This document is under revision. Please see the following documents for updated information: 34-56212, 38-58775, 38-60388, 38-58774, and
Division of Market Regulation:
Key Points About Regulation SHO
Date: April 11, 2005
I. Short Sales
A. What is a short sale?
A short sale is generally the sale of a stock you do not own (or that you will borrow for delivery).1 Short sellers believe the price of the stock will fall, or are seeking to hedge against potential price volatility in securities that they own.
If the price of the stock drops, short sellers buy the stock at the lower price and make a profit. If the price of the stock rises, short sellers will incur a loss. Short selling is used for many purposes, including to profit from an expected downward price movement, to provide liquidity in response to unanticipated buyer demand, or to hedge the risk of a long position in the same security or a related security.
B. Example of a short sale.
For example, an investor believes that there will be a decline in the stock price of Company A. Company A is trading at $60 a share, so the investor borrows shares of Company A stock at $60 a share and immediately sells them in a short sale. Later, Company A's stock price declines to $40 a share, and the investor buys shares back on the open market to replace the borrowed shares. Since the price is lower, the investor profits on the difference -- in this case $20 a share (minus transaction costs such as commissions and fees). However, if the price goes up from the original price, the investor loses money. Unlike a traditional long position — when risk is limited to the amount invested — shorting a stock leaves an investor open to the possibility of unlimited losses, since a stock can theoretically keep rising indefinitely.
C. How does short selling work?
Typically, when you sell short, your brokerage firm loans you the stock. The stock you borrow comes from either the firm's own inventory, the margin account of other brokerage firm clients, or another lender. As with buying stock on margin,2 your brokerage firm will charge you interest on the loan, and you are subject to the margin rules. If the stock you borrow pays a dividend, you must pay the dividend to the person or firm making the loan.
D. Are short sales legal?
Although the vast majority of short sales are legal, abusive short sale practices are illegal. For example, it is prohibited for any person to engage in a series of transactions in order to create actual or apparent active trading in a security or to depress the price of a security for the purpose of inducing the purchase or sale of the security by others. Thus, short sales effected to manipulate the price of a stock are prohibited.
II. "Naked" Short Sales
In a "naked" short sale, the seller does not borrow or arrange to borrow the securities in time to make delivery to the buyer within the standard three-day settlement period. 3 As a result, the seller fails to deliver securities to the buyer when delivery is due (known as a "failure to deliver" or "fail").
Failures to deliver may result from either a short or a long sale. There may be legitimate reasons for a failure to deliver. For example, human or mechanical errors or processing delays can result from transferring securities in physical certificate rather than book-entry form, thus causing a failure to deliver on a long sale within the normal three-day settlement period. A fail may also result from naked short selling. For example, market makers who sell short thinly traded, illiquid stock in response to customer demand may encounter difficulty in obtaining securities when the time for delivery arrives.
Naked short selling is not necessarily a violation of the federal securities laws or the Commission's rules. Indeed, in certain circumstances, naked short selling contributes to market liquidity. For example, broker-dealers that make a market in a security4 generally stand ready to buy and sell the security on a regular and continuous basis at a publicly quoted price, even when there are no other buyers or sellers. Thus, market makers must sell a security to a buyer even when there are temporary shortages of that security available in the market. This may occur, for example, if there is a sudden surge in buying interest in that security, or if few investors are selling the security at that time. Because it may take a market maker considerable time to purchase or arrange to borrow the security, a market maker engaged in bona fide market making, particularly in a fast-moving market, may need to sell the security short without having arranged to borrow shares. This is especially true for market makers in thinly traded, illiquid stocks such as securities quoted on the OTC Bulletin Board,5 as there may be few shares available to purchase or borrow at a given time.
III. Regulation SHO
Compliance with Regulation SHO began on January 3, 2005. Regulation SHO was adopted to update short sale regulation in light of numerous market developments since short sale regulation was first adopted in 1938. Some of the goals of Regulation SHO include:
- Establishing uniform "locate" and "close-out" requirements in order to address problems associated with failures to deliver, including potentially abusive "naked" short selling.
