
[Federal Register: October 17, 2008 (Volume 73, Number 202)]
[Rules and Regulations]               
[Page 61706-61731]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr17oc08-8]                         

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 242

[Release No. 34-58773; File No. S7-30-08]
RIN 3235-AK22

 
Amendments to Regulation SHO

AGENCY: Securities and Exchange Commission.

ACTION: Interim final temporary rule; request for comments.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
adopting an interim final temporary rule under the Securities Exchange 
Act of 1934 (``Exchange Act'') to address abusive ``naked'' short 
selling in all equity securities by requiring that participants of a 
clearing agency registered with the Commission deliver securities by 
settlement date, or if the participants have not delivered shares by 
settlement date, immediately purchase or borrow securities to close out 
the fail to deliver position by no later than the beginning of regular 
trading hours on the settlement day following the day the participant 
incurred the fail to deliver position. Failure to comply with the 
close-out requirement of the temporary rule is a violation of the 
temporary rule. In addition, a participant that does not comply with 
this close-out requirement, and any broker-dealer from which it 
receives trades for clearance and settlement, will not be able to short 
sell the security either for itself or for the account of another, 
unless it has previously arranged to borrow or borrowed the security, 
until the fail to deliver position is closed out.

DATES: Effective Date: October 17, 2008 until July 31, 2009. Comment 
Date: Comments should be received on or before December 16, 2008.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/final.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number S7-30-08 on the subject line; or
     Use the Federal eRulemaking Portal (http://
www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Florence E. Harmon, 
Acting Secretary, Securities and Exchange Commission, 100 F Street, 
NE., Washington, DC 20549-1090.

All submissions should refer to File Number S7-30-08. This file number 
should be included on the subject line if e-mail is used. To help us 
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/final.shtml).

[[Page 61707]]

Comments are also available for public inspection and copying in the 
Commission's Public Reference Room, 100 F Street, NE., Washington, DC 
20549 on official business days between the hours of 10 a.m. and 3 p.m. 
All comments received will be posted without change; we do not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: James A. Brigagliano, Associate 
Director, Josephine J. Tao, Assistant Director, Victoria L. Crane, 
Branch Chief, Joan M. Collopy, Special Counsel, Christina M. Adams and 
Matthew Sparkes, Staff Attorneys, Office of Trading Practices and 
Processing, Division of Trading and Markets, at (202) 551-5720, at the 
Commission, 100 F Street, NE., Washington, DC 20549-6628.

SUPPLEMENTARY INFORMATION: We are adopting temporary Rule 204T of 
Regulation SHO [17 CFR 242.204T] as an interim final temporary rule. We 
are soliciting comments on all aspects of the rule. We will carefully 
consider the comments that we receive and intend to respond to them in 
a subsequent release.

I. Introduction

    Recently, we have become concerned that there is a substantial 
threat of sudden and excessive fluctuations of securities prices and 
disruption in the functioning of the securities markets that could 
threaten fair and orderly markets. These concerns with respect to 
financial institutions are evidenced by our recent publication of 
emergency orders under section 12(k) of the Exchange Act in July (the 
``July Emergency Order'') \1\ and September of this year (the ``Short 
Sale Ban Emergency Order'').\2\ In these orders we noted our concerns 
about the possible use of unfounded rumors regarding the stability of 
financial institutions by short sellers for the purpose of manipulating 
the prices of securities issued by the financial institutions to 
increase profits through ``naked'' short selling.\3\
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    \1\ See Exchange Act Release No. 58166 (July 15, 2008), 73 FR 
42379 (July 21, 2008) (imposing borrowing and delivery requirements 
on short sales of the equity securities of certain financial 
institutions).
    \2\ See Exchange Act Release No. 58592 (Sept. 18, 2008), 73 FR 
55169 (Sept. 24, 2008) (temporarily prohibiting short selling in the 
publicly traded securities of certain financial institutions); see 
also Exchange Act Release No. 58611 (Sept. 21, 2008), 73 FR 55556 
(Sept. 25, 2008) (amending the Short Sale Ban Emergency Order).
    \3\ ''Naked'' short selling generally refers to selling short 
without having borrowed the securities to make delivery. See 
Exchange Act Release No. 50103 (July 28, 2004), 69 FR 48008, 48009 
n.10 (Aug. 6, 2004) (``2004 Regulation SHO Adopting Release''); see 
also Commission press release, dated July 13, 2008, announcing that 
the Commission's Office of Compliance Inspections and Examinations, 
as well as the Financial Industry Regulatory Authority (``FINRA'') 
and New York Stock Exchange Regulation, Inc., (``NYSE'') will 
immediately conduct examinations aimed at the prevention of the 
intentional spreading of false information intended to manipulate 
securities prices. See http://www.sec.gov/news/press/2008/2008-
140.htm. In addition, in April of this year, the Commission charged 
Paul S. Berliner, a trader, with securities fraud and market 
manipulation for intentionally disseminating a false rumor 
concerning The Blackstone Group's acquisition of Alliance Data 
Systems Corp (``ADS''). The Commission alleged that this false rumor 
caused the price of ADS stock to plummet, and that Berliner profited 
by short selling ADS stock and covering those sales as the false 
rumor caused the price of ADS stock to fall. See http://www.sec.gov/
litigation/litreleases/2008/lr20537.htm.
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    Our concerns, however, are not limited to just the financial 
institutions that were the subject of the July Emergency Order and the 
Short Sale Ban Emergency Order. Given the importance of confidence in 
our financial markets as a whole, we have become concerned about sudden 
and unexplained declines in the prices of equity securities generally. 
Such price declines can give rise to questions about the underlying 
financial condition of an institution, which in turn can create a 
crisis of confidence even without a fundamental underlying basis. This 
crisis of confidence can impair the liquidity and ultimate viability of 
an institution, with potentially broad market consequences. These 
concerns resulted in our issuance on September 17 of this year of an 
emergency order under section 12(k) of the Exchange Act (the 
``September Emergency Order'').\4\ Pursuant to that emergency order we 
imposed enhanced delivery requirements on sales of all equity 
securities by adding and making immediately effective a temporary rule 
to Regulation SHO, Rule 204T.\5\
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    \4\ See Exchange Act Release No. 58572 (Sept. 17, 2008), 73 FR 
54875 (Sept. 23, 2008).
    \5\ See id. The September Emergency Order also made immediately 
effective amendments to Rule 203(b)(3) of Regulation SHO that 
eliminate the options market maker exception from Regulation SHO's 
close-out requirement. It also made immediately effective Rule 10b-
21, a ``naked'' short selling antifraud rule.
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    To further our goal of preventing substantial disruption in the 
securities markets, we are adopting Rule 204T as an interim final 
temporary rule, with some modifications to address operational and 
technical concerns resulting from the requirements of the temporary 
rule as adopted in the September Emergency Order. We intend that the 
temporary rule will address potentially abusive ``naked'' short selling 
by requiring that securities be purchased or borrowed to close out any 
fail to deliver position in an equity security by no later than the 
beginning of regular trading hours on the settlement day following the 
date on which the fail to deliver position occurred. This temporary 
rule should provide a powerful disincentive to those who might 
otherwise engage in potentially abusive ``naked'' short selling.

II. Background

    Short selling involves a sale of a security that the seller does 
not own or a sale which is consummated by the delivery of a security 
borrowed by, or for the account of, the seller.\6\ Short sales normally 
are settled by the delivery of a security borrowed by or on behalf of 
the seller. In a ``naked'' short sale, however, the short seller does 
not borrow securities in time to make delivery to the buyer within the 
standard three-day settlement period.\7\ As a result, the seller fails 
to deliver securities to the buyer when delivery is due (known as a 
``fail'' or ``fail to deliver'').\8\ Sellers sometimes intentionally 
fail to deliver securities as part of a scheme to manipulate the price 
of a security,\9\ or possibly to avoid

[[Page 61708]]

