# Regulation SHO Explained: Short Sale Rules and Key Requirements

## What Is Regulation SHO?

Regulation SHO is a set of rules from the [Securities and Exchange Commission](https://www.investopedia.com/terms/s/sec.asp) (SEC) implemented in 2005 that regulates [short sale](https://www.investopedia.com/terms/s/shortsale.asp) practices.

Regulation SHO introduced "locate" and "close-out" rules to stop [naked short selling](https://www.investopedia.com/terms/n/nakedshorting.asp), where investors sell shares they don't own or haven't secured. Later amendments also suspend short selling for shares that have dropped 10% in a single day.

### Key Takeaways

*   Regulation SHO was introduced by the SEC in 2005 to update rules governing short sales.  
    
*   The "locate" requirement ensures brokers can borrow and deliver shares before short selling.  
    
*   Naked short selling, selling shares not owned, is restricted under Regulation SHO.  
    
*   Rule 201, amended in 2010, prevents short sales if a stock drops 10% in one day.  
    
*   Brokers mark certain exempt short sales as "short exempt" using special pricing quotes.

## In-Depth Look at Regulation SHO

Short selling refers to an exchange of securities through a broker on margin. An investor borrows a stock, sells it, and then buys the stock back to return to the lender. Short sellers are betting the stock they sell will drop in price. [Broker-dealers](https://www.investopedia.com/terms/b/broker-dealer.asp) loan securities to clients for the purpose of short selling.  

The SEC launched Regulation SHO on January 3, 2005, marking the first major update to short selling rules since 1938. Regulation SHO's "locate" standard requires [brokers](https://www.investopedia.com/terms/b/broker.asp) to have a reasonable belief the equity to be shorted can be borrowed and delivered on a specific date before short selling can occur. The "close-out" rule raises delivery demands for securities with multiple extended delivery failures at clearing agencies.

Regulation SHO requires reporting when the following has occurred for five consecutive settlement days:

*   The aggregate fails to deliver at a registered clearing agency of 10,000 shares or more per security.
*   The number of fails is equal to at least one-half of one percent of the issue's total shares outstanding.
*   The security is included on a list published by a self-regulatory organization (SRO).

## The Evolution of Regulation SHO

Regulation SHO has been amended over the years. After initial adoption came two exceptions to the close-out requirement: the legacy provision and the options market maker exception. There were ongoing concerns, though, regarding instances where requirements were not being met for closing out securities that had failed to deliver positions. Those concerns eventually led to the elimination of both exceptions in 2008. The result of this change was the strengthening of the close-out requirements by applying them to failures to deliver as a result of a sales of all equity securities (as well as cutting down the time allowed for failures to deliver to be closed out).

More changes to Regulation SHO occurred in 2010. The SEC aimed to prevent short selling from unfairly lowering security prices, addressing this with Rule 201, which restricts short sale prices during steep price drops.

> **Important**
>
> Rule 201 is colloquially known as the alternative uptick rule.

Rule 201 is triggered in the midst of a substantial decrease in a stock's price during intraday trading—specifically when its shares fall at least 10% in one day. It mandates that short-sale orders must include a price above the current bid, a move that prevents sellers from accelerating the downward momentum of a security already in sharp decline.﻿﻿﻿

As a part of Rule 201, trading centers are required to establish and enforce policies that prevent short sales at what would be deemed impermissible prices after a stock is dealt a 10% decrease in its price within the trading day. This would trigger a "circuit breaker" that would bring price test restrictions into effect on short sales on that day and into the next trading day.﻿﻿﻿

## Notable Exceptions to Regulation SHO

Certain types of short sales can qualify for an exception to Regulation SHO. These orders are known as [short exempt](https://www.investopedia.com/terms/s/shortexempt.asp) and are marked by brokers with the initials SSE. The primary exception is the use of non-standard pricing quotes for trade execution.﻿﻿

> **Article Sources**
>
> 1.  U.S. Securities and Exchange Commission. "[Key Points About Regulation SHO](https://www.sec.gov/investor/pubs/regsho.htm)."
>     
> 2.  U.S. Securities and Exchange Commission. "[SEC Approves Short Selling Restrictions](https://www.sec.gov/news/press/2010/2010-26.htm)."