Document ID: SEC-2008-0975-0001
Agency: sec
Document Type: Proposed Rule
Title: Amendment to Regulation SHO
Posted Date: 2008-07-14T04:00Z

[Federal Register: July 14, 2008 (Volume 73, Number 135)]
[Proposed Rules]               
[Page 40201-40203]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr14jy08-13]                         

=======================================================================
-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 242

[Release No. 34-58107; File No. S7-19-07]
RIN 3235-AJ57

 
Amendment to Regulation SHO

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule; notice of re-opening of comment period.

-----------------------------------------------------------------------

SUMMARY: The Securities and Exchange Commission is re-opening the 
comment period on the ``Amendments to Regulation SHO'' it re-proposed 
in Securities Exchange Act Release No. 56213 (August 7, 2007), 72 FR 
45558 (August 14, 2007), (the ``Proposal''). In view of the continuing 
public interest in the Proposal we believe that it is appropriate to 
re-open the comment period to provide the public with additional 
information before we take action on the Proposal.

DATES: Comments should be received on or before August 13, 2008.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/proposed.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number S7-19-07 on the subject line; or
     Use the Federal eRulemaking Portal (http://
www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number S7-19-07. This file number 
should be included on the subject line if e-mail is used. To help us 
process and review your comments more efficiently, please use only one 
method. The Commission will post all comments on the Commission's 
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments 
are also available for public inspection and copying in the 
Commission's Public Reference Room, 100 F Street, NE., Washington, DC 
20549 on official business days between the hours of 10 a.m. and 3 p.m. 
All comments received will be posted without change; we do not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: James A. Brigagliano, Associate 
Director, Josephine J. Tao, Assistant Director, Victoria L. Crane, 
Branch Chief and Christina M. Adams, Staff Attorney, Office of Trading 
Practices and Processing, Division of Market Regulation, at (202) 551-
5720, at the Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549.

SUPPLEMENTARY INFORMATION: The Commission is requesting additional 
public comment on proposed amendments to Rules 200 and 203 of 
Regulation SHO [17 CFR 242.200 and 242.203] under the Securities 
Exchange Act of 1934 (``Exchange Act''). In the Proposal, the 
Commission re-proposed amendments to Regulation SHO under the Exchange 
Act intended to further reduce the number of persistent fails to 
deliver \1\ in certain equity securities by eliminating the options 
market maker exception to the close-out requirement of Regulation SHO. 
The Commission also sought comment on two alternatives to elimination 
that would limit the scope of the options market maker exception. The 
Commission is re-opening the comment period, which ended on September 
13, 2007, to provide additional information with respect to the 
Proposal to the public.
---------------------------------------------------------------------------

    \1\ A ``fail to deliver'' occurs when the seller of a security 
fails to deliver the security by settlement date. Generally, 
investors must complete or settle their security transactions within 
three business days. This settlement cycle is known as T+3 (or 
``trade date plus three days''). T+3 means that when the investor 
purchases a security, the purchaser's payment generally must be 
received by its brokerage firm no later than three business days 
after the trade is executed. When the investor sells a security, the 
seller generally must deliver its securities, in certificated or 
electronic form, to its brokerage firm no later than three business 
days after the sale.
---------------------------------------------------------------------------

    At the same time that the Commission re-proposed amendments to 
Regulation SHO to eliminate the options market maker exception to 
Regulation SHO's close-out requirement, the Commission approved 
amendments to Regulation SHO to eliminate the rule's ``grandfather'' 
provision.\2\ The ``grandfather'' provision had provided that fails to 
deliver established prior to a security becoming a threshold security 
did not have to be closed out in accordance with Regulation SHO's 
thirteen consecutive settlement day close-out requirement. The 
amendment to eliminate the ``grandfather'' exception became effective 
on October 15, 2007.

