Document ID: SEC-2005-0249-0001
Agency: sec
Document Type: Notice
Title: Self-regulatory organizations; proposed rule changes: National Association of Securities Dealers, Inc.
Posted Date: 2005-11-16T05:00Z

[Federal Register: November 16, 2005 (Volume 70, Number 220)]
[Notices]               
[Page 69614-69617]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr16no05-132]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-52752; File No. SR-NASD-2004-044]

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

November 8, 2005.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'')\1 \ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on March 10, 2005, the National Association of Securities Dealers, Inc.

[[Page 69615]]

(``NASD'') filed with the Securities and Exchange Commission (``SEC'' 
or ``Commission'') the proposed rule change as described in Items I, 
II, and III below, which Items have been prepared by NASD. On October 
6, 2005, NASD filed Amendment No. 1 to the proposed rule change.\3\ On 
October 28, 2005, NASD filed Amendment No. 2 to the proposed rule 
change.\4\ The Commission is publishing this notice to solicit comments 
on the proposed rule change, as amended, from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ On account of the adoption of Regulation SHO, Amendment No. 
1 to SR-NASD-2004-044, among other things, narrows the scope of the 
proposed rule change to those equity securities not otherwise 
covered by the delivery requirements of Rule 203(b) of Regulation 
SHO.
    \4\ Amendment No. 2 to SR-NASD-2004-044, which replaces and 
supersedes Amendment No. 1, makes technical changes to the proposed 
rule change.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NASD is proposing new Rule 3210 to require participants \5\ of 
registered clearing agencies \6\ (referred to herein as ``clearing 
agency participants'') to take action on failures to deliver that exist 
for 13 consecutive settlement days in certain specified securities. In 
addition, 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.
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    \5\ See Section 3(a)(24) of the Act.
    \6\ 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.
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    Below is the text of the proposed rule change. Proposed new 
language is in italics; proposed deletions are in brackets.
* * * * *
3210. [Reserved.] Short Sale Delivery Requirements

    (a) If a participant of a registered clearing agency has a fail to 
deliver position at a registered clearing agency in a non-reporting 
threshold security for 13 consecutive settlement days, the participant 
shall immediately thereafter close out the fail to deliver position by 
purchasing securities of like kind and quantity.
    (b) The provisions of this rule shall not apply to the amount of 
the fail to deliver position that the participant of a registered 
clearing agency had at a registered clearing agency on the settlement 
day immediately preceding the day that the security became a non-
reporting threshold security; provided, however, that if the fail to 
deliver position at the clearing agency is subsequently reduced below 
the fail to deliver position on the settlement day immediately 
preceding the day that the security became a non-reporting threshold 
security, then the fail to deliver position excepted by this paragraph 
(b)(1) shall be the lesser amount.
    (c) If a participant of a registered clearing agency has a fail to 
deliver position at a registered clearing agency in a non-reporting 
threshold security for 13 consecutive settlement days, the participant 
and any broker or dealer for which it clears transactions, including 
any market maker that would otherwise be entitled to rely on the 
exception provided in paragraph (b)(2)(iii) of SEC Rule 203 of 
Regulation SHO, may not accept a short sale order in the non-reporting 
threshold security from another person, or effect 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 closes out the fail to deliver position 
by purchasing securities of like kind and quantity.
    (d) If a participant of a registered clearing agency reasonably 
allocates a portion of a fail to deliver position to another registered 
broker or dealer for which it clears trades or for which it is 
responsible for settlement, based on such broker or dealer's short 
position, then the provisions of this rule relating to such fail to 
deliver position shall apply to the portion of such registered broker 
or dealer that was allocated the fail to deliver position, and not to 
the participant.
    (e) A participant of a registered clearing agency shall not be 
deemed to have fulfilled the requirements of this rule where the 
participant enters into an arrangement with another person to purchase 
securities as required by this rule, and the participant knows or has 
reason to know that the other person will not deliver securities in 
settlement of the purchase.
    (f) For the purposes of this rule, the following terms shall have 
the meanings below:
    (1) the term ``market maker'' has the same meaning as in section 
3(a)(38) of the Exchange Act.
    (2) the term ``non-reporting threshold security'' means any equity 
security of an issuer that is not registered pursuant to section 12 of 
the Exchange Act and for which the issuer is not required to file 
reports pursuant to section 15(d) of the Exchange Act:
    (A) for which there is an aggregate fail to deliver position for 
five consecutive settlement days at a registered clearing agency of 
10,000 shares or more and for which on each settlement day during the 
five consecutive settlement day period, the reported last sale during 
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 NASD.
    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.
    (3) the term ``participant'' means a participant as defined in 
section 3(a)(24) of the Exchange Act, that is an NASD member.
    (4) the term ``registered clearing agency'' means a clearing 
agency, as defined in section 3(a)(23)(A) of the Exchange Act, that is 
registered with the Commission pursuant to section 17A of the Exchange 
Act.
    (5) the term ``settlement day'' means any business day on which 
deliveries of securities and payments of money may be made through the 
facilities of a registered clearing agency.
    (g) Pursuant to the Rule 9600 Series, the staff, for good cause 
shown after taking into consideration all relevant factors, may grant 
an exemption from the provisions of this rule, either unconditionally 
or on specified terms and conditions, to any transaction or class of 
transactions, or to any security or class of securities, or to any 
person or class of persons, if such exemption is consistent with the 
protection of investors and the public interest.
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, NASD included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified

