costs on brokerdealers. As discussed above, temporary
Rule 204T(e) allows a broker-dealer to
obtain pre-fail credit if it purchases
securities in accordance with the
conditions specified in the temporary
rule. To receive pre-fail credit, the
temporary rule requires, among other
things, that a broker-dealer demonstrate
that it has a net long position or net flat
position on its books and records on the
settlement day for which the broker or
dealer is claiming credit.
This demonstration requirement may
result in participants incurring costs
related to personnel, recordkeeping,
systems, and surveillance mechanisms.
For example, as discussed in detail in
section VII above, for purposes of the
Paperwork Reduction Act, we estimate
that it will take each broker-dealer no
more than approximately 0.16 hours (10
minutes) to comply with the
demonstration requirements of the
temporary rule. In addition, we estimate
that the total annual hour burden per
year for each broker-dealer subject to the
demonstration requirement will be 71.0
hours.
2. Borrowing Requirements
We believe that temporary Rule
204T’s borrow requirements for fail to
deliver positions that are not closed out
in accordance with the temporary rule
will result in limited, if any,
implementation costs to participants of
a registered clearing agency, and brokerdealers from which they receive trades
for clearance and settlement. These
entities must already comply with the
borrow requirements of Rule
203(b)(3)(iv) of Regulation SHO if a fail
to deliver position has not been closed
out in accordance with Regulation
SHO’s mandatory close-out
requirement. Accordingly, these entities
should already have in place the
personnel, recordkeeping, systems, and
surveillance mechanisms necessary to
PO 00000
Frm 00070
Fmt 4700
Sfmt 4700
comply with the temporary rule’s
borrow requirements. Nevertheless, we
recognize that each pre-borrow will
impose costs on participants, brokerdealers, and investors and these costs
can accumulate to significant amounts if
the borrow requirement is imposed
often.
The pre-borrow notification
requirement of temporary Rule 204T(c)
will impose costs on participants of a
registered clearing agency. Temporary
Rule 204T(c) requires a participant to
notify any broker or dealer from which
it receives trades for clearance and
settlement, including any market maker
that would otherwise be entitled to rely
on the exception provided in Rule
203(b)(2)(iii) of Regulation SHO,143 (1)
that the participant has a fail to deliver
position in an equity security at a
registered clearing agency that has not
been closed out in accordance with the
requirements of temporary Rule 204T(a),
and (2) when the purchase that the
participant has made to close out the
fail to deliver position has cleared and
settled at a registered clearing agency.144
This notification requirement may result
in participants incurring costs related to
personnel, recordkeeping, systems, and
surveillance mechanisms. For example,
as discussed in detail in section VII,
above, for purposes of the Paperwork
Reduction Act, we estimate that it will
take each participant of a registered
clearing agency no more than
approximately 0.16 hours (10 minutes)
to comply with the pre-borrow
notification requirements of temporary
Rule 204T(b). In addition, we estimate
that the total annual hour burden per
year for each participant subject to the
notification requirement will be 2,016
hours.
Moreover, we believe any additional
costs incurred in connection with the
borrowing requirements of temporary
Rule 204T(b) will be limited by the fact
that if a participant becomes subject to
the borrowing requirements of
temporary Rule 204T(b), a broker-dealer
that clears through the participant will
not also be subject to the borrowing
requirements of temporary Rule 204T(b)
if the broker-dealer can demonstrate that
it was not responsible for any part of the
fail to deliver position of the
participant. This provision allows a
broker-dealer to avoid the costs of being
subject to the temporary rule’s
borrowing requirements, provided that
the broker-dealer can demonstrate that it
143 See 17 CFR 203(b)(2)(iii) (providing for an
exception from the ‘‘locate’’ requirement for market
makers engaged in bona fide market making in that
security at the time of the short sale).
144 See temporary Rule 204T(c).
E:\FR\FM\17OCR1.SGM
17OCR1
jlentini on PROD1PC65 with RULES
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
did not incur a fail to deliver position
in the security on settlement date.
The certification requirement of
temporary Rule 204T(b)(1) may impose
some costs on broker-dealers having to
demonstrate that it was not responsible
for any part of the fail to deliver
position of the participant. As discussed
above, temporary Rule 204T(b)(1)
requires the broker-dealer to timely
certify to the participant that it has not
incurred a fail to deliver position on
settlement date in an equity security for
which the participant has a fail to
deliver position at a registered clearing
agency or the broker-dealer is in
compliance with the requirements set
forth in the temporary rule’s Pre-Fail
Credit provision. This certification
requirement may result in brokerdealers incurring costs related to
personnel, recordkeeping, systems, and
surveillance mechanisms. For example,
as discussed in detail in section VII,
above, for purposes of the Paperwork
Reduction Act, we estimate that it will
take each broker-dealer no more than
approximately 0.16 hours (10 minutes)
to comply with the certification
requirement of temporary Rule
204T(b)(1). In addition, we estimate that
the total annual hour burden per year
for each broker-dealer subject to the
certification requirement will be 71.0
hours.
Any potential additional costs
associated with the temporary
borrowing requirements will be limited
by the fact that the temporary rule’s
borrowing requirements will not apply
to Market Makers, provided that the
Market Maker can demonstrate that it
does not have an open fail to deliver
position at the time of any additional
short sales. This allows Market Makers
to facilitate customer orders in a fast
moving market without possible delays
and added costs associated with
complying with the pre-borrow penalty
provision of temporary Rule 204T(b).
The demonstration requirement of
temporary Rule 204T(b)(2) may impose
costs on Market Makers. This
demonstration requirement may result
in Market Makers incurring costs related
to personnel, recordkeeping, systems,
and surveillance mechanisms. For
example, as discussed in detail in
section VII, above, for purposes of the
Paperwork Reduction Act, we estimate
that it will take each Market Maker no
more than approximately 0.16 hours (10
minutes) to comply with the
demonstration requirement of
temporary Rule 204T(b)(2). In addition,
we estimate that the total annual hour
burden per year for each Market Maker
subject to this demonstration
requirement will be 604.8 hours.
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
3. Sales of Securities Pursuant to Rule
144
Consistent with our statements in
connection with our recent amendments
to Regulation SHO in connection with
closing out fails to deliver in threshold
securities sold pursuant to Rule 144,145
we do not believe the temporary rule’s
close-out requirement will impose any
significant burden or cost on market
participants. We believe that a close-out
requirement of thirty-five consecutive
settlement days from settlement date for
fails to deliver resulting from sales of
equity securities sold pursuant to Rule
144 will reduce costs by allowing
participants of a registered clearing
agency with a fail to deliver position
additional time for delivery of these
securities.
Participants may incur, however,
some added costs for minor changes to
their current systems to reflect the
application of the temporary rule’s
close-out requirement to fails to deliver
resulting from sales of all equity
securities, rather than just threshold
securities, sold pursuant to Rule 144 of
the Securities Act.
D. Request for Comment
The Commission is sensitive to the
costs and benefits of the temporary rule,
and encourages commenters to discuss
any additional costs or benefits beyond
those discussed herein, as well as any
reduction in costs. Commenters should
provide analysis and data to support
their views of the costs and benefits
associated with the temporary rule.
• What, if any, additional benefits are
involved in complying with the
temporary rule? Should the temporary
rule be modified in any way to increase
the benefits of the temporary rule? If so,
how?
• What, if any, additional costs are
involved in complying with the
temporary rule? What are the types of
costs, and what are the amounts?
Should the temporary rule be modified
in any way to mitigate costs? If so, how?
• The temporary rule requires that
participants of a registered clearing
agency deliver securities by settlement
date, or if the participants have not
delivered shares by settlement date,
borrow or purchase securities to close
out the fail to deliver position by no
later than the beginning of regular
trading hours on the settlement day
following the day the participant
incurred the fail to deliver position.
What are the costs and benefits
associated with purchasing versus
145 See 2007 Regulation SHO Final Amendments,
72 FR at 45550–45551.
PO 00000
Frm 00071
Fmt 4700
Sfmt 4700
61727
borrowing securities to close out a fail
to deliver position?
• What impact will the temporary
rule have on borrowing costs? Please
explain. What effect will the temporary
rule have on the availability of equity
securities for lending and borrowing?
• The temporary rule will allow a
participant that has a fail to deliver
position at a registered clearing agency
in an equity security and can
demonstrate that such fail to deliver
position resulted from a long sale, two
additional settlement days in which to
close out that fail to deliver position by
purchasing securities of like kind and
quantity. What costs and benefits are
associated with the long sale
documentation requirement? Are there
any operational or compliance concerns
associated with this provision of the
temporary rule?
• The temporary rule will allow a
participant of a registered clearing
agency two additional settlement days
to close out any fail to deliver positions
attributable to a Market Maker. What are
the costs and benefits of allowing this
additional time to close-out fails to
deliver attributable to Market Makers?
Are there any operational or compliance
concerns associated with this provision
of the temporary rule?
• Will the temporary rule create any
additional implementation or
operational costs associated with
systems (including computer hardware
and software), surveillance, procedural,
recordkeeping, or personnel
modifications?
• To comply with the temporary rule,
will broker-dealers be required to
purchase new systems or implement
changes to existing systems? Will
changes to existing systems be
significant? What are the costs and
benefits associated with acquiring new
systems or making changes to existing
systems? What, if any, changes will
need to be made to existing records?
What are the costs and benefits
associated with any changes?
• Will there be any increases in
staffing and associated overhead costs?
What are the costs and benefits
associated with hiring new staff or
retraining existing staff? Will other
resources need to be re-dedicated to
comply with the temporary rule?
• How much, if any, will the
temporary rule affect compliance costs
for small, medium, and large brokerdealers (e.g., personnel or system
changes)? We seek comment on the
costs of compliance that may arise.
• We solicit comment on whether the
costs will be incurred on a one-time or
ongoing basis, as well as cost estimates.
In addition, we seek comment as to
E:\FR\FM\17OCR1.SGM
17OCR1
jlentini on PROD1PC65 with RULES
61728
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
whether the temporary rule will
decrease any costs for any market
participants. We seek comment about
any other costs and cost reductions
associated with the temporary rule.
• We recognize that the temporary
rule may increase the costs of legitimate
short selling and lessen some of the
benefits of legitimate short selling,
which, in turn, could result in a
reduction of short selling. To what
extent, if any, will the temporary rule
impact legitimate short selling and
market efficiency?
• The temporary rule does not allow
any exceptions for fails to deliver due to
mechanical aspects of corporate events,
such as equity offers, including initial
public offerings, and tender offers. Will
the temporary rule cause any disruption
to these corporate events? Can the costs
of any disruption be quantified?
• What, if any, additional costs are
involved in complying with the
borrowing requirements under
temporary Rule 204T(b)? What are the
types of costs, and what are the
amounts? Should the temporary rule be
modified in any way to mitigate costs?
