[Federal Register Volume 69, Number 239 (Tuesday, December 14, 2004)]
[Notices]
[Pages 74554-74557]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E4-3636]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50822; File No. SR-NASD-2004-175]


Self Regulatory Organizations, Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change by National Association of 
Securities Dealers, Inc. Relating to Repeal of Existing NASD Short Sale 
Rules in Light of SEC Regulation SHO

December 8, 2004.
    Pursuant to Section 19(b)(3) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on November 30, 2004, the National Association of Securities Dealers, 
Inc. (``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. 
NASD has designated the proposed rule change as constituting a ``non-
controversial'' rule change under paragraph (f)(6) of Rule 19b-4 under 
the Act,\3\ which renders the proposal effective upon receipt of this 
filing by the Commission. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change
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    \1\ 15 U.S.C. 78s(b)(3).
    \2\ 17 CFR 240.19b-4.
    \3\ 17 CFR 240.19b-4
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    NASD is proposing to repeal NASD Rule 3110(b)(1), Rule 3210, Rule 
3370(b) and Rule 11830 in light of the requirements of the SEC's new 
short sale regulation, Regulation SHO under the Act. Below is the text 
of the proposed rule change. Proposed deletions are in brackets.
* * * * *
3110. Books and Records
    (a) No change.
    (b) Marking of Customer Order Tickets.
    [(1) A person associated with a member shall indicate on the 
memorandum for the sale of any security whether the order is ``long'' 
or ``short,'' except that this requirement shall not apply to 
transactions in debt securities. An order may be marked ``long'' if (A) 
the customer's account is long the security involved or (B) the 
customer owns the security and agrees to deliver the security as soon 
as possible without undue inconvenience or expense.]
    [(2)] A person associated with a member shall indicate on the 
memorandum for each transaction in a non-Nasdaq security, as that term 
is defined in the Rule 6700 Series, the name of each dealer contacted 
and the quotations received to determine the best inter-dealer market; 
however, the requirements of this subparagraph shall not apply if two 
or more priced quotations for the security are displayed in an inter-
dealer quotation system, as defined in Rule 2320(g), that permits 
quotation updates on a real-time basis for which NASD Regulation has 
access to historical quotation information.
    (c) No change.
* * * * *
3210. Reserved. [Securities ``Failed to Receive'' and ``Failed to 
Deliver'']
    [(a) No member, or person associated with a member, shall sell a 
security for his own account, or buy a security as a broker for a 
customer (except exempt securities), if,]
    [(1) in respect to domestic securities, he has a fail to deliver in 
that security 60 days old or older; or]
    [(2) in respect to foreign securities, he has a fail to deliver in 
that security 90 days old or older (except American Depositary Receipt 
and Canadian securities, which shall be subject to the provisions of 
subparagraph (1)).]
    [(b) Pursuant to the Rule 9600 Series, for good cause shown and in 
exceptional circumstances, the Association may exempt a member or a 
person associated with a member from the provisions of this Rule.]
* * * * *
3370. [Prompt Receipt and Delivery of Securities] Purchases
    [(a) Purchases].
    No member or person associated with a member may accept a 
customer's purchase order for any security unless it has first 
ascertained that the customer placing the order or its agent agrees to

[[Page 74555]]