[[Page 69616]]

in Item IV below. NASD has prepared summaries, set forth in sections A, 
B, and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose

Rule Filing History

    On March 10, 2004, NASD filed with the Commission proposed rule 
change SR-NASD-2004-044, proposing amendments relating to short sale 
delivery requirements in all classes of equity securities. Given the 
SEC's adoption of Regulation SHO under the Act, which imposes delivery 
requirements related to short selling activities, on October 6, 2005, 
NASD filed Amendment No. 1 to SR-NASD-2004-044 to, among other things, 
narrow the scope of its proposal to those equity securities not 
otherwise covered by the delivery requirements of Rule 203 of 
Regulation SHO.\7\ NASD filed Amendment No. 2 to SR-NASD-2004-044 
(``Amendment No. 2'') to make certain technical changes. Amendment No. 
2 replaces and supersedes in its entirety the filing made on October 6, 
2005.
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    \7\ On November 30, 2004, NASD filed for immediate effectiveness 
a rule change that repealed, among others, Rule 3210 and Rule 11830 
in light of the requirements of the SEC's new short sale regulation, 
Regulation SHO under the Act. See Exchange Act Release No. 50822 
(December 8, 2004), 69 FR 74554 (December 14, 2004) (File No. SR-
NASD-2004-175). Therefore, deletion of those rules as part of this 
filing is no longer necessary.
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Background

    On June 23, 2004, the SEC adopted Regulation SHO under the Act, 
which provides a new regulatory framework governing the short selling 
of equity securities.\8\ 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. Specifically, Rule 203(b)(3) 
of Regulation SHO requires clearing agency participants to close out 
all failures to deliver in a ``threshold security,'' as defined in 
Regulation SHO, that have existed for thirteen consecutive settlement 
days. Regulation SHO defines a ``threshold security'' as any equity 
security of an issuer that is registered under Section 12 of the Act or 
that is required to file reports under Section 15(d) of the Act 
(commonly referred to as ``reporting securities'') that (1) for five 
consecutive settlement days has had aggregate fails to deliver at a 
registered clearing agency of 10,000 shares or more; (2) the level of 
fails is equal to at least one-half of one percent of the issue's total 
shares outstanding (``TSO''); and (3) is included on a list published 
by a self-regulatory organization.
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    \8\ See Exchange Act Release No. 50103 (July 28, 2004), 69 FR 
48008 (August 6, 2004) (``Regulation SHO Adopting Release'').
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    If the fail to deliver is not closed out in the requisite time 
period, the clearing agency participant and any broker-dealer for which 
it clears transactions, including market makers, are prohibited from 
effecting further short sales in the particular threshold 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 should 
apply only to those particular broker-dealers.

