Client Newsflash

Short Sales: SEC Staff Provides Guidance on Short Sale Order-Marking Issues, Updates Regulation SHO FAQs

August 31, 2009

On August 28, 2009, the staff (the “Staff”) of the Division of Trading and Markets of the Securities and Exchange Commission released updates to its Regulation SHO FAQs, providing guidance concerning:

  • marking multiple orders “in flight”;
  • marking an order where only a part of the order is net long; and
  • relying on a locate provided by a non-U.S. registered broker-dealer.

These updates provide helpful clarity on issues that were causing confusion in the market.  In addition, we believe that the Staff’s guidance is critical in advance of the possible adoption of a price test restriction.


Marking Multiple Orders “In Flight”

Broker-dealers whose clients are high frequency traders are faced with the question of how to mark orders where the client enters multiple orders nearly simultaneously, and after execution of the first order, the client will be net short in the position.  For example, a high frequency trader that is net long 1,000 shares may enter multiple orders nearly simultaneously to sell 1,000 shares, with the intent of cancelling all trades that remain outstanding after one trade is executed.


The Staff’s new guidance, found in Question 2.5 of the Regulation SHO FAQs, states that the Staff’s view of Rule 200(g)(1) is that after the first long sale order is entered to sell 1,000 shares, “it is no longer reasonable to expect that delivery can be made by settlement date on additional orders to sell the same shares.”  Therefore, a broker-dealer must mark only one order long, and the additional orders must be marked short.


The Staff’s guidance should provide clarity for many broker-dealers that have faced this question in setting compliance procedures or in examinations.


Marking an Order Where the Seller is Net Long for Only Part of the Order

The Staff provided guidance in Question 2.4 of the Regulation SHO FAQs, stating that where a seller is net long a security but desires to enter an order to sell for more than its net long position, the sell order for the sale of the long shares must be marked long, and the sell order for the additional shares must be marked short.  For example, if a seller is net long 500 shares, but wants to sell 600 shares, only 500 shares can be marked long.  The excess 100 shares must be marked short.


We understand that the Staff intended to make clear that Rule 200(g)(1) requires mixed orders to be entered as two separate orders, and to correct divergent market practices (including marking mixed orders as short).


Relying on a Locate of a Foreign Broker-Dealer

The Staff provided guidance in Question 4.6 of the Regulation SHO FAQs regarding reliance on a locate of a non-U.S. registered broker-dealer.  Previously, there had been varying interpretations among market participants regarding whether Rule 203(b)(2)(i), which subject to certain exceptions allows a U.S. broker-dealer to rely on a locate of another U.S. broker-dealer, extended to non-U.S. registered broker-dealers from certain countries that have incorporated Regulation SHO’s locate requirements into their local regulatory regime.


The Staff has put this question to rest, stating unequivocally that the Rule 203(b)(2)(i) “broker to broker” exception “applies only to transactions undertaken between broker-dealers registered in the U.S. pursuant to the requirements of Rule 15(a) of the Securities Exchange Act of 1934.”  U.S. broker-dealers, therefore, must treat non-U.S. registered broker-dealers in the same manner as a non-broker-dealer customer.  Specifically, the U.S. broker-dealer must have a reasonable belief that the non-U.S. registered broker-dealer will have the securities available for delivery on the date delivery is due, and must document such information as provided by Regulation SHO.



If you have questions regarding this newsflash, please call any of the lawyers listed below or your regular Davis Polk contact.

Annette L. Nazareth202 962
Lanny A. Schwartz212 450
Gerard Citera 212 450 4881
Robert L.D. Colby202 962
     Davis Polk & Wardwell LLP
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