Document ID: SEC-2006-0474-0001
Agency: sec
Document Type: Notice
Title: Self-regulatory organizations; proposed rule changes: National Association of Securities Dealers, Inc.
Posted Date: 2006-04-11T04:00Z

[Federal Register: April 11, 2006 (Volume 71, Number 69)]
[Notices]               
[Page 18392-18395]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr11ap06-148]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-53596; File No. SR-NASD-2004-044]

 
Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Approving Proposed Rule Change and Amendment Nos. 
1 and 2 Thereto Relating to Short Sale Delivery Requirements

April 4, 2006.

I. Introduction

    On March 10, 2004, the National Association of Securities Dealers, 
Inc. (``NASD'') filed with the Securities and Exchange Commission 
(``Commission'' or ``SEC''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to apply a delivery framework to 
certain non-reporting equity securities similar to that imposed on 
reporting equity securities by Regulation SHO.\3\ The NASD submitted 
Amendment No. 1 to its proposed rule change on October 6, 2005 and 
submitted Amendment No. 2 to its proposed rule change on October 28, 
2005.\4\ The proposed rule change, as amended, was published for notice 
and comment in the Federal Register on November 16, 2005.\5\ The 
Commission received nine comment letters on the proposal.\6\ The NASD 
filed a response to the comment letters on March 15, 2006.\7\

[[Page 18393]]

This order approves the proposed rule change, as amended.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Exchange Act Release No. 50103 (July 28, 2004), 69 FR 
48008 (Aug. 6, 2004) (``Regulation SHO Adopting Release''). The 
Commission adopted Regulation SHO to, among other things, impose a 
requirement on a participant of a registered clearing agency to take 
action to close out fail to deliver positions in ``threshold 
securities.'' Regulation SHO defines a ``threshold security'' as any 
equity security that is registered under Section 12 of the Act, or 
where the issuer of such security is required to file reports under 
Section 15(d) of the Act, and which security has, for five 
consecutive settlement days, had aggregate fails to deliver at a 
registered clearing agency of at least 10,000 shares that are also 
equal to at least 0.5% of the issuer's total shares outstanding 
(``TSO''). See 17 CFR 242.203(c)(6). In the Regulation SHO Adopting 
Release, the Commission noted that because the calculation of the 
threshold that would trigger the delivery requirements under the 
rule depends on identifying the aggregate fails to deliver as a 
percentage of the TSO, the Commission believed it was necessary to 
limit the close out requirement to companies that are subject to the 
reporting requirements of the Act. See Regulation SHO Adopting 
Release, 69 FR at 48016, fn. 82.
    \4\ On account of the adoption of Regulation SHO, Amendment No. 
1, among other things, narrowed the scope of the proposal to those 
equity securities not otherwise covered by the delivery requirements 
of Rule 203(b) of Regulation SHO. Amendment No. 2 replaced and 
superseded Amendment No. 1 in its entirety and made technical 
changes to the proposed rule change.
    \5\ See Securities Exchange Act Release No. 52752 (Nov. 8, 
2005), 70 FR 69614 (Nov. 16, 2005) (``Proposing Release'').
    \6\ See Letter from Paul Vuksich, II, dated December 22, 2005; 
letter from Amal Aly, Vice President and Associate General Counsel, 
Securities Industry Association, on behalf of the Securities 
Industry Association Regulation SHO Working Group, dated December 
14, 2005 (``SIA Letter''); letter from Jim L. Hoch, dated December 
14, 2005; letter from Paul Vuksich, II, dated December 12, 2005 
(``Vuksich Letter''); letter from Donald J. Stoecklein, President, 
Stoecklein Law Group, dated December 13, 2005 (``Stoecklein Law 
Group Letter''); letter from Peter J. Chepucavage, General Counsel, 
Plexus Consulting, dated December 1, 2005; letter from Bob O'Brien, 
dated November 17, 2005; letter from David Patch, dated November 14, 
2005; and letter from Richard M. Rosenthal, Esq, dated November 10, 
2005.
    \7\ See letter from Andrea D. Orr, Assistant General Counsel, 
NASD, to Nancy M. Morris, Secretary, SEC, dated March 15, 2006 
(``Response to Comments'').
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II. Description of the Proposal

