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U.S. Securities and Exchange Commission

Division of Trading and Markets:
Responses to Frequently Asked Questions Concerning Rule 201 of Regulation SHO

Responses to these frequently asked questions were prepared by and represent the views of the staff of the Division of Trading and Markets (“Staff”). They are not rules, regulations, or statements of the Securities and Exchange Commission (“Commission”). Further, the Commission has neither approved nor disapproved these interpretive answers.

For Further Information Contact: Any of the following attorneys in the Office of Trading Practices, Division of Trading and Markets, Securities and Exchange Commission, 100 F Street, NE, Washington, DC 20549, at (202) 551-5720: Josephine Tao, Assistant Director, Andrea Orr and Katrina Wilson, Special Counsels, and Angela Moudy, Attorney Advisor.

I. Introduction

On February 26, 2010, the Commission adopted Rule 201 of Regulation SHO. Rule 201 restricts the price at which short sales may be effected when a stock has experienced significant downward price pressure. Rule 201 became effective on May 10, 2010. (Securities Exchange Act Release No. 61595 (Feb. 26, 2010), 75 FR 11232 (Mar. 10, 2010) (“Rule 201 Adopting Release”)). Compliance with the new rule is required as of February 28, 2011. (Securities Exchange Act Release No. 63247 (Nov. 4, 2010), 75 FR 68702 (Nov. 9, 2010)).

Among other things, Rule 201 requires that a trading center establish, maintain, and enforce written policies and procedures reasonably designed to prevent the execution or display of a short sale order of a covered security at a price that is less than or equal to the current national best bid if the price of that covered security decreases by 10% or more from the covered security’s closing price as of the end of regular trading hours on the prior day. Once the circuit breaker in Rule 201 has been triggered, the price test restriction will apply to short sale orders in that security for the remainder of the day and the following day, unless an exception applies.

The following questions and answers regarding Rule 201 of Regulation SHO have been compiled by the Staff to assist in the understanding and application of this Rule. These questions and answers are intended to provide general guidance. Facts and circumstances of a particular transaction may differ, and the Staff notes that even slight variations may require different responses. In addition, the questions and answers reflect current technological and other industry conditions, and may require modifications in the future if such conditions change materially.

The Staff may update these questions and answers periodically. In each update, the questions added after publication of the last version will be marked with “MODIFIED!” or “NEW!”

II. Responses to Frequently Asked Questions

1. General

Question 1.1: Does the current national best bid factor into the calculation regarding whether the price of a covered security has decreased by 10% or more from the covered security's closing price as of the end of regular trading hours on the prior day?

Answer: No. For purposes of the determination of when the price of a covered security has declined by 10% or more from its prior day's closing price, the covered security's price is based on trades reported in the consolidated system for the covered security during regular trading hours (as defined under Regulation NMS). Thus, a covered security's listing market will base its determination on last-sale eligible trade prices.

Question 1.2: Is the determination regarding whether the Rule 201 circuit breaker has been triggered limited to regular trading hours (as defined under Regulation NMS)?

Answer: Yes. Regular trading hours is defined by Rule 600(b)(64) of Regulation NMS to mean the time between 9:30 a.m. and 4:00 p.m. Eastern Time, or such other time as is set forth in the procedures established pursuant to Rule 605(a)(2) of Regulation NMS.

Question 1.3: If a trading center’s own data indicates that a stock is down 10% from the prior day’s close, is the Rule 201 circuit breaker applicable?

Answer: The determination regarding whether the price of a covered security has decreased by 10% or more from the covered security’s closing price and, therefore, whether the circuit breaker in Rule 201 has been triggered, is made by the covered security’s listing market. Thus, the short sale price test restrictions of Rule 201 will not be in effect with respect to a covered security until the listing market for the covered security has determined that the price of the covered security has decreased by 10% or more from its prior day’s closing price, has notified the applicable single plan processor and the information has been disseminated by the applicable single plan processor.

2. Duration of the Short Sale Price Test Restriction

Question 2.1: Will the short sale price test restriction, once triggered, apply to short sale orders on the next trading day and outside of regular trading hours?

Answer: Yes. Once triggered, the short sale price test restriction of Rule 201 applies “for the remainder of the day and the following day when a national best bid for the covered security is calculated and disseminated on a current and continuing basis by a plan processor pursuant to an effective national market system plan.” 17 CFR 242.201(b)(1)(ii). The “following day” refers to the next trading day. Thus, if the Rule 201 circuit breaker is triggered on a Friday, the price test restriction will be in effect on that Friday and on the following Monday.

