[Federal Register Volume 69, Number 250 (Thursday, December 30, 2004)]
[Notices]
[Pages 78511-78514]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E4-3899]


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

DEPARTMENT OF SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50929; File No. SR-NYSE-2004-68]


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule and Amendment No. 1 Thereto by the New 
York Stock Exchange, Inc. To Amend Exchange Rules 440B (``Short Sales) 
and 440C (``Deliveries Against Short Sales'')

December 23, 2004.
    Pursuant to Section 19(b)(1) \1\ of the Securities Exchange Act of 
1934 (``SEA'' or the ``Exchange Act''),\2\ and Rule 19b-4 
thereunder,\3\ notice is hereby given that on December 1, 2004, the New 
York Stock Exchange, Inc. (``NYSE'' or the ``Exchange'') filed with the 
Securities and Exchange Commission (the ``Commission'' or ``SEC'') the 
proposed rule change as described in Items I, II, and III below, which 
Items have been prepared by the Exchange. On December 23, 2004, NYSE 
filed Amendment No. 1 to the proposed rule change.\4\ The proposed rule 
change, as amended, was filed by NYSE as a non-controversial filing, 
under Rule 19b-4(f)(6) of the Act.\5\ The Commission is publishing this 
notice to solicit comments on the proposed rule change from interested 
persons.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 15 U.S.C. 78a et seq.
    \3\ 17 CFR 240.19b-4.
    \4\ See letter from Mary Yeager, Assistant Corporate Secretary, 
NYSE, to Nancy Sanow, Assistant Director, Division of Market 
Regulation, Commission, dated December 23, 2004 (``Amendment No. 
1'').
    \5\ 17 CFR 240.19b-4(f)(6). For purposes of determining the 
effective date and calculating the sixty-day period within which the 
Commission may summarily abrogate the proposed rule change under 
Section 19(b)(3)(C) of the Act, the Commission considers that period 
to commence on December 22, 2004, the date NYSE filed Amendment No. 
1. See 15 U.S.C. 78s(b)(3)(C).
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The New York Stock Exchange, Inc. (``NYSE'' or the ``Exchange'') is 
filing with the Securities and Exchange Commission (``SEC'' or 
``Commission'') proposed amendments to Rule 440B (``Short Sales'') and 
440C (``Delivery Against Short Sales''), including Supplementary 
Material to conform Exchange rules to the requirements of recent 
Commission rule amendments regarding short sales, and adoption of 
Regulation SHO--Regulation of Short Sales (``Regulation SHO'').\6\ The 
text of the proposed amendments is available from the NYSE and the 
Commission.\7\ New language is italicized; deletions are in brackets.
---------------------------------------------------------------------------

    \6\ See Securities Exchange Act Release No. 50103 (July 28, 
2004), 69 FR 48008 (August 6, 2004) (``Adopting Release''), 
available at http://www.sec.gov/rules/final/34-50103.htm.
    \7\ Both Exhibits A and B are available at http://www.nyse.com/regulation/ and http://www.sec.gov/rules/sro.shtml.
---------------------------------------------------------------------------

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

    In its filing with the Commission, the Exchange 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. The Exchange has prepared summaries, set forth in 
Sections A, B, and C below, of the most significant aspects of such 
statements.
(1) Purpose
    Background. On June 23, 2004, the SEC adopted new Regulation SHO, 
under the Exchange Act.\8\ Regulation SHO, which together with other 
concurrent Commission actions, provide for significant changes to SEC 
short sale \9\ rules that are referenced in, and apply to members and 
member organizations through, Exchange Rules 440B (``Short Sales'') and 
440C

[[Page 78512]]

(``Deliveries Against Short Sales'').\10\ These SEC amendments rescind 
Rules 3b-3 (``Definition of Short Sale'') \11\ and 10a-2 
(``Requirements for Covering Purchases''),\12\ under the Exchange Act, 
and replace them with new Rules 200 (``Definition of Short Sale and 
Marking Requirements'') \13\ and 203 (``Borrowing and Delivery 
Requirements''),\14\ to Regulation SHO. In addition, the Commission has 
amended Rule 10a-1 \15\ (``Short Sales'') to conform to Regulation SHO.
---------------------------------------------------------------------------