borrowing costs associated with short sales, especially when the costs 
of borrowing stock are high.
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    \6\ 17 CFR 242.200(a).
    \7\ See 2004 Regulation SHO Adopting Release, 69 FR at 48009 
n.10.
    \8\ Generally, investors complete or settle their security 
transactions within three settlement days. This settlement cycle is 
known as T+3 (or ``trade date plus three days''). T+3 means that 
when a trade occurs, the participants to the trade deliver and pay 
for the security at a clearing agency three settlement days after 
the trade is executed so the brokerage firm can exchange those funds 
for the securities on that third settlement day. The three-day 
settlement period applies to most security transactions, including 
stocks, bonds, municipal securities, mutual funds traded through a 
brokerage firm, and limited partnerships that trade on an exchange. 
Government securities and stock options settle on the next 
settlement day following the trade (or T+1). In addition, Rule 15c6-
1 prohibits broker-dealers from effecting or entering into a 
contract for the purchase or sale of a security that provides for 
payment of funds and delivery of securities later than the third 
business day after the date of the contract unless otherwise 
expressly agreed to by the parties at the time of the transaction. 
17 CFR 240.15c6-1; Exchange Act Release No. 33023 (Oct. 7, 1993), 58 
FR 52891 (Oct. 13, 1993). However, failure to deliver securities on 
T+3 does not violate Rule 15c6-1; see also Exchange Act Release No. 
56212 (Aug. 7, 2007), 72 FR 45544, n. 2 (Aug. 14, 2007) (``2007 
Regulation SHO Final Amendments'').
    \9\ In 2003, the Commission settled a case against certain 
parties relating to allegations of manipulative short selling in the 
stock of a corporation. The Commission alleged that the defendants 
profited from engaging in massive ``naked'' short selling that 
flooded the market with the stock, and depressed its price. See 
Rhino Advisors, Inc. and Thomas Badian, Lit. Rel. No. 18003 (Feb. 
27, 2003); see also SEC v. Rhino Advisors, Inc. and Thomas Badian, 
Civ. Action No. 03 civ 1310 (RO) (S.D.N.Y); see also Exchange Act 
Release No. 48709 (Oct. 28, 2003), 68 FR 62972, 62975 (Nov. 6, 2003) 
(``2003 Regulation SHO Proposing Release'') (describing the alleged 
activity in the case involving stock of Sedona Corporation); 2004 
Regulation SHO Adopting Release, 69 FR at 48016, n.76.
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    Although the majority of trades settle within the standard three-
day settlement cycle (``T+3''),\10\ we adopted Regulation SHO \11\ on 
July 28, 2004, in part to address problems associated with persistent 
fails to deliver securities and potentially abusive ``naked'' short 
selling. For example, Regulation SHO requires broker-dealers to 
``locate'' securities that the broker-dealer reasonably believes can be 
delivered within the standard three-day settlement period.\12\
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    \10\ According to the National Securities Clearing Corporation 
(``NSCC''), 99% (by dollar value) of all trades settle within T+3. 
Thus, on an average day, approximately 1% (by dollar value) of all 
trades, including equity, debt, and municipal securities fail to 
settle on time.
    \11\ 17 CFR 242.200. Regulation SHO became effective on January 
3, 2005.
    \12\ 17 CFR 242.203(b)(1). Rule 203(b)(1) of Regulation SHO 
requires that, ``A broker or dealer may not accept a short sale 
order in an equity security from another person, or effect a short 
sale in an equity security for its own account, unless the broker or 
dealer has: (i) Borrowed the security, or entered into a bona-fide 
arrangement to borrow the security; or (ii) Reasonable grounds to 
believe that the security can be borrowed so that it can be 
delivered on the date delivery is due; and (iii) Documented 
compliance with this paragraph (b)(1).'' This is known as the 
``locate'' requirement. Market makers engaged in bona fide market 
making in the security at the time they effect the short sale are 
excepted from this requirement.
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    Another requirement of Regulation SHO aimed at potentially abusive 
``naked'' short selling and reducing fails to deliver in certain equity 
securities is the rule's ``close-out'' requirement. Specifically, Rule 
203(b)(3) requires participants \13\ of a registered clearing 
agency,\14\ which includes broker-dealers, to purchase shares to close 
out fails to deliver in securities with large and persistent fails to 
deliver, i.e., ``threshold securities.'' \15\ Until the position is 
closed out, the participant responsible for the fail to deliver 
position and any broker-dealer from which it receives trades for 
clearance and settlement may not effect further short sales in that 
threshold security without first borrowing or arranging to borrow the 
securities.\16\
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    \13\ For purposes of Regulation SHO, the term ``participant'' 
has the same meaning as in section 3(a)(24) of the Exchange Act. See 
15 U.S.C. 78c(a)(24).
    \14\ The term ``registered clearing agency'' means a clearing 
agency, as defined in Section 3(a)(23)(A) of the Exchange Act, that 
is registered as such pursuant to Section 17A of the Exchange Act. 
See 15 U.S.C. 78c(a)(23)(A) and 78q-1, respectively; see also 2004 
Regulation SHO Adopting Release, 69 FR at 48031. The majority of 
equity trades in the United States are cleared and settled through 
systems administered by clearing agencies registered with the 
Commission. The National Securities Clearing Corporation (``NSCC'') 
clears and settles the majority of equity securities trades 
conducted on the exchanges and in the over-the-counter market. NSCC 
clears and settles trades through the Continuous Net Settlement 
(``CNS'') system, which nets the securities delivery and payment 
obligations of all of its members. NSCC notifies its members of 
their securities delivery and payment obligations daily. In 
addition, NSCC guarantees the completion of all transactions and 
interposes itself as the contraparty to both sides of the 
transaction.
    \15\ Rule 203(c)(6) of Regulation SHO defines a ``threshold 
security'' as any equity security of an issuer that is registered 
pursuant to Section 12 of the Exchange Act (15 U.S.C. 78l) or for 
which the issuer is required to file reports pursuant to Section 
15(d) of the Exchange Act (15 U.S.C. 78o(d)) for which there is an 
aggregate fail to deliver position for five consecutive settlement 
days at a registered clearing agency of 10,000 shares or more, and 
that is equal to at least 0.5% of the issue's total shares 
outstanding; and is included on a list disseminated to its members 
by a self-regulatory organization (``SRO''). See 17 CFR 
242.203(c)(6).
    \16\ See 17 CFR 242.203(b)(3)(iv).
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    As adopted, Regulation SHO included two major exceptions to the 
close-out requirement: The ``grandfather'' provision and the ``options 
market maker'' exception. The ``grandfather'' provision had provided 
that fails to deliver established prior to a security becoming a 
threshold security did not have to be closed out in accordance with 
Regulation SHO's thirteen consecutive settlement day close-out 
requirement.
    Due to our concerns about the potentially negative market impact of 
large and persistent fails to deliver, and the fact that we continued 
to observe threshold securities with fail to deliver positions that are 
not being closed out under existing delivery and settlement 
requirements, effective on October 15, 2007, we adopted an amendment to 
Regulation SHO that eliminated the ``grandfather'' exception to 
Regulation SHO's close-out requirement.\17\
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    \17\ See 2007 Regulation SHO Final Amendments, 72 FR 45544. This 
amendment also contained a one-time phase-in period that provided 
that previously-grandfathered fails to deliver in a security that 
was a threshold security on the effective date of the amendment must 
be closed out within 35 consecutive settlement days from the 
effective date of the amendment. The phase-in period ended on 
December 5, 2007.
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    The options market maker exception excepted any fail to deliver 
position in a threshold security resulting from short sales effected by 
a registered options market maker to establish or maintain a hedge on 
options positions that were created before the underlying security 
became a threshold security. On September 17, 2008, as part of the 
September Emergency Order, we adopted and made immediately effective an 
amendment to Rule 203(b)(3) of Regulation SHO to eliminate the options 
market maker exception to the rule's close-out requirement.\18\ 
Following the issuance of the September Emergency Order, we adopted 
amendments making permanent the elimination of the options market maker 
exception.\19\ As we discussed in the 2008 Regulation SHO Final 
Amendments, we believe it was appropriate to eliminate the options 
market maker exception in part because substantial levels of fails to 
deliver continue to persist in threshold securities and it appears that 
a significant number of these fails to deliver are as a result of the 
options market maker exception.\20\
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    \18\ See September Emergency Order, supra note 4.
    \19\ See Exchange Act Release No. 58775 (Oct. 14, 2008) 
(adopting final amendments to Rule 203(b)(3) of Regulation SHO to 
eliminate the options market maker exception from the rule's close-
out requirement) (``2008 Regulation SHO Final Amendments''); see 
also Exchange Act Release No. 56213 (Aug. 7, 2007), 72 FR 45558 
(Aug. 14. 2007) (``2007 Regulation SHO Proposed Amendments); 
Exchange Act Release No. 54154 (July 14, 2006), 71 FR 41710 (July 
21, 2006) (``2006 Regulation SHO Proposed Amendments''); Exchange 
Act Release No. 58107 (July 7, 2008), 73 FR 40201 (July 14, 2008) 
(``2008 Regulation SHO Re-Opening Release'').
    \20\ See 2008 Regulation SHO Final Amendments, supra note 19; 
see also 2008 Regulation SHO Re-Opening Release, 73 FR 40201.
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    In addition to the actions we have taken aimed at reducing fails to 
deliver and addressing potentially abusive ``naked'' short selling in 
threshold securities, we have also taken action targeting potentially 
abusive ``naked'' short selling in both threshold and non-threshold 
securities. For example, in the September Emergency Order we adopted 
and made immediately effective a ``naked'' short selling anti-fraud 
rule, Rule 10b-21, aimed at sellers, including broker-dealers acting 
for their own accounts, who deceive certain specified persons about 
their intention or ability to deliver securities in time for settlement 
and that fail to deliver securities by settlement date.\21\ Following 
the issuance of the September Emergency Order, we adopted final 
amendments making Rule 10b-21 permanent.\22\
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    \21\ See September Emergency Order, supra note 4.
    \22\ See Exchange Act Release No. 58774 (Oct. 14, 2008) (``Anti-
Fraud Rule Adopting Release''); see also Exchange Act Release No. 
57511 (March 17, 2008), 73 FR 15376 (March 21, 2008) (``Anti-Fraud 
Rule Proposing Release'').
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    Also, as mentioned above, in the July Emergency Order and the Short 
Sale Ban Emergency Order, we took emergency action targeting ``naked'' 
short selling in the securities of certain financial firms that 
included non-threshold securities. Specifically, on July 15, 2008, we 
published the July

[[Page 61709]]

Emergency Order \23\ that temporarily imposed enhanced requirements on 
short sales in the publicly traded securities of certain substantial 
financial firms. The July Emergency Order required that, in connection 
with transactions in the publicly traded securities of the substantial 
financial firms identified in Appendix A to the Emergency Order 
(``Appendix A Securities''), no person could effect a short sale in the 
Appendix A Securities using the means or instrumentalities of 
interstate commerce unless such person or its agent had borrowed, or 
arranged to borrow, the security or otherwise had the security 
available to borrow in its inventory, prior to effecting such short 
sale. The July Emergency Order also required that the short seller 
deliver the security on settlement date, prohibiting any fails to 
deliver in the Appendix A Securities.\24\
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    \23\ See supra note 1.
    \24\ See id.
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    We issued the July Emergency Order because we were concerned that 
false rumors regarding financial institutions of significance in the 
U.S. may have fueled market volatility in the securities of some of 
these institutions. As we noted in the July Emergency Order, false 
rumors can lead to a loss of confidence in our markets. Such loss of 
confidence can lead to panic selling, which may be further exacerbated 
by ``naked'' short selling. As a result, the prices of securities may 
artificially and unnecessarily decline below the price level that would 
have resulted from the normal price discovery process. If significant 
financial institutions are involved, this chain of events can threaten 
disruption of our markets.\25\
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    \25\ We delayed the effective date of the July Emergency Order 
to July 21, 2008 to create the opportunity to address, and to allow 
sufficient time for market participants to make, adjustments to 
their operations to implement the enhanced requirements. Moreover, 
in addressing anticipated operational accommodations necessary for 
implementation of the July Emergency Order, we issued an amendment 
to the July Emergency Order on July 18, 2008. See Exchange Act 
Release No. 58190 (July 18, 2008) (excepting from the July Emergency 
Order bona fide market makers, short sales in Appendix A Securities 
sold pursuant to Rule 144 of the Securities Act of 1933, and certain 
short sales by underwriters, or members of a syndicate or group 
participating in distributions of Appendix A Securities).
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    On July 29, 2008, we extended the July Emergency Order after 
carefully reevaluating the current state of the markets in consultation 
with officials of the Board of Governors of the Federal Reserve System, 
the Department of the Treasury, and the Federal Reserve Bank of New 
York and remaining concerned about the ongoing threat of market 
disruption and effects on investor confidence.\26\ Pursuant to the 
extension, the July Emergency Order terminated at 11:59 p.m. EDT on 
August 12, 2008.
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    \26\ See Exchange Act Release No. 58248 (July 29, 2008), 73 FR 
45257 (Aug. 4, 2008).
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    Due to our continued concerns regarding recent market conditions 
and that short selling in the securities of a wider range of financial 
institutions than those subject to the July Emergency Order may be 
causing sudden and excessive fluctuations of the prices of such 
securities that could threaten fair and orderly markets, on September 
18, 2008, we issued the Short Sale Ban Emergency Order.\27\ The Short 
Sale Ban Emergency Order temporarily prohibited any person from 
effecting a short sale in the publicly traded securities of certain 
financial institutions. On October 2, 2008, we extended the Short Sale 
Ban Emergency Order due to our continued concerns regarding the ongoing 
threat of market disruption and investor confidence in the financial 
markets.\28\ Pursuant to the extension, the Short Sale Ban Emergency 
Order terminated at 11:59 p.m. EDT on October 8, 2008.
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    \27\ See supra note 2.
    \28\ See Exchange Act Release No. 58723 (Oct. 2, 2008) (stating 
that the Short Sale Ban Emergency Order would terminate the earlier 
of (i) three business days from the President's signing of the 
Emergency Economic Stabilization Act of 2008 (H.R. 1424), or (ii) 
11:59 p.m. E.D.T. on Friday, October 17, 2008).
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    Our concerns are no longer limited to just the financial 
institutions that were the subject of the July Emergency Order and the 
Short Sale Ban Emergency Order. Given the importance of confidence in 
our financial markets as a whole, we have become concerned about sudden 
and unexplained declines in the prices of equity securities generally. 
These concerns resulted in our adopting and making immediately 
effective in the September Emergency Order the enhanced delivery 
requirements contained in temporary Rule 204T.\29\ For the reasons 
explained in detail herein, today we are adopting the temporary rule as 
set forth in the September Emergency Order, with modifications to 
address technical and operational concerns resulting from the 
requirements of the temporary rule.
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    \29\ See September Emergency Order, supra note 4.
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III. Concerns About ``Naked'' Short Selling

    We have been concerned about ``naked'' short selling and, in 
particular, abusive ``naked'' short selling, for some time. As 
discussed above, such concerns were a primary reason for our adoption 
of Regulation SHO in 2004, the elimination of the ``grandfather'' and 
options market maker exceptions to Regulation SHO's close-out 
requirement, the adoption of a ``naked'' short selling antifraud rule, 
and our recent issuance of the July Emergency Order, Short Sale Ban 
Emergency Order, and the September Emergency Order.
    Despite these Commission actions, due to our continuing concerns 
about the potential impact of ``naked'' short selling on the weakened 
financial markets, we believe it is necessary to immediately adopt as 
an interim final temporary rule, temporary rule 204T, with some 
modifications to address technical and operational concerns resulting 
from the rule's requirements as set forth in the September Emergency 
Order. We believe that adoption of temporary rule 204T as an interim 
final temporary rule is necessary to further address abusive ``naked'' 
short selling and, therefore, fails to deliver resulting from such 
short sales, in all equity securities. As we have stated on several 
prior occasions, we believe that all sellers of securities should 
promptly deliver, or arrange for delivery of, securities to the 
respective buyer and all buyers of securities have a right to expect 
prompt delivery of securities purchased.\30\ In addition, as we have 
stated on several prior occasions, we are concerned about the negative 
effect that fails to deliver may have on the markets and 
shareholders.\31\
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    \30\ See, e.g., Anti-Fraud Rule Proposing Release, 73 FR at 
15376.
    \31\ See, e.g., 2007 Regulation SHO Final Amendments, 72 FR at 
45544; 2006 Regulation SHO Proposed Amendments, 71 FR at 41712; 2007 
Regulation SHO Proposed Amendments, 72 FR at 45558-45559; Anti-Fraud 
Rule Proposing Release, 73 FR at 15378.
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    For example, large and persistent fails to deliver may deprive 
shareholders of the benefits of ownership, such as voting and 
lending.\32\ In addition, where a seller of securities fails to deliver 
securities on settlement date, in effect the seller unilaterally 
converts a securities contract (which is expected to settle within the 
standard three-day settlement period) into an undated futures-type 
contract, to which the buyer might not have agreed, or that might have 
been priced differently.\33\ Moreover, sellers that fail to deliver 
securities on settlement date may attempt to use this additional 
freedom to engage in trading activities to improperly depress the price 
of a security. For example, by not borrowing securities and, therefore, 
not making delivery within the standard three-day settlement period, 
the seller does not incur the costs of borrowing.
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    \32\ See id.
    \33\ See id.