If so, how? Are there any operational or
compliance concerns associated with
the borrowing requirements under
temporary Rule 204T(b)?
• The temporary rule will allow a
broker-dealer that clears through a
participant that becomes subject to the
borrowing requirements of temporary
Rule 204T(b) to avoid being subject to
the temporary rule’s borrowing
requirements if the broker-dealer can
demonstrate that it was not responsible
for any part of the fail to deliver
position of the participant. What costs
and benefits are associated with the
certification requirement? Are there any
operational or compliance concerns
associated with this provision of the
temporary rule?
• Temporary Rule 204T(c) imposes a
pre-borrow notification requirement on
participants. Will such a notification
requirement impose operational or
systems costs on participants? What
types of communication mechanisms do
participants use to comply with this
requirement of the temporary rule?
What are the costs and benefits of this
notification requirement?
• What, if any, additional costs are
associated with extending the close-out
requirement for Rule 144 securities?
What are the types of costs, and what
are the amounts? Who bears these costs?
Should the exception be modified in
any way to mitigate costs? If so, how?
• Please identify any other costs,
including reductions in costs, associated
with sales of Rule 144 restricted
securities not already discussed.
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
IX. Consideration of Burden on
Competition and Promotion of
Efficiency, Competition, and Capital
Formation
Section 3(f) of the Exchange Act
requires the Commission, whenever it
engages in rulemaking and whenever it
is required to consider or determine if
an action is necessary or appropriate in
the public interest, to consider whether
the action would promote efficiency,
competition, and capital
formation.146 In addition, section
23(a)(2) of the Exchange Act requires the
Commission, when adopting rules
under the Exchange Act, to consider the
impact such rules would have on
competition.147 Exchange Act section
23(a)(2) prohibits the Commission from
adopting any rule that would impose a
burden on competition not necessary or
appropriate in furtherance of the
purposes of the Exchange Act.
We believe the temporary rule will
have minimal impact on the promotion
of efficiency. The temporary rule is
intended to further reduce fails to
deliver and address abusive ‘‘naked’’
short selling in equity securities by
requiring that participants of a
registered clearing agency deliver
securities by settlement date, or if the
participants have not delivered shares
by settlement date, the participants
must, by no later than the beginning of
regular trading hours on the Close-Out
Date, immediately close out the fail to
deliver position by borrowing or
purchasing securities of like kind and
quantity. A participant that does not
comply with this close-out requirement,
and any broker-dealer from which it
receives trades for clearance and
settlement, will not be able to short sell
the security either for itself or for the
account of another, unless it has first
arranged to borrow the security, until
the fail to deliver position is closed out.
The temporary rule is designed to
ensure that buyers of equity securities
receive delivery of their shares, thereby
helping to reduce persistent fails to
deliver, which may have a negative
effect on the securities markets and
investors and also may be used to
facilitate some manipulative strategies.
By requiring that participants of a
registered clearing agency deliver
securities by settlement date and to the
extent that participants have not
delivered shares by settlement date,
borrow or purchase securities to close
out the fail to deliver position by no
later than the beginning of regular
trading hours on the Close-Out Date, the
146 15
147 15
PO 00000
U.S.C. 78c(f).
U.S.C. 78w(a)(2).
Frm 00072
Fmt 4700
Sfmt 4700
temporary rule will promote the prompt
clearance and settlement of securities
transactions. By doing so, the temporary
rule will further our goals of helping to
eliminate any possibility that abusive
‘‘naked’’ short selling, as well as
persistent fails to deliver, will
contribute to the disruption of markets
in equity securities and, thereby, will
help ensure that investors remain
confident that trading can be conducted
without the illegal influence of
manipulation. A loss of confidence in
the market for these securities can lead
to panic selling, which may be further
exacerbated by potentially abusive
‘‘naked’’ short selling. As a result, prices
of these securities may artificially and
unnecessarily decline below the price
level that would have resulted from the
normal price discovery process,
threatening the disruption of the
markets for these securities. We seek
comment regarding whether the
temporary rule may adversely impact
liquidity, disrupt markets, or
unnecessarily increase risks or costs to
participants of a registered clearing
agency.
In addition, we believe that the
temporary rule will have minimal
impact on the promotion of capital
formation. Issuers and investors have
repeatedly expressed concerns about
fails to deliver in connection with
manipulative ‘‘naked’’ short selling.148
The perception that abusive ‘‘naked’’
short selling is occurring in securities
could undermine the confidence of
investors. These investors, in turn, may
be reluctant to commit capital to an
issuer they believe to be subject to such
manipulative conduct.149 To the extent
that ‘‘naked’’ short selling and fails to
deliver result in an unwarranted decline
in investor confidence about a security,
the temporary rule will improve
investor confidence about the security.
In addition, the temporary rule may lead
to a greater certainty in the settlement
of these securities which should
148 See, e.g., 2008 Regulation SHO Final
Amendments, supra note 19.
149 In connection with prior proposed
amendments to Regulation SHO aimed at reducing
fails to deliver and addressing potentially abusive
‘‘naked’’ short selling, such as the 2007 Regulation
SHO Proposed Amendments, we sought comment
on whether such proposed amendments would
promote capital formation, including whether the
proposed increased short sale restrictions would
affect investors’ decisions to invest in certain equity
securities. In response, commenters expressed
concern about the potential impact of ‘‘naked’’ short
selling on capital formation claiming that ‘‘naked’’
short selling causes a drop in an issuer’s stock price
that may limit the issuer’s ability to access the
capital markets. See, e.g., letter from Robert K.
Lifton, Chairman and CEO, Medis Technologies,
Inc., dated Sept. 12, 2007; letter from NCANS.
E:\FR\FM\17OCR1.SGM
17OCR1
jlentini on PROD1PC65 with RULES
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
strengthen investor confidence in the
settlement process.
We also believe that the temporary
rule will not impose any burden on
competition not necessary or
appropriate in furtherance of the
purposes of the Exchange Act. By
requiring that participants of a
registered clearing agency deliver
securities by settlement date, and to the
extent that participants have not
delivered shares by settlement date,
borrow or purchase securities to close
out the fail to deliver position by no
later than the beginning of regular
trading hours on the Close-Out Date, we
believe the temporary rule will promote
competition by requiring similarly
situated participants of a registered
clearing agency, including brokerdealers from which they receive trades
for clearance and settlement, to close
out fail to deliver positions in any
equity securities within similar timeframes. Moreover, the requirements of
the temporary rule will help to
eliminate any possibility that abusive
‘‘naked’’ short selling may contribute to
the disruption of markets in equity
securities and, therefore, will help
ensure that all investors remain
confident that trading in these securities
can be conducted without the influence
of illegal manipulation. We also believe
that the temporary rule will promote
competition by protecting and
enhancing the operation, integrity, and
stability of the markets. At the same
time, the temporary rule will help to
maintain fair and orderly markets
without unduly restricting legitimate
short selling.
In addition, by providing a close-out
requirement of 35 consecutive
settlement days from settlement date for
fails to deliver resulting from sales of
equity securities sold pursuant to Rule
144 of the Securities Act, we believe the
temporary rule will promote
competition by requiring similarly
situated participants to close out fail to
deliver positions in any equity
securities resulting from sales of Rule
144 securities within the same timeframe.
Similarly, an extended close-out
requirement for fails to deliver resulting
from long sales that are attributable to
a Market Maker, will promote
competition by requiring similarly
situated participants to close out these
fail to deliver positions within the same
time-frame.
We request comment on whether the
temporary rule is likely to promote
efficiency, capital formation, and
competition.
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
X. Final Regulatory Flexibility Analysis
The Final Regulatory Flexibility
Analysis (‘‘FRFA’’) has been prepared in
accordance with 5 U.S.C. 604. This
FRFA relates to the amendments that
add temporary Rule 204T to Regulation
SHO, which we are adopting in this
release.150
A. Need for and Objectives of the Rule
Sections I through VI of this release
describe the reasons for and objectives
of temporary Rule 204T. As we discuss
in detail above, we have become
concerned that there is a substantial
threat of sudden and excessive
fluctuations of securities prices and
disruption in the functioning of the
securities markets that could threaten
fair and orderly markets.
B. Small Entities Affected by the Rule
The entities covered by the temporary
rule will include small entities that are
participants of a registered clearing
agency and small broker-dealers from
which participants receive trades for
clearance and settlement. In addition,
the entities covered by the temporary
rule will include small entities that are
market participants that effect sales
subject to the requirements of
Regulation SHO. Although it is
impossible to quantify every type of
small entity covered by the temporary
rule, Paragraph (c)(1) of Rule 0–10
under the Exchange Act 151 states that
the term ‘‘small business’’ or ‘‘small
organization,’’ when referring to a
broker-dealer, means a broker or dealer
that had total capital (net worth plus
subordinated liabilities) of less than
$500,000 on the date in the prior fiscal
year as of which its audited financial
statements were prepared pursuant to
§ 240.17a–5(d); and is not affiliated with
any person (other than a natural person)
that is not a small business or small
organization. We estimate that as of
2007 there were approximately 896
broker-dealers that qualified as small
entities as defined above.152
As noted above, the entities covered
by the temporary rule will include small
entities that are participants of a
registered clearing agency. As of July 31,
2008, approximately 91% of
150 Although the requirements of the Regulatory
Flexibility Act are not applicable to rules adopted
under the Administrative Procedure Act’s ‘‘good
cause’’ exception, see 5 U.S.C. 601(2) (defining
‘‘rule’’ and notice requirements under the
Administrative Procedures Act), we nevertheless
prepared a FRFA.
151 17 CFR 240.0–10(c)(1).
152 These numbers are based on OEA’s review of
2007 FOCUS Report filings reflecting registered
broker-dealers. This number does not include
broker-dealers that are delinquent on FOCUS
Report filings.
PO 00000
Frm 00073
Fmt 4700
Sfmt 4700
61729
participants of the NSCC, the primary
registered clearing agency responsible
for clearing U.S. transactions, were
registered as broker-dealers. Participants
not registered as broker-dealers include
such entities as banks, U.S.-registered
exchanges, and clearing agencies.
Although these entities are participants
of a registered clearing agency, generally
these entities do not engage in the types
of activities that would implicate the
close-out requirements of Regulation
SHO. Such activities of these entities
include creating and redeeming
Exchange Traded Funds, trading in
municipal securities, and using NSCC’s
Envelope Settlement Service or Intercity Envelope Settlement Service. These
activities rarely lead to fails to deliver
and, if fails to deliver do occur, they are
small in number and are usually
cleaned up within a day. Thus, such
fails to deliver would not trigger the
close-out provisions of Regulation SHO.
The federal securities laws do not
define what is a ‘‘small business’’ or
‘‘small organization’’ when referring to
a bank. The Small Business
Administration regulations define
‘‘small entities’’ to include banks and
savings associations with total assets of
$165 million or less.153 As of July 31,
2008, no bank that was a participant of
the NSCC was a small entity because
none met these criteria.