receive securities against payment in an amount equal to any execution, 
even though such an execution may represent the purchase of only a part 
of a larger order.
    [(b) Sales].
    [(1) Long Sales].
    [No member or persons associated with a member shall accept a long 
sale order from any customer in any security (except exempt securities 
other than municipals) unless:]
    [(A) The member has possession of the security;]
    [(B) The customer is long in his account with the member;]
    [(C) The member or person associated with a member makes an 
affirmative determination that the customer owns the security and will 
deliver it in good deliverable form within three (3) business days of 
the execution of the order; or]
    [(D) The security is on deposit in good deliverable form with a 
member of the Association, a member of a national securities exchange, 
a broker/dealer registered with the Commission, or any organization 
subject to state or federal banking regulations and that instructions 
have been forwarded to that depository to deliver the securities 
against payment.]
    [(2) ``Short Sales''].
    [(A) Customer and non-member broker/dealer short sales].
    [No member or person associated with a member shall accept a 
``short'' sale order for any customer or non-member broker/dealer in 
any security unless the member or person associated with a member makes 
an affirmative determination that the member will receive delivery of 
the security from the customer or non-member broker/dealer or that the 
member can borrow the security on behalf of the customer or non-member 
broker/dealer for delivery by settlement date. This requirement shall 
not apply, however, to transactions in corporate debt securities or 
transactions in security futures, as defined in Section 3(a)(55) of the 
Act, or proprietary orders of a non-member broker/dealer that meet one 
of the exceptions in subparagraph (B) below, provided, however, that 
(i) the non-member broker/dealer is registered with the Securities and 
Exchange Commission, and (ii) if using the market maker exception, the 
non-member broker/dealer is registered or qualified as a market maker 
in the securities and is selling such securities in connection with 
bona fide market making.]
    [(B) Proprietary short sales].
    [No member shall effect a ``short'' sale for its own account in any 
security unless the member or person associated with a member makes an 
affirmative determination that the member can borrow the securities or 
otherwise provide for delivery of the securities by the settlement 
date. This requirement will not apply to transactions in corporate debt 
securities, to transactions in security futures, as defined in Section 
3(a)(55) of the Act, to bona fide market making transactions by a 
member in securities in which it is registered as a Nasdaq or ADF 
market maker, to bona fide market maker transactions in non-Nasdaq 
securities in which the market maker publishes a two-sided quotation in 
an independent quotation medium, or to transactions that result in 
fully hedged or arbitraged positions.]
    [(3) Public Offering].
    [In the case of a public offering of securities, paragraph (b)(1) 
hereof shall not apply during the period from the commencement of the 
public offering until seven (7) business days following the date of 
settlement between the underwriter and issuer of the securities; 
provided, however, that the member believes in good faith that the 
customer has purchased the securities.]
    [(4) ``Affirmative Determination''].
    [(A) To satisfy the requirements for an ``affirmative 
determination'' contained in paragraph (b)(1)(C) above for long sales, 
the member or person associated with a member must make a notation on 
the order ticket at the time the order is taken which reflects the 
conversation with the customer as to the present location of the 
securities in question, whether they are in good deliverable form and 
the customer's ability to deliver them to the member within three (3) 
business days.]
    [(B) To satisfy the requirement for an ``affirmative 
determination'' contained in paragraph (b)(2) above for customer, non-
member broker/dealer, and proprietary short sales, the member or person 
associated with a member must keep a written record that includes:]
    [(i) if a customer or non-member broker/dealer assures delivery, 
the present location of the securities in question, whether they are in 
good deliverable form and the customer's or non-member broker/dealer's 
ability to deliver them to the member within three (3) business days; 
or]
    [(ii) if the member or person associated with a member locates the 
stock, the identity of the individual and firm contacted who offered 
assurance that the shares would be delivered or that were available for 
borrowing by settlement date and the number of shares needed to cover 
the short sale.]
    [(C) The manner by which a member or person associated with a 
member annotates compliance with the ``affirmative determination'' 
requirement contained in subsection (b)(2) above (e.g., marking the 
order ticket, recording inquiries in a log, etc.) is not specified by 
this Rule and, therefore, shall be decided by each member. Members may 
rely on ``blanket'' or standing assurances (i.e., ``Easy to Borrow'' 
lists) that securities will be available for borrowing on settlement 
date to satisfy their affirmative determination requirements under this 
Rule. For any short sales executed in Nasdaq National Market (NNM) or 
national securities exchange-listed (listed) securities, members also 
may rely on ``Hard to Borrow'' lists indicating NNM or listed 
securities that are difficult to borrow or unavailable for borrowing on 
settlement date to satisfy their affirmative determination requirements 
under this Rule, provided that: (i) Any securities restricted pursuant 
to UPC 11830 must be included on such a list; and (ii) the creator of 
the list attests in writing on the document or otherwise that any NNM 
or listed securities not included on the list are easy to borrow or are 
available for borrowing. Members are permitted to use Easy to Borrow or 
Hard to Borrow lists provided: (i) The information used to generate the 
list is less than 24-hours old; and (ii) the member delivers the 
security on settlement date. Should a member relying on an Easy to 
Borrow or Hard to Borrow list fail to deliver the security on 
settlement date, the Association shall deem such conduct inconsistent 
with the terms of this Rule, absent mitigating circumstances adequately 
documented by the member.]
    [(5) ``Bona Fide Fully Hedged'' and ``Bona Fide Fully 
Arbitraged''].
    [In determining the availability of the exemption provided in 
paragraph (b)(2)(B) above and in Rule 11830 from short sale 
requirements for ``bona fide fully hedged'' and ``bona fide fully 
arbitraged'' transactions, the following guidelines shall apply. These 
guidelines are for illustrative purposes and are not intended to limit 
the Association's ability to determine the proper scope of the terms 
``bona fide fully hedged'' or ``bona fide fully arbitraged'' pursuant 
to this provision, on a case-by-case basis.]
    [(A) Bona Fide Fully Hedged].
    [The following transactions shall be considered bona fide fully 
hedged:]
    [(i) Short a security and long a convertible debenture, preferred 
or other security which has a conversion price at or in the money and 
is convertible within ninety days into the short security.]
    [Example: Long ABCD Company 9% convertible subordinated debentures