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[[Page 61710]]

    In addition, issuers and investors have repeatedly expressed 
concerns about fails to deliver in connection with manipulative 
``naked'' short selling. For example, in response to proposed 
amendments to Regulation SHO in 2006 \34\ designed to further reduce 
the number of persistent fails to deliver in certain equity securities 
by eliminating Regulation SHO's ``grandfather'' exception, and limiting 
the duration of the rule's options market maker exception, we received 
a number of comments that expressed concerns about ``naked'' short 
selling and extended delivery failures.\35\ Commenters continued to 
express these concerns in response to proposed amendments to eliminate 
the options market maker exception to the close-out requirement of 
Regulation SHO in 2007.\36\
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    \34\ See 2006 Regulation SHO Proposed Amendments, 71 FR 41710.
    \35\ See, e.g., letter from Patrick M. Byrne, Chairman and Chief 
Executive Officer, Overstock.com, Inc., dated Sept. 11, 2006; letter 
from Daniel Behrendt, Chief Financial Officer, and Douglas Klint, 
General Counsel, TASER International, dated Sept. 18, 2006; letter 
from John Royce, dated April 30, 2007; letter from Michael Read, 
dated April 29, 2007; letter from Robert DeVivo, dated April 26, 
2007; letter from Ahmed Akhtar, dated April 26, 2007.
    \36\ See, e.g., letter from Jack M. Wedam, dated Oct. 16, 2007; 
letter from Michael J. Ryan, Executive Director and Senior Vice 
President, Center for Capital Markets Competitiveness, U.S. Chamber 
of Commerce, dated Sept. 13, 2007 (``U.S. Chamber of Commerce''); 
letter from Robert W. Raybould, CEO Enteleke Capital Corp., dated 
Sept. 12, 2007 (``Raybould''); letter from Mary Helburn, Executive 
Director, National Coalition Against Naked Shorting, dated Sept. 11, 
2007 (``NCANS'').
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    To the extent that fails to deliver might be part of manipulative 
``naked'' short selling, which could be used as a tool to drive down a 
company's stock price,\37\ such fails to deliver may undermine the 
confidence of investors.\38\ These investors, in turn, may be reluctant 
to commit capital to an issuer they believe to be subject to such 
manipulative conduct.\39\ In addition, issuers may believe that they 
have suffered unwarranted reputational damage due to investors' 
negative perceptions regarding fails to deliver in the issuer's 
security.\40\ Unwarranted reputational damage caused by fails to 
deliver might have an adverse impact on the security's price.\41\
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    \37\ See supra note 9 (discussing a case in which we alleged 
that the defendants profited from engaging in massive ``naked'' 
short selling that flooded the market with the company's stock, and 
depressed its price); see also S.E.C. v. Gardiner, 48 S.E.C. Docket 
811, No. 91 Civ. 2091 (S.D.N.Y. March 27, 1991) (alleged 
manipulation by sales representative by directing or inducing 
customers to sell stock short in order to depress its price); U.S. 
v. Russo, 74 F.3d 1383, 1392 (2d Cir. 1996) (short sales were 
sufficiently connected to the manipulation scheme as to constitute a 
violation of Exchange Act Section 10(b) and Rule 10b-5).
    \38\ In response to the 2007 Regulation SHO Proposed Amendments, 
we received comment letters discussing the impact of fails to 
deliver on investor confidence. See, e.g., letter from NCANS. 
Commenters expressed similar concerns in response to the 2006 
Regulation SHO Proposed Amendments. See, e.g., letter from Mary 
Helburn, Executive Director, National Coalition Against Naked 
Shorting, dated Sept. 30, 2006 (``NCANS (2006)''); letter from 
Richard Blumenthal, Attorney General, State of Connecticut, dated 
Sept. 19, 2006 (``Blumenthal'').
    \39\ In response to the 2007 Regulation SHO Proposed Amendments, 
we received comment letters expressing concern about the impact of 
potential ``naked'' short selling on capital formation, claiming 
that ``naked'' short selling causes a drop in an issuer's stock 
price and may limit the issuer's ability to access the capital 
markets. See, e.g., letter from Robert K. Lifton, Chairman and CEO, 
Medis Technologies, Inc., dated Sept. 12, 2007 (``Medis''); letter 
from NCANS. Commenters expressed similar concerns in response to the 
2006 Regulation SHO Proposed Amendments. See, e.g., letter from 
Congressman Tom Feeney--Florida, U.S. House of Representatives, 
dated Sept. 25, 2006 (``Feeney''); see also letter from Zix 
Corporation, dated Sept. 19, 2006 (``Zix'') (stating that ``[m]any 
investors attribute the Company's frequent re-appearances on the 
Regulation SHO list to manipulative short selling and frequently 
demand that the Company ``do something'' about the perceived 
manipulative short selling. This perception that manipulative short 
selling of the Company's securities is continually occurring has 
undermined the confidence of many of the Company's investors in the 
integrity of the market for the Company's securities.'').
    \40\ Due in part to such concerns, some issuers have taken 
actions to attempt to make transfer of their securities ``custody 
only,'' (i.e., certificating the securities and prohibiting 
ownership by a securities intermediary) thus preventing transfer of 
their stock to or from securities intermediaries such as the 
Depository Trust Company (``DTC'') or broker-dealers. See Exchange 
Act Release No. 48709 (Oct. 28, 2003), 68 FR 62972, at 62975 (Nov. 
6, 2003). Some issuers have attempted to withdraw their issued 
securities on deposit at DTC in order to make the securities 
ineligible for book-entry transfer at a securities depository. See 
id. Withdrawing securities from DTC or requiring custody-only 
transfers would undermine the goal of a national clearance and 
settlement system designed to reduce the physical movement of 
certificates in the trading markets. See id. We note, however, that 
in 2003 the Commission approved a DTC rule change clarifying that 
its rules provide that only its participants may withdraw securities 
from their accounts at DTC, and establishing a procedure to process 
issuer withdrawal requests. See Exchange Act Release No. 47978 (June 
4, 2003), 68 FR 35037 (June 11, 2003).
    \41\ See 2006 Regulation SHO Proposed Amendments, 71 FR at 
41712; 2007 Regulation SHO Amendments, 72 FR at 45544; 2007 
Regulation SHO Proposed Amendments, 72 FR at 45558-45559; Anti-Fraud 
Rule Proposing Release, 73 FR at 15378 (providing additional 
discussion of the impact of fails to deliver on the market); see 
also Exchange Act Release No. 48709 (Oct. 28, 2003), 68 FR 62972, 
62975 (Nov. 6, 2003) (discussing the impact of ``naked'' short 
selling on the market).
---------------------------------------------------------------------------

IV. Discussion of Temporary Rule 204T

A. Rule 204T's Close-Out Requirement

    In these unusual and extraordinary times and in an effort to 
prevent substantial disruption to the securities markets, we have 
concluded that it is necessary to immediately adopt as an interim final 
temporary rule, temporary rule Rule 204T, with some modifications to 
address technical and operational concerns resulting from the rule's 
requirements as set forth in the September Emergency Order. We believe 
that adoption of the temporary rule will substantially restrict the 
practice of potentially abusive ``naked'' short selling in all equity 
securities by strengthening the delivery requirements for such 
securities.\42\
---------------------------------------------------------------------------

    \42\ As noted above, in a ``naked'' short sale, the short seller 
does not borrow or arrange to borrow securities in time to make 
delivery to the buyer within the standard three-day settlement 
period. As a result, the seller fails to deliver securities to the 
buyer when delivery is due. See supra note 7 and supporting text.
---------------------------------------------------------------------------

    Specifically, temporary Rule 204T(a) provides that a participant of 
a registered clearing agency must deliver securities to a registered 
clearing agency for clearance and settlement on a long or short sale in 
any equity security by settlement date, or if a participant of a 
registered clearing agency has a fail to deliver position at a 
registered clearing agency in any equity security for a long or short 
sale transaction in that equity security, the participant shall, by no 
later than the beginning of regular trading hours \43\ on the 
settlement day \44\ following the settlement date, immediately close 
out the fail to deliver position by borrowing or purchasing securities 
of like kind and quantity.\45\
---------------------------------------------------------------------------

    \43\ ``Regular trading hours'' has the same meaning as in Rule 
600(b)(64) of Regulation NMS. Rule 600(b)(64) provides that 
``Regular trading hours means the time between 9:30 a.m. and 4 p.m. 
Eastern Time, or such other time as is set forth in the procedures 
established pursuant to Sec.  242.605(a)(2).''
    \44\ The term ``settlement day'' is defined in Rule 203(c)(5) of 
Regulation SHO as: ``* * * any business day on which deliveries of 
securities and payments of money may be made through the facilities 
of a registered clearing agency.'' 17 CFR 242.203(c)(5).
    \45\ See temporary Rule 204T(a).
---------------------------------------------------------------------------

    Temporary Rule 204T(a)'s close-out requirement requires a 
participant of a registered clearing agency that has a fail to deliver 
position at a registered clearing agency on the settlement date for a 
transaction to immediately borrow or purchase securities to close out 
the amount of the fail to deliver position by no later than the 
beginning of regular trading hours on the settlement day following the 
settlement date (the ``Close-Out Date''). This close-out requirement 
requires that the participant take affirmative action to purchase or 
borrow securities. Thus, a participant may not offset the amount of its 
settlement date fail to deliver position with shares that the 
participant receives or will receive on the Close-Out

[[Page 61711]]

Date.\46\ To meet its close-out obligation a participant also must be 
able to demonstrate on its books and records that on the Close-Out Date 
it purchased or borrowed shares in the full quantity of its settlement 
date fail to deliver position and, therefore, that the participant has 
a net flat or net long position on its books and records in that equity 
security on the Close-Out Date.
---------------------------------------------------------------------------

    \46\ In determining its close-out obligation, a participant may 
rely on its net delivery obligation as reflected in its notification 
from NSCC regarding its securities delivery and payment obligations, 
provided such notification is received prior to the beginning of 
regular trading hours on the Close-Out Date.
---------------------------------------------------------------------------

    The temporary rule defines a ``settlement date'' as ``the business 
day on which delivery of a security and payment of money is to be made 
through the facilities of a registered clearing agency in connection 
with the sale of a security.'' \47\ This definition is consistent with 
Rule 15c6-1 that prohibits broker-dealers from effecting or entering 
into a contract for the purchase or sale of a security that provides 
for payment of funds and delivery of securities later than the third 
business day after the date of the contract unless otherwise expressly 
agreed to by the parties at the time of the transaction.\48\
---------------------------------------------------------------------------

    \47\ See temporary Rule 204T(f)(1).
    \48\ See 17 CFR 240.15c6-1.
---------------------------------------------------------------------------

    Because most transactions settle by T+3 and because delivery on all 
sales should be made by settlement date, participants should consider 
having in place policies and procedures to help ensure that delivery is 
being made by settlement date. We intend to examine participants' 
policies and procedures to determine whether such policies and 
procedures monitor for delivery by settlement date.\49\
---------------------------------------------------------------------------

    \49\ Of course, broker-dealers must comply with any applicable 
SRO policies and procedures requirements. For example, NASD Rule 
3010 contains, among other things, written procedures requirements 
for member firms.
---------------------------------------------------------------------------

    Similar to the existing close-out requirement of Rule 203(b)(3) of 
Regulation SHO, the temporary rule is based on a participant's fail to 
deliver position at a registered clearing agency. As noted above, the 
NSCC clears and settles the majority of equity securities trades 
conducted on the exchanges and in the over-the-counter markets. NSCC 
clears and settles trades through the CNS system, which nets the 
securities delivery and payment obligations of all of its members. NSCC 
notifies its members of their securities delivery and payment 
obligations daily. Because the temporary rule is based on a 
participant's fail to deliver position at a registered clearing agency, 
the temporary rule is consistent with current settlement practices and 
procedures and with the Regulation SHO framework regarding delivery of 
securities.\50\
---------------------------------------------------------------------------