- Locate Requirement: Regulation SHO requires a broker-dealer to have reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due before effecting a short sale order in any equity security.6 This "locate" must be made and documented prior to effecting the short sale.
- "Close-out" Requirement: Regulation SHO imposes additional delivery requirements on broker-dealers for securities in which there are a relatively substantial number of extended delivery failures at a registered clearing agency7 ("threshold securities"). For instance, with limited exception, Regulation SHO requires brokers and dealers that are participants of a registered clearing agency8 to take action to "close-out" failure-to-deliver positions ("open fails") in threshold securities that have persisted for 13 consecutive settlement days.9 Closing out requires the broker or dealer to purchase securities of like kind and quantity. Until the position is closed out, the broker or dealer and any broker or dealer for which it clears transactions (for example, an introducing broker)10 may not effect further short sales in that threshold security without borrowing or entering into a bona fide agreement to borrow the security (known as the "pre-borrowing" requirement).
- Temporarily suspending Commission and SRO11 short sale price tests12 in a group of securities to evaluate the overall effectiveness and necessity of such restrictions. The Commission will study the impact of relaxing the price tests for a period of one year.13
- Creating uniform order marking requirements for sales of all equity securities. This means that orders you place with your broker-dealer must be marked "long," "short," or "short exempt."14
IV. Threshold Securities
A. The Basics
1. What is a Threshold Security?
Threshold securities are equity securities that have an aggregate fail to deliver position for:
- five consecutive settlement days at a registered clearing agency (e.g., National Securities Clearing Corporation (NSCC));15
- totaling 10,000 shares or more; and
- equal to at least 0.5% of the issuer's total shares outstanding.16
Threshold securities only include issuers registered or required to file reports with the Commission ("reporting companies").17 Therefore, securities of issuers that are not registered or required to file reports with the Commission, which includes the majority of issuers on the Pink Sheets,18 cannot be threshold securities. This is because the SROs need to look to the total outstanding shares of the issuer in order to calculate whether or not the securities meet the definition of a "threshold security." For non-reporting companies, reliable information on total outstanding shares is difficult to determine.
2. Who is Responsible for Identifying Threshold Securities?
Regulation SHO requires the SROs to disseminate a daily list of threshold securities where such SRO, or its market center,19 is the primary listing venue for any such security.
3. Where Can I Find Threshold Lists?
Each SRO is responsible for providing the threshold securities list for those securities for which the SRO is the primary market. You can obtain SRO threshold lists at the following websites:
The Boston Stock Exchange, Philadelphia Stock Exchange and National Stock Exchange are not the primary listing exchange for any securities at this time and, therefore, are currently not publishing threshold securities lists.
4. Inclusion on, and Removal from, Threshold Lists.
At the conclusion of each settlement day, NSCC provides the SROs with data on securities that have aggregate fails to deliver at NSCC of 10,000 shares or more. For the securities for which an SRO is the primary market, that SRO calculates whether the level of fails for each security is equal to, or greater than, 0.5% of the issuer's total shares outstanding of the security. If, for five consecutive settlement days, such security satisfies these criteria, then such security is a threshold security. Each SRO includes such security on its daily threshold list until the aggregate fails level for the security falls below these levels for five consecutive days. (See below for a discussion as to why a security may appear or remain on a threshold list.)
5. Implementation Dates for Threshold Lists.
The SROs disseminated the first threshold lists on January 10, 2005. Regulation SHO does not require a broker or dealer to close-out the open fail position until a security appears on a threshold list for 13 consecutive settlement days and an open fail position for such security exists for each of those days.. Therefore, the first day on which a close-out action could have been required for a threshold security was January 28, 2005.
6. Mandatory Close-Outs of Threshold Securities.
Regulation SHO requires broker-dealers to close-out all failures to deliver that exist in threshold securities for thirteen consecutive settlement days by purchasing securities of like kind and quantity ("close-out").20
Until the position is closed out, the broker or dealer and any broker or dealer for which it clears transactions (for example, an introducing broker),21 may not effect further short sales in that threshold security without borrowing or entering into a bona fide agreement to borrow the security (known as a "pre-borrowing" requirement).
