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October 16, 2019

Short Sales

Regulatory Obligations

Regulation SHO Rules 200 to 204 require firms to address risks relating to market manipulation, market liquidity and investor confidence by regulating excessive and “naked” short sales so that purchasers of securities from short sellers receive their securities positions in a timely manner. Regulation SHO requires firms to appropriately mark their securities orders; confirm that they have deliverable securities to complete short sale transactions; and have a process to close-out fails to deliver within the required timeframes.

Noteworthy Examination Findings

In addition to the findings FINRA shared in the Regulation SHO section of the 2017 Report, we found some firms were not able to satisfy the Continuous Net Settlement (CNS) System fail-to-deliver close-out requirements pursuant to Rule 204 because they did not implement a sufficient process to age fails, resulting in fails not being closed out timely. In other instances, firms did not accurately allocate CNS fails to correspondents. For example, some firms faced challenges relating to both inaccurate calculation of pre-fail credits prior to allocating fails to the correspondent, and used inconsistent methods when allocating fails to the correspondents where the share quantities exceeded the CNS fails.

In addition, firms may consider as an effective practice to periodically review their policies relating to rates charged for borrowing, sourcing or locating securities in connection with short sales, including monitoring the aging of short positions and determining whether the rates assigned at the onset of those positions are still appropriate.