    \50\ See 17 CFR 242.203(b)(3) (Regulation SHO's close-out 
requirement). Consistent with current industry practice under 
Regulation SHO, with respect to a net syndicate short position 
created in connection with a distribution of a security that is part 
of a fail to deliver position at a registered clearing agency, the 
requirements of temporary Rule 204T shall not apply provided action 
is taken to close out the net syndicate short position by no later 
than the beginning of regular trading hours on the thirtieth day 
after commencement of sales in the distribution. See e.g., Exchange 
Act Release No. 58190 (July 18, 2008) (amending the July Emergency 
Order to provide an exception from its requirements for fails to 
deliver in connection with syndicate offerings).
---------------------------------------------------------------------------

    In addition, similar to Rule 203(b)(3)(vi) of Regulation SHO, the 
temporary rule provides that a participant may reasonably allocate its 
responsibility to close out a fail to deliver position to another 
broker-dealer from which the participant receives trades for clearance 
or settlement.\51\ Specifically, temporary Rule 204T(d) provides that 
if a participant of a registered clearing agency reasonably allocates a 
portion of a fail to deliver position to another registered broker or 
dealer for which it clears trades or from which it receives trades for 
settlement, based on such broker's or dealer's short position, the 
provisions of Rule 204T(a) and (b) relating to such fail to deliver 
position shall apply to such registered broker or dealer that was 
allocated the fail to deliver position, and not to the participant.\52\
---------------------------------------------------------------------------

    \51\ See 17 CFR 242.203(b)(3)(vi). Rule 203(b)(3)(vi) provides 
that ``[i]f a participant of a registered clearing agency reasonably 
allocates a portion of a fail to deliver position to another 
registered broker or dealer for which it clears trades or for which 
it is responsible for settlement, based on such broker or dealer's 
short position, then the provisions of this paragraph (b)(3) 
relating to such fail to deliver position shall apply to the portion 
of such registered broker or dealer that was allocated the fail to 
deliver position, and not to the participant.''
    \52\ See temporary Rule 204T(d).
---------------------------------------------------------------------------

    Thus, participants that are able to identify the accounts of 
broker-dealers for which they clear or from which they receive trades 
for settlement, could allocate the responsibility to close out the fail 
to deliver position to the particular broker-dealer account(s) whose 
trading activities have caused the fail to deliver position provided 
the allocation is reasonable (e.g., the allocation must be timely). 
Absent such identification, however, the participant would remain 
subject to the close-out requirement.
    Unlike Rule 203(b)(3)(vi) of Regulation SHO, temporary Rule 204T(d) 
imposes an additional notification requirement on a broker-dealer that 
has been allocated responsibility for complying with the rule's 
requirements. Specifically, temporary Rule 204T(d) provides that a 
broker or dealer that has been allocated a portion of a fail to deliver 
position that does not comply with the provisions of temporary Rule 
204T(a) must immediately notify the participant that it has become 
subject to the borrowing requirements of temporary Rule 204T(b).\53\ We 
are adopting this notification requirement so that participants will 
know when a broker-dealer for which they clear and settle trades has 
become subject to the temporary rule's borrowing requirements.
---------------------------------------------------------------------------

    \53\ See id.
---------------------------------------------------------------------------

    The temporary rule also differs from the current close-out 
requirement of Regulation SHO in that it applies to fails to deliver in 
all equity securities rather than only to those securities with a large 
and persistent level of fails to deliver, i.e., threshold securities. A 
primary purpose of the temporary rule is to prevent the use of 
``naked'' short selling as part of a manipulative scheme. To achieve 
this purpose, the rule must apply to all equity securities, regardless 
of the level or persistence of any fails to deliver in such securities. 
In addition, as discussed above, we believe that all sellers of 
securities should promptly deliver, or arrange for delivery of, 
securities to the respective buyer and all buyers of securities have a 
right to expect prompt delivery of securities purchased. We believe 
this should be the case for sales in all equity securities and are 
adopting this temporary rule to further that goal.
    Regulation SHO, as adopted in 2004, was a first step in trying to 
reduce persistent fails to deliver and address abusive ``naked'' short 
selling. In Regulation SHO, we took a targeted approach, imposing 
additional delivery requirements on securities with a substantial and 
persistent amount of fails to deliver. As we stated in the 2004 
Regulation SHO Adopting Release, we took this targeted approach at that 
time in an effort not to burden the vast majority of securities where 
there are not similar concerns regarding settlement.\54\ In addition, 
Regulation SHO's close-out requirement was adopted to address potential 
abuses that may occur with large, extended fails to deliver.\55\ We 
also noted in the 2004 Regulation SHO Adopting Release, however, that 
we would pay close attention to the operation and efficacy of

[[Page 61712]]

the provisions we were adopting at that time and would consider whether 
any further action was warranted.\56\
---------------------------------------------------------------------------

    \54\ See 2004 Regulation SHO Adopting Release, 69 FR at 48016.
    \55\ See id. at 48017.
    \56\ See id. at 48018.
---------------------------------------------------------------------------

    Because of continued concerns about the potentially negative market 
impact of fails to deliver, and the fact that through our monitoring of 
the efficacy of Regulation SHO's close-out requirement we continued to 
observe threshold securities with fail to deliver positions that are 
not being closed out under existing delivery and settlement 
requirements, we eliminated the ``grandfather'' and options market 
maker exceptions to Regulation SHO's close-out requirements.\57\
---------------------------------------------------------------------------

    \57\ On June 13, 2007, we adopted amendments to eliminate the 
``grandfather'' exception to Regulation SHO's close-out requirement. 
On September 17, 2008, in the September Emergency Order, we adopted 
amendments to eliminate the options market maker exception, which 
amendments were subsequently made permanent. See supra notes 17, 18 
and 19.
---------------------------------------------------------------------------

    However, we are concerned that Regulation SHO's current provisions 
have not gone far enough in reducing fails to deliver and addressing 
potentially abusive ``naked'' short selling.\58\ More is needed to 
reduce fails to deliver and to address potentially abusive ``naked'' 
short selling, especially in light of the current instability and lack 
of investor confidence in the financial markets.\59\ In addition, 
because Regulation SHO's close-out requirement applies only to 
threshold securities, fails to deliver in non-threshold securities 
never have to be closed out.\60\ We believe that adoption of temporary 
rule 204T as an interim final temporary rule is necessary to curtail 
fails to deliver in both threshold and non-threshold securities to 
further address abusive ``naked'' short selling in such securities.
---------------------------------------------------------------------------

    \58\ See, e.g., 2007 Regulation SHO Final Amendments, 72 FR 
45544 (eliminating the ``grandfather'' exception to Regulation SHO's 
close-out requirement due to our observing continued fails to 
deliver in threshold securities); 2008 Regulation SHO Final 
Amendments, supra note 19 (eliminating the options market maker 
exception to Regulation SHO's close-out requirement due to 
substantial levels of fails to deliver continuing to persist in 
optionable threshold securities).
    \59\ See, e.g., letter from Leland Chan, General Counsel, 
California Bankers Association, dated Aug. 21, 2008; letter from 
Eric C. Jensen, Esq., Cooley Godward Kronish L.P., dated Aug. 21, 
2008; letter from Steven B. Boehm and Cynthia M. Krus, Sutherland 
Asbill Brennan LLP, dated July 31, 2008; letter from James J. Angel, 
Professor of Finance, Georgetown University, McDonough School of 
Business, dated Aug. 20, 2008; letter from Tuan Nguyen, dated Aug. 
8, 2008.
    \60\ OEA estimates that fails to deliver in non-threshold 
securities averaged approximately 624 million shares or $4.6 billion 
in value per day from January to July 2008. These fails account for 
approximately 54.5% (56.6%) of all fail to deliver shares (by dollar 
value).
---------------------------------------------------------------------------

    As discussed above, due to our concerns about potentially abusive 
``naked'' short selling in certain non-threshold securities, we 
recently issued the July Emergency Order to temporarily impose enhanced 
requirements on short sales in the Appendix A Securities. Following our 
issuance of the July Emergency Order, we issued the Short Sale Ban 
Emergency Order in which we took the additional step of prohibiting 
short selling in the securities of a wider range of financial 
institutions than those subject to the July Emergency Order. In 
addition, we issued the September Emergency Order which, in part, 
imposed enhanced delivery requirements for transactions in all equity 
securities and made effective immediately a ``naked'' short selling 
antifraud rule. We took these emergency actions because we were 
concerned about panic selling in securities due to a loss of confidence 
that could be further exacerbated by ``naked'' short selling.
    Following the issuance of the July Emergency Order, members of the 
public have repeatedly expressed their concerns about a loss of 
confidence in the financial markets.\61\ In addition, since the 
termination of the July Emergency Order and the issuance of the Short 
Sale Ban Emergency Order and the September Emergency Order, we have 
continued our evaluation of the markets and our discussions with the 
Federal Reserve, Treasury, and the Federal Reserve Bank of New York 
regarding the state of the financial markets. In light of these 
processes, we have determined that we must take action to adopt as an 
interim final temporary rule, temporary Rule 204T, to substantially 
restrict ``naked'' short selling in all equity securities. As with the 
July Emergency Order, the Short Sale Ban Emergency Order, and the 
September Emergency Order, we are adopting this temporary rule as a 
preventative step to help restore market confidence.
---------------------------------------------------------------------------

    \61\ See, e.g., letter from Tom Donohue, President, U.S. Chamber 
of Commerce, dated July 15, 2008; letter from Ron Heller, dated July 
21, 2008; letter from Ronald L. Rourk, dated July 21, 2008; letter 
from Wayne Jett, Managing Principal and Chief Economist at Classical 
Capital, LLC, dated July 24, 2008; letter from Edward Herlilhy and 
Theodore Levine, Wachtell, Lipton, Rosen and Katz, LLP, dated Sept. 
16, 2008; letter from Sen. Hillary Rodham Clinton, dated Sept. 17, 
2008; letter from Representative D. Burton, dated Sept. 18, 2008; 
letter from Elliott Bossen, Chief Investment Officer at Silverback 
Asset Management, dated Sept. 24, 2008.
---------------------------------------------------------------------------

    In addition to applying the temporary rule to fails to deliver in 
all equity securities, rather than just threshold securities, the 
temporary rule also differs from the close-out requirement of Rule 
203(b)(3) of Regulation SHO in that it shortens the close-out period 
for such fails to deliver.\62\ For the reasons discussed below, rather 
than requiring close out of a fail to deliver position within thirteen 
consecutive settlement days (or 10 days after settlement date), 
temporary Rule 204T requires a participant to immediately purchase or 
borrow shares to close out a fail to deliver position by no later than 
the beginning of regular trading hours on the settlement day following 
the day on which the fail to deliver position occurs.
---------------------------------------------------------------------------

    \62\ Rule 203(b)(3) of Regulation SHO provides: ``If a 
participant of a registered clearing agency has a fail to deliver 
position at a registered clearing agency in a threshold security for 
thirteen consecutive settlement days, the participant shall 
immediately thereafter close out the fail to deliver position by 
purchasing securities of like kind and quantity.'' See 17 CFR 
242.203(b)(3).
---------------------------------------------------------------------------

    As noted above, trades in most securities generally settle within a 
three-day settlement cycle, known as T+3 (or ``trade date plus three 
days''). T+3 means that when a trade occurs, the participants to the 
trade are expected to deliver and pay for the security at a clearing 
agency three settlement days after the trade is executed so the 
brokerage firm can exchange those funds for the securities on that 
third business day. The three-day settlement period applies to most 
security transactions, including stocks, bonds, municipal securities, 
mutual funds traded through a brokerage firm, and limited partnerships 
that trade on an exchange. Government securities and stock options 
typically settle on the next business day following the trade (or 
T+1).\63\ We believe that delivery on all sales should be made by 
settlement date and, therefore, in temporary Rule 204T we are requiring 
that fails to deliver in all equity securities be closed out by no 
later than the beginning of regular trading hours on the Close-Out 
Date.
---------------------------------------------------------------------------

    \63\ See supra note 8.
---------------------------------------------------------------------------

    In the 2004 Regulation SHO Adopting Release we stated we were 
adopting a thirteen consecutive settlement day close-out requirement in 
part because the close-out requirement applied to fails to deliver 
resulting from long and short sales in threshold securities, and 
extending the time period to ten days after settlement date for a 
transaction would make the close-out requirement consistent with Rule 
15c3-3(m).\64\ In addition, we noted in that release that ten days 
after settlement was also the timeframe used at that time in NASD Rule 
11830.\65\ We also acknowledged that a shorter timeframe, such as two 
days after settlement, may capture many

[[Page 61713]]

instances of ordinary course settlement delays.\66\
---------------------------------------------------------------------------