7. Key Points to Remember.
Any equity security of an issuer that is registered or required to file reports with the Commission could qualify as a threshold security. Therefore, threshold securities may include equity securities:
- listed on an exchange, 22
- quoted on Nasdaq,23 or
- quoted on the OTCBB.24
Whether or not a security is a threshold security does not affect the Commission's ability to prosecute manipulative or fraudulent activity that may have occurred before or after adoption of Regulation SHO.
B. Reasons Why A Security May Appear on a Threshold List
A security's appearance on a threshold list does not necessarily mean that any improper activity has occurred or is occurring. An equity security will appear on a threshold list if it meets the definition of a threshold security set forth in Regulation SHO, meaning that failures to deliver the stock (i.e. to the party on the other side of the trade) have reached an aggregate of 10,000 shares or greater at NSCC for five consecutive settlement days and are equal to 0.5% of total shares outstanding;
C. Reasons Why A Security May Stay on a Threshold List for Longer Than 13 Consecutive Settlement Days
Even when broker-dealers close-out delivery failures, a security may remain on an SRO's threshold securities list for longer than 13 days. Examples of why securities may remain on the threshold securities list:
- after broker-dealers close-out all delivery failures, the security stays on the threshold list for five consecutive days;
- new delivery failures resulting from long or short sales may have crossed the threshold, keeping the security on the SRO's threshold securities list; or
- the delivery failures at NSCC may have been established prior to a security's appearance on the SRO's threshold securities list, and are grandfathered from the close-out requirement of Regulation SHO.
For information about specific securities, contact the appropriate SRO or its market center listed above.
D. Reasons Why A Security With a Large Short Position May Not Appear on a Threshold List
There are various reasons why an equity security with a large short position may not appear on an SRO's threshold securities list, 25 for example:
- the aggregate delivery failures do not meet the definition of a threshold security in Regulation SHO;
- the security's issuer is not registered or required to file reports with the Commission. For instance, the majority of issuers quoted on the Pink Sheets do not file reports or register with the Commission, and so would not appear on threshold lists.26
E. Who Do I Contact For More Information About Securities On a Threshold List?
If you have a question regarding a security on a particular SRO's threshold security list, contact that SRO directly. The following SROs are publishing threshold securities lists:
F. Grandfathering Under Regulation SHO
The requirement to close-out fail to deliver positions in threshold securities that remain for 13 consecutive settlement days does not apply to positions that were established prior to the security becoming a threshold security. This is known as "grandfathering." For example, open fail positions in securities that existed prior to the effective date of Regulation SHO on January 3, 2005 are not required to be closed out under Regulation SHO.
The grandfathering provisions of Regulation SHO were adopted because the Commission was concerned about creating volatility where there were large pre-existing open positions. The Commission will continue to monitor whether grandfathered open fail positions are being cleaned up under existing delivery and settlement guidelines or whether further action is warranted.
It is important to note that the "grandfathering" clause of the Regulation does not affect the Commission's ability to prosecute violations of law that may involve such securities or violations that may have occurred before the adoption of Regulation SHO or that occurred before the security became a threshold security.
V. Answers to Frequently-Asked Questions from Investors
1. Is all naked short selling abusive or illegal?
When considering naked short selling, it is important to know which activity is the focus of discussion.
- Selling stock short without having located stock for delivery at settlement. This activity would violate Regulation SHO, except for short sales by market makers engaged in bona fide market making. Market makers do not have to locate stock before selling short, because they need to be able to provide liquidity. However, market makers are not excepted from Regulation SHO's close-out and pre-borrow requirements.
- Selling stock short and failing to deliver shares at the time of settlement. This activity doesn't necessarily violate any rules. There are legitimate reasons why a seller may fail to deliver on the scheduled settlement date.
- Selling stock short and failing to deliver shares at the time of settlement with the purpose of driving down the security's price. This manipulative activity, in general, would violate various securities laws, including Rule 10b-5 under the Exchange Act. Regulation SHO does not address this issue.
2. Is naked short selling the reason my stock has lost value?
Investors should always use caution before investing in high-risk, speculative stocks, especially with regard to their retirement portfolios, because all stocks may decline in value. There are many reasons why a stock may decline in value. The value of a stock is determined by the basic relationship between supply and demand. If many people want a stock (demand is high), then the price will rise. If a few people want a stock (demand is low), then the price will fall. The main factor determining the demand for a stock is the quality of the company itself. If the company is fundamentally strong, that is, if it is generating positive income, its stock is less likely to lose value.