Although the Rule 201 circuit breaker can only be triggered during regular trading hours, once triggered, the short sale price test restrictions of Rule 201 apply at all times when quotation information and, therefore, the national best bid, is collected, processed, and disseminated pursuant to a national market system plan, even though this period may vary and may extend beyond regular trading hours.

Question 2.2: Can the circuit breaker in Rule 201 be re-triggered if the price of a covered security declines by 10% or more on consecutive days? Is there a limit to how many times the circuit breaker can be re-triggered?

Answer: Under Rule 201(b)(1)(ii), once triggered, the short sale price test restriction of Rule 201 remains in place “for the remainder of the day and the following day when a national best bid for the covered security is calculated and disseminated on a current and continuing basis by a plan processor pursuant to an effective national market system plan.” 17 CFR 242.201(b)(1)(ii). Thus, under Rule 201(b), once the circuit breaker has been triggered, the price test restriction will remain in place for the remainder of the day and for the following day.

Further, the Rule 201 Adopting Release states that “if the price of a covered security declines intra-day by at least 10% on a day on which the security is already subject to the short sale price test restriction of Rule 201, the restriction will be re-triggered and, therefore, will continue in effect for the remainder of that day and the following day. For example, if on Monday, the price of XYZ security declines intra-day by at least 10%, XYZ security will be subject to the alternative uptick rule for the remainder of Monday and for the following day, Tuesday. If then on Tuesday, the price of XYZ security again declines intra-day by at least 10%, the circuit breaker will be re-triggered for that security such that the alternative uptick rule will apply for the following day, i.e., Wednesday, as well as for the remainder of the day on Tuesday.” Rule 201 Adopting Release, 75 FR 11232, 11253 n.290.

Rule 201 does not place any limit on the frequency or number of times the circuit breaker can be re-triggered with respect to a particular stock.

3. Determining the Prior Day’s Closing Price

Question 3.1: How will the listing market for a covered security determine the covered security’s prior day’s closing price if the covered security has been subject to a trading suspension or trading halt?

Answer: In the case of a covered security that has been subject to a regulatory or trading halt, although there may not be a closing price for the covered security for the prior day, there is a closing price or a last sale price, in the event there is not a closing price, for the covered security on the last day it traded. Thus, the circuit breaker under Rule 201 would be triggered for a covered security subject to a regulatory or trading halt, once trading has resumed, if the price of that covered security decreases by 10% or more from the covered security’s closing price or last sale price, in the event there is not a closing price, as determined by the listing market for the covered security as of the end of regular trading hours on the last day it traded.

Question 3.2: How will Rule 201 apply on the first day of trading of a covered security on any listing market, pursuant to a new security offering (e.g., IPOs, spin-offs, etc.)?

Answer: On the first day of trading of a covered security on any listing market, pursuant to a new security offering, there will not be a closing price for the covered security for the prior day. Thus, Rule 201 will not apply to such covered securities until the second day of trading. On the second day of trading, the listing market for the covered security will have determined the closing price of the covered security as of the end of regular trading hours on the first day of trading. Listing markets are responsible for ensuring that they correctly determine situations in which no prior day’s closing price exists for a covered security due to the fact that the security has not previously traded on any listing market and is part of a new security offering, in accordance with the listing markets’ responsibilities under Rule 201(b)(3).

4. Un-Displayed Orders

Question 4.1: If there are un-displayed “dark liquidity” orders for a covered security and the Rule 201 circuit breaker is triggered for such covered security, can the order be executed at or below the national best bid?

Answer: No. If the circuit breaker in Rule 201 has been triggered for a covered security, an un-displayed “dark liquidity” short sale order may only be executed at a price above the current national best bid.

(NEW! 01/20/11)

Question 4.2: If a broker-dealer sends a short sale order to a trading center that is intended to be fully un-displayed, may the broker-dealer mark such order “short exempt” in reliance on Rule 201(c), provided that the order is priced above the current national best bid at the time of submission?