    The proposed rule change would require participants \8\ of 
registered clearing agencies \9\ to take action to immediately close 
out fail to deliver positions that exist for thirteen consecutive 
settlement days in non-reporting threshold securities by purchasing 
securities of like kind and quantity. A ``non-reporting threshold 
security'' is ``any equity security of an issuer that is not registered 
pursuant to Section 12 of the Act \10\ and for which the issuer is not 
required to file reports pursuant to Section 15(d) of the Act: \11\ (A) 
For which there is an aggregate fail to deliver position for five 
consecutive settlement dates at a registered clearing agency of 10,000 
shares or more and for which on each settlement day during the five 
consecutive day period, the reported last sale during the normal market 
hours for the security on that settlement day would value the aggregate 
fail to deliver position at $50,000 or more, provided that, if there is 
no reported last sale on a particular settlement day, then the price 
used to value the position on such settlement day would be the 
previously reported last sale; and (B) is included on a list published 
by the NASD.''
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    \8\ A ``participant'' means a participant as defined in Section 
3(a)(24) of the Act, that is an NASD member. See Proposing Release, 
supra note 5, 70 FR at 69615.
    \9\ A ``registered clearing agency'' is a clearing agency, as 
defined in Section 3(a)(23)(A) of the Act, that is registered with 
the SEC pursuant to Section 17A of the Act.
    \10\ 15 U.S.C. 78l.
    \11\ 15 U.S.C. 78o(d).
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    In addition, if the fail to deliver position is not closed out in 
the requisite time period, a participant or any broker-dealer for which 
it clears transactions, including market-makers, would be prohibited 
from accepting any short sale order in the non-reporting threshold 
security from another person, or effecting a short sale in the non-
reporting threshold security for its own account, without borrowing the 
security or entering into a bona-fide arrangement to borrow the 
security, until the participant has closed out the fail to deliver 
position by purchasing securities of like kind and quantity.
    Under the proposed rule change, NASD would publish a list daily of 
the non-reporting threshold securities.\12\ In order to be removed from 
the non-reporting threshold securities list, a security must not meet 
or exceed the threshold requirements in the proposed rule change for 
five consecutive settlement days.\13\
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    \12\ Proposing Release, supra note 5, 70 FR at 69616.
    \13\ Id., 70 FR at 69615.
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III. Summary of Comments

    The Commission received nine comment letters on the proposal.\14\ 
Several commenters supported the proposal.
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    \14\ See supra note 6.
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A. Delivery Requirements for Non-Reporting Threshold Securities

    Several commenters supported applying a delivery framework to non-
reporting threshold securities. Some commenters, however, objected to 
certain provisions of the proposed rule change.
i. Uniform Short Sale Delivery Requirements
    One commenter asserted that a uniform short sale delivery 
requirement for reporting and non-reporting equity securities would be 
preferable.\15\ This commenter argued that the adoption of the proposed 
rule change would upset the regulatory uniformity that Regulation SHO 
\16\ was intended to create because it would result in additional rules 
that apply only to NASD member firms.\17\ In addition, this commenter 
expressed concern that separate rules for reporting and non-reporting 
equity securities could be subject to disparate revisions and/or 
interpretations, thereby subjecting member firms to different delivery 
requirements, depending on which securities are at issue.\18\
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    \15\ See Letter, supra note 6, at 3.
    \16\ Id.
    \17\ Id.
    \18\ Id.
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    This commenter urged the Commission to amend the Regulation SHO 
delivery requirements to also address non-reporting equity 
securities.\19\
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    \19\ Id.
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    In its Response to Comments, NASD agreed that uniformity with 
respect to rulemaking across self-regulatory organizations (``SROs'') 
is preferable to the extent possible and practicable.\20\ In addition, 
NASD noted that if, in the future, the SEC determines to amend the 
Regulation SHO delivery requirements to apply to non-reporting equity 
securities, NASD would consider repealing its rule.\21\ NASD also 
stated in its Response to Comments that, although NASD believes that 
the vast majority of trading in non-reporting securities occurs through 
NASD members, uniformity in this area can be achieved if other SROs 
propose similar requirements. NASD also noted that it did not believe 
it was appropriate to forestall an SRO proposal solely because other 
SROs have not put forth comparable requirements.\22\
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    \20\ Response to Comments, supra note 7, at 4.
    \21\ Id.
    \22\ Id.
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ii. $50,000 Threshold Requirement
    Some commenters opposed the $50,000 value threshold requirement 
contained in the definition of a ``non-reporting threshold security.'' 
For example, one commenter argued that the dollar threshold value is 
inappropriate, stating that it is not an accurate indicator of non-
reporting securities with excessive fails to deliver.\23\ Another 
commenter believed that the dollar threshold value was too high, noting 
that such a value would harm small companies,\24\ while another 
commenter argued that the dollar threshold value was too low and would 
capture a vastly expanded universe of threshold securities.\25\
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    \23\ See Stoecklein Law Group Letter, supra note 6, at 1.
    \24\ See Vuksich Letter, supra note 6, at 1.
    \25\ See SIA Letter, supra note 6, at 5.
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    In its Response to Comments, NASD noted that it proposed the dollar 
threshold value to ensure that the non-reporting threshold security 
list would not be overly broad or impracticable.\26\ NASD noted that it 
was concerned that having a security on the non-reporting threshold 
security list solely based on whether the failure to deliver position 
is equal to, or greater than, 10,000 shares may not represent a 
significant failure to deliver position relative to the price of the 
security, particularly given that many non-reporting securities trade 
at less than $1.00.\27\ Thus, NASD believes that the $50,000 value 
threshold strikes an appropriate balance to ensure that the threshold 
list is not overly broad or narrow.\28\
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    \26\ Response to Comments, supra note 7, at 3.
    \27\ Id.
    \28\ Id. In addition, in its Response to Comments, NASD noted 
that NASD staff analyzed data relating to non-reporting securities 
over a five-day settlement period in February 2006 to get an 
indication of the number of non-reporting securities that would meet 
the proposed threshold requirements. During this time period, the 
analysis indicated that 44 securities would be deemed non-reporting 
threshold securities under the proposed threshold requirements. See 
Response to Comments, supra note 7, at fn. 20.
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iii. Impact on Liquidity in the Marketplace
    One commenter believed that the proposed rule change may result in 
negative consequences for this class of securities, such as further 
reducing liquidity in already illiquid securities and having a greater 
impact on price