Speculative stocks, such as microcap stocks, often have a high probability of declining in value and a low probability of experiencing above average gains.27 For example, investors should take extra care to thoroughly research any company quoted exclusively in the Pink Sheets.28 With the exception of a few foreign issuers, the companies quoted in the Pink Sheets tend to be closely held, extremely small or thinly traded. Most do not meet the minimum listing requirements for trading on a national securities exchange, such as the New York Stock Exchange or the Nasdaq Stock Market. Many of these companies do not file periodic reports or audited financial statements with the SEC, making it very difficult for investors to find reliable, unbiased information about those companies.
There also may be instances where a company insider or paid promoter provides false and misleading excuses for why a company's stock price has recently decreased. For instance, these individuals may claim that the price decrease is a temporary condition resulting from the activities of naked short sellers. The insiders or promoters may hope to use this misinformation to move the price back up so they can dump their own stock at higher prices. Often, the price decrease is a result of the company's poor financial situation rather than the reasons provided by the insiders or promoters.
Naked short selling, however, can have negative effects on the market. Fraudsters may use naked short selling as a tool to manipulate the market. Market manipulation is illegal.29 The SEC has toughened its rules and is vigilant about taking actions against wrongdoers.30 Fails to deliver that persist for an extended period of time may result in a significantly large unfulfilled delivery obligation at the clearing agency where trades are settled. Regulation SHO is intended to address these effects by reducing the number of potential failures to deliver, and by limiting the time in which a broker can permit a fail to deliver to persist. For instance, as explained above, Regulation SHO requires brokers and dealers to close-out the open fail-to-deliver positions in "threshold securities" (i.e., securities that have experienced a substantial number of extended delivery failures) that have persisted for 13 consecutive settlement days.
3. Do all failures to deliver reflect improper activity that should be closed out?
A "fail to deliver" occurs when a broker-dealer fails to deliver securities to the party on the other side of the transaction on settlement date. There are many justifiable reasons why broker-dealers do not or cannot deliver securities on settlement date. A broker-dealer may experience a problem that is either unanticipated or is out of its control, such as (1) delays in customers delivering their shares to a broker-dealer, (2) the inability to obtain borrowed shares in time for settlement, (3) issues related to the physical transfer of securities, or (4) the failure of a broker-dealer to receive shares it had purchased to fulfill its delivery obligations. Fails to deliver can result from both long and short sales.
Regulation SHO was designed to target potentially problematic failures to deliver. Prevention of fails is the goal of the locate requirement. Regulation SHO requires broker-dealers to identify a source of borrowable stock before executing a short sale in any equity security with the goal of reducing the number of situations where stock is unavailable for settlement. But, because the locate is usually done three days before settlement, the stock may not be available from the source at the time of settlement, possibly resulting in a fail.
Regulation SHO also requires some fail positions to be closed out. When a broker-dealer has a fail position in a "threshold security," and that fail position has persisted for 13 consecutive settlement days, the broker-dealer must take immediate steps to close-out the fail by purchasing securities of like kind and quantity. Even market makers that have such persistent fails in threshold securities must close-out their positions.
4. Is it a violation of law when trades do not settle on T+3?
Generally, investors must complete or "settle" their security transactions within three business days. This settlement cycle is known as "T+3," shorthand for "trade date plus three days."
T+3 means that when you buy a security, your payment must be received by your brokerage firm no later than three business days after the trade is executed. When you sell a security, you must deliver your securities, in certificated or electronic form, to your brokerage firm no later than three business days after the sale.
The three-day settlement date 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 business day following the trade.31
Because the Commission recognized that there are many reasons why broker-dealers may fail to deliver securities on settlement date, it designed and adopted Rule 15c6-1 to prohibit broker-dealers from contracting to settle transactions later than T+3. However, failure to deliver securities on T+3 does not violate the rule.