Paragraph (e) of Rule 0–10 under the
Exchange Act 154 states that the term
‘‘small business’’ or ‘‘small
organization,’’ when referring to an
exchange, means any exchange that: (1)
Has been exempted from the reporting
requirements of Rule 11Aa3–1 under the
Exchange Act; and (2) is not affiliated
with any person (other than a natural
person) that is not a small business or
small organization, as defined by Rule
0–10. No U.S. registered exchange is a
small entity because none meets these
criteria.
Paragraph (d) of Rule 0–10 under the
Exchange Act 155 states that the term
‘‘small business’’ or ‘‘small
organization,’’ when referring to a
clearing agency, means a clearing
agency that: (1) Compared, cleared and
settled less than $500 million in
securities transactions during the
preceding fiscal year (or in the time that
it has been in business, if shorter); (2)
had less than $200 million in funds and
securities in its custody or control at all
times during the preceding fiscal year
(or in the time that it has been in
business, if shorter); and (3) is not
affiliated with any person (other than a
153 See
13 CFR 121.201.
CFR 240.0–10(e).
155 17 CFR 240.0–10(d).
154 17
E:\FR\FM\17OCR1.SGM
17OCR1
61730
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
natural person) that is not a small
business or small organization as
defined by Rule 0–10. No clearing
agency that is subject to the
requirements of Regulation SHO is a
small entity because none meets these
criteria.
C. Projected Reporting, Recordkeeping
and Other Compliance Requirements
The temporary rule may impose some
new or additional reporting,
recordkeeping, or compliance costs on
small entities that are participants of a
clearing agency registered with the
Commission and small broker-dealers
from which the participant receives
trades for clearance and settlement. We
do not believe, at this time, that any
specialized professional skills will be
necessary to comply with the temporary
rule.
D. Agency Action To Minimize Effect on
Small Entities
As required by the Regulatory
Flexibility Act, we have considered
alternatives that would accomplish our
stated objectives, while minimizing any
significant adverse impact on small
entities. Temporary Rule 204T should
not adversely affect small entities
because it imposes minimal new
reporting, recordkeeping, or compliance
requirements. Moreover, it is not
appropriate to develop separate
requirements for small entities because
we think all small entities that are
broker-dealers should be subject to the
enhanced delivery requirements
imposed by the temporary rule.
jlentini on PROD1PC65 with RULES
E. Duplicative, Overlapping, or
Conflicting Federal Rules
The Commission believes that there
are no rules that duplicate, overlap, or
conflict with temporary Rule 204T. The
Commission has designed the temporary
rule so that it is consistent with the
close-out requirements of Rule 203(b)(3)
of Regulation SHO.
F. Significant Alternatives
The Regulatory Flexibility Act directs
us to consider significant alternatives
that would accomplish our stated
objective, while minimizing any
significant adverse impact on small
entities.156 In connection with the
temporary rule, we considered the
following alternatives: (1) Establishing
different compliance or reporting
standards or timetable that take into
account the resources available to small
entities; (2) clarifying, consolidating, or
simplifying compliance requirements
under the rule for small entities; (3)
156 See
5 U.S.C. 603(c).
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
using performance rather than design
standards; and (4) exempting small
entities from coverage of the rule, or any
part of the rule.
The temporary rule furthers the
Commission’s stated goal of helping to
eliminate any possibility that abusive
‘‘naked’’ short selling may contribute to
the substantial disruption in the
securities markets and, therefore, to
help ensure that investors remain
confident that trading in equity
securities can be conducted without the
illegal influence of manipulation. The
temporary rule also furthers the goals of
helping to maintain fair and orderly
markets against the threat of sudden and
excessive fluctuations of securities
prices generally and disruption in the
functioning of the securities markets.
The temporary rule should not
adversely affect small entities because
the rule may impose only minimal new
compliance requirements. Moreover, it
is not appropriate to develop different
compliance requirements for small
entities with respect to the temporary
rule because we think all entities,
including small entities, should be
subject to the requirements of the
temporary rule. We believe that
imposing different compliance
requirements, and possibly a different
timetable for implementing compliance
requirements, for small entities would
undermine the Commission’s goal of
addressing abusive ‘‘naked’’ short
selling. We have concluded similarly
that it is not consistent with the goal of
the temporary rule to further clarify,
consolidate or simplify the temporary
rule for small entities. The Commission
also believes that it is inconsistent with
the purposes of the Exchange Act to use
performance standards to specify
different requirements for small entities
or to exempt small entities from having
to comply with the temporary rule.
G. General Request for Comments
We solicit written comments
regarding our analysis. We request
comment on whether the temporary rule
will have any effects that we have not
discussed. We request that commenters
describe the nature of any impact on
small entities and provide empirical
data to support the extent of the impact.
XI. Statutory Authority
Pursuant to the Exchange Act and,
particularly, Sections 2, 3(b), 6, 9(h), 10,
11A, 15, 15A, 17, 17A, 19 and 23(a)
thereof, 15 U.S.C. 78b, 78c(b), 78f,
78i(h), 78j, 78k–1, 78o, 78o–3, 78q,
78q–1, 78s and 78w(a), the Commission
is adopting, as an interim final
temporary rule, Rule 204T, amendments
to Regulation SHO.
PO 00000
Frm 00074
Fmt 4700
Sfmt 4700
XII. Text of the Amendments to
Regulation SHO
List of Subjects in 17 CFR Part 242
Brokers, Fraud, Reporting and
recordkeeping requirements, Securities.
■ For the reasons set out in the
preamble, Title 17, Chapter II, Part 242,
of the Code of Federal Regulations is
amended as follows.
PART 242—REGULATIONS M, SHO,
ATS, AC, AND NMS, AND CUSTOMER
MARGIN REQUIREMENTS FOR
SECURITY FUTURES
1. The authority citation for part 242
continues to read as follows:
■
Authority: 15 U.S.C. 77g, 77q(a), 77s(a),
78b, 78c, 78g(c)(2), 78i(a), 78j, 78k–1(c), 78l,
78m, 78n, 78o(b), 78o(c), 78o(g), 78q(a),
78q(b), 78q(h), 78w(a), 78dd–1, 78mm,
80a–23, 80a–29, and 80a–37.
2. Section 242.204T is added to read
as follows:
■
§ 242.204T
Short sales.
(a) 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 that equity
security, the participant shall, by no
later than the beginning of regular
trading hours on the settlement day
following the settlement date,
immediately close out its fail to deliver
position by borrowing or purchasing
securities of like kind and quantity;
Provided, however:
(1) If a participant of a registered
clearing agency has a fail to deliver
position at a registered clearing agency
in any equity security and the
participant can demonstrate on its books
and records that such fail to deliver
position resulted from a long sale, the
participant shall by no later than the
beginning of regular trading hours on
the third consecutive settlement day
following the settlement date,
immediately close out the fail to deliver
position by purchasing securities of like
kind and quantity;
(2) If a participant of a registered
clearing agency has a fail to deliver
position at a registered clearing agency
in any equity security sold pursuant to
§ 230.144 of this chapter for thirty-five
consecutive settlement days after the
settlement date for a sale in that equity
security, the participant shall, by no
later than the beginning of regular
trading hours on the thirty-sixth
E:\FR\FM\17OCR1.SGM
17OCR1
jlentini on PROD1PC65 with RULES
Federal Register / Vol. 73, No. 202 / Friday, October 17, 2008 / Rules and Regulations
consecutive settlement day following
the settlement date for the transaction,
immediately close out the fail to deliver
position by purchasing securities of like
kind and quantity; or
(3) If a participant of a registered
clearing agency has a fail to deliver
position at a registered clearing agency
in any equity security that is attributable
to bona fide market making activities by
a registered market maker, options
market maker, or other market maker
obligated to quote in the over-thecounter market (individually a ‘‘Market
Maker,’’ collectively ‘‘Market Makers’’),
the participant shall by no later than the
beginning of regular trading hours on
the third consecutive settlement day
following the settlement date,
immediately close out the fail to deliver
position by purchasing securities of like
kind and quantity.
(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
paragraph (a) of this section, the
participant and any broker or dealer
from which it receives trades for
clearance and settlement, including any
market maker that would otherwise be
entitled to rely on the exception
provided in § 242.203(b)(2)(iii), 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, to the extent that the
broker or dealer submits its short sales
to that participant for clearance and
settlement, 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; Provided,
however:
(1) A broker or dealer shall not be
subject to the requirements of paragraph
(b) of this section if the broker or dealer
timely certifies to the participant of a
registered clearing agency that it has not
incurred a fail to deliver position on
settlement date for a long or short sale
in an equity security for which the
participant has a fail to deliver position
at a registered clearing agency or that
the broker or dealer is in compliance
with paragraph (e) of this section.
(2) The requirements of paragraph (b)
of this section shall not apply to Market
Makers provided the Market Maker can
demonstrate that it does not have an
open short position in the equity
security at the time of any additional
short sales.
VerDate Aug<31>2005
17:16 Oct 16, 2008
Jkt 217001
(c) The participant must notify any
broker or dealer from which it receives
trades for clearance and settlement,
including any market maker that would
otherwise be entitled to rely on the
exception provided in
§ 242.203(b)(2)(iii):
(1) That the participant has a fail to
deliver position in an equity security at
a registered clearing agency that has not
been closed out in accordance with the
requirements of paragraph (a) of this
section; and
(2) When the purchase that the
participant has made to close out the
fail to deliver position has cleared and
settled at a registered clearing agency.
(d) If a participant of a registered
clearing agency reasonably allocates a
portion of a fail to deliver position to
another registered broker or dealer for
which it clears trades or from which it
receives trades for settlement, based on
such broker’s or dealer’s short position,
the provisions of paragraphs (a) and (b)
of this section relating to such fail to
deliver position shall apply to such
registered broker or dealer that was
allocated the fail to deliver position, and
not to the participant. A broker or dealer
that has been allocated a portion of a fail
to deliver position that does not comply
with the provisions of paragraph (a) of
this section must immediately notify the
participant that it has become subject to
the requirements of paragraph (b) of this
section.
(e) Even if a participant of a registered
clearing agency has not closed out a fail
to deliver position at a registered
clearing agency in accordance with
paragraph (a) of this section, or has not
allocated a fail to deliver position to a
broker or dealer in accordance with
paragraph (d) of this section, a broker or
dealer shall not be subject to the
requirements of paragraph (a) or (b) of
this section if the broker or dealer
purchases securities prior to the
beginning of regular trading hours on
the settlement day after the settlement
date for a long or short sale to close out
an open short position, and if:
(1) The purchase is bona fide;
(2) The purchase is executed on, or
after, trade date but by no later than the
end of regular trading hours on
settlement date for the transaction;
(3) The purchase is of a quantity of
securities sufficient to cover the entire
amount of the open short position; and
(4) The broker or dealer can
demonstrate that it has a net long
position or net flat position on its books
and records on the settlement day for
which the broker or dealer is seeking to
demonstrate that it has purchased
shares to close out its open short
position.