    \64\ See 17 CFR 240.15c3-3(m).
    \65\ See 2004 Regulation SHO Adopting Release, 69 FR at 48017, 
n.93.
    \66\ See id.
---------------------------------------------------------------------------

    In addition, we have stated previously that the vast majority of 
fails to deliver are closed out within five days after T+3.\67\ In 
addition, a recent analysis by our Office of Economic Analysis found 
that more than half of all fails to deliver and more than 70% of all 
fail to deliver positions are closed out within two settlement days 
after T+3.\68\ Although this information shows that delivery is being 
made, it demonstrates that often delivery is not being made until 
several days following the standard three-day settlement cycle. In 
addition, the current close-out requirement for threshold securities 
under Regulation SHO and the lack of any close-out requirement for non-
threshold securities under Regulation SHO enables fails to deliver to 
persist for many days beyond settlement date. We believe that allowing 
fails to deliver to extend out beyond settlement date for a transaction 
is too long.
---------------------------------------------------------------------------

    \67\ See, e.g., 2007 Regulation SHO Final Amendments, 72 FR at 
45544, n.5.
    \68\ OEA's analysis examined the period from January to July 
2008 and used the age of the fail to deliver position as reported by 
the NSCC. The NSCC data included only securities with at least 
10,000 shares in fails to deliver. We note that these numbers 
included securities that were not subject to the close-out 
requirement in Rule 203(b)(3) of Regulation SHO, which applies only 
to ``threshold securities'' as defined in Rule 203(c)(6) of 
Regulation SHO.
---------------------------------------------------------------------------

    We have continuously monitored the extent of fails to deliver and 
abusive ``naked'' short selling in the markets. We believe that 
allowing fails to deliver in all equity securities to persist for 
thirteen consecutive settlement days (10 days after settlement date) if 
such securities are threshold securities, or indefinitely if such 
securities are not threshold securities, is too long. As discussed 
above, fails to deliver may be indicative of a scheme to manipulate the 
price of a security. In addition, we are concerned about the negative 
effect that fails to deliver and potentially abusive ``naked'' short 
selling may have on the market and the broader economy, including on 
investor confidence. Temporary Rule 204T addresses these concerns by 
requiring a participant to immediately close out a fail to deliver 
position by purchasing or borrowing securities by no later than the 
beginning of regular trading hours on the Close-Out Date.
    We believe we should act to require earlier close out so that more 
sales settle by settlement date. Indeed, we believe that delivery on 
all sales should be made by settlement date. As we discuss above, and 
as we have stated on several prior occasions, we believe that all 
sellers of securities should promptly deliver, or arrange for delivery 
of, securities to the respective buyer and all buyers of securities 
have a right to expect prompt delivery of securities purchased.\69\ 
Although the temporary rule's close-out requirement may capture some 
instances of ordinary course settlement delays, we believe that the 
temporary rule's close-out requirement is necessary to help ensure that 
fails to deliver in all equity securities settle by settlement date. In 
addition, as discussed above, due to our belief that delivery should be 
made by settlement date, participants should consider having policies 
and procedures in place to monitor for the delivery of securities by 
settlement date.
---------------------------------------------------------------------------

    \69\ See supra note 30.
---------------------------------------------------------------------------

    We understand, however, that fails to deliver may occur from long 
sales within the first two settlement days after settlement date for 
legitimate reasons. For example, human or mechanical errors or 
processing delays can result from transferring securities in custodial 
or other form rather than book-entry form, thereby causing a fail to 
deliver on a long sale within the normal three-day settlement period.
    Thus, temporary Rule 204T(a)(1) includes an exception from the 
temporary rule's close-out requirement for fail to deliver positions 
resulting from long sales of all equity securities. Specifically, 
temporary Rule 204T(a)(1) provides that if a participant of a 
registered clearing agency has a fail to deliver position at a 
registered clearing agency in any equity security and the participant 
can demonstrate on its books and records that such fail to deliver 
position resulted from a long sale, the participant shall by no later 
than the beginning of regular trading hours on the third consecutive 
settlement day following the settlement date, immediately close out the 
fail to deliver position by purchasing securities of like kind and 
quantity.\70\
---------------------------------------------------------------------------

    \70\ See temporary Rule 204T(a)(1). We note that if a person 
that has loaned a security to another person sells the security and 
a bona fide recall of the security is initiated within two business 
days after trade date, the person that has loaned the security will 
be ``deemed to own'' the security for purposes of Rule 200(g)(1) of 
Regulation SHO, and such sale will not be treated as a short sale 
for purposes of temporary Rule 204T. In addition, a broker-dealer 
may mark such orders as ``long'' sales provided such marking is also 
in compliance with Rule 200(c) of Regulation SHO. Thus, the close-
out requirement of temporary Rule 204T(a)(1) applies to sales of 
such securities.
---------------------------------------------------------------------------

B. Borrowing Requirements

    If a participant does not purchase or borrow shares, as applicable, 
to close out a fail to deliver position in accordance with temporary 
Rule 204T, the participant violates the close-out requirement of the 
temporary rule. In addition, the temporary rule imposes on the 
participant for its own trades and on all broker-dealers from which 
that participant receives trades for clearance and settlement 
(including introducing and executing brokers), a requirement to borrow 
or arrange to borrow securities prior to accepting or effecting further 
short sales in that security.
    Specifically, temporary Rule 204T(b) provides that the participant 
and any broker or dealer from which it receives trades for clearance 
and settlement, including any market maker that is otherwise entitled 
to rely on the exception provided in Rule 203(b)(2)(iii) of Regulation 
SHO,\71\ may not accept a short sale order in an equity security from 
another person, or effect a short sale order in such equity security 
for its own account, to the extent that the broker or dealer submits 
its short sales to that participant for clearance and settlement, 
without first borrowing the security, or entering into a bona-fide 
arrangement to borrow the security, until the participant closes out 
the fail to deliver position by purchasing securities of like kind and 
quantity and that purchase has cleared and settled at a registered 
clearing agency.\72\
---------------------------------------------------------------------------

    \71\ See 17 CFR 242.203(b)(2)(iii) (providing an exception from 
Regulation SHO's ``locate'' requirement for short sales effected by 
a market maker in connection with bona fide market making activities 
in the securities for which the exception is claimed).
    \72\ See temporary Rule 204T(b).
---------------------------------------------------------------------------

    The borrow requirements of temporary Rule 204T(b) are consistent 
with the requirements of Rule 203(b)(3)(iv) of Regulation SHO for a 
participant that has not closed out a fail to deliver position in a 
threshold security that has persisted for thirteen consecutive 
settlement days.\73\ Similar to Regulation SHO, the temporary rule is 
aimed at addressing potentially abusive ``naked'' short selling. To 
that end, we believe it is appropriate to include in the temporary rule 
borrow requirements for broker-dealers,

[[Page 61714]]

including participants, that sell short a security that has a fail to 
deliver position that has not been closed out in accordance with the 
requirements of the temporary rule. We believe that the borrow 
requirements of temporary Rule 204T(b) will further our goal of 
limiting fails to deliver and addressing abusive ``naked'' short 
selling by promoting the prompt and accurate clearance and settlement 
of securities transactions. By requiring that participants and broker-
dealers from which they receive trades for clearance and settlement 
borrow or arrange to borrow securities prior to accepting or effecting 
short sales in the security that has a fail to deliver position that 
has not been closed out, the temporary rule will help to ensure that 
shares will be available for delivery on the short sale by settlement 
date and, thereby, help to avoid additional fails to deliver occurring 
in the security.
---------------------------------------------------------------------------

    \73\ See 17 CFR 242.203(b)(3)(iv). Rule 203(b)(3)(iv) of 
Regulation SHO provides that ``[i]f a participant of a registered 
clearing agency has a fail to deliver position at a registered 
clearing agency in a threshold security for thirteen consecutive 
settlement days, the participant and any broker or dealer for which 
it clears transactions, including any market maker that would 
otherwise be entitled to rely on the exception provided in paragraph 
(b)(2)(iii) of this section, many not accept a short sale order in 
the threshold security from another person, or effect a short sale 
in the threshold security for its own account, without borrowing the 
security or entering into a bona fide arrangement to borrow the 
security, until the participant closes out the fail to deliver 
position by purchasing securities of like kind and quantity.''
---------------------------------------------------------------------------

    Unlike the borrow requirements of Rule 203(b)(3)(iv) of Regulation 
SHO, however, the borrow requirements of the temporary rule specify 
that participants must notify all broker-dealers from which they 
receive trades for clearance and settlement that a fail to deliver 
position has not been closed out in accordance with temporary Rule 
204T. Specifically, temporary Rule 204T(c) provides that the 
participant must notify any broker or dealer from which it receives 
trades for clearance and settlement, including any market maker that is 
otherwise entitled to rely on the exception provided in Rule 
203(b)(2)(iii) of Regulation SHO,\74\ (a) that the participant has a 
fail to deliver position in an equity security at a registered clearing 
agency that has not been closed out in accordance with the requirements 
of temporary Rule 204T, and (b) when the purchase that the participant 
has made to close out the fail to deliver position has cleared and 
settled at a registered clearing agency.\75\
---------------------------------------------------------------------------

    \74\ See 17 CFR 203(b)(2)(iii) (providing for an exception from 
the ``locate'' requirement for market makers engaged in bona fide 
market making in that security at the time of the short sale).
    \75\ See temporary Rule 204T(c).
---------------------------------------------------------------------------

    We are including this notification requirement in temporary Rule 
204T(c) so that all broker-dealers that submit trades for clearance and 
settlement to a participant that has a fail to deliver position in a 
security that has not been closed out in accordance with temporary Rule 
204T will be on notice that short sales in that security to be cleared 
or settled through that participant will be subject to the borrow 
requirements of temporary Rule 204T(b) until the fail to deliver 
position has been closed out.
    The temporary rule, however, includes an exception from the 
borrowing requirements for any broker-dealer that can demonstrate that 
it was not responsible for any part of the fail to deliver position of 
the participant. Specifically, temporary Rule 204T(b)(1) provides that 
a broker or dealer shall not be subject to the requirements of 
temporary Rule 204T(b) if the broker or dealer timely certifies to the 
participant that it has not incurred a fail to deliver position on 
settlement date for a long or short sale in an equity security for 
which the participant has a fail to deliver position at a registered 
clearing agency or that the broker or dealer is in compliance with the 
requirements of temporary Rule 204T(e).\76\ We have included this 
exception because we do not believe that a broker-dealer should be 
subject to the borrowing requirements of the temporary rule if the 
broker-dealer can demonstrate that it did not incur a fail to deliver 
position in the security on settlement date.
---------------------------------------------------------------------------

    \76\ See temporary Rule 204T(b)(1). Temporary Rule 204T(e) is 
discussed in detail below in Section IV.C.
---------------------------------------------------------------------------

    In addition, as noted above, the temporary rule provides that a 
participant may reasonably allocate (e.g., the allocation must be 
timely) its responsibility to close out a fail to deliver position to 
another broker-dealer for which the participant clears or from which 
the participant receives trades for settlement. Thus, to the extent 
that the participant can identify the broker-dealer(s) that have 
contributed to the fail to deliver position, and the participant has 
reasonably allocated the close-out obligation to the broker-dealer(s), 
the requirement to borrow or arrange to borrow prior to effecting 
further short sales in that security will apply to only those 
particular broker-dealer(s).