5. Does inclusion of a stock on the threshold list mean that improper trading is occurring in the stock?
The appearance of a security on a threshold list does not necessarily mean that there has been abusive naked short selling or any impermissible trading in the stock. Delivery failures can be caused by both long and short sales. In addition, notwithstanding actions by broker-dealers to close-out delivery failures, certain securities may remain on an SRO's threshold securities list for an extended period for a variety of legitimate reasons, such as:
- Despite proper action to close-out fails, new delivery failures from long or short sales, at the same or other broker-dealers, result in the security staying on the threshold list;
- One or more broker-dealers may have temporary but legitimate problems in obtaining the stock they borrowed in time for delivery;
- Long sellers may have difficulty in producing stock in good deliverable form to their broker-dealer;
- The delivery failures were established prior to a security's appearance on the SRO's threshold securities list, and thus are "grandfathered" from the close-out requirement.
6. Should all equity securities with high levels of fails appear on a threshold list?
Although Regulation SHO's locate provision applies to all equity securities, the close-out provisions and inclusion on a threshold securities list apply only to equity securities of companies required to register or file reports with the Commission ("reporting companies").32 As described above, reporting companies typically trade on an exchange or are quoted on the Nasdaq or OTCBB. Only some reporting companies are quoted on the Pink Sheets.33 Regulation SHO is limited to reporting companies because of the difficulty in obtaining accurate total shares outstanding data for non-reporting companies.
7. Does grandfathering permit illegal activity to go unaddressed?
Regulation SHO does not require close-outs of "grandfathered" fails. As noted above, "grandfathered" status applies where the fail position was established prior to the security becoming a threshold security. However, any new fails in a security on the threshold list are subject to the mandatory close-out provisions.
Any grandfathered position that resulted from illegal activity, such as manipulation, continues to be fully subject to redress by the Commission.34 The Commission will continue to monitor whether grandfathered open fail positions are being cleaned up under existing delivery and settlement guidelines or whether further action is warranted.
8. Do the issuers of threshold securities have "problems?"
Inclusion on the threshold list simply indicates that the aggregate failures to deliver in an issuer's equity securities have reached the level required to become a "threshold security" as defined in Regulation SHO. Inclusion on the list should not be interpreted as connoting anything negative about the particular issuer.
9. Will close-out purchases required by Regulation SHO drive up a security's price?
Close-out purchases of stock on threshold securities lists will not necessarily drive up prices of such stocks. One of the primary purposes of Regulation SHO is to clean up open fail positions in threshold securities when they reach a relatively low aggregate level, but not to cause short squeezes. The term "short squeeze" refers to the pressure on short sellers to cover their positions as a result of sharp price increases or difficulty in borrowing the security the sellers are short. The rush by short sellers to cover produces additional upward pressure on the price of the stock, which then can cause an even greater squeeze. Although some short squeezes may occur naturally in the market, a scheme to manipulate the price or availability of stock in order to cause a short squeeze is illegal.
To date, there has been little evidence of rapid and unusual upward price movement in threshold stocks.
10. Where can I obtain information on short sale positions?
The SROs publish monthly statistics on short interest in securities that trade on their markets.35 Short interest is the aggregate number of open short sale positions. Short interest does not address the number of fails to deliver that may have occurred or may occur in connection with these short sales.
Short interest for NYSE stocks can be found at: http://www.nyse.com/marketinfo/datalib/1022221393023.html#moshortint. You also can learn the short interest for individual stocks that trade on the NYSE, American Stock Exchange, and Nasdaq at http://www.nasdaqtrader.com/asp/short_interest.asp or by visiting the NasdaqTrader's website at www.nasdaqtrader.com.
There also are many commercial websites and some newspapers that offer this information. If you enter the words "short interest" into most Internet search engines, you'll quickly find websites that can provide this information.
11. Can I obtain fails information?
Currently, threshold lists include the name and ticker symbol of securities that meet the threshold level on a particular settlement date. Some investors have requested that the SROs provide more detailed information for each threshold security, including the total number of fails, the total short interest position, the name of the broker-dealer firm responsible for the fails, and the names of the customers of responsible brokers and dealers responsible for the short sales. The fails statistics of individual firms and customers is proprietary information and may reflect firms' trading strategies. The release of this information could be used to engage in unlawful upward manipulation of the price of the securities in order to "squeeze" the firms improperly.