    \8\ U.S.C. 78a et seq.
    \9\ A short sale is the sale of a security that the seller does 
not own or any sale that is consummated by the delivery of a 
security borrowed by, or for the account of, the seller. In order to 
deliver the security to the purchaser, the short seller will borrow 
the security, typically from a broker-dealer or an institutional 
investor. The short seller later closes out the position by 
purchasing equivalent securities on the open market, or by using an 
equivalent security it already owned, and returning the security to 
the lender. In general, short selling is used to profit from an 
expected downward price movement, to provide liquidity in response 
to unanticipated demand, or to hedge the risk of a long position in 
the same, or related, security.
    \10\ The ``tick test'' of Rule 440B, which limits short sales 
only to an advancing market, and delivery requirements of Rule 440C, 
which requires short sellers to ``locate'' the stock to deliver 
prior to making a trade, are designed to prevent abusive short 
selling activities, including ``short squeezes'' and ``naked'' short 
selling. Regulation SHO also seeks to reduce the number of ``fails 
to deliver'' in the Continuous Net Settlement (``CNS'') system.
    \11\ 17 CFR 240.3b-3.
    \12\ 17 CFR 240.10a-2.
    \13\ 17 CFR 242.200.
    \14\ 17 CFR 242.203.
    \15\ 17 CFR 240.10a-1.
---------------------------------------------------------------------------

    New SEA Rule 202T. Regulation SHO includes new Rule 202T,\16\ which 
provides procedures for the SEC to temporarily suspend the application 
of the tick test and any short sale price test of any exchange or 
national securities association for designated securities.\17\ 
Concurrently with the adoption of Regulation SHO, the SEC issued a 
Pilot Order \18\ suspending the provisions of the tick test and any 
self-regulatory organization (``SRO'') price test for short sales in: 
(1) Certain ``designated securities'' (identified in Appendix A of the 
Pilot Order); (2) any security included in the Russell 1000 index 
effected between 4:15 p.m. EST and the open of the consolidated tape on 
the following day; and (3) any other security effected between the 
close of the consolidated tape (i.e., 8 p.m. EST) and the open of the 
tape on the following day. During the Pilot, all other provisions of 
Rule 10a-1 and Regulation SHO--including the marking, locate and 
delivery requirements--remain in effect.
---------------------------------------------------------------------------

    \16\ 17 CFR 242.202T.
    \17\ The SEC deferred consideration of their proposal to replace 
the current ``tick test'' with a new uniform bid test restricting 
short sales to a price above the consolidated best bid, and also 
deferred consideration of the proposed exceptions to the uniform bid 
test. The SEC will reconsider any further action on these proposals 
after the completion of the Pilot.
    \18\ See Securities Exchange Act Release No. 50104 (July 28, 
2004), 69 FR 48032 (August 6, 2004) (``Pilot Order''), available at 
http://www.sec.gov/rules/other/34-50104.htm. See also Securities 
Exchange Act Release No. 50747 (November 29, 2004)(Order Delaying 
Pilot Period for Suspension of the Operation of the Operation of 
Short Sale Price Provisions) (``Second Pilot Order''), available at 
http://www.sec.gov/rules/other/34-50747.htm.
---------------------------------------------------------------------------

    The Exchange proposes to amend Rule 440B by adding new paragraph 
(c), which suspends the requirements of the price test for the period 
that the Pilot remains in effect.
    New SEA Rule 200. Rule 200 \19\ to Regulation SHO replaces Rule 3b-
3,\20\ which had defined ownership of securities for purposes of short 
sales. Rule 200 incorporates the substance of Rule 3b-3, with some 
modifications, and provides guidance to broker-dealers to calculate net 
positions within defined aggregation units rather than on a firm-wide 
basis. Rule 200 also requires broker-dealers to mark sales in all 
equity securities ``long,'' ``short,'' or ``short exempt.'' In this 
regard, an order can be marked ``long'' only when the seller owns the 
security being sold and the security is in the physical possession or 
control of the broker-dealer, or it is reasonably expected that the 
security will be in the physical possession or control of the broker-
dealer prior to settlement. An order can be marked ``short exempt'' if 
the seller is entitled to rely on any exception from the tick test, 
under Rule 10a-1, or any SRO rule (e.g., Rule 440B). As a general 
matter, orders marked ``short exempt'' still need to comply with the 
locate requirement. Short sales of securities in the Pilot should be 
marked ``short exempt.''
---------------------------------------------------------------------------

    \19\ 17 CFR 242.200.
    \20\ 17 CFR 240.3b-3.
---------------------------------------------------------------------------