[[Page 74556]]

due 2003. Each debenture is convertible into common at $27.90 per share 
of common equal to 35.842 shares of common per 1M debenture.
     With the price of the ABCD at 8\3/4\-9 or 8.75-9 and a 
short position of 100 shares of ABCD the short position would not be 
exempt.
     If the price of ABCD was $28 with a short position of 100 
shares, 35 shares would be exempt and the remaining 65 shares would not 
be exempt.]
    [(ii) Short a security and long a call which has a strike price at 
or in the money and which is exercisable within 90 calendar days into 
the underlying short security.]
    [Example: Long 1 call of EFGH at a price of either 44\1/8\ or 
$44.10 with a strike price of 40 expiring within 90 calendar days.
     With the circumstances as above 100 shares would be 
exempt.
     If the strike price was 50 a short position of 100 shares 
would not be exempt.
     With any strike price and the call expiring in more than 
90 days any short of the common would not be exempt.]
    [(iii) Short a security and long a position in warrants or rights 
which are exercisable within 90 days into the short security. To the 
extent that the long warrants or rights are ``out of the money,'' then 
the short position shall be exempt up to the market value of the long 
warrants or rights.]
    [Example: Long 100 warrants of IJKL (IJKLW: 2\1/4\-2\3/4\ or 2.25-
2.75). Each warrant is exercisable into 1 share of common at $2. (IJKL: 
4-4\1/2\ or $4-4.50).
     With the circumstances as above a short position of 100 
shares would be exempt.
     If the price of IJKL is $1.50 and the market value of long 
warrants is \1/4\ of a point, or $.25, a short position of 16 shares 
would be exempt.]
    [(iv) Short a security and long a single stock future of the 
underlying security.]
    [Example: Long 1 single stock future of MNOP.
     With the circumstances as above (and assuming a contract 
size of 100) 100 shares would be exempt.
     Even if the expiration date for the single stock future 
was more than 90 calendar days, 100 shares would be exempt.]
    [(B) Bona Fide Fully Arbitraged].
    [The following transactions shall be considered bona fide fully 
arbitraged:]
    [(i) Long a security purchased in one market together with a short 
position from an offsetting sale of the same security in a different 
market at as nearly the same time as practicable for the purpose of 
taking advantage of a difference in price in the two markets.]
    [Example: Purchase 100 shares of EFGH on the London Stock Exchange 
and simultaneously effecting a short sale of 100 shares of EFGH on 
Nasdaq.
     Under the above circumstances, the 100 shares short would 
be exempt.]
    [(ii) Long a security which is without restriction other than the 
payment of money exchangeable or convertible within 90 calendar days of 
the purchase into a second security together with a short position from 
an off-setting sale of the second security at or about the same time 
for the purpose of taking advantage of a concurrent disparity in the 
prices of the securities.]
    [Example: Long 100 shares of MNOP (MNOP: 51-51\1/4\ or 51.00-51.25) 
which is being acquired by QRST Corp. (QRST: 52\1/8\-52\3/8\ or 52.10-
52.30) at the rate of 1.15 shares per MNOP share.
     If the exchange is to take place within 90 days then a 
short of 115 shares of QRST would be exempt from the mandatory buy-in. 
Also, if the exchange was to take place at a date later than 90, all 
short positions in the above example would be subject to the mandatory 
buy-in.]
    [(C) The transaction date of the short sale shall govern when a 
fully hedged or fully arbitraged position exists.]
* * * * *
11830. Reserved. [Mandatory Close-Out for Short Sales]
    [(a) A contract involving a short sale in Nasdaq securities 
described in paragraph (b) hereof, for the account of a customer or for 
a member's own account, which has not resulted in delivery by the 
broker/dealer representing the seller within 10 business days after the 
normal settlement date, must be closed by the broker/dealer 
representing the seller by purchasing for cash or guaranteed delivery 
securities of like kind and quantity.]
    [(b) This requirement shall apply to Nasdaq securities, as 
published by the Association, which have clearing short position of 
10,000 shares or more and that are equal to at least one-half (\1/2\) 
of one percent of the issue's total shares outstanding.]
    [(c) This mandatory close-out requirement shall not apply to bona 
fide market making transactions and transactions that result in fully 
hedged or arbitraged positions.]
* * * * *