PO 00000
Frm 00075
Fmt 4700
Sfmt 4700
61731
(f) Definitions. (1) For purposes of this
section, the term settlement date shall
mean the business day on which
delivery of a security and payment of
money is to be made through the
facilities of a registered clearing agency
in connection with the sale of a security.
(2) For purposes of this section, the
term regular trading hours has the same
meaning as in Rule 600(b)(64) of
Regulation NMS (17 CFR
242.600(b)(64)).
(g) This temporary section will expire
and no longer be effective on July 31,
2009.
By the Commission.
Dated: October 14, 2008.
Florence E. Harmon,
Acting Secretary.
[FR Doc. E8–24785 Filed 10–16–08; 8:45 am]
BILLING CODE 8011–01–P
DEPARTMENT OF LABOR
Employee Benefits Security
Administration
29 CFR Part 2509
RIN 1210–AB28
Interpretive Bulletin Relating to
Exercise of Shareholder Rights
Employee Benefits Security
Administration.
ACTION: Interpretive bulletin.
AGENCY:
SUMMARY: This document sets forth the
views of the Department of Labor
concerning the legal standards imposed
by sections 402, 403 and 404 of Title I
of the Employee Retirement Income
Security Act (ERISA) with respect to the
exercise of shareholder rights and
written statements of investment policy,
including proxy voting policies or
guidelines. These guidelines affect
fiduciaries of employee benefit plans,
including trustees, investment managers
and others responsible for the
management of employee benefit plan
assets.
This interpretive bulletin is
effective on October 17, 2008.
FOR FURTHER INFORMATION CONTACT:
Office of Regulations and
Interpretations, Employee Benefits
Security Administration, (202) 693–
8500. This is not a toll-free number.
SUPPLEMENTARY INFORMATION: On July
29, 1994, the Department of Labor (the
Department) issued guidance with
respect to the duties of employee benefit
plan fiduciaries under sections 402, 403
and 404 of Title I of the Employee
Retirement Income Security Act (ERISA)
DATES:
E:\FR\FM\17OCR1.SGM
17OCR1
Agencies
[Federal Register Volume 73, Number 202 (Friday, October 17, 2008)]
[Rules and Regulations]
[Pages 61706-61731]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E8-24785]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 242
[Release No. 34-58773; File No. S7-30-08]
RIN 3235-AK22
Amendments to Regulation SHO
AGENCY: Securities and Exchange Commission.
ACTION: Interim final temporary rule; request for comments.
-----------------------------------------------------------------------
SUMMARY: The Securities and Exchange Commission (``Commission'') is
adopting an interim final temporary rule under the Securities Exchange
Act of 1934 (``Exchange Act'') to address abusive ``naked'' short
selling in all equity securities by requiring that participants of a
clearing agency registered with the Commission deliver securities by
settlement date, or if the participants have not delivered shares by
settlement date, immediately purchase or borrow securities to close out
the fail to deliver position by no later than the beginning of regular
trading hours on the settlement day following the day the participant
incurred the fail to deliver position. Failure to comply with the
close-out requirement of the temporary rule is a violation of the
temporary rule. In addition, a participant that does not comply with
this close-out requirement, and any broker-dealer from which it
receives trades for clearance and settlement, will not be able to short
sell the security either for itself or for the account of another,
unless it has previously arranged to borrow or borrowed the security,
until the fail to deliver position is closed out.
DATES: Effective Date: October 17, 2008 until July 31, 2009. Comment
Date: Comments should be received on or before December 16, 2008.
ADDRESSES: Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (https://
www.sec.gov/rules/final.shtml); or
Send an e-mail to rule-comments@sec.gov. Please include
File Number S7-30-08 on the subject line; or
Use the Federal eRulemaking Portal (https://
www.regulations.gov). Follow the instructions for submitting comments.
Paper Comments
Send paper comments in triplicate to Florence E. Harmon,
Acting Secretary, Securities and Exchange Commission, 100 F Street,
NE., Washington, DC 20549-1090.
All submissions should refer to File Number S7-30-08. This file number
should be included on the subject line if e-mail is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
Internet Web site (https://www.sec.gov/rules/final.shtml).
[[Page 61707]]
Comments are also available for public inspection and copying in the
Commission's Public Reference Room, 100 F Street, NE., Washington, DC
20549 on official business days between the hours of 10 a.m. and 3 p.m.
All comments received will be posted without change; we do not edit
personal identifying information from submissions. You should submit
only information that you wish to make available publicly.
FOR FURTHER INFORMATION CONTACT: James A. Brigagliano, Associate
Director, Josephine J. Tao, Assistant Director, Victoria L. Crane,
Branch Chief, Joan M. Collopy, Special Counsel, Christina M. Adams and
Matthew Sparkes, Staff Attorneys, Office of Trading Practices and
Processing, Division of Trading and Markets, at (202) 551-5720, at the
Commission, 100 F Street, NE., Washington, DC 20549-6628.
SUPPLEMENTARY INFORMATION: We are adopting temporary Rule 204T of
Regulation SHO [17 CFR 242.204T] as an interim final temporary rule. We
are soliciting comments on all aspects of the rule. We will carefully
consider the comments that we receive and intend to respond to them in
a subsequent release.
I. Introduction
Recently, we have become concerned that there is a substantial
threat of sudden and excessive fluctuations of securities prices and
disruption in the functioning of the securities markets that could
threaten fair and orderly markets. These concerns with respect to
financial institutions are evidenced by our recent publication of
emergency orders under section 12(k) of the Exchange Act in July (the
``July Emergency Order'') \1\ and September of this year (the ``Short
Sale Ban Emergency Order'').\2\ In these orders we noted our concerns
about the possible use of unfounded rumors regarding the stability of
financial institutions by short sellers for the purpose of manipulating
the prices of securities issued by the financial institutions to
increase profits through ``naked'' short selling.\3\
---------------------------------------------------------------------------
\1\ See Exchange Act Release No. 58166 (July 15, 2008), 73 FR
42379 (July 21, 2008) (imposing borrowing and delivery requirements
on short sales of the equity securities of certain financial
institutions).
\2\ See Exchange Act Release No. 58592 (Sept. 18, 2008), 73 FR
55169 (Sept. 24, 2008) (temporarily prohibiting short selling in the
publicly traded securities of certain financial institutions); see
also Exchange Act Release No. 58611 (Sept. 21, 2008), 73 FR 55556
(Sept. 25, 2008) (amending the Short Sale Ban Emergency Order).
\3\ ''Naked'' short selling generally refers to selling short
without having borrowed the securities to make delivery. See
Exchange Act Release No. 50103 (July 28, 2004), 69 FR 48008, 48009
n.10 (Aug. 6, 2004) (``2004 Regulation SHO Adopting Release''); see
also Commission press release, dated July 13, 2008, announcing that
the Commission's Office of Compliance Inspections and Examinations,
as well as the Financial Industry Regulatory Authority (``FINRA'')
and New York Stock Exchange Regulation, Inc., (``NYSE'') will
immediately conduct examinations aimed at the prevention of the
intentional spreading of false information intended to manipulate
securities prices. See https://www.sec.gov/news/press/2008/2008-
140.htm. In addition, in April of this year, the Commission charged
Paul S. Berliner, a trader, with securities fraud and market
manipulation for intentionally disseminating a false rumor
concerning The Blackstone Group's acquisition of Alliance Data
Systems Corp (``ADS''). The Commission alleged that this false rumor
caused the price of ADS stock to plummet, and that Berliner profited
by short selling ADS stock and covering those sales as the false
rumor caused the price of ADS stock to fall. See https://www.sec.gov/
litigation/litreleases/2008/lr20537.htm.
---------------------------------------------------------------------------
Our concerns, however, are not limited to just the financial
institutions that were the subject of the July Emergency Order and the
Short Sale Ban Emergency Order. Given the importance of confidence in
our financial markets as a whole, we have become concerned about sudden
and unexplained declines in the prices of equity securities generally.
Such price declines can give rise to questions about the underlying
financial condition of an institution, which in turn can create a
crisis of confidence even without a fundamental underlying basis. This
crisis of confidence can impair the liquidity and ultimate viability of
an institution, with potentially broad market consequences. These
concerns resulted in our issuance on September 17 of this year of an
emergency order under section 12(k) of the Exchange Act (the
``September Emergency Order'').\4\ Pursuant to that emergency order we
imposed enhanced delivery requirements on sales of all equity
securities by adding and making immediately effective a temporary rule
to Regulation SHO, Rule 204T.\5\
---------------------------------------------------------------------------
\4\ See Exchange Act Release No. 58572 (Sept. 17, 2008), 73 FR
54875 (Sept. 23, 2008).
\5\ See id. The September Emergency Order also made immediately
effective amendments to Rule 203(b)(3) of Regulation SHO that
eliminate the options market maker exception from Regulation SHO's
close-out requirement. It also made immediately effective Rule 10b-
21, a ``naked'' short selling antifraud rule.
---------------------------------------------------------------------------
To further our goal of preventing substantial disruption in the
securities markets, we are adopting Rule 204T as an interim final
temporary rule, with some modifications to address operational and
technical concerns resulting from the requirements of the temporary
rule as adopted in the September Emergency Order. We intend that the
temporary rule will address potentially abusive ``naked'' short selling
by requiring that securities be purchased or borrowed to close out any
fail to deliver position in an equity security by no later than the
beginning of regular trading hours on the settlement day following the
date on which the fail to deliver position occurred. This temporary
rule should provide a powerful disincentive to those who might
otherwise engage in potentially abusive ``naked'' short selling.
II. Background
Short selling involves a sale of a security that the seller does
not own or a sale which is consummated by the delivery of a security
borrowed by, or for the account of, the seller.\6\ Short sales normally
are settled by the delivery of a security borrowed by or on behalf of
the seller. In a ``naked'' short sale, however, the short seller does
not borrow securities in time to make delivery to the buyer within the
standard three-day settlement period.\7\ As a result, the seller fails
to deliver securities to the buyer when delivery is due (known as a
``fail'' or ``fail to deliver'').\8\ Sellers sometimes intentionally
fail to deliver securities as part of a scheme to manipulate the price
of a security,\9\ or possibly to avoid
[[Page 61708]]
borrowing costs associated with short sales, especially when the costs
of borrowing stock are high.
---------------------------------------------------------------------------
\6\ 17 CFR 242.200(a).
\7\ See 2004 Regulation SHO Adopting Release, 69 FR at 48009
n.10.