    The Exchange is proposing to amend the Supplementary Material to 
Exchange Rule 440B to incorporate the marking requirements and 
ownership aspects of Regulation SHO, Rule 200, to paragraphs 440B.13 
(``Marking of Orders''), 440B.14 (``Ownership of Securities'') and 
440B.20 (``Short Exempt Sell Orders'').
    New SEA Rule 203. Rule 203 \21\ provides various safeguards against 
``naked'' short selling by consolidating and expanding stock ``locate 
requirements,'' and imposing new delivery requirements for securities 
in which a substantial number of fails have occurred (``threshold 
securities'' \22\). In this regard, Rule 203 requires broker-dealers, 
prior to effecting short sales in all equity securities, to locate 
securities available for borrowing. Specifically, Rule 203(b) \23\ 
prohibits a broker-dealer from accepting a short sale in any equity 
security from another person, or effecting a short sale for the broker-
dealer's own account, unless the broker-dealer has: (1) Borrowed the 
security, or entered into an arrangement to borrow the security; or (2) 
has ``reasonable grounds'' to the believe that the security can be 
borrowed so that it can be delivered on the delivery date; and (3) has 
documented compliance with the rule.
---------------------------------------------------------------------------

    \21\ 17 CFR 242.203.
    \22\ Regulation SHO defines ``threshold securities'' as equity 
securities of reporting issuers, where: for five consecutive days 
the security has aggregate fails to deliver at a registered clearing 
agency of 10,000 shares or more; this figure is equal to at least 
0.5% of the issue's total shares outstanding; and a list of such 
threshold securities is calculated and disseminated daily by the SRO 
on which the security is listed or for which the SRO bears primary 
surveillance responsibility. The SEC has estimated that 
approximately 4% of all equity securities would meet this threshold.
    \23\ 17 CFR 242.203(b).
---------------------------------------------------------------------------

    The Commission has set forth two ways to show a broker-dealer has 
``reasonable grounds'' to believe the security can be borrowed: (1) 
Reliance on an ``easy to borrow'' list, provided the information used 
to generate the list is less than 24 hours old, and securities on the 
list are so readily available that fails to deliver are unlikely 
(reliance on the fact that a security is not on a ``hard to borrow'' 
list is not sufficient); \24\ and (2) reliance on a customer's 
assurance that a ``locate'' was received from another source (e.g., a 
prime broker), provided the broker-dealer documents the customer's 
source, and prior assurances from such customer resulted in timely 
deliveries in settlement of the customer's transactions.
---------------------------------------------------------------------------

    \24\ In the Adopting Release, the SEC noted that ``threshold 
securities'' generally should not be included on ``easy to borrow'' 
lists. While the Commission has stated that easy to borrow lists 
could satisfy the ``reasonable grounds'' determination in Rule 203, 
it has also clearly stated that reliance on the fact that a security 
is not on a ``hard to borrow'' list cannot satisfy the ``reasonable 
grounds test.
---------------------------------------------------------------------------

    The SEC also identified a number of exceptions to this locate 
requirement, including exceptions for transactions in security futures, 
and for broker-dealers that have accepted a short sale order from 
another registered broker-dealer required to comply with Rule 203(b), 
unless the broker-dealer contractually undertook responsibility for 
compliance. Rule 203(a) \25\ replaces current Rule 10a-2 \26\ and 
incorporates its substantive requirements and extends them to all 
equity securities, as opposed to only exchange-listed securities. With 
certain exceptions, Rule 203(a) prohibits a broker-dealer from failing 
to deliver, or lending securities to prevent a fail to deliver, on a 
sale that it knows, or has reasonable grounds to believe, is marked 
``long.''
---------------------------------------------------------------------------

    \25\ 25 17 CFR 242.203(a).
    \26\ 17 CFR 240.10a-2.
---------------------------------------------------------------------------

    To conform with Regulation SHO, the Exchange is proposing to change 
the title of Rule 440C to ``Short Sale Borrowing and Delivery 
Requirements,'' delete paragraph .10 (``Failure to Deliver''), and 
incorporate by reference Rule 10a-1 and Regulation SHO, as if they were 
fully set forth therein. The

[[Page 78513]]

Exchange expects additional interpretations to be added to the rule at 
a later date, after experience with the operation of Regulation SHO.
    New SEA Rule 203(b). Rule 203(b) of Regulation SHO requires 
clearing brokers to close-out any fail to deliver position in a 
threshold security that has remained open for 13 consecutive settlement 
days, by purchasing securities of like kind and quantity. A list of 
threshold securities will be disseminated daily by the Exchange prior 
to the opening bell.\27\ In addition, certain restrictions are 
triggered if the clearing broker does not take action to close-out the 
open fail to deliver position.
---------------------------------------------------------------------------

    \27\ As the exact means of conveying the list of threshold 
securities has not yet been determined, members and member 
organizations will be informed by a later Information Memo of the 
exact time, location and form of dissemination of the list prior to 
the launch of the Pilot.
---------------------------------------------------------------------------