Answer: No. If a short sale order in a covered security subject to Rule 201’s short sale price test is to be un-displayed, the order must be executed at a price above the current national best bid at the time of execution. The Rule 201 Adopting Release states: “[T]o the extent that a short sale order is un-displayed, Rule 201 will prevent the trading center from executing the order unless at the time of execution, the execution price complies with the Rule.” Rule 201 Adopting Release, 75 FR 11232, 11260 n.386. If a broker-dealer were to mark an order “short exempt” in reliance on Rule 201(c), where such order is intended to be fully un-displayed, the short sale order may be executed by a trading center at a price at or below the current national best bid under Rule 201(b)(1)(iii)(B). This result would be contrary to the requirement that un-displayed short sale orders be executed at a price that complies with Rule 201 at the time of execution. Thus, a broker-dealer may not mark an order “short exempt” under Rule 201(c) if the order will be fully un-displayed by a trading center.

5. Order Marking

Question 5.1: Can the “short exempt” marking be used for an order that qualifies for an exception from Rule 203’s locate requirement?

Answer: No. Rule 200(g)(2) provides that “A sale order shall be marked ‘short exempt’ only if the provisions of 242.201(c) or (d) are met.” 17 CFR 242.200(g)(2). Thus, the “short exempt” marking is only available for orders that are exempt from the pricing requirements of Rule 201 in accordance with paragraphs (c) or (d) of Rule 201.

As noted in the Rule 201 Adopting Release, to the extent that an exception to Regulation SHO’s locate requirement applies to a short sale order, such order must be marked “short” in accordance with Rule 200(g) of Regulation SHO unless the order can be marked “short exempt” pursuant to Rule 200(g)(2) of Regulation SHO. See Rule 201 Adopting Release, 75 FR 11232, 11266 n.472. The “short exempt” marking is not available for a short sale order that qualifies for an exception from the locate requirement under Rule 203 unless that order also meets the specific criteria set forth in Rule 201(c), fulfills the conditions of a subparagraph of Rule 201(d), or otherwise qualifies for exemptive relief provided by the Commission that allows the short sale order to be marked “short exempt.” An order may not be marked “short exempt” solely on the basis that it qualifies for an exception to the requirements of Rule 203(b)(1) pursuant to Rule 203(b)(2).

Question 5.2: May an originating broker-dealer that sends a short sale order to a receiving broker-dealer for routing purposes, where the receiving broker-dealer will not in turn display or execute the order as a trading center, mark the order “short exempt” in reliance on Rule 201(d) if the originating broker-dealer has a reasonable basis to believe that the order qualifies for an exception listed in Rule 201(d)?

Answer: Yes, an originating broker-dealer may mark a short sale order in a covered security “short exempt” pursuant to Rule 201(d) when it has a reasonable basis to believe that the order qualifies for an exception listed in Rule 201(d), regardless of whether it sends the order directly to a trading center for display or execution or otherwise routes the order through another broker-dealer or trading center. As a reminder, any broker-dealer relying on an exception in Rule 201(d) must be able to demonstrate that it had a reasonable basis for such reliance. As used in this FAQ, the term “originating broker-dealer” refers to the first broker-dealer to mark the order “short exempt” in reliance on Rule 201(d).

Thereafter, another broker-dealer may receive the short sale order in a covered security marked “short exempt” in reliance on Rule 201(d) and route the order to a trading center without independently developing a reasonable basis to believe that the order qualifies for a provision of Rule 201(d).

Question 5.3: If a short sale order in a covered security marked “short exempt” in reliance on Rule 201(c) or Rule 201(d) is submitted to a trading center for display or execution, may the trading center or another broker-dealer acting as a conduit thereafter route the “short exempt” order to another trading center without independently evaluating the appropriateness of the “short exempt” marking?

Answer: Yes. Rule 201(b)(1)(ii)(B) requires that the policies and procedures established, maintained, and enforced by a trading center pursuant to Rule 201 be reasonably designed to permit the execution or display of a short sale order in a covered security marked “short exempt” without regard to whether the order is at a price that is less than or equal to the current national best bid. It would be consistent for such reasonably designed policies and procedures to permit the trading center to route the “short exempt” order submitted to it for display or execution, in the event that the trading center cannot display or execute the order itself, to another trading center without independently determining whether the order was correctly marked “short exempt” by a broker-dealer in reliance on Rule 201(c) or Rule 201(d).

A trading center that is routing a “short exempt” order to another trading center, in accordance with the above, may use another broker-dealer acting as a conduit to route the order if it cannot access the trading center on its own (e.g., it is not a member of the exchange). In this instance, the broker-dealer acting as a conduit may also route the “short exempt” order without evaluating the appropriateness of the “short exempt” marking.

