April 15, 2005
Senior Vice President and General Counsel
Securities Industry Association
120 Broadway, 35th Floor
New York, NY 10271-0080
No-Action Relief From Rule 200(g) of Regulation SHO
Dear Mr. Hammerman:
In your letter dated April 15, 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 any security included in the Regulation SHO Pilot Program (the "Pilot"),1 suspending the operation of 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 described herein, each broker-dealer relying on this no-action letter must route orders during the Pilot to market centers that have "masking" processes in place that provide auditable records of short sale order executions. 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:
- The requested relief shall be conditioned upon the broker-dealer routing the order to a "market center" (as defined in Exchange Act Rule 11Ac1-5(a)(14) to include "any exchange market maker, OTC market maker, alternative trading system, national securities exchange, or national securities association") that has made programming changes to remove the Price Test restrictions for all such securities that will be included in the Pilot (i.e., such that 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 Pilot Securities as "short," and in no circumstance should such sales be marked "long." The requested relief would be consistent with the relief that the Division has previously granted from the "short exempt" marking requirement for short sales effected in certain classes of securities, or during certain periods of time, that have been granted an exemption from the Price Test.
- The requested relief is only intended to apply to short sale orders in Pilot Securities that are routed to market centers that have made programming changes to "mask" (i.e., remove) the Price Test restrictions. If the requested relief is granted, it will be incumbent upon each broker-dealer seeking to rely on such relief to submit orders in Pilot Securities only to those market centers that have implemented the proper masking procedures. Upon commencement of the Pilot and throughout its duration, such market centers also will be required to monitor on a regular basis to confirm that securities are properly included in the Pilot, and make programming changes to re-institute the Price Test, as applicable, for any security to the extent it ceases to be included in the Pilot. This could occur if, for example, the Commission were to issue a subsequent order terminating or modifying the Pilot, which could include altering the composition of the Category A or Category B Pilot Securities. After the close of the Consolidated Tape, however, such security would still be a Category C Pilot Security and, as such, would be exempt from the Price Test during that time.2
- Where the market centers have automatic programming procedures in place to "mask" the application of the Price Test for the Pilot Securities, it is not necessary for market participants submitting orders in such securities to those market centers to distinguish between "short" and "short exempt" orders, as such market centers will generally allow orders marked "short" in these Pilot Securities to be executed without regard to a Price Test.
- Absent relief, upon commencement of the Pilot on May 2, 2005, broker-dealers would be required to mark short sales in all Pilot Securities "short exempt." 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 broker-dealers extreme technology and financial burdens.
- As part of the requested relief, broker-dealers will route short sale orders in Pilot Securities only to those market centers that have 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. 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 a Pilot Security is subject to a wholesale exemption from a Price Test.
- Requiring short sales in Pilot Securities to be marked "short exempt" could actually act to the detriment of investors by needlessly slowing down executions. For example, absent the requested relief, an order in a Category B Pilot Security (which was not otherwise a Category A Pilot Security) that was marked "short" during the regular trading session would need to be withdrawn and re-marked "short exempt" in order to participate as a Category B Pilot Security after 4:15 p.m. Eastern Time, which could in turn cause these orders to lose priority, and risk their receiving only a partial execution, or no execution at all.
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. Since short sales in Pilot Securities effected during any pilot period would be exempt from any such Price Test, these orders would be required to be marked "short exempt."
Based on your representations, in particular, that: (i) a broker-dealer relying on this no-action relief must route orders in Pilot Securities to market centers that: (a) have instituted procedures to "mask" the short sale character of the transaction so that they are executed without regard to the applicable Price Test; (b) monitor on a regular basis and re-institute the Price Test for any security that ceases to be included in the Pilot; (c) make, keep, and produce the books and records of such activities as required under applicable rules and regulations; and (ii) a broker-dealer executing short sales in Pilot Securities will in no event mark short sales in Pilot Securities as "long," 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 effected in any security include in the Pilot, subject to the following conditions:
- A broker-dealer relying on this no-action relief must route orders in Pilot Securities to market centers that:
- have instituted procedures to "mask" the short sale character of the transaction so that they are executed without regard to the applicable Price Test;
- monitor on a regular basis and re-institute the Price Test for any security that ceases to be included in the Pilot;
- make, keep, and furnish promptly upon request, the books and records of such activities as required under applicable rules and regulations; and
- A broker-dealer executing short sales in Pilot Securities will in no event mark short sales in Pilot Securities as "long."
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
The Incoming Letter is in Acrobat format.