\8\ Generally, investors complete or settle their security
transactions within three settlement days. This settlement cycle is
known as T+3 (or ``trade date plus three days''). T+3 means that
when a trade occurs, the participants to the trade deliver and pay
for the security at a clearing agency three settlement days after
the trade is executed so the brokerage firm can exchange those funds
for the securities on that third settlement day. The three-day
settlement period applies to most security transactions, including
stocks, bonds, municipal securities, mutual funds traded through a
brokerage firm, and limited partnerships that trade on an exchange.
Government securities and stock options settle on the next
settlement day following the trade (or T+1). In addition, Rule 15c6-
1 prohibits broker-dealers from effecting or entering into a
contract for the purchase or sale of a security that provides for
payment of funds and delivery of securities later than the third
business day after the date of the contract unless otherwise
expressly agreed to by the parties at the time of the transaction.
17 CFR 240.15c6-1; Exchange Act Release No. 33023 (Oct. 7, 1993), 58
FR 52891 (Oct. 13, 1993). However, failure to deliver securities on
T+3 does not violate Rule 15c6-1; see also Exchange Act Release No.
56212 (Aug. 7, 2007), 72 FR 45544, n. 2 (Aug. 14, 2007) (``2007
Regulation SHO Final Amendments'').
\9\ In 2003, the Commission settled a case against certain
parties relating to allegations of manipulative short selling in the
stock of a corporation. The Commission alleged that the defendants
profited from engaging in massive ``naked'' short selling that
flooded the market with the stock, and depressed its price. See
Rhino Advisors, Inc. and Thomas Badian, Lit. Rel. No. 18003 (Feb.
27, 2003); see also SEC v. Rhino Advisors, Inc. and Thomas Badian,
Civ. Action No. 03 civ 1310 (RO) (S.D.N.Y); see also Exchange Act
Release No. 48709 (Oct. 28, 2003), 68 FR 62972, 62975 (Nov. 6, 2003)
(``2003 Regulation SHO Proposing Release'') (describing the alleged
activity in the case involving stock of Sedona Corporation); 2004
Regulation SHO Adopting Release, 69 FR at 48016, n.76.
---------------------------------------------------------------------------
Although the majority of trades settle within the standard three-
day settlement cycle (``T+3''),\10\ we adopted Regulation SHO \11\ on
July 28, 2004, in part to address problems associated with persistent
fails to deliver securities and potentially abusive ``naked'' short
selling. For example, Regulation SHO requires broker-dealers to
``locate'' securities that the broker-dealer reasonably believes can be
delivered within the standard three-day settlement period.\12\
---------------------------------------------------------------------------
\10\ According to the National Securities Clearing Corporation
(``NSCC''), 99% (by dollar value) of all trades settle within T+3.
Thus, on an average day, approximately 1% (by dollar value) of all
trades, including equity, debt, and municipal securities fail to
settle on time.
\11\ 17 CFR 242.200. Regulation SHO became effective on January
3, 2005.
\12\ 17 CFR 242.203(b)(1). Rule 203(b)(1) of Regulation SHO
requires 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).'' This is known as the
``locate'' requirement. Market makers engaged in bona fide market
making in the security at the time they effect the short sale are
excepted from this requirement.
---------------------------------------------------------------------------
Another requirement of Regulation SHO aimed at potentially abusive
``naked'' short selling and reducing fails to deliver in certain equity
securities is the rule's ``close-out'' requirement. Specifically, Rule
203(b)(3) requires participants \13\ of a registered clearing
agency,\14\ which includes broker-dealers, to purchase shares to close
out fails to deliver in securities with large and persistent fails to
deliver, i.e., ``threshold securities.'' \15\ Until the position is
closed out, the participant responsible for the fail to deliver
position and any broker-dealer from which it receives trades for
clearance and settlement may not effect further short sales in that
threshold security without first borrowing or arranging to borrow the
securities.\16\
---------------------------------------------------------------------------
\13\ For purposes of Regulation SHO, the term ``participant''
has the same meaning as in section 3(a)(24) of the Exchange Act. See
15 U.S.C. 78c(a)(24).
\14\ The term ``registered clearing agency'' means a clearing
agency, as defined in Section 3(a)(23)(A) of the Exchange Act, that
is registered as such pursuant to Section 17A of the Exchange Act.
See 15 U.S.C. 78c(a)(23)(A) and 78q-1, respectively; see also 2004
Regulation SHO Adopting Release, 69 FR at 48031. The majority of
equity trades in the United States are cleared and settled through
systems administered by clearing agencies registered with the
Commission. The National Securities Clearing Corporation (``NSCC'')
clears and settles the majority of equity securities trades
conducted on the exchanges and in the over-the-counter market. NSCC
clears and settles trades through the Continuous Net Settlement
(``CNS'') system, which nets the securities delivery and payment
obligations of all of its members. NSCC notifies its members of
their securities delivery and payment obligations daily. In
addition, NSCC guarantees the completion of all transactions and
interposes itself as the contraparty to both sides of the
transaction.
\15\ Rule 203(c)(6) of Regulation SHO defines a ``threshold
security'' as any equity security of an issuer that is registered
pursuant to Section 12 of the Exchange Act (15 U.S.C. 78l) or for
which the issuer is required to file reports pursuant to Section
15(d) of the Exchange Act (15 U.S.C. 78o(d)) for which there is an
aggregate fail to deliver position for five consecutive settlement
days at a registered clearing agency of 10,000 shares or more, and
that is equal to at least 0.5% of the issue's total shares
outstanding; and is included on a list disseminated to its members
by a self-regulatory organization (``SRO''). See 17 CFR
242.203(c)(6).
\16\ See 17 CFR 242.203(b)(3)(iv).
---------------------------------------------------------------------------
As adopted, Regulation SHO included two major exceptions to the
close-out requirement: The ``grandfather'' provision and the ``options
market maker'' exception. The ``grandfather'' provision had provided
that fails to deliver established prior to a security becoming a
threshold security did not have to be closed out in accordance with
Regulation SHO's thirteen consecutive settlement day close-out
requirement.
Due to our concerns about the potentially negative market impact of
large and persistent fails to deliver, and the fact that we continued
to observe threshold securities with fail to deliver positions that are
not being closed out under existing delivery and settlement
requirements, effective on October 15, 2007, we adopted an amendment to
Regulation SHO that eliminated the ``grandfather'' exception to
Regulation SHO's close-out requirement.\17\
---------------------------------------------------------------------------
\17\ See 2007 Regulation SHO Final Amendments, 72 FR 45544. This
amendment also contained a one-time phase-in period that provided
that previously-grandfathered fails to deliver in a security that
was a threshold security on the effective date of the amendment must
be closed out within 35 consecutive settlement days from the
effective date of the amendment. The phase-in period ended on
December 5, 2007.
---------------------------------------------------------------------------
The options market maker exception excepted any fail to deliver
position in a threshold security resulting from short sales effected by
a registered options market maker to establish or maintain a hedge on
options positions that were created before the underlying security
became a threshold security. On September 17, 2008, as part of the
September Emergency Order, we adopted and made immediately effective an
amendment to Rule 203(b)(3) of Regulation SHO to eliminate the options
market maker exception to the rule's close-out requirement.\18\
Following the issuance of the September Emergency Order, we adopted
amendments making permanent the elimination of the options market maker
exception.\19\ As we discussed in the 2008 Regulation SHO Final
Amendments, we believe it was appropriate to eliminate the options
market maker exception in part because substantial levels of fails to
deliver continue to persist in threshold securities and it appears that
a significant number of these fails to deliver are as a result of the
options market maker exception.\20\
---------------------------------------------------------------------------
\18\ See September Emergency Order, supra note 4.
\19\ See Exchange Act Release No. 58775 (Oct. 14, 2008)
(adopting final amendments to Rule 203(b)(3) of Regulation SHO to
eliminate the options market maker exception from the rule's close-
out requirement) (``2008 Regulation SHO Final Amendments''); see
also Exchange Act Release No. 56213 (Aug. 7, 2007), 72 FR 45558
(Aug. 14. 2007) (``2007 Regulation SHO Proposed Amendments);
Exchange Act Release No. 54154 (July 14, 2006), 71 FR 41710 (July
21, 2006) (``2006 Regulation SHO Proposed Amendments''); Exchange
Act Release No. 58107 (July 7, 2008), 73 FR 40201 (July 14, 2008)
(``2008 Regulation SHO Re-Opening Release'').
\20\ See 2008 Regulation SHO Final Amendments, supra note 19;
see also 2008 Regulation SHO Re-Opening Release, 73 FR 40201.
---------------------------------------------------------------------------
In addition to the actions we have taken aimed at reducing fails to
deliver and addressing potentially abusive ``naked'' short selling in
threshold securities, we have also taken action targeting potentially
abusive ``naked'' short selling in both threshold and non-threshold
securities. For example, in the September Emergency Order we adopted
and made immediately effective a ``naked'' short selling anti-fraud
rule, Rule 10b-21, aimed at sellers, including broker-dealers acting
for their own accounts, who deceive certain specified persons about
their intention or ability to deliver securities in time for settlement
and that fail to deliver securities by settlement date.\21\ Following
the issuance of the September Emergency Order, we adopted final
amendments making Rule 10b-21 permanent.\22\
---------------------------------------------------------------------------
\21\ See September Emergency Order, supra note 4.
\22\ See Exchange Act Release No. 58774 (Oct. 14, 2008) (``Anti-
Fraud Rule Adopting Release''); see also Exchange Act Release No.
57511 (March 17, 2008), 73 FR 15376 (March 21, 2008) (``Anti-Fraud
Rule Proposing Release'').
---------------------------------------------------------------------------
Also, as mentioned above, in the July Emergency Order and the Short
Sale Ban Emergency Order, we took emergency action targeting ``naked''
short selling in the securities of certain financial firms that
included non-threshold securities. Specifically, on July 15, 2008, we
published the July
[[Page 61709]]
Emergency Order \23\ that temporarily imposed enhanced requirements on
short sales in the publicly traded securities of certain substantial
financial firms. The July Emergency Order required that, in connection
with transactions in the publicly traded securities of the substantial
financial firms identified in Appendix A to the Emergency Order
(``Appendix A Securities''), no person could effect a short sale in the
Appendix A Securities using the means or instrumentalities of
interstate commerce unless such person or its agent had borrowed, or
arranged to borrow, the security or otherwise had the security
available to borrow in its inventory, prior to effecting such short
sale. The July Emergency Order also required that the short seller
deliver the security on settlement date, prohibiting any fails to
deliver in the Appendix A Securities.\24\
---------------------------------------------------------------------------
\23\ See supra note 1.
\24\ See id.
