SEC Approves New Rule 3210 Applying Short Sale Delivery Requirements to Non-Reporting OTC Equity Securities
Short Sale Delivery Requirements
Legal & Compliance
On April 4, 2006, the Securities and Exchange Commission (SEC) approved new Rule 3210, Short Sale Delivery Requirements, which applies short sale delivery requirements to those equity securities not otherwise covered by the delivery requirements of Regulation SHO, namely non-reporting OTC equity securities.1Rule 3210, among other things, requires participants of registered clearing agencies to take action on failures to deliver that exist for 13 consecutive settlement days in certain non-reporting securities. In addition, if the fail to deliver position is not closed out in the requisite time period, a participant of a registered clearing agency or any broker-dealer for which it clears transactions is prohibited from effecting further short sales in the particular specified security without borrowing, or entering into a bona-fide arrangement to borrow, the security until the fail to deliver position is closed out.
Rule 3210, as adopted, is set forth in Attachment A of this Notice. Also included in this Notice is information about the list of non-reporting securities that meet the requirements of Rule 3210 ("Rule 3210 Threshold Securities List") that NASD will publish. The rule becomes effective on July 3, 2006.
Questions regarding this Notice may be directed as follows: for questions regarding Rule 3210, contact the Legal Section, Market Regulation, at (240) 386-5126; or Office of General Counsel, Regulatory Policy and Oversight, at (202) 728-8071. For questions regarding the Rule 3210 Threshold Securities List, contact NASD Operations at (866) 776-0800.
Background and Discussion
On June 23, 2004, the SEC adopted Regulation SHO under the Exchange Act, which provides a new regulatory framework governing the short selling of equity securities.2 Regulation SHO includes several new provisions relating to short sales, one of which imposes delivery requirements on clearing agency participants for certain securities that have a substantial level of failures to deliver.3 Specifically, Regulation SHO requires clearing agency participants to close out all failures to deliver in a "threshold security" that have existed for 13 consecutive settlement days. Regulation SHO defines a" threshold security" as any equity security of an issuer that is registered under Section 12 of the Exchange Act or that is required to file reports under Section 15(d) of the Exchange Act (referred to as "reporting securities") that (1) for five consecutive settlement days had aggregate fails to deliver at a registered clearing agency of 10,000 shares or more; (2) the level of fails is equal to a least one-half of one percent of the issue's total shares outstanding; and (3) is included on a list published by a self-regulatory organization.
The Regulation SHO delivery requirements apply only to reporting securities. NASD believes applying delivery requirements to non-reporting securities is an important step in reducing long-term fails to deliver in this sector of the marketplace. Therefore, NASD proposed, and the SEC approved, new Rule 3210, which applies a delivery framework to non-reporting OTC equity securities substantially similar to the Regulation SHO delivery framework. Rule 3210 requires clearing agency participants to close out all failures to deliver in "non-reporting threshold securities" that have existed for 13 consecutive settlement days. For purposes of Rule 3210, a non-reporting threshold security is any equity security that is not a reporting security and, for five consecutive settlement days, has: (1) aggregate fails to deliver at a registered clearing agency of 10,000 shares or more; and (2) a reported last sale during normal market hours (9:30 a.m. to 4 p.m., Eastern Time (ET)) for the security on that settlement day that would value the aggregate fail to deliver position at $50,000 or more.4
If the fail to deliver position is not closed out in the requisite time period, a clearing agency participant or any broker-dealer for which it clears transactions would be prohibited from effecting further short sales in the particular specified security without borrowing, or entering into a bona-fide arrangement to borrow, the security until the fail to deliver position is closed out. To the extent that the participant can identify the broker-dealer(s) that have contributed to the fail to deliver position, the requirement to borrow or arrange to borrow prior to effecting further short sales may apply only to those particular broker-dealers to which the participant has allocated such fail to deliver position.
NASD will publish daily a list of the non-reporting securities that meet the threshold requirements of Rule 3210 (Rule 3210 Threshold Securities List). To be removed from the Rule 3210 Threshold Securities List, a security must not meet either of the threshold tests in Rule 3210 for five consecutive settlement days.
NASD intends to apply and interpret the requirements of Rule 3210 consistent with the SEC's application and interpretation of Regulation SHO. In this regard, the SEC Division of Market Regulation published Responses to Frequently Asked Questions Concerning Regulation SHO, in which the SEC staff addresses, among other things, questions relating to the Regulation SHO delivery requirements, close-out requirements and pre-borrow requirements. A copy of the interpretive guidance is available on the SEC's Web site at www.sec.gov/divisions/marketreg/mrfaqregsho1204.htm. NASD encourages members and other interested parties to review the interpretive guidance.