12. I read on an internet chat room or website that a specific security has a large number of fails; are these sources reliable?
Investors should always be cautious that issuers, promoters, or shareholders may be seeking to stimulate buying interest by making false, misleading or unfounded statements in internet chat rooms or other such forums about alleged large naked short positions in some smaller issuers, particularly those trading on the OTCBB or Pink Sheets. Some individuals may encourage other investors to buy these issuers' securities by claiming that there will be an imminent "short squeeze," in which the alleged naked short sellers will be forced to cover open short positions at increasing prices. These claims in fact may be false.
The Commission's Office of Investor Education and Assistance has made available publications on the Commission's Internet web site (www.sec.gov) that provide helpful guidance on the securities markets and sales and trading practices, including short selling. Investors and prospective investors should be cautious of rumors on chat rooms where the intent of nameless and faceless computer users is in doubt.
13. Where can I find information on specific issuers or securities?
To find information on issuers and securities, see http://www.sec.gov/investor/pubs/easyaccess.htm.
14. Does NSCC's stock borrow program create "counterfeit shares?"
NSCC's stock borrow program, as approved by the Commission, permits NSCC to borrow securities from its participants for the purpose of completing settlements only if participants have made those securities available to NSCC for this purpose and those securities are on deposit in the participant's account at DTC.
15. Where can I submit information on potential violations of the federal securities laws?
If you have specific enforcement-related information, please see http://www.sec.gov/complaint.shtml for information on how to submit a complaint. You may also call 1-800-SEC-0330.
16. Where can I find information on investigations or enforcement actions pending against specific issuers or regarding specific securities?
As a policy, the SEC will neither confirm nor deny the existence of an investigation unless, and until, it becomes a matter of public record as the result of a court action or administrative proceeding. SEC investigations are conducted on a non-public and confidential basis to help assure the integrity of the investigative process. See http://www.sec.gov/investor/pubs/howoiea.htm for more information on how the Commission handles complaints.
To view enforcement actions that the Commission has taken, see http://www.sec.gov/litigation/litreleases.shtml.
VI. Reporting Alleged Abusive Naked Short Selling Activity
The markets and the SROs are primarily responsible for the surveillance and enforcement of trading activity pursuant to their rules. The SEC, however, independently or in conjunction with the SROs and other regulatory authorities, actively investigates and prosecutes violations of the federal securities laws.
The SEC takes information alleging violations of the federal securities laws very seriously. If you have specific enforcement-related information, please send it in an email to firstname.lastname@example.org. Please note, however, the SEC will neither confirm nor deny the existence of an investigation unless, and until, it becomes a matter of public record as the result of a court action or administrative proceeding. As you may also be aware, SEC investigations are conducted on a non-public and confidential basis to help assure the integrity of the investigative process. See http://www.sec.gov/investor/pubs/howoiea.htm for more information on how the Commission handles complaints.
VII. Regulation SHO – Releases and Other Guidance
The final adopting release for Regulation SHO and other key documents relating to short sale regulation, such as the "Frequently Asked Questions Regarding Regulation SHO" published by the Staff of the Division of Market Regulation, are available on the Commission's website at: http://www.sec.gov/spotlight/shortsales.htm.
The NasdaqTrader has also issued guidance on Regulation SHO through a Frequently Asked Questions release on its website at: http://www.nasdaqtrader.com/trader/hottopics/RegSHOFAQs.pdf.
VIII. Who Do I Contact If I Have Questions about Regulation SHO?
Individual investors who have comments or information should feel free to contact the SEC's Office of Investor Education and Assistance at 1-800-SEC-0330 or (202) 942-7040. Investors can also file complaints at http://www.sec.gov/complaint.shtml.
|1|| For more information on short sales, see http://www.sec.gov/answers/shortsale.htm.
|2|| For information regarding margin, please see http://www.sec.gov/answers/margin.htm.
|3|| For more information on the three-day settlement period, also known as "T+3," see http://www.sec.gov/answers/tplus3.htm and http://www.sec.gov/investor/pubs/tplus3.htm.