Description of Proposed Rule Change

    As noted above, the Regulation SHO delivery requirements apply only 
to reporting securities. NASD staff 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.
    Accordingly, NASD is proposing new Rule 3210, which would apply a 
delivery framework to non-reporting OTC equity securities substantially 
similar to that described above. Under the proposal, a non-reporting 
security that, for five consecutive settlement dates, has: (1) A 
failure to deliver equal to or greater than 10,000 shares; 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; would 
be deemed a non-reporting threshold security and thus, subject to the 
delivery requirements proposed herein. In the event there is no 
reported last sale on any settlement day during such five-day period, 
the aggregate fail position would be valued based on the previously 
reported last sale.
    In the Regulation SHO Adopting Release, the SEC indicated that it 
did not apply the Regulation SHO delivery framework to non-reporting 
securities because of the difficulties in capturing TSO information for 
those securities to determine whether they met the Regulation SHO 
threshold requirements.\9\ NASD believes that under the proposed rule 
change described herein, the lack of TSO information for non-reporting 
securities would not be an issue, given that the only calculations 
necessary would be whether the failure to deliver position is equal to 
or greater than 10,000 shares and whether the failure to deliver 
position meets the dollar threshold test specified above.\10\
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    \9\ See id. Footnote 82.
    \10\ According to the NASD, similar to the rationale behind the 
Regulation SHO threshold test relative to TSO, NASD has proposed the 
dollar threshold test to ensure that the non-reporting threshold 
security list is not overly broad or impracticable. NASD is 
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. As noted in the Regulation SHO Adopting 
Release, there may be many different causes of fails to deliver that 
could be unrelated to a market participant engaging in naked short 
selling. See Regulation SHO Adopting Release. Thus, NASD staff 
believes that imposing too low of a threshold may be an overly broad 
method of addressing any potential abuses and also could disrupt the 
efficient functioning of the Continuous Net Settlement system 
operated by the National Securities Clearing Corporation.
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    NASD will publish a list daily of the non-reporting securities that 
meet the threshold requirements under proposed Rule 3210. To be removed 
from the list, a security must not meet or exceed either of the 
threshold tests described above for five consecutive settlement days.
    NASD believes that, as discussed previously, the proposed rule 
change would apply a delivery framework substantially similar to 
Regulation SHO to non-reporting securities. As such, NASD intends to 
apply and interpret these proposed requirements consistent with the 
SEC's application and interpretation of Regulation SHO, and to the 
extent there are subsequent amendments to Regulation SHO, NASD will 
consider amending its requirements accordingly.
    Among other issues relating to the filing, NASD is seeking comment 
on the proposed threshold tests for non-reporting OTC equity securities 
described above. Specifically, NASD is seeking comment on whether the 
proposed thresholds are an accurate indicator of non-reporting OTC 
equity securities with excessive fails to deliver, including but not 
limited to, whether the $50,000 aggregate fail to deliver position is 
the appropriate dollar threshold and whether the 10,000 shares or 
greater failure to deliver threshold is the appropriate share 
threshold, given the trading characteristics in this sector of the 
marketplace.

[[Page 69617]]

    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. The effective date will be 30 days following 
publication of the Notice to Members announcing Commission approval.
 2. Statutory Basis
    NASD believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\11\ which requires, among 
other things, that NASD rules must be designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest. NASD believes that the proposed rule change will 
reduce significant, long-term fails to deliver in the marketplace.
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    \11\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    NASD does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act, as amended.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (a) By order approve such proposed rule change, or
    (b) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    The Commission notes that in Section 3210(b) of the proposed rule, 
consistent with the application of Regulation SHO, the NASD excludes 
from the close out requirement of Section 3210(a) of the proposed rule 
the amount of the fail to deliver position that the participant of a 
registered clearing agency had at a registered clearing agency on the 
settlement day immediately preceding the day that the security became a 
non-reporting threshold security. The Commission specifically requests 
comment on this aspect of proposed Rule 3210.
    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. Comments may be 
submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml.
); or     Send an e-mail to rule-comments@sec.gov. Please include 

File Number SR-NASD-2004-044 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-9303.
    All submissions should refer to File Number SR-NASD-2004-044. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission 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/sro.shtml
). Copies of the submission, all subsequent amendments, 

all written statements with respect to the proposed rule change that 
are filed with the Commission, and all written communications relating 
to the proposed rule change between the Commission and any person, 
other than those that may be withheld from the public in accordance 
with the provisions of 5 U.S.C. 552, will be available for inspection 
and copying in the Commission's Public Reference Room, 100 F Street, 
NE., Washington, DC 20549. Copies of such filing also will be available 
for inspection and copying at the principal office of NASD. All 
comments received will be posted without change; the Commission does 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly. All 
submissions should refer to the File Number SR-NASD-2004-044 and should 
be submitted on or before December 7, 2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\12\
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    \12\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
 [FR Doc. E5-6306 Filed 11-15-05; 8:45 am]

BILLING CODE 8010-01-P