Rule 3210 becomes effective July 3, 2006. Consistent with the application and interpretation of Regulation SHO, open fail positions in non-reporting securities that exist prior to July 3, 2006 will not be required to be closed out under Rule 3210.5 As such, on July 3, 2006, NASD will begin the calculations necessary to determine whether securities qualify as non-reporting threshold securities, and July 11, 2006 is the first day for which NASD will publish a non-reporting threshold list. Until a security appears on a non-reporting threshold list for 13 consecutive settlement days and an open fail position for such security exists for that same period, Rule 3210 does not require a broker-dealer to close out the open fail position. Therefore, the first day on which a close-out action would be required under Rule 3210 is July 28, 2006.
Questions and Answers Relating to New Rule 3210
To help members implement Rule 3210, NASD is publishing the following questions and answers relating to the Rule 3210 Threshold Securities List.
Q1 What is a non-reporting threshold security?
A1 As defined in Rule 3210, a "non-reporting threshold security" is any equity security of any issuer that is not registered under Section 12 of the Exchange Act, and for which the issuer is not required to file reports under Section 15(d) of the Exchange Act, where, (1) for five consecutive settlement days:
(2) The security is included on a list published by NASD.
A security ceases to be a non-reporting threshold security if it does not meet either of the threshold tests in (1) above for five consecutive settlement days.
Q2 How can I access the Rule 3210 Threshold Securities List?
A2 NASD will calculate the Rule 3210 Threshold Securities List on a daily basis. The Rule 3210 Threshold Securities List will be combined with the Regulation SHO Threshold Security List currently posted on www.nasdaqtrader.com/aspx/regsho.aspx. The combined list will contain a separate column indicating that the security is subject to Rule 3210.
Q3 What will be the format of the file?
A3 The file layout and data field definitions are the same as the Regulation SHO file layout and data fields, found at: www.nasdaqtrader.com/aspx/regsho.aspx.
Q4 What does the date in the file name mean?
A4 The date in the file name reflects the settlement date that the data is based on. For example, the file name for the file posted containing July 11, 2006 settlement date data will be 20060711.
Q5 How can I tell what time the Rule 3210 Threshold Securities List was created?
A5 The end of the data file will contain a file creation timestamp, reflecting the date and time the file is complete. The timestamp will be in the following format: yyyymmddhhmmss.
Q6 What if the Rule 3210 Threshold Securities List is posted late?
A6 Consistent with guidance provided by staff of the SEC Division of Market Regulation regarding the Regulation SHO Threshold List, firms will be permitted to use the previous settlement day's Rule 3210 Threshold Securities List to comply with Rule 3210 if the file is unavailable by midnight (00:00 ET). Firms are still obligated to analyze the current settlement day's data when it becomes available to determine compliance with Rule 3210's close-out requirements.
Q7 When will the Rule 3210 Threshold Securities List be posted?
A7 As noted above, Rule 3210 defines a "non-reporting threshold security" as one that exceeds the specified level of fails for five consecutive settlement days. Since the new rule takes effect on July 3, 2006, the first date a security can meet this definition will be five settlement days after the effective date. Accordingly, the first Rule 3210 Threshold Securities List will be posted before midnight on July 10, 2006, and will be available before the opening of trading on July 11, 2006.
1See Securities Exchange Act Release No. 53596 (April 4, 2006), 71 FR 18392 (April 11, 2006) (File No. SR-NASD-2004-044).
2See Exchange Act Release No. 50103 (July 28, 2004), 69 FR 48008 (August 6, 2004).
3 The term "clearing agency participants" refers to "participants" (as defined in Section 3(a)(24) of the Exchange Act) of a "registered clearing agency," meaning a clearing agency (as defined in Section 3(a)(23)(A) of the Exchange Act) that is registered with the SEC pursuant to Section 17A of the Exchange Act.
4 In the event there is no reported last sale on any settlement day during such five-day period, the value of the aggregate fail position would be based on the previously reported last sale.
5See Division of Market Regulation: Responses to Frequently Asked Questions Concerning Regulation SHO (Question 5.1). As noted in Question 5.1, this does not affect the obligations of sellers of securities to deliver those securities to buyers under existing delivery and settlement guidelines.
New language is underlined; deletions are in brackets.
3210. [Reserved.]Short Sale Delivery Requirements
A security shall cease to be a non-reporting threshold security if the aggregate fail to deliver position at a registered clearing agency does not meet or exceed either of the threshold tests specified in paragraph (f)(2)(A) of this rule for five consecutive settlement days.