|4|| For more information about market making, see http://www.sec.gov/answers/mktmaker.htm and http://www.sec.gov/answers/specialist.htm.
|5|| For more information on the OCTBB, see http://www.sec.gov/answers/otcbb.htm.
|6|| Broker-dealers engaged in bona-fide market making are excepted from having to borrow or arrange to borrow shares due to their potential need to facilitate customer orders in fast-moving markets without possible delays associated with complying with Regulation SHO. For instance, as explained above, they may be required by their market making obligations to sell short in situations where it may be difficult to quickly locate and borrow securities. However, this exception is limited. For example, bona-fide market making does not include activity that is related to speculative selling strategies or investment purposes of the broker-dealer or that is disproportionate to the usual market making patterns or practices of the broker-dealer in that security. Further, bona-fide market making does not include transactions whereby a market maker enters into an arrangement with another broker-dealer or customer in an attempt to use the market maker's exception for the purpose of avoiding compliance with Regulation SHO by the other broker-dealer or customer.
|7|| Clearing Agencies are self-regulatory organizations that are required to register with the Commission. There are two types of clearing agencies -- clearing corporations and depositories. Clearing corporations compare member transactions (or report to members the results of exchange comparison operations), clear those trades and prepare instructions for automated settlement of those trades, and often act as intermediaries in making those settlements. Depositories hold securities certificates in bulk form for their participants and maintain ownership records of the securities on their own books. Clearing corporations generally instruct depositories to make securities deliveries that result from settlement of securities transactions. In addition, depositories receive instructions from participants to move securities from one participant's account to another participant's account, either for free or in exchange for a payment of money. See http://www.sec.gov/divisions/marketreg/mrclearing.shtml and www.dtcc.com for more information about the clearance and settlement process and DTCC.
|8|| A participant of a clearing agency means any person or firm, such as a broker-dealer, that uses a clearing agency to clear and settle securities transactions or to transfer, pledge, lend, or hypothecate securities. It does not include a person or firm whose only use of a clearing agency is (a) through another person or firm that is a participant or (b) as a pledge of securities. Section 3(a)(24) of the Exchange Act, 15 U.S.C. 78c(a)(24).
|9|| Settlement day means any business day on which deliveries of securities and payments of money may be made through the facilities of a registered clearing agency.
|10||Introducing brokers are typically brokers that perform all the functions of a broker except for the ability to accept money, securities, or property from a customer. They are usually not participants of registered clearing agencies and do not perform clearance and settlement functions. See Footnote 9 for more information about participants of a clearing agency.
|11|| A self-regulatory organization is a membership-based organization that creates and enforces rules for its members based on the federal securities laws. SROs, which are overseen by the SEC, are the front line in regulating broker-dealers. See http://www.sec.gov/about/whatwedo.shtml for more information.
|12|| For example, the tick test of Rule 10a-1 of the Securities Exchange Act of 1934 provides that, subject to certain exceptions, an exchange-listed security may only be sold short: (i) at a price above the immediately preceding reported price ("plus tick"), or (ii) at the last sale price if it is higher than the last different reported price ("zero-plus tick"). The New York Stock Exchange has a similar tick test under NYSE Rule 440B, and NASD has a bid test under NASD Rule 3350.
|13|| Specifically, the price tests will be relaxed for securities included on a list of approximately 1,000 actively-traded securities, and after-hours trading (4:15 p.m. until the open of the consolidated tape the following day) of another list of approximately 1,000 securities. For more information on this pilot, see http://www.sec.gov/spotlight/shopilot.htm, and http://www.sec.gov/news/press/2004-164.htm.
|14|| Under the rule, an order can be marked "long" when the seller owns the security being sold and the security either is in the physical possession or control of the broker-dealer, or it is reasonably expected that the security will be in the physical possession or control of the broker or dealer no later than settlement. However, if a person does not own the security, or owns the security sold and does not reasonably believe that the security will be in the possession or control of the broker-dealer prior to settlement, the sale should be marked "short." The sale could be marked "short exempt" if the seller is entitled to rely on an exception from the tick test of Rule 10a-1, or the price test of an exchange or national securities association. Short sales of pilot securities effected during the pilot should be marked "short exempt."