---------------------------------------------------------------------------
We issued the July Emergency Order because we were concerned that
false rumors regarding financial institutions of significance in the
U.S. may have fueled market volatility in the securities of some of
these institutions. As we noted in the July Emergency Order, false
rumors can lead to a loss of confidence in our markets. Such loss of
confidence can lead to panic selling, which may be further exacerbated
by ``naked'' short selling. As a result, the prices of securities may
artificially and unnecessarily decline below the price level that would
have resulted from the normal price discovery process. If significant
financial institutions are involved, this chain of events can threaten
disruption of our markets.\25\
---------------------------------------------------------------------------
\25\ We delayed the effective date of the July Emergency Order
to July 21, 2008 to create the opportunity to address, and to allow
sufficient time for market participants to make, adjustments to
their operations to implement the enhanced requirements. Moreover,
in addressing anticipated operational accommodations necessary for
implementation of the July Emergency Order, we issued an amendment
to the July Emergency Order on July 18, 2008. See Exchange Act
Release No. 58190 (July 18, 2008) (excepting from the July Emergency
Order bona fide market makers, short sales in Appendix A Securities
sold pursuant to Rule 144 of the Securities Act of 1933, and certain
short sales by underwriters, or members of a syndicate or group
participating in distributions of Appendix A Securities).
---------------------------------------------------------------------------
On July 29, 2008, we extended the July Emergency Order after
carefully reevaluating the current state of the markets in consultation
with officials of the Board of Governors of the Federal Reserve System,
the Department of the Treasury, and the Federal Reserve Bank of New
York and remaining concerned about the ongoing threat of market
disruption and effects on investor confidence.\26\ Pursuant to the
extension, the July Emergency Order terminated at 11:59 p.m. EDT on
August 12, 2008.
---------------------------------------------------------------------------
\26\ See Exchange Act Release No. 58248 (July 29, 2008), 73 FR
45257 (Aug. 4, 2008).
---------------------------------------------------------------------------
Due to our continued concerns regarding recent market conditions
and that short selling in the securities of a wider range of financial
institutions than those subject to the July Emergency Order may be
causing sudden and excessive fluctuations of the prices of such
securities that could threaten fair and orderly markets, on September
18, 2008, we issued the Short Sale Ban Emergency Order.\27\ The Short
Sale Ban Emergency Order temporarily prohibited any person from
effecting a short sale in the publicly traded securities of certain
financial institutions. On October 2, 2008, we extended the Short Sale
Ban Emergency Order due to our continued concerns regarding the ongoing
threat of market disruption and investor confidence in the financial
markets.\28\ Pursuant to the extension, the Short Sale Ban Emergency
Order terminated at 11:59 p.m. EDT on October 8, 2008.
---------------------------------------------------------------------------
\27\ See supra note 2.
\28\ See Exchange Act Release No. 58723 (Oct. 2, 2008) (stating
that the Short Sale Ban Emergency Order would terminate the earlier
of (i) three business days from the President's signing of the
Emergency Economic Stabilization Act of 2008 (H.R. 1424), or (ii)
11:59 p.m. E.D.T. on Friday, October 17, 2008).
---------------------------------------------------------------------------
Our concerns are no longer limited to just the financial
institutions that were the subject of the July Emergency Order and the
Short Sale Ban Emergency Order. Given the importance of confidence in
our financial markets as a whole, we have become concerned about sudden
and unexplained declines in the prices of equity securities generally.
These concerns resulted in our adopting and making immediately
effective in the September Emergency Order the enhanced delivery
requirements contained in temporary Rule 204T.\29\ For the reasons
explained in detail herein, today we are adopting the temporary rule as
set forth in the September Emergency Order, with modifications to
address technical and operational concerns resulting from the
requirements of the temporary rule.
---------------------------------------------------------------------------
\29\ See September Emergency Order, supra note 4.
---------------------------------------------------------------------------
III. Concerns About ``Naked'' Short Selling
We have been concerned about ``naked'' short selling and, in
particular, abusive ``naked'' short selling, for some time. As
discussed above, such concerns were a primary reason for our adoption
of Regulation SHO in 2004, the elimination of the ``grandfather'' and
options market maker exceptions to Regulation SHO's close-out
requirement, the adoption of a ``naked'' short selling antifraud rule,
and our recent issuance of the July Emergency Order, Short Sale Ban
Emergency Order, and the September Emergency Order.
Despite these Commission actions, due to our continuing concerns
about the potential impact of ``naked'' short selling on the weakened
financial markets, we believe it is necessary to immediately adopt as
an interim final temporary rule, temporary rule 204T, with some
modifications to address technical and operational concerns resulting
from the rule's requirements as set forth in the September Emergency
Order. We believe that adoption of temporary rule 204T as an interim
final temporary rule is necessary to further address abusive ``naked''
short selling and, therefore, fails to deliver resulting from such
short sales, in all equity securities. As we have stated on several
prior occasions, we believe that all sellers of securities should
promptly deliver, or arrange for delivery of, securities to the
respective buyer and all buyers of securities have a right to expect
prompt delivery of securities purchased.\30\ In addition, as we have
stated on several prior occasions, we are concerned about the negative
effect that fails to deliver may have on the markets and
shareholders.\31\
---------------------------------------------------------------------------
\30\ See, e.g., Anti-Fraud Rule Proposing Release, 73 FR at
15376.
\31\ See, e.g., 2007 Regulation SHO Final Amendments, 72 FR at
45544; 2006 Regulation SHO Proposed Amendments, 71 FR at 41712; 2007
Regulation SHO Proposed Amendments, 72 FR at 45558-45559; Anti-Fraud
Rule Proposing Release, 73 FR at 15378.
---------------------------------------------------------------------------
For example, large and persistent fails to deliver may deprive
shareholders of the benefits of ownership, such as voting and
lending.\32\ In addition, where a seller of securities fails to deliver
securities on settlement date, in effect the seller unilaterally
converts a securities contract (which is expected to settle within the
standard three-day settlement period) into an undated futures-type
contract, to which the buyer might not have agreed, or that might have
been priced differently.\33\ Moreover, 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. For example, by not borrowing securities and, therefore,
not making delivery within the standard three-day settlement period,
the seller does not incur the costs of borrowing.
---------------------------------------------------------------------------
\32\ See id.
\33\ See id.
---------------------------------------------------------------------------
[[Page 61710]]
In addition, issuers and investors have repeatedly expressed
concerns about fails to deliver in connection with manipulative
``naked'' short selling. For example, in response to proposed
amendments to Regulation SHO in 2006 \34\ designed to further reduce
the number of persistent fails to deliver in certain equity securities
by eliminating Regulation SHO's ``grandfather'' exception, and limiting
the duration of the rule's options market maker exception, we received
a number of comments that expressed concerns about ``naked'' short
selling and extended delivery failures.\35\ Commenters continued to
express these concerns in response to proposed amendments to eliminate
the options market maker exception to the close-out requirement of
Regulation SHO in 2007.\36\
---------------------------------------------------------------------------
\34\ See 2006 Regulation SHO Proposed Amendments, 71 FR 41710.
\35\ See, e.g., letter from Patrick M. Byrne, Chairman and Chief
Executive Officer, Overstock.com, Inc., dated Sept. 11, 2006; letter
from Daniel Behrendt, Chief Financial Officer, and Douglas Klint,
General Counsel, TASER International, dated Sept. 18, 2006; letter
from John Royce, dated April 30, 2007; letter from Michael Read,
dated April 29, 2007; letter from Robert DeVivo, dated April 26,
2007; letter from Ahmed Akhtar, dated April 26, 2007.
\36\ See, e.g., letter from Jack M. Wedam, dated Oct. 16, 2007;
letter from Michael J. Ryan, Executive Director and Senior Vice
President, Center for Capital Markets Competitiveness, U.S. Chamber
of Commerce, dated Sept. 13, 2007 (``U.S. Chamber of Commerce'');
letter from Robert W. Raybould, CEO Enteleke Capital Corp., dated
Sept. 12, 2007 (``Raybould''); letter from Mary Helburn, Executive
Director, National Coalition Against Naked Shorting, dated Sept. 11,
2007 (``NCANS'').
---------------------------------------------------------------------------
To the extent that fails to deliver might be part of manipulative
``naked'' short selling, which could be used as a tool to drive down a
company's stock price,\37\ such fails to deliver may undermine the
confidence of investors.\38\ These investors, in turn, may be reluctant
to commit capital to an issuer they believe to be subject to such
manipulative conduct.\39\ In addition, issuers may believe that they
have suffered unwarranted reputational damage due to investors'
negative perceptions regarding fails to deliver in the issuer's
security.\40\ Unwarranted reputational damage caused by fails to
deliver might have an adverse impact on the security's price.\41\
---------------------------------------------------------------------------
\37\ See supra note 9 (discussing a case in which we alleged
that the defendants profited from engaging in massive ``naked''
short selling that flooded the market with the company's stock, and
depressed its price); see also S.E.C. v. Gardiner, 48 S.E.C. Docket
811, No. 91 Civ. 2091 (S.D.N.Y. March 27, 1991) (alleged
manipulation by sales representative by directing or inducing
customers to sell stock short in order to depress its price); U.S.
v. Russo, 74 F.3d 1383, 1392 (2d Cir. 1996) (short sales were
sufficiently connected to the manipulation scheme as to constitute a
violation of Exchange Act Section 10(b) and Rule 10b-5).
\38\ In response to the 2007 Regulation SHO Proposed Amendments,
we received comment letters discussing the impact of fails to
deliver on investor confidence. See, e.g., letter from NCANS.
Commenters expressed similar concerns in response to the 2006
Regulation SHO Proposed Amendments. See, e.g., letter from Mary
Helburn, Executive Director, National Coalition Against Naked
Shorting, dated Sept. 30, 2006 (``NCANS (2006)''); letter from
Richard Blumenthal, Attorney General, State of Connecticut, dated
Sept. 19, 2006 (``Blumenthal'').
\39\ In response to the 2007 Regulation SHO Proposed Amendments,
we received comment letters expressing concern about the impact of
potential ``naked'' short selling on capital formation, claiming
that ``naked'' short selling causes a drop in an issuer's stock
price and may limit the issuer's ability to access the capital
markets. See, e.g., letter from Robert K. Lifton, Chairman and CEO,
Medis Technologies, Inc., dated Sept. 12, 2007 (``Medis''); letter
from NCANS. Commenters expressed similar concerns in response to the
2006 Regulation SHO Proposed Amendments. See, e.g., letter from
Congressman Tom Feeney--Florida, U.S. House of Representatives,
dated Sept. 25, 2006 (``Feeney''); see also letter from Zix
Corporation, dated Sept. 19, 2006 (``Zix'') (stating that ``[m]any
investors attribute the Company's frequent re-appearances on the
Regulation SHO list to manipulative short selling and frequently
demand that the Company ``do something'' about the perceived
manipulative short selling. This perception that manipulative short
selling of the Company's securities is continually occurring has
undermined the confidence of many of the Company's investors in the
integrity of the market for the Company's securities.'').