[[Page 40202]]

The amendment also contained a one-time phase-in period that provided 
that previously-grandfathered fails to deliver in a security that was a 
threshold security on the effective date of the amendment must be 
closed out within 35 consecutive settlement days from the effective 
date of the amendment. The phase-in period ended on December 5, 
2007.\3\
---------------------------------------------------------------------------

    \2\ Securities Exchange Act Release No. 56212 (Aug. 7, 2007), 72 
FR 45544 (Aug. 14, 2007).
    \3\ See id.
---------------------------------------------------------------------------

    In response to the Proposal, commenters urged the Commission to 
obtain empirical data to demonstrate the relationship between fails to 
deliver and the options market maker exception before it determines 
whether additional rulemaking is necessary. In particular, commenters 
urged the Commission to obtain data relating to the impact of the 
elimination of the grandfather provision and connecting fails to 
deliver to the options market maker exception.\4\ The Commission has 
obtained additional data on fails to deliver since the Proposal was 
published. Accordingly, in response to commenters and because the 
Commission believes the additional data will aid the public in 
commenting on the Proposal, the Commission is re-opening the comment 
period to share with the public data obtained by the Commission 
regarding fails to deliver and the options market maker exception, and 
to provide the public with an opportunity to comment on the data.
---------------------------------------------------------------------------

    \4\ See e.g., Comments of Keith F. Higgins, Committee on Federal 
Regulation of Securities, American Bar Association, Section of 
Business Law (Oct. 5, 2007); comments of John Gilmartin and Ben 
Londergan, Group One Trading, LP (Sept. 28, 2007); see also comments 
of Gerald D. O'Connell, Susquehanna Investment Group (Oct. 11, 
2007).
---------------------------------------------------------------------------

    To ascertain whether fails to deliver are not being closed out due 
to the options market maker exception to the close-out requirement 
since the elimination of the ``grandfather'' provision, Commission 
staff obtained data on securities with extended fails to deliver from a 
National Securities Clearing Corporation (``NSCC'') participant which 
settles and clears for a large segment of the options market for 
January and February 2008. A review of this data reveals that a high 
number of fails to deliver were not closed out as a result of the 
options market maker exception.\5\ Specifically, the data indicated 
that as of January 31, 2008, the options market maker exception was 
claimed in 16 threshold securities for a total of 6,365,158 fails to 
deliver. As of February 29, 2008, the data indicated that the options 
market maker exception was claimed in 20 threshold securities for a 
total of 6,963,949 fails to deliver.
---------------------------------------------------------------------------

    \5\ We note that the data reflects only those extended fails to 
deliver not closed out due to the options market maker exception 
and, therefore, does not reflect all fails to deliver in the 
securities included in the data.
---------------------------------------------------------------------------

    In addition, the Commission is releasing the results of a recent 
analysis by the Commissions' Office of Economic Analysis (``OEA'') of 
fails to deliver before and after the elimination of Regulation SHO's 
``grandfather'' provision.\6\ As set forth below, these results show 
that extended fails to deliver in non-optionable threshold securities 
declined significantly after the elimination of the ``grandfather'' 
provision while extended fails to deliver in optionable threshold 
securities increased significantly. Specifically, changes for 
optionable threshold securities include:
---------------------------------------------------------------------------

    \6\ See Memorandum from the Commission's Office of Economic 
Analysis (dated June 9, 2008), which is available on the 
Commission's Internet Web site at http://www.sec.gov/comments/s7-19-
07/s71907.shtml (the ``OEA Memorandum''). As discussed above, the 
``grandfather'' provision was eliminated as of October 15, 2007 with 
a one-time phase in period which expired on December 5, 2007. The 
sample data used in the OEA Memorandum compares two time periods: 
April 9, 2007-October 14, 2007, which is defined as the ``pre-
amendment period'' and December 10, 2007-March 31, 2008, which is 
defined as the ``post-amendment period.''
---------------------------------------------------------------------------

     The average daily number of optionable threshold list 
securities increased by 25.0%.
     The average daily number of new fail to deliver positions 
in optionable threshold securities increased by 45.3%.
     For fails aged more than 17 days in optionable threshold 
securities, the average daily dollar value of fails to deliver 
increased by 73.4%.
     For fails aged more than 17 days in optionable threshold 
securities, the average daily number of fail to deliver positions 
increased by 30.7%.
     The average daily number of optionable threshold list 
securities with fails aged more than 17 days increased by 40.9%.
    Further, changes for non-optionable threshold securities include:
     The average daily number of non-optionable threshold list 
securities decreased by 3.5%.
     The average daily number of new fail to deliver positions 
in non-optionable threshold securities increased by 7.4%.
     For fails aged more than 17 days in non-optionable 
threshold securities, the average daily dollar value of fails to 
deliver decreased by 34.5%.
     For fails aged more than 17 days in non-optionable 
threshold securities, the average daily number of fail to deliver 
positions decreased by 38.8%.
     The average daily number of non-optionable threshold list 
securities with fails aged more than 17 days decreased by 32.6%.\7\
---------------------------------------------------------------------------

