July 18, 2005
Re: Rule 10a-1; Exemptive Relief under Short Sale Rule
Dear Mr. Hammerman:
In your letter dated July 18, 2005, as supplemented by telephone conversations with the staff of the Division of Market Regulation ("Division"), you requested on behalf of the Securities Industry Association ("SIA") an exemption from Rule 10a-1 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), for any broker or dealer (collectively, a "broker-dealer") that facilitates customer buy or sell orders on a riskless principal basis. Specifically, the requested relief would allow broker-dealers to fill customer orders, without the restrictions of the short sale "tick" test, in the following situations: (i) a broker-dealer receives a sell order from a customer who is net "long" the securities being sold, and the broker-dealer then seeks to execute that order, either in whole or in part, by selling the security as riskless principal, even if the broker-dealer has an overall net "short" position in such security; or (ii) a broker-dealer receives a buy order from a customer, and the broker-dealer then seeks to execute that order, either in whole or in part, by purchasing the security as riskless principal, and then selling the security to the customer, even if the broker-dealer has an overall net "short" position in such security.
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:
In view of these representations, you have requested that the Commission grant any broker-dealer engaged in riskless principal transactions in the manner described herein an exemption from the tick provisions of Rule 10a-1.
Rule 200 of Regulation SHO3 defines the term "short sale," and Rule 10a-1 governs short sales generally. Paragraph (a) of Rule 10a-1 covers transactions in any security registered on a national securities exchange, if trades in such security are reported pursuant to an "effective transaction reporting plan" ("Reported Securities"). A short sale of a Reported Security may not be effected at a price either: (1) below the last reported price of a transaction reported in the consolidated transaction reporting system ("minus tick"); or (2) at the last reported price if that price is lower than the last reported different price ("zero-minus tick").
The Commission deferred consideration of the adoption of the proposed riskless principal exception to Rule 10a-1 pending the completion of the Regulation SHO Pilot program. However, Regulation NMS was adopted on June 9, 2005, requiring, among other things, trading centers to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the execution of trades at prices inferior to protected quotations displayed by other trading centers.4 In adopting the Order Protection Rule, in particular, the Commission considered several factors, including whether the rule promoted best execution of customer market orders.5 You represent that a broker-dealer may send an order to another market center for execution in order to provide "best execution" to a customer's order, or to facilitate price discovery, and to access displayed or hidden liquidity. This would be consistent with the Order Protection Rule, as well as the proposed riskless principal exception.
Absent relief, a broker-dealer may not consummate a sale transaction from a proprietary account, including in a riskless principal capacity, unless it has an overall net "long" position in the security being sold, or if the last-reported price is a plus or zero-plus tick. Based on your representations, in particular, that: (i) where the broker-dealer is facilitating a customer sale in a riskless principal transaction, the ultimate seller has a net long position in the shares being sold; (ii) compliance with the tick test under these circumstances may adversely affect a broker-dealer's ability to provide best execution to a customer order; and (iii) the riskless principal transactions will be effected in the following manner: the broker-dealer, after having received an order to sell a security from a customer who has a net long position, will sell the security as principal at the same price to satisfy the order to sell, or, after having received an order to buy a security, will purchase the security as principal at the same price and then sell to the customer, the Division is of the view that broker-dealers facilitating customer buy and sell orders on a riskless principal basis is not inconsistent with the purposes of Rule 10a-1 of the Exchange Act, subject to the conditions specified below.
Accordingly, on the basis of your representations and the facts presented, and without necessarily concurring in your analysis, the Commission hereby grants an exemption from Rule 10a-1 to permit a broker-dealer to fill customer orders, without complying with the "tick" provisions of the rule, in the following situations: (i) a broker-dealer receives a sell order from a customer who is net "long" the securities being sold, and the broker-dealer then seeks to execute that order, either in whole or in part, by selling the security as riskless principal, even if the broker-dealer has an overall net "short" position in such security; or (ii) a broker-dealer receives a buy order from a customer, and the broker-dealer then seeks to execute that order, either in whole or in part, by purchasing the security as riskless principal, and then selling the security to the customer, even if the broker-dealer has an overall net "short" position in such security, subject to the following conditions:
The foregoing exemption from Rule 10a-1(a) is based solely on your representations and the facts presented, and is strictly limited to the application of this rule to the proposed transactions as described above. Such transactions should be discontinued, pending presentation of the facts for our consideration, in the event that any material change occurs with respect to any of those facts and representations. The exemption granted herein 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.
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 broker-dealer effecting riskless principal transactions. The 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.
For the Commission, by the Division of Market Regulation, pursuant to delegated authority,
James A. Brigagliano
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