Adoption of "Naked" Short Selling Antifraud Rule, Exchange Act Rule 10b-21 — A Small Entity Compliance Guide¹

Introduction

The Securities and Exchange Commission ("Commission") adopted a "naked" short selling antifraud rule, Exchange Act Rule 10b-21.

Background

In a "naked" short sale, a seller does not borrow or arrange to borrow the necessary securities in time to deliver them to the buyer within the standard three day settlement period. Although abusive "naked" short selling is not defined in the federal securities laws, it refers generally to selling short without having stock available for delivery and intentionally failing to deliver stock within the standard three day settlement period.

Rule 10b-21 specifies that it is unlawful for any person to submit an order to sell a security if that person deceives a broker-dealer, participant of a registered clearing agency, or purchaser regarding his/her intention, or ability, to deliver the security by settlement date and that person fails to deliver the security by settlement date. Among other things, Rule 10b-21 targets short sellers who deceive broker-dealers about their source of borrowable shares for purposes of complying with the "locate" requirement of Rule 203(b)(1) of Regulation SHO. Rule 10b-21 also applies to sellers who misrepresent to their broker-dealers that they own the shares being sold.

How Does the Adoption of Rule 10b-21 Affect Small Entities?

The entities covered by Rule 10b-21 include small broker-dealers, small businesses, and any investor who effects a short sale as a small entity. Adoption of Rule 10b-21 may impose new or additional reporting, recordkeeping, or compliance costs on every covered entity, including small entities. When Regulation SHO was adopted in 2004, small broker-dealers were required to modify their systems and surveillance mechanisms to ensure compliance. Consequently, any compliance systems and surveillance mechanisms needed to comply with the provisions of Rule 10b-21 should already be in place. Any additional systems and surveillance changes by sellers who are not broker-dealers will be similar to those required on implementation of Regulation SHO.

Other Resources

The proposing release for Rule 10b-21 can be found on the Commission's Internet Web site at http://www.sec.gov/rules/proposed/2008/34-57511.pdf. Additionally, the adopting release for Rule 10b-21 may also be found on the Commission's Internet Web site at http://www.sec.gov/rules/final/2008/34-58774.pdf.

Contacting the Securities and Exchange Commission

The Commission's Division of Trading and Markets is happy to assist small entities with questions regarding Rule 10b-21. The Division's Office of Interpretation and Guidance answers questions submitted by telephone at (202) 551-5777, or via e-mail at tradingandmarkets@sec.gov.

¹ This guide was prepared by the staff of the U.S. Securities and Exchange Commission as a "small entity compliance guide" under Section 212 of the Small Business Regulatory Enforcement Fairness Act of 1996 as amended. The guide summarizes and explains rules adopted by the Commission, but is not a substitute for any rule itself. Only the rule itself can provide complete and definitive information regarding its requirements.