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 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
    On June 23, 2004, the SEC adopted certain provisions of a new short 
sale regulation, designated Regulation SHO (Reg SHO). Reg SHO includes 
several new provisions that are duplicative of or overlap with existing 
NASD rules. These include: (1) SEC Rule 200(g) of Reg SHO, which 
requires that sell orders in all equity securities be marked ``long,'' 
``short,'' or ``short exempt''; (2) SEC Rule 203(a) of Reg SHO, which 
provides that, with limited exception, if a broker-dealer knows or 
should know that a sale of an equity security is marked long, the 
broker-dealer must make delivery when due and cannot use borrowed 
securities to do so; (3) SEC Rule 203(b)(1) of Reg SHO, which applies a 
uniform rule, with certain limited exceptions, requiring all broker-
dealers, prior to effecting short sales in equity securities, to 
``locate'' securities available for borrowing; and (4) SEC Rule 
203(b)(3) of Reg SHO, which requires registered clearing agency 
participants to close out all failures to deliver 10 days after the 
normal settlement date for securities in which a substantial amount of 
failures to deliver have occurred, referred to as ``threshold 
securities.'' \4\
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    \4\ Reg 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 (a reporting company) where for five consecutive 
settlement days there are aggregate fails to deliver at a registered 
clearing agency of 10,000 shares or more per security; that the 
level of fails is equal to a least one-half of one percent of the 
issue's total shares outstanding (TSO); and the security is included 
on a listed published by a self-regulatory organization.
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    As noted in the adopting release for Reg SHO, as well as in 
discussions between SEC and NASD staff, the SEC has indicated that it 
expects that Reg SHO provisions will supplant existing overlapping 
self-regulatory organization (SRO) rules. Accordingly, NASD believes 
that certain of its rules are duplicative of or overlap with Reg SHO 
requirements and therefore should be repealed. As a result, NASD is 
proposing to repeal NASD Rule