[[Page 18394]]

than would be the case with reporting equity securities.\29\
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    \29\ See SIA Letter, supra note 6, at 4.
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    In its Response to Comments, NASD noted that similar concerns were 
raised in the context of Regulation SHO, to which the SEC responded 
that the requirements would only apply to a limited number of 
securities and would not apply to any fail to deliver positions 
existing prior to the security meeting the threshold requirements.\30\ 
NASD noted in its Response to Comments that it believes these same 
assertions apply in the context of the proposed rule change as well, 
given the Commission's Office of Economic Analysis' (``OEA'') estimates 
on non-reporting securities with fails to deliver of 10,000 shares or 
greater,\31\ and that NASD's proposal would further reduce this 
estimate due to the proposed additional $50,000 value threshold 
requirement.\32\
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    \30\ Response to Comments, supra note 7, at 5.
    \31\ In its Response to Comments, NASD noted that general 
estimates relating to the number of non-reporting securities with 
fails to deliver in excess of 10,000 shares were made publicly 
available as part of the Regulation SHO Adopting Release. NASD noted 
that the Regulation SHO Adopting Release provided that the 
Commission's OEA analyzed NSCC data on fails to deliver in excess of 
10,000 shares for non-reporting issuers and estimated that only an 
additional 1% of all securities would be added to its estimate of 
the number of securities that would be subject to the close out 
requirements of Regulation SHO. See Response to Comments supra note 
7, at 4 (referencing the Regulation SHO Adopting Release at fn. 86).
    \32\ See id. at 5.
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iv. Exemptive Authority
    One commenter raised concerns with the provision that permits NASD 
to grant exemptive relief under certain specified conditions, arguing 
that NASD may abuse such discretion or the provision may provide a 
blanket exemption to firms.\33\
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    \33\ See Stoecklein Law Group Letter, supra note 6, at 1.
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    In its Response to Comments, NASD commented that it believes this 
comment is without merit.\34\ NASD believes that it is important to 
have the ability to address, through the exemptive process, situations 
that may warrant relief.\35\ In addition, NASD noted that the proposed 
exemptive authority, by its terms, is specifically limited to those 
situations where granting such relief is consistent with the protection 
of investors and the public interest, and NASD will execute such 
authority consistent with this requirement.\36\
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    \34\ Response to Comments, supra note 7, at 4.
    \35\ Id.
    \36\ Id.
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B. Defined Terms

