Amendment to Regulation SHO to Adopt Exchange Act Rule 204T — A Small Entity Compliance Guide1
The Securities and Exchange Commission ("Commission") adopted as an interim final temporary rule, Rule 204T of Regulation SHO under the Securities Exchange Act of 1934 ("Exchange Act") to address potentially abusive "naked" short selling in all equity securities. The temporary rule expires on July 31, 2009.
A. Regulation SHO and Short Selling
Regulation SHO establishes a regulatory framework to govern short sales. The term short selling refers to the sale of a security that the seller does not own, or any sale that is consummated by the delivery of a security that was borrowed by, or for the account of, the seller. To deliver the security to the buyer, the short seller will borrow securities, usually from a broker-dealer or institutional investor. The short seller later closes-out the position by purchasing equivalent securities on the open market. Generally, short selling is used to profit from an expected downward price movement. Short selling can provide liquidity in response to unanticipated demand, or function as a hedge to the risk of a long position in the same security or a related security.
B. Regulation SHO's Close-out Requirement
Among other things, Regulation SHO includes a close-out requirement intended to address persistent failures to deliver stock on trade settlement date ("fails to deliver"). 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 (i.e., T+3). Regulation SHO's close-out requirement provides that a participant of a registered clearing agency must take immediate action to close-out fails to deliver. The participant must close-out such fails to deliver by purchasing securities of like kind and quantity. Until the position is closed out, the participant and any broker-dealer for which it clears transactions, including market makers, may not effect further short sales in that security without borrowing or entering into a bona fide arrangement to borrow the security until the participant closes out the entire fail to deliver position by purchasing securities of like kind and quantity (also known as the "pre-borrow" requirement).
C. Temporary Rule 204T and Regulation SHO
To further address abusive "naked" short selling in all equity securities, temporary Rule 204T enhances the delivery requirements of Regulation SHO by requiring that participants of a registered clearing agency deliver securities by settlement date, or if the participants have not delivered securities by settlement date, immediately purchase or borrow securities to close out the fail to deliver position by no later than the beginning of regular trading hours on the settlement date following the day the participant incurred the fail to deliver position. Failure to comply with this close-out requirement is a violation of the temporary rule. In addition, a participant that does not comply with this close-out requirement, and any broker-dealer from which it receives trades for clearance and settlement, will not be able to short sell the security for itself or for the account of another, unless it has first arranged to borrow or borrowed the security, until the fail to deliver position is closed out.
How does adoption of Exchange Act Rule 204T impact small entities?
The entities covered by the temporary rule will include small entities that are participants of a registered clearing agency, and small broker-dealers from which the participant receives trades for clearance and settlement. Additionally, the entities covered by the temporary rule will include small entities that are market participants effecting sales subject to the provisions of Regulation SHO. The temporary rule may impose new or additional reporting, recordkeeping or compliance costs on small entities that are participants of a registered clearing agency, and small entity broker-dealers from which the participant receives trades for clearance and settlement. We do not believe at this time that any specialized professional skills will be necessary to comply with the temporary rule.
The interim final temporary rule adopting release for temporary rule 204T may be found on the Commission's Internet Web site at http://www.sec.gov/rules/final/2008/34-58773.pdf.
Contacting the Securities and Exchange Commission
The Commission's Division of Trading and Markets is happy to assist small entities with questions regarding this amendment to Regulation SHO. The Division's Office of Interpretation and Guidance answers questions submitted by telephone at (202) 551-5777, or via e-mail at firstname.lastname@example.org.
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.