    The Exchange is proposing to amend paragraph .17 (``Covering 
Transactions'') to Rule 440B to delete aspects of the rule that do not 
conform with Regulation SHO, and to reference Rule 203(b)(3) to 
determine how to handle covering transactions.
    Proposed Amendments to Exchange Rules. Currently, Exchange Rule 
440B includes the complete text of Rule 10a-1, under the Exchange Act, 
and Rules 440B and 440C set forth many sections of repealed Rules 3b-3 
and 10a-2, under the Exchange Act, respectively. The proposed 
amendments to Rules 440B and 440C, including Supplementary Material, 
conform to the changes in Rule 10a-1 and recently adopted Regulation 
SHO, under the Exchange Act. The changes remove the text of SEA Rule 
10a-1 from Exchange Rule 440B, and instead incorporate both SEA Rule 
10a-1 and Regulation SHO by reference, as though they were fully set 
forth therein.
    The amendments to Exchange Rule 440B conform to Regulation SHO and 
also include a revised Explanatory Note, which generally describes the 
recent changes to short sale regulation and implementation dates. The 
Exchange proposes to amend the Supplementary Material to Rule 440B to 
delete references to repealed rules and incorporate amendments to 
conform to and reference amended Rule 10a-1 and Regulation SHO. In 
addition, the Exchange proposes to amend .10 (``General Rule''), .12 
(``Place of Transaction'') and .15 (``Price At Which Short Sales May Be 
Made'') to make clear, consistent with the Adopting Release of 
Regulation SHO, that the Exchange short sale regulations apply to all 
trades in listed securities: (a) whenever they occur, including the 
after-hours market, and (b) which have been agreed to in the US, 
regardless of where the transaction is executed or ``booked.''
(2) Statutory Basis
    The statutory basis for the proposed rule change is Sections 
6(b)(5) and 17A of the Exchange Act \28\ which require, among other 
things, that the rules of the Exchange 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 perfect the mechanism of a free 
and open market and national market system, and in general to protect 
investors and the public interest; and the prompt and accurate 
clearance and settlement of securities transactions.
---------------------------------------------------------------------------

    \28\ 15 U.S.C. 78f(b)(5) and 15 U.S.C. 78q-1, respectively.
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will 
impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Exchange Act.

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

    The Exchange has neither solicited nor received written comments on 
the proposed rule change.

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

    The proposed rule change is filed pursuant to paragraph (A) of 
Section 19(b)(3) \29\ and Rule 19b-4(f)(6).\30\ 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, it has become effective pursuant to Section 19(b)(3)(A) of 
the Exchange Act and Rule 19b-4(f)(6) thereunder.
---------------------------------------------------------------------------

    \29\ 15 U.S.C. 78s(b)(3)(A).
    \30\ 17 CFR 240.19b-4(f)(6).
---------------------------------------------------------------------------

    At any time within 60 days of the filing of the 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 Exchange Act.\31\
---------------------------------------------------------------------------

    \31\ For purposes of determining the effective date and 
calculating the sixty-day period within which the Commission may 
summarily abrogate the proposed rule change under Section 
19(b)(3)(C) of the Exchange Act, the Commission considers that 
period to commence on December 23, 2004, the date NYSE filed 
Amendment No. 1. See 15 U.S.C. 78s(b)(3)(C).
---------------------------------------------------------------------------

    The Exchange requests the Commission waive the five-day 
notification period and the 30-day pre-operative delay specified in 
Rule 19b-4(f)(6)(iii).\32\ Waiver of these periods will allow the 
Exchange to have the proposed rule change in place at the same time as 
the Commission's compliance date for Regulation SHO. The Exchange 
expects to make the proposed rule change operative on January 3, 2005.
---------------------------------------------------------------------------

    \32\ 17 CFR 240.19b-4(f)(6)(iii).
---------------------------------------------------------------------------

    The Commission believes that waiving both the 5-day notification 
period and the 30-day pre-operative delay requirements is consistent 
with the protection of investors and the public interest. The 
Commission believes that waiving these requirements does not raise any 
new regulatory issues, significantly affect the protection of investors 
or the public interest, or impose any significant burden on 
competition. Additionally, The Commission notes that the operative date 
of this proposed rule change, January 3, 2004, is the same date as the 
compliance date of Regulation SHO.

IV. Solicitation of Comments

    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 Exchange Act.

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send e-mail to [email protected]. Please include File 
Number SR-NYSE-2004-68 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-NYSE-2004-68. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your

[[Page 78514]]

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. Copies of such filing also will be available for 
inspection and copying at the principal office of the NYSE. 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 File Number SR-NYSE-2004-68 and should be 
submitted on or before January 20, 2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\33\
---------------------------------------------------------------------------

    \33\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E4-3899 Filed 12-29-04; 8:45 am]
BILLING CODE 8010-01-P