C. Pre-Fail Credit

    To avoid the borrow or arrangement to borrow requirement of 
temporary Rule 204T(a), a participant could close-out the fail by 
borrowing and delivering securities sufficient to close-out the fail to 
deliver position prior to the beginning of regular trading hours on the 
Close-Out Date. If, however, the participant does not succeed in 
eliminating the fail to deliver position the participant can only close 
out that position by immediately borrowing or purchasing securities to 
close out the fail to deliver position by no later than the beginning 
of regular trading hours on the Close-Out Date in accordance with 
temporary Rule 204T.
    To encourage close outs of fail to deliver positions prior to the 
Close-Out Date, similar to the September Emergency Order,\77\ temporary 
Rule 204T(e) provides that a broker-dealer can satisfy the temporary 
rule's close-out requirement by purchasing securities in accordance 
with the conditions of that provision (i.e., broker-dealers will 
receive ``pre-fail credit'' for the purchase). Specifically, temporary 
Rule 204T(e) provides that even if a participant of a registered 
clearing agency has not closed out a fail to deliver position at a 
registered clearing agency in accordance with temporary Rule 204T(a), 
or has not allocated a fail to deliver position to a broker or dealer 
in accordance with temporary Rule 204T(d), a broker or dealer shall not 
be subject to the requirements of paragraphs (a) or (b) of the 
temporary rule if the broker or dealer purchases securities prior to 
the beginning of regular trading hours on the Close-Out Date for a long 
or short sale to close out an open short position, and if:
---------------------------------------------------------------------------

    \77\ See Exchange Act Release No. 58711 (Oct. 1, 2008) (stating 
that in connection with extending the September Emergency Order, the 
Commission incorporates and adopts the Division of Trading and 
Markets: Guidance Regarding the Commission's Emergency Order 
Concerning Rules to Protect Investors Against ``Naked'' Short 
Selling Abuses and the Division of Trading and Markets Guidance 
Regarding Sale of Loaned but Recalled Securities).
---------------------------------------------------------------------------

    (1) The purchase is bona fide;
    (2) The purchase is executed on, or after, trade date but by no 
later than the end of regular trading hours on settlement date for the 
transaction;
    (3) The purchase is of a quantity of securities sufficient to cover 
the entire amount of the open short position; and
    (4) The broker or 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 or dealer is seeking to demonstrate 
that it has purchased shares to close out its open short position.
    To receive pre-fail credit under temporary Rule 204T(e), the 
purchase must be ``bona fide.'' Thus, where a broker-dealer enters into 
an arrangement with another person to purchase securities, and the 
broker-dealer knows or has reason to know that the other person will 
not deliver securities in settlement of the transaction, the purchase 
will not be considered to be ``bona fide.'' \78\ In addition, the 
purchase

[[Page 61715]]

must be of a quantity of securities sufficient to cover the entire 
amount of the open short position.\79\
---------------------------------------------------------------------------

    \78\ See 17 CFR 203(b)(3)(vii) (discussing bona fide purchases 
for purposes of Regulation SHO). It is possible under Regulation SHO 
that a close out by a participant of a registered clearing agency 
may result in a fail to deliver position at another participant if 
the counterparty from which the participant purchases securities 
fails to deliver. However, Regulation SHO prohibits a participant of 
a registered clearing agency, or a broker-dealer for which it clears 
transactions, from engaging in ``sham close outs'' by entering into 
an arrangement with a counterparty to purchase securities for 
purposes of closing out a fail to deliver position and the purchaser 
knows or has reason to know that the counterparty will not deliver 
the securities, and which thus creates another fail to deliver 
position. See id. at (b)(3)(vii); 2004 Regulation SHO Adopting 
Release, 69 FR at 48018 n.96. In addition, we note that borrowing 
securities, or otherwise entering into an arrangement with another 
person to create the appearance of a purchase would not satisfy the 
close-out requirement of Regulation SHO. For example, the purchase 
of paired positions of stock and options that are designed to create 
the appearance of a bona fide purchase of securities but that are 
nothing more than a temporary stock lending arrangement would not 
satisfy Regulation SHO's close-out requirement.
    \79\ See temporary Rule 204T(e)(3).
---------------------------------------------------------------------------

    Temporary Rule 204T(e) also requires that to receive pre-fail 
credit, the purchase must be executed on, or after, trade date but by 
no later than the end of regular trading hours on the settlement date 
of the transaction that resulted in the fail to deliver position at a 
registered clearing agency.\80\ The purpose of this provision is to 
encourage broker-dealers to close out fail to deliver positions prior 
to the beginning of regular trading hours on the Close-Out Date.
---------------------------------------------------------------------------

    \80\ See temporary Rule 204T(e)(2).
---------------------------------------------------------------------------

    In addition, to help ensure that broker-dealers purchase sufficient 
shares to close out their fail to deliver positions, temporary Rule 
204T(e) requires that the broker-dealer claiming pre-fail credit be net 
long or net flat on the settlement day on which the broker-dealer is 
claiming pre-fail credit.\81\ In addition, the temporary Rule 204T(e) 
requires that the broker-dealer be able to demonstrate that it has 
complied with this requirement.\82\ This requirement will enable the 
Commission and SROs to monitor more effectively whether or not a 
broker-dealer has complied with the requirements of temporary Rule 
204T(e).
---------------------------------------------------------------------------

    \81\ See temporary Rule 204T(e)(4).
    \82\ See id.
---------------------------------------------------------------------------

D. Market Makers

    To allow market makers to facilitate customer orders in a fast 
moving market, similar to the September Emergency Order,\83\ temporary 
rule includes a limited exception from the rule's close-out and 
borrowing requirements for fails to deliver attributable to bona fide 
market making activities by registered market makers, options market 
makers, or other market makers obligated to quote in the over-the-
counter market. Specifically, temporary Rule 204T(a)(3) provides that 
if a participant of a registered clearing agency has a fail to deliver 
position at a registered clearing agency in any equity security that is 
attributable to bona fide market making activities by a registered 
market maker, options market maker, or other market maker obligated to 
quote in the over-the-counter market (individually a ``Market Maker,'' 
collectively ``Market Makers''), the participant shall by no later than 
the beginning of regular trading hours on the third consecutive 
settlement day following the settlement date, immediately close out the 
fail to deliver position by purchasing securities of like kind and 
quantity.\84\
---------------------------------------------------------------------------

    \83\ See supra note 77.
    \84\ See temporary Rule 204T(a)(3). Unlike the September 
Emergency Order, however, the temporary rule does not require a 
Market Maker to which a fail to deliver position at a registered 
clearing agency is attributable to attest in writing to the market 
on which it is registered that the fail to deliver position at issue 
was established solely for the purpose of meeting its bona fide 
market making obligations and the steps the Market Maker has taken 
in an effort to deliver securities to its registered clearing 
agency. We believe the costs of such a requirement would outweigh 
the benefits. We note, however, that as with any exception, a 
broker-dealer would have to evidence eligibility for, and compliance 
with, the requirements of the exception.
---------------------------------------------------------------------------

    In addition, similar to the September Emergency Order,\85\ the 
temporary rule excepts Market Makers from the borrowing requirements of 
temporary Rule 204T(b) if the Market Maker can demonstrate that it does 
not have an open fail to deliver position at the time of any additional 
short sales. The borrowing requirements of the temporary rule apply to 
all broker-dealers from which a participant of a registered clearing 
agency receives trades for clearance and settlement. To allow Market 
Makers to facilitate customer orders, we do not believe that a Market 
Maker should be subject to the temporary rule's borrowing requirements 
if the Market Maker does not have an open fail to deliver at the time 
of any additional short sales.
---------------------------------------------------------------------------

    \85\ See supra note 77.
---------------------------------------------------------------------------

E. Sales Pursuant to Rule 144

    The temporary rule includes an exception for sales of all equity 
securities pursuant to Rule 144 under the Securities Act of 1933 
(``Securities Act'').\86\ Specifically, temporary Rule 204T(a)(2) 
provides that if a participant of a registered clearing agency has a 
fail to deliver position at a registered clearing agency in an equity 
security sold pursuant to Rule 144 for thirty-five consecutive 
settlement days after the settlement date for a sale in that equity 
security, the participant shall, by no later than the beginning of 
regular trading hours on the thirty-sixth consecutive settlement day 
following the settlement date for the transaction, immediately close 
out the fail to deliver position by purchasing securities of like kind 
and quantity.\87\
---------------------------------------------------------------------------

    \86\ See 17 CFR 230.144.
    \87\ See temporary Rule 204T(a)(2).
---------------------------------------------------------------------------

    Regulation SHO provides an exception from the ``locate'' 
requirement of Rule 203(b)(1) for situations where a broker-dealer 
effects a short sale on behalf of a customer that is deemed to own the 
security pursuant to Rule 200 of Regulation SHO, although, through no 
fault of the customer or broker-dealer, it is not reasonably expected 
that the security will be in the physical possession or control of the 
broker-dealer by settlement date and, therefore, is a ``short'' sale 
under the marking requirements of Rule 200(g).\88\ Rule 203(b)(2)(ii) 
of Regulation SHO provides that in such circumstances, delivery must be 
made on the sale as soon as all restrictions on delivery have been 
removed, and in any event no later than 35 days after trade date, at 
which time the broker-dealer that sold on behalf of the person must 
either borrow securities or close out the open position by purchasing 
securities of like kind and quantity.\89\ In addition, recently we 
adopted amendments to the close-out requirement of Regulation SHO to 
allow fails to deliver resulting from sales of threshold securities 
pursuant to Rule 144 to be closed out within 35 rather than 13 
consecutive settlement days.\90\
---------------------------------------------------------------------------

    \88\ Pursuant to Rule 200(g)(2) of Regulation SHO, as adopted in 
August 2004, generally these sales were marked ``short exempt.'' See 
2004 Regulation SHO Adopting Release, 69 FR at 48030-48031; but cf. 
Exchange Act Release No. 55970 (June 28, 2007), 72 FR 36348 (July 3, 
2007) (removing the ``short exempt'' marking requirement).
    \89\ See 17 CFR 242.203(b)(2)(ii). In the 2004 Regulation SHO 
Adopting Release, the Commission stated that it believed that 35 
calendar days is a reasonable outer limit to allow for restrictions 
on a security to be removed if ownership is certain. In addition, 
the Commission noted that Section 220.8(b)(2) of Regulation T of the 
Federal Reserve Board allows 35 calendar days to pay for securities 
delivered against payment if the delivery delay is due to the 
mechanics of the transactions. See 2004 Regulation SHO Adopting 
Release, 69 FR at 48015, n.72.
    \90\ See 2007 Regulation SHO Final Amendments, 72 FR at 45550-
45551.
---------------------------------------------------------------------------

    Securities sold pursuant to Rule 144 under the Securities Act are 
formerly restricted securities that a seller is ``deemed to own,'' as 
defined by Rule 200(a) of Regulation SHO.\91\ The securities, however, 
may not be capable of being delivered on the settlement date due to 
processing delays related to removal of the restricted legend and, 
therefore, sales of these securities frequently result in fails to 
deliver.

[[Page 61716]]

Consistent with our statements in connection with our recent amendments 
to Regulation SHO in connection with closing out fails to deliver in 
threshold securities sold pursuant to Rule 144, we believe that a 
close-out requirement of 35 consecutive settlement days from settlement 
date for fails to deliver resulting from sales of all equity securities 
sold pursuant to Rule 144, will permit the orderly settlement of such 
sales without the risk of causing market disruption due to unnecessary 
purchasing activity (particularly if the purchases are for sizable 
quantities of stock). Because the security being sold will be received 
as soon as all processing delays have been removed, this additional 
time will allow participants to close out fails to deliver resulting 
from the sale of the security with the security sold, rather than 
having to close out such fail to deliver position by purchasing 
securities in the market.\92\
---------------------------------------------------------------------------

    \91\ See 17 CFR 242.200(a).
    \92\ We understand that sellers that own restricted equity 
securities that wish to sell pursuant to an effective resale 
registration statement under Rule 415 under the Securities Act 
experience similar types of potential settlement delays as sales of 
securities pursuant to Rule 144 under the Securities Act. Thus, 
fails to deliver in such securities may be closed out in accordance 
with temporary Rule 204T(a)(2) if the fails to deliver resulted from 
sales of securities that were outstanding at the time they were sold 
and the sale occurred after a registration has become effective. In 
addition, we understand that sales pursuant to broker-assisted 
cashless exercises of compensatory options to purchase a company's 
stock, may result in potential settlement delays and, therefore, 
fails to deliver. Such fails to deliver may be closed out in 
accordance with temporary Rule 204T(a)(2).
---------------------------------------------------------------------------

    If, however, a fail to deliver position resulting from the sale of 
an equity security pursuant to Rule 144 is not closed out in accordance 
with temporary Rule 204T(a)(2), the borrowing requirements of temporary 
Rule 204T(b) will apply. Thus, if a participant does not close out a 
fail to deliver position at a registered clearing agency in accordance 
with temporary Rule 204T(a)(2), the temporary rule prohibits the 
participant, and any broker-dealer from which it receives trades for 
clearance and settlement, including market makers, from accepting any 
short sale orders or effecting further short sales in the particular 
security without borrowing, or entering into a bona-fide arrangement to 
borrow, the security until the participant closes out the entire fail 
to deliver position by purchasing securities of like kind and quantity 
and that purchase has cleared and settled at a registered clearing 
agency.\93\
---------------------------------------------------------------------------

    \93\ See temporary Rule 204T(b).
---------------------------------------------------------------------------