(MODIFIED! 01/20/11)

Question 5.4: When the short sale price test restriction is not in effect for a covered security, may a broker-dealer mark a short sale order in that covered security “short exempt” if the order would otherwise qualify for an exception under Rule 201(d)? If a broker-dealer is routing an ISO solely to facilitate its execution of a customer long sale in compliance with Rule 611 of Regulation NMS, may such ISOs be marked “short exempt” when the short sale price test restriction is not in effect?

Answer: Yes. Rule 201(d) provides that a broker-dealer may only mark a short sale order in a covered security “short exempt” after the covered security has experienced a 10% or more intra-day price decline from its previous day’s closing price, as determined by the listing market pursuant to Rule 201(b)(3). However, given the nature of orders eligible for exceptions under Rule 201(d), we believe it would be reasonable for a short sale order in a covered security to be marked “short exempt” in reliance on Rule 201(d) at times when the short sale price test is not in effect for that covered security, as long as the broker-dealer has a reasonable basis to believe that the order meets the requirements of an exception under Rule 201(d) at that time.

In addition, broker-dealers may mark ISOs “short exempt,” provided they are routed solely to facilitate the broker-dealer’s execution of a customer long sale in compliance with Rule 611 of Regulation NMS, at times when the short sale price test is and is not in effect for the covered security. See Rule 201 Adopting Release, 75 FR 11232, 11262 – 11263 n.423.

Question 5.5: When the short sale price test restriction is not in effect for a covered security, may a broker-dealer mark a short sale order in that covered security “short exempt” if the order would otherwise qualify under Rule 201(c)?

Answer: No.

(NEW! 01/20/11)

Question 5.6: If a broker-dealer is effecting the execution of a customer short sale order in a covered security on a riskless principal basis after the price of the covered security has decreased by 10% or more such that the Rule 201 circuit breaker has been triggered for the covered security, how should the broker-dealer mark the proprietary portion of the riskless principal order if the broker-dealer is net long?

Answer: In cases where the short sale price test restriction of Rule 201 is in effect for a covered security and the broker-dealer that is effecting the execution of the short sale order on a riskless principal basis is net long the covered security, the broker-dealer shall mark its principal trade to complete the first leg of the riskless principal transaction as “short.” Such “short” sale order must comply with all of the requirements of Regulation SHO pertaining to orders marked “short” as well as any SRO requirements relating to riskless principal transactions.

In all other cases, the broker-dealer must continue to mark principal sell orders on the basis of its net position in the security in accordance with Rule 200 of Regulation SHO.

6. Exceptions

Question 6.1: If the national best bid and offer are crossed, must a short sale order in a covered security that is subject to the price test restriction of Rule 201 be at a price above the current national best bid?

Answer: No. If the national best bid and offer for a covered security subject to the short sale price test restriction of Rule 201 become crossed, a short sale order in the covered security may be displayed or executed at a price that is less than or equal to the current national best bid while the market is crossed.

(MODIFIED! 01/20/11)

Question 6.2: Is the VWAP exception of Rule 201(d)(7) limited to VWAP transactions that are arranged or “matched” before the market opens at 9:30 a.m., or that are not assigned a price until after the close of trading when the VWAP value is calculated?

Answer: No. The VWAP exception of Rule 201(d)(7) is not limited to VWAP transactions that are arranged or “matched” before the market opens at 9:30 a.m., or that are not assigned a price until after the close of trading when the VWAP value is calculated. See Rule 201 Adopting Release, 75 FR 11232, 11270 – 11271. To qualify for the exception, however, all of the conditions in Rule 201(d)(7) for the VWAP exception must otherwise be met. In addition, the VWAP period must be sufficiently long that the price of the VWAP trade was not reasonably determinable at the time the commitment to execute was made.

As with any exception under Rule 201(d) of Regulation SHO, any broker-dealer relying on the exception in Rule 201(d)(7) for VWAP trades must be able to demonstrate that reliance on the exception was reasonable.

In addition, when a broker-dealer seeks to act as principal to fill customer VWAP short sale orders, which include non-full day VWAPs in reliance on the above guidance, the broker-dealer should look to its position at the time of commitment, rather than at the pre-opening period, and aggregated across all customers who propose to sell the same covered security short in conducting the calculation required under Rule 201(d)(7)(v).

