The Bond Market Association

January 13, 2004

Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609

Re: File No. S7-23-03, Short Sales

The Bond Market Association ("TBMA" or the "Association")1 appreciates the opportunity to comment on the proposal by the Securities and Exchange Commission (the "Commission") to adopt Regulation SHO and to amend Rule 105 of Regulation M under the Securities Exchange Act of 1934 (the "Exchange Act").2

Our response is divided into three parts. In Part I below, we support the Commission's proposed exclusion of bonds from the uniform bid test of Regulation SHO. In Part II, we request the Commission's clarification that the proposed "locate" and related requirements of Regulation SHO would apply exclusively to transactions in equity securities. Part III addresses the Commission's request for comments regarding the application of Rule 105 to offerings of non-equity securities.

I. Exclusion of Bonds from the Regulation SHO Bid Test.

The Association supports the Commission's proposal to exclude bonds from the uniform bid test under Rule 201 of Regulation SHO.3 As the Commission noted, there is not currently a source for consolidated quote information for bonds similar to what exists for equities, so in any event the Commission's proposed bid test could not be applied in the bond markets. Even setting this practical issue aside, relevant policy considerations support the exclusion of bonds from regulatory short sale pricing requirements. Although some bonds are listed and traded on exchanges, the overwhelming majority of bond trades are effected in the over-the-counter ("OTC") markets. As noted by the Commission, there is little risk that a market participant could manipulate the primary bond market through short sales on an exchange.

In addition, bond markets generally are not as susceptible to the types of abuses that the short sale rules are intended to prevent because, among other reasons, bond prices (particularly in the investment grade context) depend significantly on applicable interest rates and are less likely to be affected by short selling activity.4 In light of a number of other unique features of the fixed income trading markets that distinguish them from the equity trading markets, moreover, the imposition of the Regulation SHO short sale pricing restrictions on debt securities could have important and potentially adverse consequences for the markets as a whole.

The Association recommends that, in order to avoid confusion among market participants as to the scope of proposed Rule 201 and its application to the fixed income markets, the text of the Rule be modified to explicitly exclude transactions in any non-equity securities.

II. Other Requirements of Regulation SHO.

Proposed Rule 203 would impose certain locate and delivery requirements on sales of securities, and proposed Rule 201(c) would impose certain marking requirements on sell orders. Although as drafted these rules could arguably apply to all securities, based on the discussion in the Proposing Release as well as the purpose and content of the rules it seems clear that they were intended to apply only to transactions in equity securities. Accordingly, if the Commission adopts these requirements, the Association respectfully requests that it clarify in the text of the final rules that they do not apply to transactions in non-equity securities, whether effected on an exchange or in the OTC markets.

In the Proposing Release, the Commission repeatedly described the locate, delivery and order marking requirements of Regulation SHO as applying to equity securities.5 It did not suggest that these requirements would apply to non-equity securities, nor did it address or request comment on any issues that might be raised by imposing these requirements in the fixed income markets. Instead, the Commission analyzed and solicited comments on the potential benefits and costs of applying the uniform short sale rules of Regulation SHO to equity securities that may not be subject to comparable requirements under existing rules. We note, moreover, that relevant Commission and self-regulatory organization rules currently imposing order marking and locate requirements contain general exceptions or exclusions for non-equity securities. Since the Commission did not discuss or articulate any need to modify current law so substantially as to include all non-equity securities within the scope of these requirements, we assume it did not intend to do so.

Certain technical requirements of the proposed rules also indicate that they were drafted to apply solely to transactions in equity securities. For example, the special delivery requirement of Rule 203(b)(3) is triggered when the number of "shares" that have not been delivered at the relevant clearing agency exceeds 10,000.6 In addition, the delivery requirements of Rule 203(a) appear to assume that the broker-dealer accepting a long sale order would execute the trade with and make delivery to another broker acting on behalf of the purchaser, as is typical in the equity markets, rather than entering into a principal transaction directly with the seller, as is more common in the fixed income markets. Similarly, it is unclear how the "borrow" requirements of Rule 203(b) - i.e., the requirement to have borrowed the security or have reasonable grounds to believe the security can be borrowed - would operate in the case of certain fixed income transactions, such as delayed delivery trades in which settlement may be extended substantially beyond the standard settlement cycle.7

For the foregoing reasons, we assume that proposed Rules 201(c) and 203 were intended to apply only to equity securities, and would recommend a clarification to this effect in any final rules adopted by the Commission. If this assumption is incorrect, we would request the opportunity to review with the Commission staff, prior to adoption of these rules, the significant technical and policy issues and potential market disruption that would arise in connection with their application to non-equity securities.

III. Application of Rule 105 of Regulation M to Debt Offerings.

The Proposing Release solicits comment on the potential elimination of the current "shelf offering" exception of Rule 105 of Regulation M, as well as on the relevance of Rule 105 to offerings of debt securities generally. TBMA believes that there are a number of special features of debt offerings that should be taken into account in considering the scope of the Rule.