V. Other Matters

    The Administrative Procedure Act generally requires an agency to 
publish notice of a proposed rulemaking in the Federal Register.\94\ 
This requirement does not apply, however, if the agency ``for good 
cause finds * * * that notice and public procedure are impracticable, 
unnecessary, or contrary to the public interest.'' \95\ Further, the 
Administrative Procedure Act also generally requires that an agency 
publish an adopted rule in the Federal Register 30 days before it 
becomes effective.\96\ This requirement, however, does not apply if the 
agency finds good cause for making the rule effective sooner.\97\
---------------------------------------------------------------------------

    \94\ See 5 U.S.C. Sec.  553(b).
    \95\ Id.
    \96\ See 5 U.S.C. Sec.  553(d).
    \97\ Id.
---------------------------------------------------------------------------

    For the reasons discussed throughout this release, we believe that 
we have good cause to act immediately to adopt this rule on an interim 
final temporary basis. The September Emergency Order, in which we 
adopted and made immediately effective temporary Rule 204T expires at 
11:59 p.m. EDT on October 17, 2008. As discussed throughout this 
release, we have determined it is necessary to act immediately and 
adopt this rule on an interim final temporary basis so that temporary 
rule 204T remains in effect in the form set forth herein following the 
expiration of the September Emergency Order.
    This temporary rule takes effect on October 17, 2008. For the 
reasons discussed above, we have acted on an interim final temporary 
basis. We emphasize that we are requesting comments on the temporary 
rule and will carefully consider the comments we receive and respond to 
them in a subsequent release. Moreover, this is a temporary rule, and 
will expire on July 31, 2009. Setting a termination date for the rule 
will necessitate further Commission action no later than the end of 
that period if the Commission intends to continue the same, or similar, 
requirements contained in the temporary rule.
    The sunset provision will enable the Commission to assess the 
operation of the temporary rule and intervening developments, including 
a restoration of stability to the financial markets, as well as public 
comments, and consider whether to continue the rule with or without 
modification or not at all.
    We find that there is good cause to have the temporary rule take 
effect on October 17, 2008 and that notice and public procedure in 
advance of effectiveness of the rule are impracticable, unnecessary, 
and contrary to the public interest.\98\
---------------------------------------------------------------------------

    \98\ This finding also satisfies the requirements of 5 U.S.C. 
808(2), allowing the rules to become immediately effective 
notwithstanding the requirements of 5 U.S.C. 801 (if a Federal 
agency finds that notice and public comment are ``impractical, 
unnecessary, or contrary to the public interest,'' a rule ``shall 
take effect at such time as the Federal agency promulgating the rule 
determines.'').
---------------------------------------------------------------------------

VI. Request for Comment

    We are requesting comments from all members of the public. We will 
carefully consider the comments that we receive and intend to respond 
to them in a subsequent release. We seek comment generally on all 
aspects of the temporary rule. In addition, we seek comment on the 
following:
    [cir] The temporary rule requires participants to immediately close 
out a fail to deliver position by no later than the beginning of 
regular trading hours on the Close-Out Date. Should we narrow the 
close-out requirement further? Should we allow a longer or shorter 
period of time within which to close out a fail to deliver position? 
What would be the justifications for allowing a shorter or longer 
close-out period?
    [cir] Are there any operational or compliance issues related to 
complying with the requirement in temporary Rule 204T(a) to immediately 
purchase or borrow securities ``by no later than the beginning of 
regular trading hours''? Should we allow a participant to take steps to 
purchase or borrow securities after the beginning of regular trading 
hours on the Close-Out Date to satisfy temporary Rule 204T(a)? If so, 
how much time after the beginning of regular trading hours should we 
provide? For example, should we allow trading during an opening auction 
that commences after the beginning of regular trading hours or should 
we provide until noon? Alternatively, should we allow participants to 
purchase or borrow securities at any time on the Close-Out Date to 
satisfy the temporary rule's close-out requirement? What would be the 
costs and benefits of allowing additional time beyond the beginning of 
regular trading hours on the Close-Out Date for the participant to 
purchase or borrow securities to close out a fail to deliver position?
    [cir] Temporary Rule 204T(f)(1) defines ``settlement date'' as 
``the business day on which delivery of a security and payment of money 
is to be made through the facilities of a registered clearing agency in 
connection with the sale of a security.'' Is this an appropriate 
definition of ``settlement date''?
    [cir] Due to our expectation that delivery of securities on all 
sales should be made

[[Page 61717]]

by settlement date, we state in the release that participants should 
consider having in place policies and procedures to monitor for the 
delivery of securities by settlement date. Should we adopt a rule 
requiring that participants have in place such policies and procedures?
    [cir] Should a de minimus amount of fails to deliver be excepted 
from the close-out requirements of the temporary rule? If so, what 
should be the de minimus amount?
    [cir] Should the temporary rule be expanded to apply to debt as 
well as equity securities? Please explain.
    [cir] The temporary rule requires that a participant purchase 
securities by no later than the beginning of regular trading hours on 
the third settlement day after the settlement date for a fail to 
deliver position resulting from a long sale transaction. What are the 
costs associated with purchasing versus borrowing securities to close 
out a fail to deliver position? Should we permit participants to close 
out a fail to deliver position for long sale transactions by borrowing 
as well as purchasing securities? Please explain.
    [cir] The temporary rule allows a participant to close out a fail 
to deliver position attributable to bona fide market making activity by 
a registered market maker, options market maker, or other market maker 
obligated to quote in the over-the-counter market by purchasing 
securities of like kind and quantity by no later than the beginning of 
regular trading hours on the third settlement day after the settlement 
date. Should this close-out period be a shorter or longer time-frame? 
Please explain. What would be the costs and benefits of a longer or 
shorter close-out period for such fails to deliver?
    [cir] The temporary rule does not include a complete exception from 
its close-out requirement for options market makers with fails to 
deliver resulting from short sales effected to establish or maintain a 
hedge on options positions. We seek comment regarding the impact of the 
temporary rule on options market makers that are subject to the close-
out requirement of the temporary rule. For example, we seek comment 
regarding the impact of the temporary rule, if any, on liquidity, 
spread widths, and quote depth in the securities that are subject to 
the temporary rule.
    [cir] The temporary rule allows a participant to close out a fail 
to deliver position resulting from a sale of an equity security 
pursuant to Rule 144 of the Securities Act by no later than the 
beginning of regular trading hours on the thirty-sixth consecutive 
settlement day after the settlement date. Are there other types of 
sales that encounter settlement delays due to processing requirements 
similar to sales of Rule 144 securities that should have an exception 
from the close-out requirements of temporary Rule 204T(a)? Please 
explain.
    [cir] What impact will the temporary rule have on borrowing costs? 
Please explain. What impact will the temporary rule have on legitimate 
short selling and market efficiency?
    [cir] An arrangement to borrow means a bona fide agreement to 
borrow the security such that the security being borrowed is set aside 
at the time of the arrangement solely for the person requesting the 
security. Should we define ``arrangement to borrow'' as requiring a 
contract between the broker-dealer and the lending source?
    [cir] Should temporary Rule 204T(b) require that participants and 
broker-dealers from which participants receive trades for clearance and 
settlement borrow securities prior to effecting further short sales, 
rather than allowing for either an arrangement to borrow or a borrow? 
If a fail to deliver position has not been closed out in accordance 
with temporary Rule 204T, should we prohibit the participant, and any 
broker-dealer from which it receives trades for clearance and 
settlement, from effecting any further short sales until the fail to 
deliver position has been closed out?
    [cir] If a participant becomes subject to the requirements of 
temporary Rule 204T(b), the participant will be required to borrow or 
arrange to borrow securities prior to settlement at a registered 
clearing agency of the purchase to close out the fail to deliver 
position. What are the costs associated with this requirement?
    [cir] Temporary Rule 204T(c) imposes a notification requirement on 
participants. Will such a notification requirement impose operational 
or systems costs on participants? What types of communication 
mechanisms will participants use to comply with this requirement of the 
temporary rule? What will be the costs and benefits of this 
notification requirement?
    [cir] The temporary rule allows a broker-dealer to obtain pre-fail 
credit if it purchases securities in accordance with the conditions 
specified in temporary Rule 204T(e). Are there any operational or 
compliance concerns associated with the conditions of temporary Rule 
204T(e)? To what extent, if any, will temporary Rule 204T(e) encourage 
broker-dealers to close out a fail to deliver position prior to the 
Close-Out Date?
    [cir] The temporary rule does not propose amendments to the 
``locate'' requirement of Rule 203(b)(1) of Regulation SHO. In addition 
to the temporary rule, should we also require that broker-dealers 
arrange to borrow, or borrow, equity securities prior to effecting 
short sales in those equity securities? How would this impact the 
liquidity and availability of such equity securities overall? How would 
this affect lending rates for such equity securities?
    [cir] The temporary rule imposes a close-out requirement on fails 
to deliver for all equity securities. Due to this hard delivery 
requirement is it necessary to retain the ``locate'' requirement of 
Regulation SHO for short sales? What are the benefits of continuing to 
require that broker-dealers have a reasonable grounds to believe that a 
security can be borrowed so that it can be delivered by settlement date 
if a participant is required to immediately close out a fail to deliver 
position by no later than the beginning of regular trading hours on the 
Close-Out Date?
    [cir] The temporary rule does not allow any exceptions for fails to 
deliver due to mechanical aspects of corporate events, such as equity 
offers, including initial public offerings (``IPOs''),\99\ and tender 
offers. Will the temporary rule cause any disruption to these corporate 
events? For example, will the temporary rule interfere with the ability 
of underwriters to provide price support? Would any disruption warrant 
an exception for certain corporate events? If so, should the exception 
focus on particular corporate events and why? How much time is needed 
for securities subject to such corporate events to be delivered? Would 
providing exceptions for such securities create opportunities for price 
manipulation?
---------------------------------------------------------------------------

    \99\ See Amy Edwards and Kathleen Weiss Hanley, Short Selling in 
Initial Public Offerings (2008) http://ssrn.com/abstract=981242 
showing that fails to deliver in IPOs are not from ``naked'' short 
selling but instead seem to be related to fails to deliver resulting 
from long sales that result from underwriter price support. The 
aggregate fails to deliver in these stocks seem to persist for the 
typical price support period. Thus, the temporary rule's close-out 
requirement could apply to a high proportion of such fails to 
deliver, potentially as much as 2.5% of the shares offered on 
average. Edwards and Hanley believe that such a result could have a 
substantial impact on the aftermarket of IPOs.
---------------------------------------------------------------------------

VII. Paperwork Reduction Act

A. Background

    Temporary Rule 204T contains ``collection of information'' 
requirements within the meaning of the Paperwork Reduction Act of 1995 
(``Paperwork Reduction Act'').\100\ We submitted these requirements to 
the

[[Page 61718]]

Office of Management and Budget (``OMB'') for review and approval in 
accordance with 44 U.S.C. 3507(j) and 5 CFR 1320.13. Separately, we 
have submitted the collection of information to OMB for review and 
approval in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The 
OMB has approved the collection of information on an emergency basis 
with an expiration date of April 30, 2009. An agency may not conduct or 
sponsor, and a person is not required to respond to, a collection of 
information unless it displays a currently valid OMB control number. 
The title for the collection of information is: ``Temporary Rule 204T'' 
and the OMB control number for the collection of information is 3235-
0647.
---------------------------------------------------------------------------

    \100\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

    Temporary Rule 204T will substantially restrict the practice of 
``naked'' short selling in all equity securities by strengthening the 
delivery requirements for such securities.\101\ Temporary Rule 204T(a) 
amends Regulation SHO to require that participants of a clearing agency 
registered with the Commission deliver securities by settlement date, 
or if the participants have not delivered shares by settlement date, 
the participants must, by no later than the beginning of regular 
trading hours on the settlement day following the settlement date (the 
``Close-Out Date''), immediately close out the fail to deliver position 
by borrowing or purchasing securities of like kind and quantity.
---------------------------------------------------------------------------

    \101\ As noted above, in a ``naked'' short sale, the short 
seller does not borrow or arrange to borrow securities in time to 
make delivery to the buyer within the standard three-day settlement 
period. As a result, the seller fails to deliver securities to the 
buyer when delivery is due.
---------------------------------------------------------------------------

    A participant that does not comply with the temporary rule's close-
out requirements will have violated temporary Rule 204T. In addition, 
the participant and any broker-dealer from which it receives trades for 
clearance and settlement, will not be able to short sell the security 
either for itself or for the account of another, unless it has 
previously arranged to borrow or has borrowed the security, until the 
participant closes out the fail to deliver position by purchasing 
securities of like kind and quantity and that purchase has cleared and 
settled at a registered clearing agency.\102\
---------------------------------------------------------------------------