    \7\ See id.
---------------------------------------------------------------------------

    To ascertain the extent to which fails to deliver were not being 
closed out due to the options market maker exception to the close-out 
requirement prior to the elimination of the ``grandfather'' provision, 
Commission staff obtained data from certain self-regulatory 
organizations for 2006 and 2007 regarding use of the options market 
maker exception. This data is explained in more detail below.
    In 2007, as part of its regular Regulation SHO surveillance, the 
Financial Industry Regulatory Authority (``FINRA'') conducted a review 
of securities with extended fails to deliver at the NSCC to ascertain 
the continuing cause of fails to deliver, and to also assess compliance 
with NYSE Rule 440/SEA \8\ and Regulation SHO. As set forth below, 
according to data provided by one NSCC participant that settles and 
clears for a large segment of the options market, a number of fails to 
deliver at that participant were not closed out due to claims that the 
fails were excepted from the close-out requirement as a result of the 
options market maker exception.
---------------------------------------------------------------------------

    \8\ NYSE Rule 440 requires that ``[e]very member not associated 
with a member organization and every member organization shall make 
and preserve books and records as the Exchange may prescribe and as 
prescribed by Rule 17a-3.''
---------------------------------------------------------------------------

    A review of the FINRA data for 2007 shows the following:

------------------------------------------------------------------------
                                                Fails to      Number of
                    Month                      deliver\9\    securities
------------------------------------------------------------------------
February....................................        35,665             1
March.......................................       900,276             5
April.......................................     3,433,639             8
May.........................................       228,878             2
June........................................     2,441,122            14
July........................................       462,414             6
August......................................     3,065,710            12
October.....................................     4,456,340            13
November....................................     1,841,063             2
December....................................     5,621,982            15
------------------------------------------------------------------------

     
---------------------------------------------------------------------------

    \9\ These numbers represent fails to deliver which, as explained 
in footnote 1 above, are shares of a security that are not delivered 
by settlement date. According to the data provided to FINRA, these 
fails to deliver were not closed out due to the options market maker 
exception.
---------------------------------------------------------------------------

    As indicated in the table above, the options market maker exception 
to the close-out requirement was claimed for a large number of fails to 
deliver for the entire year, including both before and after October 
15, 2007, the effective date of the elimination of Regulation SHO's 
``grandfather'' provision.
    On December 11, 2006 the Chicago Board of Options Exchange 
(``CBOE'')

[[Page 40203]]

along with the American Stock Exchange, NYSE Arca, Inc., and the 
Philadelphia Stock Exchange initiated a Regulation SHO review of 
options market makers covering the time period from May through July 
2006. The focus of these reviews was the options market maker exception 
to the close-out requirement for aged fails to deliver in threshold 
securities that were open for thirteen consecutive settlement days.\10\
---------------------------------------------------------------------------

    \10\ The ``grandfather'' provision was also in effect during 
this period but was not the subject of these reviews.
---------------------------------------------------------------------------

    According to CBOE, the reviews revealed that there were 598 
exceptions claimed, covering 58 threshold securities for a total of 
11,759,799 fails to deliver. For the 58 threshold securities 
identified, the number of fails to deliver for which an exemption was 
claimed from the close-out requirement ranged from 207 to 1,950,655. 
The following is a distribution of the number of fails to deliver:

------------------------------------------------------------------------
                                                             Number of
   Number of fails to deliver for which exception was        threshold
                         claimed                            securities
------------------------------------------------------------------------
0-100,000...............................................              35
100,001-200,000.........................................               4
200,001-300,000.........................................               4
300,001-400,000.........................................               5
400,001-500,000.........................................               4
500,001-600,000.........................................               2
600,001-700,000.........................................  ..............
700,001-800,000.........................................               1
800,001-900,000.........................................  ..............
900,001-1,000,000.......................................               1
>1,000,000..............................................               2
------------------------------------------------------------------------

    Therefore, the Commission is re-opening the comment period for 
Exchange Act Release No. 56213 from the date of this release through 
August 13, 2008.

    Dated: July 7, 2008.

    By the Commission.
Florence E. Harmon,
Acting Secretary.
[FR Doc. E8-15768 Filed 7-11-08; 8:45 am]

BILLING CODE 8010-01-P