Rule 105 is intended to limit the ability of market participants to artificially depress the offering price for securities by selling those securities short immediately prior to the offering and then covering such short sales with securities purchased from an underwriter participating in the offering. As stated in the Proposing Release, "[s]hort sales of securities that depress the market price shortly before an offering is priced can cause . . . the offering price to be lower than anticipated because artificial forces distort it."8

In the case of debt offerings, the type of manipulative activity that Rule 105 prohibits would seem less likely to occur. Unlike equity offerings in which an issuer sells more stock of a class that is already being traded, offerings of debt frequently involve the issuance of a new class of securities for which there is no market into which the offered securities can be sold "short" prior to their pricing. Even when short selling could occur in advance of pricing (e.g., in a "reopening" of a class of issued debt securities), however, such activity would appear less likely to affect the offering price than in the case of an equity offering. As noted in Part I above, prices for non-equity securities (particularly investment grade debt) depend significantly on applicable interest rates and the relative value of other bonds with similar features and are less likely to be affected by short selling activity.

In light of the foregoing, it may be appropriate to consider excluding non-equity securities offerings from the scope of Rule 105, especially if the current shelf offering exception in the Rule is eliminated. This exception appears to have been designed, at least in part, to limit the application of the Rule to debt offerings: upon incorporating the shelf offering exception into Rule 105 the Commission noted that it might reconsider the exception if shelf-registered offerings of equity securities were to become a more common occurrence.9 If the Commission now deems a shelf offering exception no longer appropriate because it can be used for equity offerings, the Commission could continue to accommodate the distinct features of non-equity offerings by excluding them from Rule 105.

* * *

The Association appreciates the opportunity to comment on the Proposing Release. Please feel free to contact the undersigned at (646) 637-9220 with any questions.


/s/ Michele C. David

Michele C. David
Vice President
and Assistant General Counsel

cc: Securities and Exchange Commission
William H. Donaldson, Chairman
Cynthia A. Glassman, Commissioner
Harvey J. Goldschmid, Commissioner
Paul S. Atkins, Commissioner
Roel C. Campos, Commissioner
Annette L. Nazareth, Director, Division of Market Regulation
Robert L.D. Colby, Deputy Director, Division of Market Regulation

The Bond Market Association
Micah Green, President
Paul Saltzman, Executive Vice President and General Counsel
John Vogt, Executive Vice President
Lynnette Hotchkiss, Senior Vice President and Associate General Counsel

1 TBMA represents securities firms and banks that underwrite, distribute and trade fixed income securities, both domestically and internationally. TBMA's member firms are actively involved in the funding markets for such securities, including the repurchase and securities lending markets. Further information regarding TBMA and its members and activities can be obtained from our web site (
2 Exchange Act Release No. 48709 (October 28, 2003), 68 Fed. Reg. 62972 (November 6, 2003) (the "Proposing Release").
3 See Proposing Release, 68 Fed. Reg. at 62996.
4 See, e.g., Exchange Act Release No. 30772 (June 3, 1992), 57 Fed. Reg. 24415, 24418 (June 9, 1992) (summarizing letter from the American Stock Exchange noting that because bond prices generally are related to and move in tandem with interest rate changes, the potential for market manipulation through short selling is significantly reduced).
5 For example, see pages 62972 ("[p]roposed Regulation SHO would, among other things, require short sellers in all equity securities to locate securities to borrow before selling"); 62976 ("[w]e are therefore proposing to incorporate in proposed Regulation SHO a uniform "locate" rule applicable to all equity securities, wherever they are traded"); 62977 (the Commission believes that "these additional delivery requirements [for short sales] should be extended to all equity securities registered under Section 12 of the Exchange Act"); 63000 (proposed Regulation SHO would require "that all sell orders of equity securities registered under the Exchange Act be marked `long,' `short,' or `short exempt'"); 63002 ("[t]he Commission proposes extending the marking requirements to all equity securities, including OTCBB and Pink Sheet securities", and "[t]he Commission recognizes that there is a paperwork burden cost associated with . . . extending the marking requirement to all equity securities"); 63003 ("the rule would extend current delivery requirements for long sales of listed securities to all equity securities, including Nasdaq NMS, Nasdaq SmallCap, OTCBB, and Pink Sheet securities"); and 63005 (proposed Regulation SHO would apply "enhanced locate and delivery requirements to all equity securities") (emphasis added in each instance). Other relevant pages include 62999 and 63006.
6 Similarly, one of the exceptions to the long sale delivery requirement of Rule 203(a) is available only if the sale was made at a "price permissible for a short sale" under Rule 201, which the Commission explicitly stated does not apply to debt securities.
7 In addition, the policy rationales that support order marking, locate and delivery requirements for equity securities do not necessarily support such requirements for debt securities. For example, one of the primary purposes of the order marking requirement is to help detect and prevent violations of the pricing restrictions under Rule 201, which do not apply to debt. Similarly, although a key objective of the proposed locate and delivery requirements is to limit the ability of naked short sellers to engage in market manipulation, as noted by the Commission in the Proposing Release the risk that short sellers could deliberately depress the price of a bond is quite limited.
8 Proposing Release, 68 Fed. Reg. at 62998.
9 See Exchange Act Release No. 38067 (December 20, 1996), 62 Fed. Reg. 520, at 538 (January 3, 1997).