\40\ Due in part to such concerns, some issuers have taken
actions to attempt to make transfer of their securities ``custody
only,'' (i.e., certificating the securities and prohibiting
ownership by a securities intermediary) thus preventing transfer of
their stock to or from securities intermediaries such as the
Depository Trust Company (``DTC'') or broker-dealers. See Exchange
Act Release No. 48709 (Oct. 28, 2003), 68 FR 62972, at 62975 (Nov.
6, 2003). Some issuers have attempted to withdraw their issued
securities on deposit at DTC in order to make the securities
ineligible for book-entry transfer at a securities depository. See
id. Withdrawing securities from DTC or requiring custody-only
transfers would undermine the goal of a national clearance and
settlement system designed to reduce the physical movement of
certificates in the trading markets. See id. We note, however, that
in 2003 the Commission approved a DTC rule change clarifying that
its rules provide that only its participants may withdraw securities
from their accounts at DTC, and establishing a procedure to process
issuer withdrawal requests. See Exchange Act Release No. 47978 (June
4, 2003), 68 FR 35037 (June 11, 2003).
\41\ See 2006 Regulation SHO Proposed Amendments, 71 FR at
41712; 2007 Regulation SHO Amendments, 72 FR at 45544; 2007
Regulation SHO Proposed Amendments, 72 FR at 45558-45559; Anti-Fraud
Rule Proposing Release, 73 FR at 15378 (providing additional
discussion of the impact of fails to deliver on the market); see
also Exchange Act Release No. 48709 (Oct. 28, 2003), 68 FR 62972,
62975 (Nov. 6, 2003) (discussing the impact of ``naked'' short
selling on the market).
---------------------------------------------------------------------------
IV. Discussion of Temporary Rule 204T
A. Rule 204T's Close-Out Requirement
In these unusual and extraordinary times and in an effort to
prevent substantial disruption to the securities markets, we have
concluded that it is necessary to immediately adopt as an interim final
temporary rule, temporary rule Rule 204T, with some modifications to
address technical and operational concerns resulting from the rule's
requirements as set forth in the September Emergency Order. We believe
that adoption of the temporary rule will substantially restrict the
practice of potentially abusive ``naked'' short selling in all equity
securities by strengthening the delivery requirements for such
securities.\42\
---------------------------------------------------------------------------
\42\ As noted above, in a ``naked'' short sale, the short seller
does not borrow or arrange to borrow securities in time to make
delivery to the buyer within the standard three-day settlement
period. As a result, the seller fails to deliver securities to the
buyer when delivery is due. See supra note 7 and supporting text.
---------------------------------------------------------------------------
Specifically, temporary Rule 204T(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 that equity security, the participant shall, by no
later than the beginning of regular trading hours \43\ on the
settlement day \44\ following the settlement date, immediately close
out the fail to deliver position by borrowing or purchasing securities
of like kind and quantity.\45\
---------------------------------------------------------------------------
\43\ ``Regular trading hours'' has the same meaning as in Rule
600(b)(64) of Regulation NMS. Rule 600(b)(64) provides that
``Regular trading hours means the time between 9:30 a.m. and 4 p.m.
Eastern Time, or such other time as is set forth in the procedures
established pursuant to Sec. 242.605(a)(2).''
\44\ The term ``settlement day'' is defined in Rule 203(c)(5) of
Regulation SHO as: ``* * * any business day on which deliveries of
securities and payments of money may be made through the facilities
of a registered clearing agency.'' 17 CFR 242.203(c)(5).
\45\ See temporary Rule 204T(a).
---------------------------------------------------------------------------
Temporary Rule 204T(a)'s close-out requirement requires a
participant of a registered clearing agency that has a fail to deliver
position at a registered clearing agency on the settlement date for a
transaction to immediately borrow or purchase securities to close out
the amount of the fail to deliver position by no later than the
beginning of regular trading hours on the settlement day following the
settlement date (the ``Close-Out Date''). This close-out requirement
requires that the participant take affirmative action to purchase or
borrow securities. Thus, a participant may not offset the amount of its
settlement date fail to deliver position with shares that the
participant receives or will receive on the Close-Out
[[Page 61711]]
Date.\46\ To meet its close-out obligation a participant also must be
able to demonstrate on its books and records that on the Close-Out Date
it purchased or borrowed shares in the full quantity of its settlement
date fail to deliver position and, therefore, that the participant has
a net flat or net long position on its books and records in that equity
security on the Close-Out Date.
---------------------------------------------------------------------------
\46\ In determining its close-out obligation, a participant may
rely on its net delivery obligation as reflected in its notification
from NSCC regarding its securities delivery and payment obligations,
provided such notification is received prior to the beginning of
regular trading hours on the Close-Out Date.
---------------------------------------------------------------------------
The temporary rule defines a ``settlement date'' as ``the business
day on which delivery of a security and payment of money is to be made
through the facilities of a registered clearing agency in connection
with the sale of a security.'' \47\ This definition is consistent with
Rule 15c6-1 that prohibits broker-dealers from effecting or entering
into a contract for the purchase or sale of a security that provides
for payment of funds and delivery of securities later than the third
business day after the date of the contract unless otherwise expressly
agreed to by the parties at the time of the transaction.\48\
---------------------------------------------------------------------------
\47\ See temporary Rule 204T(f)(1).
\48\ See 17 CFR 240.15c6-1.
---------------------------------------------------------------------------
Because most transactions settle by T+3 and because delivery on all
sales should be made by settlement date, participants should consider
having in place policies and procedures to help ensure that delivery is
being made by settlement date. We intend to examine participants'
policies and procedures to determine whether such policies and
procedures monitor for delivery by settlement date.\49\
---------------------------------------------------------------------------
\49\ Of course, broker-dealers must comply with any applicable
SRO policies and procedures requirements. For example, NASD Rule
3010 contains, among other things, written procedures requirements
for member firms.
---------------------------------------------------------------------------
Similar to the existing close-out requirement of Rule 203(b)(3) of
Regulation SHO, the temporary rule is based on a participant's fail to
deliver position at a registered clearing agency. As noted above, the
NSCC clears and settles the majority of equity securities trades
conducted on the exchanges and in the over-the-counter markets. NSCC
clears and settles trades through the CNS system, which nets the
securities delivery and payment obligations of all of its members. NSCC
notifies its members of their securities delivery and payment
obligations daily. Because the temporary rule is based on a
participant's fail to deliver position at a registered clearing agency,
the temporary rule is consistent with current settlement practices and
procedures and with the Regulation SHO framework regarding delivery of
securities.\50\
---------------------------------------------------------------------------
\50\ See 17 CFR 242.203(b)(3) (Regulation SHO's close-out
requirement). Consistent with current industry practice under
Regulation SHO, with respect to a net syndicate short position
created in connection with a distribution of a security that is part
of a fail to deliver position at a registered clearing agency, the
requirements of temporary Rule 204T shall not apply provided action
is taken to close out the net syndicate short position by no later
than the beginning of regular trading hours on the thirtieth day
after commencement of sales in the distribution. See e.g., Exchange
Act Release No. 58190 (July 18, 2008) (amending the July Emergency
Order to provide an exception from its requirements for fails to
deliver in connection with syndicate offerings).
---------------------------------------------------------------------------
In addition, similar to Rule 203(b)(3)(vi) of Regulation SHO, the
temporary rule provides that a participant may reasonably allocate its
responsibility to close out a fail to deliver position to another
broker-dealer from which the participant receives trades for clearance
or settlement.\51\ Specifically, temporary Rule 204T(d) provides that
if a participant of a registered clearing agency reasonably allocates a
portion of a fail to deliver position to another registered broker or
dealer for which it clears trades or from which it receives trades for
settlement, based on such broker's or dealer's short position, the
provisions of Rule 204T(a) and (b) relating to such fail to deliver
position shall apply to such registered broker or dealer that was
allocated the fail to deliver position, and not to the participant.\52\
---------------------------------------------------------------------------
\51\ See 17 CFR 242.203(b)(3)(vi). Rule 203(b)(3)(vi) provides
that ``[i]f a participant of a registered clearing agency reasonably
allocates 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 or dealer's
short position, then the provisions of this paragraph (b)(3)
relating to such fail to deliver position shall apply to the portion
of such registered broker or dealer that was allocated the fail to
deliver position, and not to the participant.''
\52\ See temporary Rule 204T(d).
---------------------------------------------------------------------------
Thus, participants that are able to identify the accounts of
broker-dealers for which they clear or from which they receive trades
for settlement, could allocate the responsibility to close out the fail
to deliver position to the particular broker-dealer account(s) whose
trading activities have caused the fail to deliver position provided
the allocation is reasonable (e.g., the allocation must be timely).
Absent such identification, however, the participant would remain
subject to the close-out requirement.
Unlike Rule 203(b)(3)(vi) of Regulation SHO, temporary Rule 204T(d)
imposes an additional notification requirement on a broker-dealer that
has been allocated responsibility for complying with the rule's
requirements. Specifically, temporary Rule 204T(d) provides that a
broker or dealer that has been allocated a portion of a fail to deliver
position that does not comply with the provisions of temporary Rule
204T(a) must immediately notify the participant that it has become
subject to the borrowing requirements of temporary Rule 204T(b).\53\ We
are adopting this notification requirement so that participants will
know when a broker-dealer for which they clear and settle trades has
become subject to the temporary rule's borrowing requirements.
---------------------------------------------------------------------------
\53\ See id.
---------------------------------------------------------------------------
The temporary rule also differs from the current close-out
requirement of Regulation SHO in that it applies to fails to deliver in
all equity securities rather than only to those securities with a large
and persistent level of fails to deliver, i.e., threshold securities. A
primary purpose of the temporary rule is to prevent the use of
``naked'' short selling as part of a manipulative scheme. To achieve
this purpose, the rule must apply to all equity securities, regardless
of the level or persistence of any fails to deliver in such securities.
In addition, as discussed above, we believe that all sellers of
securities should promptly deliver, or arrange for delivery of,
securities to the respective buyer and all buyers of securities have a
right to expect prompt delivery of securities purchased. We believe
this should be the case for sales in all equity securities and are
adopting this temporary rule to further that goal.
Regulation SHO, as adopted in 2004, was a first step in trying to
reduce persistent fails to deliver and address abusive ``naked'' short
selling. In Regulation SHO, we took a targeted approach, imposing
additional delivery requirements on securities with a substantial and
persistent amount of fails to deliver. As we stated in the 2004
Regulation SHO Adopting Release, we took this targeted approach at that
time in an effort not to burden the vast majority of securities where
there are not similar concerns regarding settlement.\54\ In addition,
Regulation SHO's close-out requirement was adopted to address potential
abuses that may occur with large, extended fails to deliver.\55\ We
also noted in the 2004 Regulation SHO Adopting Release, however, that
we would pay close attention to the operation and efficacy of
[[Page 61712]]
the provisions we were adopting at that time and would consider whether
any further action was warranted.\56\
---------------------------------------------------------------------------
\54\ See 2004 Regulation SHO Adopting Release, 69 FR at 48016.
