January 3, 2005
Dear Mr. Hammerman:
In your letter dated January 3, 2005, as supplemented by telephone conversations with the staff of the Division of Market Regulation ("Division"), you request on behalf of the Securities Industry Association ("SIA") confirmation that the Division will not recommend to the Commission enforcement action against a broker-dealer that marks "short," rather than "short exempt," a short sale effected in certain classes of securities, or during certain specified periods of time, that have been granted an exemption from the "tick" test of Rule 10a-1 under the Securities Exchange Act of 1934, as amended ("Exchange Act"), or the price test of any exchange or national securities association (collectively, a "price test"), as set forth in Appendix A of your letter. A copy of your letter is attached to this response. By including a copy of your correspondence, we avoid having to repeat or summarize the facts you presented. The defined terms in this letter have the same meaning as in your letter, unless otherwise noted.
In your letter you make the following representations, among others:
Rule 200(g) of Regulation SHO provides that a broker-dealer must mark all sell orders of any equity security as "long," "short," or "short exempt." Rule 200(g)(2) requires that a short sale order must be marked "short exempt" if the seller is relying on an exception from the tick test of Rule 10a-1 of the Exchange Act or any short sale price test of any exchange or national securities association.
Based on your representations, in particular, that: (i) for each product and after-hours crossing session qualifying for the exemptions from the price test of Rule 10a-1 listed in Appendix A of your letter ("exempt short sales"), the various market centers that execute exempt short sales have instituted procedures to "mask" the short sale character of the transaction so that they are executed as short exempt; (ii) such market centers monitor on a regular basis to confirm that any such product or transaction continues to meet the conditions for the exemptive relief and re-institute the price test for any product or transaction that fails to satisfy such conditions; (iii) a broker-dealer executing exempt short sales will mark such sales as "short," and in no event will such sales be marked "long;" and (iv) the market centers will maintain an audit trail of all such trade executions, which is capable of being produced and subject to review upon request by the Commission and other appropriate regulatory authorities, the Division is of the view that broker-dealers marking exempt short sales as "short" rather than "short exempt" is not inconsistent with the purposes of Rule 200(g) of Regulation SHO.
Accordingly, on the basis of your representations and the facts presented, and without necessarily concurring in your analysis, the Division will not recommend to the Commission enforcement action under Rule 200(g) of Regulation SHO if a broker-dealer marks "short," rather than "short exempt," a short sale that is effected in the products or in the crossing sessions pursuant to exemptions from the price test of Rule 10a-1 that have been granted, as reflected in Appendix A to this letter, subject to the following conditions:
This position concerns enforcement action only and does not represent a legal conclusion with respect to the applicability of statutory or regulatory provisions of the federal securities laws. Moreover, this position is based on the facts you have presented and the representations you have made, and any different facts or conditions may require a different response. In addition, this position is subject to modification or revocation if at any time the Commission or the Division determines that such action is necessary or appropriate in furtherance of the purposes of the Exchange Act. Finally, the Division expresses no view with respect to any other questions that the proposed activities may raise, including the applicability of other federal or state laws to those activities.
In addition, your attention is directed to the anti-fraud and anti-manipulation provisions of the Exchange Act, particularly Sections 9(a) and 10(b), and Rule 10b-5 thereunder. Responsibility for compliance with these and any other applicable provisions of the federal securities laws must rest with the registered broker-dealer. This Division expresses no view with respect to any other questions that the proposed transactions may raise, including, but not limited to, the adequacy of the disclosure concerning, and the applicability of any federal or state laws to, the proposed transactions.
Very truly yours,
James A. Brigagliano
January 3, 2005
James A. Brigagliano
Via Fax and Hand Delivery
Re: Request for No-Action Relief from Regulation SHO Marking Requirement
Dear Mr. Brigagliano:
The Securities Industry Association (the "SIA"),1 hereby requests that the Staff of the Division of Market Regulation ("Division") confirm that it will not recommend enforcement action to the Securities and Exchange Commission ("Commission") against a broker-dealer that marks "short,"2 rather than "short exempt," a short sale effected in any class of securities, or during certain specified periods of time, that have been granted an exemption3 from the "tick" test of Rule 10a-1 under the Securities Exchange Act of 1934, as amended ("Exchange Act"),4 or the price test of any national securities exchange or national securities association (collectively, a "price test").5 As the market centers will have made programming changes to remove the price test restrictions for all such classes of securities that have been granted an exemption, all orders marked "short" will be executed without regard to any price test. Any broker-dealer will still be required to mark sales in such securities "short," and in no circumstance should such sales be marked "long."6
The Commission recently adopted Regulation SHO, which provides a new regulatory framework governing short sales of securities,7 and has a compliance date of January 3, 2005.8 As adopted, among other things, Rule 200(g) of Regulation SHO requires broker-dealers to mark all sell orders of any equity security as "long," "short," or "short exempt." A short sale order shall be marked "short exempt" if the seller is relying on an exception from a price test.
