[This FAQ has been excerpted, in part or its entirety, from Division of Market Regulation: Key Points About Regulation SHO]

III. Regulation SHO

Compliance with Regulation SHO began on January 3, 2005. Regulation SHO was adopted to update short sale regulation in light of numerous market developments since short sale regulation was first adopted in 1938. Some of the goals of Regulation SHO include:


6 Broker-dealers engaged in bona-fide market making are excepted from having to borrow or arrange to borrow shares due to their potential need to facilitate customer orders in fast-moving markets without possible delays associated with complying with Regulation SHO. For instance, as explained above, they may be required by their market making obligations to sell short in situations where it may be difficult to quickly locate and borrow securities. However, this exception is limited. For example, bona-fide market making does not include activity that is related to speculative selling strategies or investment purposes of the broker-dealer or that is disproportionate to the usual market making patterns or practices of the broker-dealer in that security. Further, bona-fide market making does not include transactions whereby a market maker enters into an arrangement with another broker-dealer or customer in an attempt to use the market maker's exception for the purpose of avoiding compliance with Regulation SHO by the other broker-dealer or customer.
7 Clearing Agencies are self-regulatory organizations that are required to register with the Commission. There are two types of clearing agencies -- clearing corporations and depositories. Clearing corporations compare member transactions (or report to members the results of exchange comparison operations), clear those trades and prepare instructions for automated settlement of those trades, and often act as intermediaries in making those settlements. Depositories hold securities certificates in bulk form for their participants and maintain ownership records of the securities on their own books. Clearing corporations generally instruct depositories to make securities deliveries that result from settlement of securities transactions. In addition, depositories receive instructions from participants to move securities from one participant's account to another participant's account, either for free or in exchange for a payment of money. See http://www.sec.gov/divisions/marketreg/mrclearing.shtml and www.dtcc.com for more information about the clearance and settlement process and DTCC.
8 A participant of a clearing agency means any person or firm, such as a broker-dealer, that uses a clearing agency to clear and settle securities transactions or to transfer, pledge, lend, or hypothecate securities. It does not include a person or firm whose only use of a clearing agency is (a) through another person or firm that is a participant or (b) as a pledge of securities. Section 3(a)(24) of the Exchange Act, 15 U.S.C. 78c(a)(24).
9 Settlement day means any business day on which deliveries of securities and payments of money may be made through the facilities of a registered clearing agency.
10 Introducing brokers are typically brokers that perform all the functions of a broker except for the ability to accept money, securities, or property from a customer. They are usually not participants of registered clearing agencies and do not perform clearance and settlement functions. See Footnote 9 for more information about participants of a clearing agency.
11 A self-regulatory organization is a membership-based organization that creates and enforces rules for its members based on the federal securities laws. SROs, which are overseen by the SEC, are the front line in regulating broker-dealers. See http://www.sec.gov/about/whatwedo.shtml for more information.
12 For example, the tick test of Rule 10a-1 of the Securities Exchange Act of 1934 provides that, subject to certain exceptions, an exchange-listed security may only be sold short: (i) at a price above the immediately preceding reported price ("plus tick"), or (ii) at the last sale price if it is higher than the last different reported price ("zero-plus tick"). The New York Stock Exchange has a similar tick test under NYSE Rule 440B, and NASD has a bid test under NASD Rule 3350.
13 Specifically, the price tests will be relaxed for securities included on a list of approximately 1,000 actively-traded securities, and after-hours trading (4:15 p.m. until the open of the consolidated tape the following day) of another list of approximately 1,000 securities. For more information on this pilot, see http://www.sec.gov/spotlight/shopilot.htm, and http://www.sec.gov/news/press/2004-164.htm.
14 Under the rule, an order can be marked "long" when the seller owns the security being sold and the security either is in the physical possession or control of the broker-dealer, or it is reasonably expected that the security will be in the physical possession or control of the broker or dealer no later than settlement. However, if a person does not own the security, or owns the security sold and does not reasonably believe that the security will be in the possession or control of the broker-dealer prior to settlement, the sale should be marked "short." The sale could be marked "short exempt" if the seller is entitled to rely on an exception from the tick test of Rule 10a-1, or the price test of an exchange or national securities association. Short sales of pilot securities effected during the pilot should be marked "short exempt."

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