(NEW! 01/20/11)

Question 6.3: If a covered security has triggered Rule 201’s circuit breaker and a broker-dealer is effecting a customer short sale order in that security on a riskless principal basis, must the flip of the second leg to the customer separately comply with the short sale price test if the initial principal leg was executed in compliance with Rule 201 and the allocation occurred within 60 seconds of that execution?

Answer: No. As long as the initial principal leg was executed in compliance with the requirements of Rule 201 and that execution was allocated to a riskless principal or customer account within 60 seconds, the second leg of the transaction does not have to separately comply with the short sale price test when a broker-dealer is effecting a customer short sale, on a riskless principal basis, in a covered security that has triggered Rule 201’s circuit breaker. Under these limited circumstances, allocation of the principal execution to fill the customer short sale order may occur at a price that is at or below the current national best bid. However, the execution price of the initial principal leg, which complied with the requirements of Rule 201, must be the same price used to satisfy the customer short sale order, exclusive of any explicitly disclosed markup or markdown, commission equivalent, or other fee. See, e.g., Rule 201(a)(8).

For purposes of this guidance, the initial principal leg is considered to have been executed in compliance with Rule 201 if: (i) the broker-dealer marked the order “short” and it was displayed or executed at a price above the current national best bid by a trading center, or (ii) the broker-dealer identified the order as being at a price above the current national best bid at the time of submission to a trading center and marked it “short exempt” under Rule 201(c) (assuming all requirements for reliance on Rule 201(c) are met).

This guidance does not otherwise affect the application of Regulation SHO to the riskless principal transaction. Thus, for example, the broker-dealer would still be required to comply with the locate requirement under Rule 203(b)(1) of Regulation SHO. Further, this guidance does not affect or relate to the “short exempt” marking provided in Rule 201(d)(6). Subparagraph (d)(6) of the Rule permits a broker-dealer to mark the principal leg of a riskless principal transaction as “short exempt” under certain circumstances where the broker-dealer is effecting a customer purchase or customer long sale order. In the scenario covered by this question, the broker-dealer is effecting a customer short sale order, not a customer purchase or long sale order, on a riskless principal basis.

7. Rule 605 of Regulation NMS Statistics

Question 7.1: Should non-exempt short sales be excluded from the monthly reports required by Rule 605 of Regulation NMS?

Answer: Yes. Because in certain circumstances non-exempt short sale orders are subject to a price test, and the circumstances could vary for different securities and different days throughout the month of a Rule 605 report, the staff would view all non-exempt short sale orders as special handling orders that are excluded from the definition of “covered order” in Rule 600(b)(15) of Regulation NMS. Orders marked “short exempt” are not subject to the price test described above, but potentially could qualify for another exclusion if they meet the terms of the exclusion.

8. Customer Order Protection

(MODIFIED! 01/20/11)

Question 8.1: Firm A has a proprietary short position of 10,000 shares in XYZ covered security. Firm A buys 1,000 shares of XYZ covered security for its own account at $20, which is the national best bid at the time. The purchase by Firm A triggers SRO order protection requirements to fill a resting customer limit order to buy XYZ covered security at $20. Is the firm obligated to sell shares short to the customer to fill the limit order at $20, even if it would not comply with the short sale price test restrictions of Rule 201?

Answer: Yes. If a customer limit order to buy is activated under SRO order protection requirements, the firm must fill the customer limit order, regardless of whether such sale would meet the requirements of the price test restrictions of Rule 201. In this instance, the broker-dealer may mark the short sale order to fill the customer limit order as “short exempt.” Provided all of the requirements of this guidance are met, such orders may be marked “short exempt” both when the short sale price test is in effect for a covered security and when the short sale price test is not in effect for the security.

Question 8.2: Firm A has a long position of 20,000 shares in XYZ covered security and sells 15,000 shares of XYZ covered security for its own account at $10, which is the national best bid at the time. This sale by Firm A triggers SRO order protection requirements to fill a resting customer order to sell short XYZ covered security at $10. Is the firm obligated to execute the customer order to sell short at $10, even if such transaction would not comply with the short sale price test restrictions of Rule 201?

Answer: No. In this instance, because the customer limit order would not have been executable under Rule 201 of Regulation SHO (because it is priced at the national best bid), Firm A’s long sale at the national best bid would not require the execution of the customer’s short sale limit order under SRO order protection requirements.

 

http://www.sec.gov/divisions/marketreg/rule201faq.htm


Modified: 07/29/2013