The Commission has previously granted (pursuant to authority delegated to the Division) various exemptions from short sale price test restrictions for certain classes of securities, including exchange traded funds ("ETFs") and other similar products.9 In granting such exemptions to ETFs, the Commission noted that its decision was generally based on the fact that the market value of ETF shares would rise or fall based on changes in the net asset value of the component stocks in the particular index, and supply and demand. The relief was conditioned on the ETF meeting certain enumerated conditions, either specific to certain products or included as part of a broader "class exemption."10
For each of these products that have been granted exemptions, the various market centers that execute short sales in such products (e.g., exchanges, Nasdaq, ECNs, executing brokers) have made programming changes to "mask" (i.e., remove) the price test restrictions.11 These market centers also monitor on a regular basis to confirm that any such product continues to meet the conditions for the exemptive relief, and make programming changes to re-institute the price test for any product that fails to satisfy such conditions.12 Based on the fact that the market centers have automatic programming procedures for these broad classes of securities, it is not necessary for market participants submitting orders in such securities to distinguish between "short" and "short exempt" orders, and the market centers generally allow orders marked "short" in these products to be executed without regard to a price test.
The Commission has also previously granted exemptions from short sale price test restrictions for sales that occur during certain specified periods of time. For example, the Commission has granted relief from the price test to allow requesting exchanges and broker-dealers to execute short sales in after-hours crossing sessions at a price that is equal to a security's closing price on the primary exchange.13 Absent relief, such short sales could violate Rule 10a-1, in that the matching price (the closing price) of a security could be on a minus or zero-minus tick with respect to the last sale in the consolidated transaction reporting system. In granting such relief, the Commission has noted that short sale transactions executed at the closing price generally do not represent the types of abusive practices that Rule 10a-1 is designed to prevent, largely due to the fact that short sales entered in the after-hours crossing sessions cannot influence the matching price.14 Similar to the exemptions that have been granted for certain products, the market centers that execute short sales during such specified periods of time have made generally the same programming changes to remove the price test restrictions, and it is thus not necessary for market participants to distinguish between "short" and "short exempt" orders.
Absent relief, commencing on the Regulation SHO compliance date of January 3, 2005, broker-dealers would be required to mark "short exempt" all short sales effected in any class of products, or during certain specified periods of time, that have been granted an exemption from a price test. This would in turn have broad impacts across many systems in the firms that process orders, including front-end systems to institute order marking changes for customers, trade processing systems, and customer and regulatory reporting systems. Implementing such systems changes would impose upon firms extreme time and financial burdens.15
Moreover, it is highly questionable whether the benefits associated with such requirements would outweigh the associated costs. As noted above, the market centers that execute trades in such products, or effect short sales during such designated periods of time, have already instituted the necessary systems changes to remove the price test, where appropriate. In this regard, this is very different from the situation where a seller is relying on an exception or exemption from the price test based on discrete facts and circumstances.16 A "short exempt" marking requirement for such "transaction-based exemptions" may be necessary to inform the market center that an individual trade may properly be executed without regard to a price test. These same objectives do not exist where an entire class of security, or a short sale effected during such designated periods of time, is subject to a wholesale exemption from a price test.
To the contrary, requiring such short sales to be marked "short exempt" could actually act to the detriment of investors by needlessly slowing down executions. For example, as noted in the recent New York Stock Exchange Information Memo on Regulation SHO, orders in the specialist book and good-till-executed orders, as well as certain other orders, automatically participate in NYSE Crossing Session I.17 However, absent the requested relief, if these orders were marked "short," they would need to be withdrawn and re-marked "short exempt," which could in turn cause these orders to lose priority, and risk their receiving only a partial execution, or no execution at all.
III. Request for No-Action Relief
Based on the foregoing, we respectfully request that the Division confirm that it will not recommend enforcement action to the Commission against a broker-dealer that marks "short," rather than "short exempt," a short sale that is effected in any class of securities, or during certain periods of time, where the Commission has granted an exemption from a price test. The requested no-action relief shall be subject to the following conditions:
If you have any questions or require further information, please do not hesitate to contact Amal Aly, Vice President and Associate General Counsel, at 212-608-1500 or Ann Vlcek, Vice President and Associate General Counsel, at 202-216-2000. Thank you for your attention to this request.
Very truly yours,
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