REG 2008-45

Further guidance on SEC Emergency Order amending Short Sale Rules

The Securities and Exchange Commission (“SEC”) today issued guidance on Release No. 58572 (September 17, 2008), which imposed enhanced delivery requirements on sales of equities. The SEC guidance, which is in the form of questions and answers (“FAQs”), is available online at http://www.sec.gov/divisions/marketreg/204tfaq.htm. All members are urged to review the FAQs carefully.

Allocation of responsibility for fails

The FAQs make clear that a participant of a registered clearing agency may allocate responsibility for the close-out requirement to another broker-dealer that is responsible for the fail position. If the allocation is reasonable, then other broker-dealers that clear through that registered clearing agency participant can thereby avoid application of the requirement to borrow or arrange to borrow securities prior to effecting any further short sales.

Pre-Fail Credit

A broker-dealer may claim credit for purchases made to close out an open short position prior to settlement date, even if the broker-dealer’s clearing broker has not closed out or allocated its fail position. To claim such “Pre-Fail Credit” the broker-dealer must purchase securities prior to the beginning of regular trading hours on the settlement day after the settlement date ("close-out date"), including on trade date ("T"), T+1, T+2, or T+3, and must satisfy the following four conditions:

a. The purchase is bona fide;
b. The purchase is executed on, or after, trade date but by no later than the end of regular trading hours on settlement date (i.e., T+3);
c. The purchase is of a quantity of securities sufficient to cover the entire amount of the open short position for which the broker-dealer is claiming Pre-Fail Credit; and
d. The broker-dealer can demonstrate that it has a net long position or net flat position on its books and records on the settlement day for which the broker-dealer is claiming Pre-Fail Credit.

Avoidance of pre-borrow penalty by certification to clearing agency

If a participant of a registered clearing agency, along with any broker-dealer that clears through it, become subject to the requirement that they borrow securities prior to effecting any further short sales (the "pre-borrow penalty") a broker-dealer may nevertheless be able to avoid such pre-borrow penalty. Even if the registered clearing agency participant has not allocated the responsibility for the fail to another brokerdealer that it clears for, a broker-dealer that timely certifies to the registered clearing agency participant that it has not incurred a fail to deliver in the security on settlement date would not be subject to the pre-borrow penalty if it is in compliance with (a) through (d) above.

Rules applicable to market makers

Temporary Rule 204T provides that a fail to deliver position be closed out no later than the beginning of regular trading hours on the settlement day following settlement date (i.e., the morning of T+4). The FAQs provide that registered market makers (including specialists, options market makers, or other market makers obligated to quote in the over-the-counter market) must close out the fail to deliver position attributable to a market maker by no later than the beginning of regular trading hours on the morning of the third settlement day after the settlement date (i.e., T+6) for the transaction that resulted in the fail to deliver position.

In order for a market maker to which a fail to deliver position is attributable to receive this time extension, the market maker must attest in writing to the market on which it is registered that the fail to deliver position was established solely for the purpose of meeting its bona fide market making obligations. In addition, such written attestation must describe the steps the market maker has taken in an effort to deliver securities to its registered clearing agency. The attached Attestation Template may be used for this purpose and should be submitted in hard copy to the Regulatory Liaison Group on the Amex Trading Floor or by email to amexreg@amex.com.

If a registered clearing agency participant becomes subject to the pre-borrowing penalty, as described above, then temporary Rule 204(b) provides that any brokerdealer that clears through it is similarly penalized. Pursuant to the FAQs, however, market makers will not be subject to these borrowing requirements provided the market maker can show that it does not have an open fail to deliver position at the time of any additional short sales.

Please direct any questions about this Notice to Rick Farber at 212-306-5310 or richard.farber@amex.com, to Ellen O’Rourke at 212-306-1865 or ellen.orourke@amex.com or to Chris Twomey at 212-306-1857 or christopher.twomey@amex.com.