Regulation SHO

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The SEC's Reg SHO was a set of rules governing short sales. It went into effect in January 2006.

Compliance with Regulation SHO began on January 3, 2005. The rule was adopted to update short sale regulation in light of numerous market developments since short sale regulation was first adopted in 1938. Its goals included establishing uniform "locate" and "close-out" requirements in order to address problems associated with failure to deliver, including potentially abusive "naked" short selling.

Locate Requirement: Regulation SHO requires a broker-dealer to have reasonable grounds to believe that the security can be borrowed by the delivery date before it can effect a short sale. The "locate" must be made before the short sale takes place.

Close-out Requirement: Regulation SHO imposes additional delivery requirements on broker-dealers for securities in which there are a relatively substantial number of failures at a clearing agency. (These types of securities are known as "threshold securities.") For instance, with a few exceptions, Reg SHO requires brokers and dealers that are participants of a registered clearing agency to take action to "close-out" failure-to-deliver positions in threshold securities that have persisted for 13 consecutive settlement days. Closing out requires the broker or dealer to purchase securities of like kind and quantity. Until the position is closed out, the broker or dealer and any broker or dealer for which it clears transactions (for example, an introducing broker) may not effect further short sales in that threshold security without borrowing or formally agreeing to borrow the security. (This is known as the "pre-borrowing" requirement).[1]

Reg SHO also created uniform order marking requirements for sales of all securities. This means that orders placed with a broker-dealer must be marked "long," "short," or "short exempt."

References

  1. Division of Market Regulation, Key Points About Regulation SHO. Securities and Exchange Commission.