[[Page 74557]]

3110(b)(1), Rule 3210, Rule 3370(b) and Rule 11830. Specifically, Rule 
3110(b)(1),\5\ overlaps or is duplicative with Rule 200(g) of Reg SHO, 
which governs order marking in all equity securities. In addition, Rule 
3210,\6\ Rule 3370(b) \7\ and Rule 11830 \8\ overlap with or are 
duplicative of Rule 203 of Reg SHO.
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    \5\ Rule 3110(b)(1) requires that an associated person indicate 
on the order ticket whether an order is ``long'' or ``short.''
    \6\ Rule 3210 prohibits a member from selling a security for its 
own account or buying a security as a broker for a customer, if the 
member has a fail to deliver in that security that is 60 days old or 
older, or 90 days old or older for foreign securities.
    \7\ Rule 3370(b) requires, among other things, that (1) no 
member accept a long sale order from a customer unless the member 
has possession of the security, the customer is long in his account, 
the member makes an affirmative determination that the customer owns 
the security and will deliver it on settlement date or that it is in 
good deliverable form on deposit with a member or other permissible 
entity; and (2) no member effect a ``short'' sale order for a 
customer, non-member broker-dealer or proprietary account in any 
security unless the member makes an affirmative determination that 
the member will receive delivery of the security or that the member 
can borrow the security for delivery by settlement date, subject to 
certain exemptions.
    \8\ Rule 11830 generally mandates delivery of a security within 
10 days of the settlement date for short sales executed in Nasdaq 
securities that, on the trade date of the transaction, had a 
clearing short position equal to at least one-half of one percent of 
the issue's total shares outstanding.
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    As noted below, NASD is filing the proposed rule change for 
immediate effectiveness, with an operative date of January 3, 2005.\9\ 
NASD will announce the implementation date in a Notice to Members to be 
published prior to January 3, 2005.
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    \9\ The Commission understands that the operative date of this 
proposed rule change is the same date as the compliance date of 
Rules 200 and 203 of Regulation SHO. See Securities Exchange Act 
Release No. 50103 (July 28, 2004), 69 FR 48008 (August 6, 2004).
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2. Statutory Basis
    NASD believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\10\ 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 SEC's Reg SHO will address 
potentially abusive short selling activities in the marketplace that 
NASD Rule 3110(b)(1), Rule 3210, Rule 3370(b) and Rule 11830 were 
intended to address, and therefore repeal of these rules is consistent 
with the Act.
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    \10\ 15 U.S.C. 78o-3(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

    Because the foregoing proposed rule change does not: (i) 
Significantly affect the protection of investors or the public 
interest; (ii) impose any significant burden on competition; and (iii) 
become operative for 30 days from the date on which it was filed, or 
such shorter time as the Commission may designate if consistent with 
the protection of investors and the public interest, it has become 
effective pursuant to Section 19(b)(3)(A) of the Act and Rule 19b-
4(f)(6) thereunder.
    In accordance with Rule 19b-4, NASD submitted written notice of its 
intent to file the proposed rule change, along with a brief description 
and text of the proposed rule change, at least five business days prior 
to the date of filing. NASD proposes to make the proposed rule change 
operative on January 3, 2005.
    At any time within 60 days of the filing of such proposed rule 
change, the Commission may summarily abrogate such rule change if it 
appears to the Commission that such action is necessary or appropriate 
in the public interest, for the protection of investors, or otherwise 
in furtherance of the purposes of the Act.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change 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 [email protected]. Please include 
File Number SR-NASD-2004-175 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609.
    All submissions should refer to File Number SR-NASD-2004-175. 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 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-2004-175 and should be 
submitted on or before January 4, 2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\11\
J. Lynn Taylor,
Assistant Secretary.
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    \11\ 17 CFR 200.30-3(a)(12).
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[FR Doc. E4-3636 Filed 12-13-04; 8:45 am]
BILLING CODE 8010-01-P