\55\ See id. at 48017.
\56\ See id. at 48018.
---------------------------------------------------------------------------
Because of continued concerns about the potentially negative market
impact of fails to deliver, and the fact that through our monitoring of
the efficacy of Regulation SHO's close-out requirement we continued to
observe threshold securities with fail to deliver positions that are
not being closed out under existing delivery and settlement
requirements, we eliminated the ``grandfather'' and options market
maker exceptions to Regulation SHO's close-out requirements.\57\
---------------------------------------------------------------------------
\57\ On June 13, 2007, we adopted amendments to eliminate the
``grandfather'' exception to Regulation SHO's close-out requirement.
On September 17, 2008, in the September Emergency Order, we adopted
amendments to eliminate the options market maker exception, which
amendments were subsequently made permanent. See supra notes 17, 18
and 19.
---------------------------------------------------------------------------
However, we are concerned that Regulation SHO's current provisions
have not gone far enough in reducing fails to deliver and addressing
potentially abusive ``naked'' short selling.\58\ More is needed to
reduce fails to deliver and to address potentially abusive ``naked''
short selling, especially in light of the current instability and lack
of investor confidence in the financial markets.\59\ In addition,
because Regulation SHO's close-out requirement applies only to
threshold securities, fails to deliver in non-threshold securities
never have to be closed out.\60\ We believe that adoption of temporary
rule 204T as an interim final temporary rule is necessary to curtail
fails to deliver in both threshold and non-threshold securities to
further address abusive ``naked'' short selling in such securities.
---------------------------------------------------------------------------
\58\ See, e.g., 2007 Regulation SHO Final Amendments, 72 FR
45544 (eliminating the ``grandfather'' exception to Regulation SHO's
close-out requirement due to our observing continued fails to
deliver in threshold securities); 2008 Regulation SHO Final
Amendments, supra note 19 (eliminating the options market maker
exception to Regulation SHO's close-out requirement due to
substantial levels of fails to deliver continuing to persist in
optionable threshold securities).
\59\ See, e.g., letter from Leland Chan, General Counsel,
California Bankers Association, dated Aug. 21, 2008; letter from
Eric C. Jensen, Esq., Cooley Godward Kronish L.P., dated Aug. 21,
2008; letter from Steven B. Boehm and Cynthia M. Krus, Sutherland
Asbill Brennan LLP, dated July 31, 2008; letter from James J. Angel,
Professor of Finance, Georgetown University, McDonough School of
Business, dated Aug. 20, 2008; letter from Tuan Nguyen, dated Aug.
8, 2008.
\60\ OEA estimates that fails to deliver in non-threshold
securities averaged approximately 624 million shares or $4.6 billion
in value per day from January to July 2008. These fails account for
approximately 54.5% (56.6%) of all fail to deliver shares (by dollar
value).
---------------------------------------------------------------------------
As discussed above, due to our concerns about potentially abusive
``naked'' short selling in certain non-threshold securities, we
recently issued the July Emergency Order to temporarily impose enhanced
requirements on short sales in the Appendix A Securities. Following our
issuance of the July Emergency Order, we issued the Short Sale Ban
Emergency Order in which we took the additional step of prohibiting
short selling in the securities of a wider range of financial
institutions than those subject to the July Emergency Order. In
addition, we issued the September Emergency Order which, in part,
imposed enhanced delivery requirements for transactions in all equity
securities and made effective immediately a ``naked'' short selling
antifraud rule. We took these emergency actions because we were
concerned about panic selling in securities due to a loss of confidence
that could be further exacerbated by ``naked'' short selling.
Following the issuance of the July Emergency Order, members of the
public have repeatedly expressed their concerns about a loss of
confidence in the financial markets.\61\ In addition, since the
termination of the July Emergency Order and the issuance of the Short
Sale Ban Emergency Order and the September Emergency Order, we have
continued our evaluation of the markets and our discussions with the
Federal Reserve, Treasury, and the Federal Reserve Bank of New York
regarding the state of the financial markets. In light of these
processes, we have determined that we must take action to adopt as an
interim final temporary rule, temporary Rule 204T, to substantially
restrict ``naked'' short selling in all equity securities. As with the
July Emergency Order, the Short Sale Ban Emergency Order, and the
September Emergency Order, we are adopting this temporary rule as a
preventative step to help restore market confidence.
---------------------------------------------------------------------------
\61\ See, e.g., letter from Tom Donohue, President, U.S. Chamber
of Commerce, dated July 15, 2008; letter from Ron Heller, dated July
21, 2008; letter from Ronald L. Rourk, dated July 21, 2008; letter
from Wayne Jett, Managing Principal and Chief Economist at Classical
Capital, LLC, dated July 24, 2008; letter from Edward Herlilhy and
Theodore Levine, Wachtell, Lipton, Rosen and Katz, LLP, dated Sept.
16, 2008; letter from Sen. Hillary Rodham Clinton, dated Sept. 17,
2008; letter from Representative D. Burton, dated Sept. 18, 2008;
letter from Elliott Bossen, Chief Investment Officer at Silverback
Asset Management, dated Sept. 24, 2008.
---------------------------------------------------------------------------
In addition to applying the temporary rule to fails to deliver in
all equity securities, rather than just threshold securities, the
temporary rule also differs from the close-out requirement of Rule
203(b)(3) of Regulation SHO in that it shortens the close-out period
for such fails to deliver.\62\ For the reasons discussed below, rather
than requiring close out of a fail to deliver position within thirteen
consecutive settlement days (or 10 days after settlement date),
temporary Rule 204T requires a participant to immediately purchase or
borrow shares to close out a fail to deliver position by no later than
the beginning of regular trading hours on the settlement day following
the day on which the fail to deliver position occurs.
---------------------------------------------------------------------------
\62\ Rule 203(b)(3) of Regulation SHO provides: ``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, the participant shall
immediately thereafter close out the fail to deliver position by
purchasing securities of like kind and quantity.'' See 17 CFR
242.203(b)(3).
---------------------------------------------------------------------------
As noted above, trades in most securities generally settle within a
three-day settlement cycle, known as T+3 (or ``trade date plus three
days''). T+3 means that when a trade occurs, the participants to the
trade are expected to deliver and pay for the security at a clearing
agency three settlement days after the trade is executed so the
brokerage firm can exchange those funds for the securities on that
third business day. The three-day settlement period applies to most
security transactions, including stocks, bonds, municipal securities,
mutual funds traded through a brokerage firm, and limited partnerships
that trade on an exchange. Government securities and stock options
typically settle on the next business day following the trade (or
T+1).\63\ We believe that delivery on all sales should be made by
settlement date and, therefore, in temporary Rule 204T we are requiring
that fails to deliver in all equity securities be closed out by no
later than the beginning of regular trading hours on the Close-Out
Date.
---------------------------------------------------------------------------
\63\ See supra note 8.
---------------------------------------------------------------------------
In the 2004 Regulation SHO Adopting Release we stated we were
adopting a thirteen consecutive settlement day close-out requirement in
part because the close-out requirement applied to fails to deliver
resulting from long and short sales in threshold securities, and
extending the time period to ten days after settlement date for a
transaction would make the close-out requirement consistent with Rule
15c3-3(m).\64\ In addition, we noted in that release that ten days
after settlement was also the timeframe used at that time in NASD Rule
11830.\65\ We also acknowledged that a shorter timeframe, such as two
days after settlement, may capture many
[[Page 61713]]
instances of ordinary course settlement delays.\66\
---------------------------------------------------------------------------
\64\ See 17 CFR 240.15c3-3(m).
\65\ See 2004 Regulation SHO Adopting Release, 69 FR at 48017,
n.93.
\66\ See id.
---------------------------------------------------------------------------
In addition, we have stated previously that the vast majority of
fails to deliver are closed out within five days after T+3.\67\ In
addition, a recent analysis by our Office of Economic Analysis found
that more than half of all fails to deliver and more than 70% of all
fail to deliver positions are closed out within two settlement days
after T+3.\68\ Although this information shows that delivery is being
made, it demonstrates that often delivery is not being made until
several days following the standard three-day settlement cycle. In
addition, the current close-out requirement for threshold securities
under Regulation SHO and the lack of any close-out requirement for non-
threshold securities under Regulation SHO enables fails to deliver to
persist for many days beyond settlement date. We believe that allowing
fails to deliver to extend out beyond settlement date for a transaction
is too long.
---------------------------------------------------------------------------
\67\ See, e.g., 2007 Regulation SHO Final Amendments, 72 FR at
45544, n.5.
\68\ OEA's analysis examined the period from January to July
2008 and used the age of the fail to deliver position as reported by
the NSCC. The NSCC data included only securities with at least
10,000 shares in fails to deliver. We note that these numbers
included securities that were not subject to the close-out
requirement in Rule 203(b)(3) of Regulation SHO, which applies only
to ``threshold securities'' as defined in Rule 203(c)(6) of
Regulation SHO.
---------------------------------------------------------------------------
We have continuously monitored the extent of fails to deliver and
abusive ``naked'' short selling in the markets. We believe that
allowing fails to deliver in all equity securities to persist for
thirteen consecutive settlement days (10 days after settlement date) if
such securities are threshold securities, or indefinitely if such
securities are not threshold securities, is too long. As discussed
above, fails to deliver may be indicative of a scheme to manipulate the
price of a security. In addition, we are concerned about the negative
effect that fails to deliver and potentially abusive ``naked'' short
selling may have on the market and the broader economy, including on
investor confidence. Temporary Rule 204T addresses these concerns by
requiring a participant to immediately close out a fail to deliver
position by purchasing or borrowing securities by no later than the
beginning of regular trading hours on the Close-Out Date.
We believe we should act to require earlier close out so that more
sales settle by settlement date. Indeed, we believe that delivery on
all sales should be made by settlement date. As we discuss above, and
as we have stated on several prior occasions, we believe that all
sellers of securities should promptly deliver, or arrange for delivery
of, securities to the respective buyer and all buyers of securities
have a right to expect prompt delivery of securities purchased.\69\
Although the temporary rule's close-out requirement may capture some
instances of ordinary course settlement delays, we believe that the
temporary rule's close-out requirement is necessary to help ensure that
fails to deliver in all equity securities settle by settlement date. In
addition, as discussed above, due to our belief that delivery should be
made by settlement date, participants should consider having policies
and procedures in place to monitor for the delivery of securities by
settlement date.
---------------------------------------------------------------------------
\69\ See supra note 30.
---------------------------------------------------------------------------
We understand, however, that fails to deliver may occur from long
sales within the first two settlement days after settlement date for
legitimate reasons. For example, human or mechanical errors or
processing delays can result from transferring securities in custodial
or other form rather than book-entry form, thereb