Proposed Amendments To Nasd Uniform Practice Code Re: Mandatory Buy-In for Short Sales; Last Date for Comments: September 1, 1989

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REQUEST FOR COMMENTS

EXECUTIVE SUMMARY

The NASD requests comments on proposed amendments to Section 59 of the NASD Uniform Practice Code regarding buying in. The proposed amendments would impose a mandatory buy-in for guaranteed delivery 10 days after normal settlement date in connection with a short sale in certain NASDAQ securities. The rule would apply to short sales for the accounts of customers and the proprietary accounts of registered broker-dealers in securities that have a clearing short position of 10,000 shares or more that is equal to at least one half of one percent of the total shares outstanding. Short sales as a result of bona fide market-making activity and short sales in which the resulting position is fully hedged or arbitraged would be exempt from the rule.

BACKGROUND

A mandatory buy-in rule was first suggested in the 1986 Report on Short Sale Regulation of NASDAQ Securities. The report included the following recommendation:

A mandatory buy-in requirement for guaranteed delivery should be adopted. The fail-to-deliver/fail-to-receive problem has the potential for causing serious difficulties in a lengthy bear market. While the evidence does not suggest that delivery problems exist in many securities, the fact that there is no automatic mechanism preventing the substantial buildup of short positions at the clearing corporation and of fails to receive in brokerage firms carries the potential for serious problems, particularly in the event of crisis market conditions, such as existed in the late 1960s. A mandatory buy-in requirement would force short sellers to borrow and deliver or cover; and a requirement for guaranteed delivery would prevent short sellers from again selling short to the brokers executing the buy-in.

The NASD Board of Governors deferred action on this recommendation until it had an opportunity to assess the effect that other recommendations — set forth in the report and implemented by the Association — had on abusive short-selling practices. In July 1988, the Quality of Markets Committee submitted its final report to the NASD Board. That Committee also examined short selling in NASDAQ and again recommended that "... the NASD formulate the necessary rules to require a mandatory buy-in for the account of the short-selling party if it fails to deliver after a short period of time." The Trading Committee took this recommendation under consideration and formed, along with the Uniform Practice Committee, a mandatory buy-in subcommittee to study the issue further. The subcommittee's efforts culminated in the Board's determination to request comment on the proposed rule amendment.

PROPOSED AMENDMENTS

The mandatory buy-in requirement is aimed primarily at curbing "naked" or abusive short selling in NASDAQ securities. The mandatory buy-in rale is designed to specifically address "problem situations," e.g., where shorts to clearing equal a significant percentage of a company's total shares outstanding. The rule has been drafted so as to identify securities whose short positions at the clearing corporation represent a significant percentage of the issues' total shares outstanding. These securities could be placed on a "restricted list," meaning that any subsequent short sale would be subject to a mandatory buy-in after a specified period of time.

The mandatory buy-in rule would apply to NASDAQ securities only. As proposed, the rule would impose a mandatory buy-in for guaranteed delivery in connection with short sales if a fail-to-deliver exists 10 days after the normal settlement date. The rale would apply to short sales in securities that have a clearing short position of 10,000 shares or more that is equal to at least one half of one percent of the total shares outstanding. According to NASD staff research, application of this parameter as of March 7, 1989, would have resulted in a total of 91 NASDAQ securities being covered by the rule.

The buy-in requirement would be applicable to short sales for the accounts of customers and the proprietary accounts of registered broker-dealers. Short sales as a result of bona fide market-making activity and short sales in which the resulting position is fully hedged or arbitraged would be exempt from the rule.

The buy-in requirement will be triggered 10 business days after normal settlement date. This is consistent with the approach taken in SEC Rule 15c3-3, which requires a broker-dealer to close a transaction with a customer by purchasing securities of like kind and quantity when a fail-to-deliver exists 10 business days after settlement date in a customer long sale.

As drafted, the mandatory buy-in requirement would be added to Section 59 of the Code as a new subsection. The new subsection (o) would be mandatory and would incorporate by reference the provisions of Section 59 otherwise available on a discretionary basis.

The NASD encourages all members and interested persons to comment on the proposed amendments. Comments should be directed to Mr. Lynn Nellius, Secretary, National Association of Securities Dealers, Inc., 1735 K Street, NW, Washington, DC 20006.

Questions concerning this notice can be directed to Ms. Therese M. Haberle, Special Counsel, at (202) 728-8287.

Comments must be received no later than September 1, 1989. Changes to the Uniform Practice Code must be approved by the Board of Governors and filed with, and approved by, the SEC before becoming effective.

PROPOSED AMENDMENT TO THE UNIFORM PRACTICE CODE

(Note: New text is underlined.)

UNIFORM PRACTICE CODE

Sec. 59. Close-Out Procedure; Buying-in ((a) through (n) are unchanged.)

Mandatory Buy-in for Short Sales