|15|| The majority of equity trades in the U.S. are cleared and settled through systems administered by clearing agencies registered with the Commission. The National Securities Clearing Corporation ("NSCC"), the largest registered clearing agency for equity securities, clears and settles through its Continuous Net Settlement system ("CNS"). The CNS system nets the securities delivery obligations and the payment obligations of all clearing corporation participants. Clearing corporations notify participants of their securities delivery and payment obligations each day. In addition, the clearing corporation guarantees the completion of all transactions and interposes itself as the contraparty to both sides of any transaction. Clearance may be accomplished on a trade-by-trade basis or through netting of trades either bilaterally between the two counterparties or multilaterally among all members of a clearing corporation to yield balance orders reflecting a single day's trades or all open positions to date (continuous net settlement or "CNS"). See http://www.sec.gov/divisions/marketreg/mrclearing.shtml for more information on clearance and settlement.
|16|| Outstanding shares (or outstanding stock) are the total amount of shares of a corporation's stock that have been issued.
|17|| See http://www.sec.gov/answers/regis33.htm, http://www.sec.gov/investor/pubs/microcapstock.htm and http://www.sec.gov/info/smallbus/qasbsec.htm for more information on who is required to register and report.
|18|| See http://www.sec.gov/answers/pink.htm for more information about the Pink Sheets.
|19|| See http://www.sec.gov/answers/market.htm for information on market centers.
|20|| The requirement to close-out fail to deliver positions in threshold securities that remain for 13 consecutive settlement days does not apply to any positions that were established prior to the security becoming a threshold security. This is explained in more detail below.
|21|| Introducing brokers are typically brokers that perform all the functions of a broker except for the ability to accept money, securities, or property from a customer. They are usually not participants of registered clearing agencies. See Footnote 9 for more information about participants of a clearing agency.
|22|| See http://www.sec.gov/answers/market.htm for more information about the exchanges.
|23|| See http://www.sec.gov/answers/nasdaq.htm for more information about Nasdaq.
|24||See http://www.sec.gov/answers/otcbb.htm for more information about the OTCBB.
|25|| These lists do not reflect short interest positions of securities. Short interest is the aggregate number of open short sale positions. Short interest does not address the number of fails to deliver that may have occurred or may occur in connection with these short sales.
|26|| See http://www.sec.gov/answers/noinfo.htm for more information on which companies are required to register and report.
|27|| See http://www.sec.gov/investor/pubs/microcapstock.htm for more information.
|28|| Many of these stocks are also considered "penny stocks." See http://www.sec.gov/answers/penny.htm. Because penny stocks are generally risky investments, before a broker-dealer can sell a penny stock, SEC rules require the firm to first approve the customer for the transaction and receive from the customer a written agreement to the transaction. The firm must furnish the customer a document describing the risks of investing in penny stocks. The broker-dealer must tell the customer the current market quotation, if any, for the penny stock and the compensation the firm and its broker will receive for the trade. Finally, the firm must send monthly account statements showing the market value of each penny stock held in the customer's account.
|29|| The Commission recently brought an enforcement action against certain parties, alleging manipulative naked short selling, in a scheme sometimes termed as a "death spiral." See Rhino Advisors, Inc. and Thomas Badian, Lit. Rel. No. 18003 (February 27, 2003) at http://www.sec.gov/litigation/litreleases/lr18003.htm.
|30|| See http://www.sec.gov/investor/pubs/microcapstock.htm.
|31|| For more information about T+3, see http://www.sec.gov/investor/pubs/tplus3.htm.
|32|| See http://www.sec.gov/investor/pubs/microcapstock.htm for more information.
|33|| See http://www.sec.gov/answers/pink.htm for more information about the Pink Sheets.
|34|| See http://www.sec.gov/answers/tmanipul.htm for more information on manipulation.
|35|| In addition, each SRO has agreed to make publicly available the trading data in connection with the pilot. The trading data will contain information on each executed short sale involving an exchange-listed or Nasdaq National Market equity security reported by an SRO to a securities information processor. For information on where to find this data, please see http://www.sec.gov/spotlight/shopilot.htm.