    NASD proposed that the term ``non-reporting threshold security'' 
means ``any equity security of an issuer that is not registered 
pursuant to Section 12 of the Act \37\ and for which the issuer is not 
required to file reports pursuant to Section 15(d) of the Act:\38\ (A) 
for which there is an aggregate fail to deliver position for five 
consecutive settlement dates at a registered clearing agency of 10,000 
shares or more and for which on each settlement day during the five 
consecutive day period, the reported last sale during the normal market 
hours for the security on that settlement day that would value the 
aggregate fail to deliver position at $50,000 or more, provided that, 
if there is no reported last sale on a particular settlement day, then 
the price used to value the position on such settlement day would be 
the previously reported last sale; and (B) is included on a list 
published by the NASD.'' \39\
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    \37\ 15 U.S.C. 78l.
    \38\ 15 U.S.C. 78o(d).
    \39\ Proposing Release, supra note 5, 70 FR at 69615.
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    The Commission agrees with NASD that imposing a lower dollar value 
threshold requirement, or eliminating it altogether, as some commenters 
suggested, might be impracticable or an overly-broad method of 
addressing any potential abuses in this sector of the marketplace. 
Similarly, the Commission agrees with NASD that increasing the dollar 
value threshold requirement could be too limiting. As noted above, a 
five-day settlement period analysis by NASD staff found that under the 
proposed threshold requirements, only approximately 44 securities would 
qualify as non-reporting threshold securities.\40\
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    \40\ See supra note 28.
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C. Implementation

    NASD suggests that the effective date of the proposed rule change 
will be 30 days following publication of NASD's Notice to Members 
announcing Commission approval \41\ and the Commission believes that 
this is reasonable.
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    \41\ NASD will announce the effective date of the proposed rule 
change in a Notice to Members to be published no later than 60 days 
following Commission approval.
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IV. Discussion and Commission Findings

    After careful review, the Commission finds, as discussed more fully 
below, that the proposed rule change is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to a national securities association. The Commission finds 
specifically that the proposed rule change, as amended, is consistent 
with Sections 15A(b)(6) and 15A(b)(9) of the Act.\42\
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    \42\ 15 U.S.C. 78o-3(b)(6) and (b)(9).
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    Section 15A(b)(6) of the Act requires that NASD's rules are 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, to foster cooperation 
and coordination with persons engaged in regulating, clearing, 
settling, processing information with respect to, and facilitating 
transactions in securities, to remove impediments to and perfect the 
mechanism of a free and open market and a national market system, and, 
in general, to protect investors and the public interest.\43\ Section 
15A(b)(9) of the Act requires that NASD's rules do not impose any 
burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.\44\
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    \43\ See 15 U.S.C. 78o-3(b)(6).
    \44\ See 15 U.S.C. 78o-3(b)(9).
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    Section 3(f) of the Act directs the Commission to consider, in 
addition to the protection of investors, whether approval of a rule 
change will promote efficiency, competition, and capital formation.\45\ 
In approving the proposed rule change, the Commission has considered 
its impact on efficiency, competition, and capital formation. In 
particular, the Commission determined that requiring a delivery 
framework for non-reporting threshold securities similar to that 
required under Regulation SHO would increase investor confidence in 
this sector of the marketplace by helping to reduce fails to deliver 
which, in turn, would promote capital formation.
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    \45\ 15 U.S.C. 78c(f).
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    When the Commission adopted Regulation SHO, it did not apply the 
Regulation SHO delivery requirements to non-reporting threshold 
securities because the calculation of the threshold that would trigger 
the delivery requirements under Regulation SHO depends on identifying 
the aggregate fails to deliver as a percentage of the TSO that is 
generally obtained from periodic reports filed with the Commission. 
Thus, the Commission believed it was necessary to limit the delivery 
requirement to companies that are subject to the reporting requirements 
of the Act.
    The Commission believes that applying a delivery framework similar 
to that contained in Regulation SHO to non-reporting threshold 
securities will protect investors and the public interest by helping to 
reduce fails to deliver in

[[Page 18395]]

this sector of the marketplace. Thus, the Commission finds that the 
proposed rule change is consistent with Sections 15A(b)(6) and 
15A(b)(9) of the Act.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\46\ that the proposed rule change (SR-NASD-2004-044), as amended, 
be, and it hereby is, approved.
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    \46\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\47\
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    \47\ 17 CFR 200.30-3(a)(12).
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Nancy M. Morris,
Secretary.
 [FR Doc. E6-5236 Filed 4-10-06; 8:45 am]

BILLING CODE 8010-01-P