    \102\ See temporary Rule 204T(b).
---------------------------------------------------------------------------

    Several provisions under temporary Rule 204T will impose a new 
``collection of information'' within the meaning of the Paperwork 
Reduction Act. These collections of information are mandatory for 
broker-dealers relying on the rule. The information collected will be 
retained and/or provided to other entities pursuant to the specific 
rule provisions and will be available to the Commission and SRO 
examiners upon request. The information collected will aid the 
Commission and SROs in monitoring compliance with the rule's 
requirements.
1. Allocation Notification Requirement
    Similar to Rule 203(b)(3)(vi) of Regulation SHO, temporary Rule 
204T(d) provides that a participant may reasonably allocate its 
responsibility to close out a fail to deliver position to another 
broker-dealer for which the participant clears or from which the 
participant receives trades for settlement.\103\ Unlike Rule 
203(b)(3)(vi) of Regulation SHO, however, temporary Rule 204T(d) 
imposes an additional notification requirement on a broker-dealer that 
has been allocated responsibility for complying with the rule's 
requirements (the ``allocation notification requirement'').\104\
---------------------------------------------------------------------------

    \103\ See 17 CFR 242.203(b)(3)(vi). Rule 203(b)(3)(vi) provides 
that ``[i]f a participant of a registered clearing agency reasonably 
allocates a portion of a fail to deliver position to another 
registered broker or dealer for which it clears trades or for which 
it is responsible for settlement, based on such broker or dealer's 
short position, then the provisions of this paragraph (b)(3) 
relating to such fail to deliver position shall apply to the portion 
of such registered broker or dealer that was allocated the fail to 
deliver position, and not to the participant.''
    \104\ See temporary Rule 204T(d).
---------------------------------------------------------------------------

    Specifically, temporary Rule 204T(d) provides that a broker or 
dealer that has been allocated a portion of a fail to deliver position 
that does not comply with the provisions of temporary Rule 204T(a) must 
immediately notify the participant that it has become subject to the 
borrowing requirements of temporary Rule 204T(b).\105\ This allocation 
notification requirement is designed to help ensure that participants 
that receive trades for clearance and settlement from broker-dealers 
will be on notice that the broker-dealer is subject to the borrow 
requirements of temporary Rule 204T(b) until the fail to deliver 
position has been closed out.
---------------------------------------------------------------------------

    \105\ See id.
---------------------------------------------------------------------------

    Such notification will require a broker-dealer to determine that it 
has a fail to deliver that does not comply with the provisions of 
temporary Rule 204T(a) and, therefore, has become subject to the 
requirements of temporary Rule 204T(b). After making such 
determination, the temporary rule requires that the broker-dealer 
notify such participant regarding this information.
    We estimate that such procedures will take a broker-dealer no more 
than approximately 0.16 hours (10 minutes) to complete. We base this 
estimate in part on the fact that, in accordance with Rule 
203(b)(3)(vi) of Regulation SHO, participants are permitted to allocate 
responsibility to close out a portion of a fail to deliver position to 
a broker-dealer that is responsible for the fail to deliver position; 
the fact that most broker-dealers already have the necessary 
communication mechanisms in place and are already familiar with 
notification processes and procedures to comply with the borrowing 
requirements of Rule 203(b)(3)(iv) of Regulation SHO for threshold 
securities; and the fact that broker-dealers will be able to continue 
to use the same communication mechanisms, processes and procedures to 
comply with the notification requirement of temporary Rule 204T(b). On 
average, participants estimate that currently it takes approximately 
0.16 hours (10 minutes) to notify broker-dealers pursuant to Rule 
203(b)(3)(iv) of Regulation SHO.\106\
---------------------------------------------------------------------------

    \106\ We base this estimate on information provided to our staff 
by three small, three medium, and three large registered clearing 
agency participants.
---------------------------------------------------------------------------

    If a broker-dealer has been allocated a portion of a fail to 
deliver position in an equity security and after the beginning of 
regular trading hours on the Close-Out Date, the broker-dealer has to 
determine whether or not that portion of the fail to deliver position 
was not closed out in accordance with temporary Rule 204T(a), we 
estimate that a broker-dealer will have to make such determination with 
respect to approximately 1.76 equity securities per day.\107\
---------------------------------------------------------------------------

    \107\ OEA estimates that there are approximately 9,809 fail to 
deliver positions per settlement day. Across 5,561 broker-dealers, 
the number of securities per broker-dealer per day is approximately 
1.76 equity securities. During the period from January to July 2008, 
approximately 4,321 new fail to deliver positions occurred per day. 
The NSCC data for this period includes only securities with at least 
10,000 shares in fails to deliver. To account for securities with 
fails to deliver below 10,000 shares, the figure is multiplied by a 
factor of 2.27. The factor is estimated from a more complete data 
set obtained from NSCC during the period from September 16, 2008 to 
September 22, 2008. It should be noted that these numbers include 
securities that were not subject to the close-out requirement of 
Rule 203(b)(3) of Regulation SHO.
---------------------------------------------------------------------------

    As of December 31, 2007, there were 5,561 registered broker-
dealers. Each of these broker-dealers could clear trades through a 
participant of a registered clearing agency and, therefore, become 
subject to the notification requirements of temporary Rule 204T(b). We 
estimate a total of 2,466,415 notifications in accordance with 
temporary Rule 204T(b) across all broker-dealers (that were allocated 
responsibility to close out a fail to deliver position) per year

[[Page 61719]]

(5,561 broker-dealers notifying participants once per day \108\ on 1.76 
securities, multiplied by 252 trading days in a year). The total 
estimated annual burden hours per year will be approximately 394,626 
burden hours (2,466,415 multiplied by 0.16 hours/notification). We 
estimate that the paperwork compliance for the allocation notification 
requirement for each broker-dealer will be approximately 71.0 burden 
hours per year.
---------------------------------------------------------------------------

    \108\ Because failure to comply with the close-out requirements 
of temporary Rule 204T(a) is a violation of the temporary rule, we 
believe that a broker-dealer would make the notification to a 
participant that it is subject to the borrowing requirements of 
temporary Rule 204T(b) at most once per day.
---------------------------------------------------------------------------

2. Demonstration Requirement for Fails To Deliver on Long Sales
    Temporary Rule 204T(a)(1) includes an exception from temporary 
rule's close-out requirement for fail to deliver positions resulting 
from long sales of all equity securities. Under this exception, if a 
participant has a fail to deliver position at a registered clearing 
agency in an equity security and can demonstrate on its books and 
records that such fail to deliver position resulted from a long sale 
(the ``demonstration requirement for fails to deliver on long sales''), 
such participant will have until no later than the beginning of regular 
trading hours on the third consecutive settlement day following the 
settlement date to immediately close out the fail to deliver position 
by purchasing securities of like kind and quantity.\109\
---------------------------------------------------------------------------

    \109\ See temporary Rule 204T(a)(1).
---------------------------------------------------------------------------

    This provision allows a participant an additional two settlement 
days in which to close out the fail to deliver position that resulted 
from a long sale, provided that the participant's books and records 
reflect the fact that the fail to deliver resulted from a long 
sale.\110\
---------------------------------------------------------------------------

    \110\ See id.
---------------------------------------------------------------------------

    The demonstration requirement will require a participant of a 
registered clearing agency to determine whether it has a fail to 
deliver position at a registered clearing agency in an equity security 
that resulted from a long sale. After making such determination, the 
temporary rule requires that the participant demonstrate or reflect 
this information in its books and records. We estimate that such 
procedures will take a participant of a registered clearing agency no 
more than approximately 0.16 hours (10 minutes) to complete.
    We base this estimate on the fact that, to comply with Regulation 
SHO's marking requirements, broker-dealers are already required to 
ascertain whether a customer is ``deemed to own'' the securities being 
sold before marking a sell order ``long'' and, if the securities are 
not in the broker-dealer's physical possession or control, whether the 
broker-dealer reasonably expects that the shares will be in the broker-
dealer's physical possession or control by settlement date.\111\ This 
reasonableness determination includes consideration of whether or not a 
prior sale resulted in a fail to deliver position. In addition, broker-
dealers already must comply with the documentation requirement 
contained in the ``locate'' requirement of Rule 203(b)(1) of Regulation 
SHO. Participants will be able to use similar mechanisms, processes and 
procedures to demonstrate compliance with the temporary rule's close-
out requirement for fails to deliver resulting from long sales as they 
use for compliance with the current requirements of Regulation SHO.
---------------------------------------------------------------------------

    \111\ See 17 CFR 242.200(g)(1).
---------------------------------------------------------------------------

    If a participant of a registered clearing agency has a fail to 
deliver position in an equity security at a registered clearing agency 
and determined that such fail to deliver position resulted from a long 
sale, we estimate that a participant of a registered clearing agency 
will have to make such determination with respect to approximately 34 
securities per day.\112\
---------------------------------------------------------------------------

    \112\ OEA estimates approximately 68% of trades are long sales 
and applies this percentage to the number of fail to deliver 
positions per day. 68% of 50 securities per day is 34 securities per 
day. The 68% figure is estimated as 100% minus the proportion of 
short sale trades found in the Regulation SHO Pilot Study. See 
http://www.sec.gov/news/studies/2007/regshopilot020607.pdf.
---------------------------------------------------------------------------

    As of July 31, 2008, there were 197 participants of NSCC, the 
primary registered clearing agency responsible for clearing U.S. 
transactions that were registered as broker-dealers. We estimate a 
total of 1,687,896 demonstrations in accordance with temporary Rule 
204T(a)(1) across all participants per year (197 participants checking 
for compliance once per day on 34 securities, multiplied by 252 trading 
days in a year). The total approximate estimated annual burden hour per 
year will be approximately 270,063 burden hours (1,687,896 multiplied 
by 0.16 hours/documentation). We estimate that the paperwork burden for 
the temporary demonstration provision for each participant will be 
approximately 1,371 burden hours per year.
3. Pre-Borrow Notification Requirement
    The borrowing requirements of temporary Rule 204T(b) are similar to 
the requirements of Rule 203(b)(3)(iv) of Regulation SHO for a 
participant that has failed to close out a fail to deliver position in 
a threshold security that has persisted for thirteen consecutive 
settlement days.\113\ Unlike the current borrow requirements of Rule 
203(b)(3)(iv) of Regulation SHO, however, temporary Rule 204T(c) 
specifies that participants must notify all broker-dealers from which 
they receive trades for clearance and settlement that a fail to deliver 
position has not been closed out in accordance with temporary Rule 
204T(a) (the ``pre-borrow notification requirement'').
---------------------------------------------------------------------------

    \113\ See 17 CFR 242.203(b)(3)(iv). Rule 203(b)(3)(iv) of 
Regulation SHO provides that ``[i]f a participant of a registered 
clearing agency has a fail to deliver position at a registered 
clearing agency in a threshold security for thirteen consecutive 
settlement days, the participant and any broker or dealer for which 
it clears transactions, including any market maker that would 
otherwise be entitled to rely on the exception provided in paragraph 
(b)(2)(iii) of this section, may not accept a short sale order in 
the threshold security from another person, or effect a short sale 
in the threshold security for its own account, without borrowing the 
security or entering into a bona fide arrangement to borrow the 
security, until the participant closes out the fail to deliver 
position by purchasing securities of like kind and quantity.''
---------------------------------------------------------------------------

    Specifically, temporary Rule 204T(c) provides that the participant 
must notify any broker or dealer from which it receives trades for 
clearance and settlement, including any market maker that would 
otherwise be entitled to rely on the exception provided in Rule 
203(b)(2)(iii) of Regulation SHO,\114\ (1) that the participant has a 
fail to deliver position in an equity security at a registered clearing 
agency that has not been closed out in accordance with the requirements 
of temporary Rule 204T(a), and (2) when the purchase that the 
participant has made to close out the fail to deliver position has 
cleared and settled at a registered clearing agency.\115\
---------------------------------------------------------------------------

    \114\ See 17 CFR 203(b)(2)(iii) (providing for an exception from 
the ``locate'' requirement for market makers engaged in bona fide 
market making in that security at the time of the short sale).
    \115\ See temporary Rule 204T(c).
---------------------------------------------------------------------------

    The notification requirement will involve a participant of a 
registered clearing agency determining whether it has a fail to deliver 
position in an equity security at a registered clearing agency that has 
not been closed out in accordance with the requirements of temporary 
Rule 204T(a), and when the purchase that the participant has made to 
close out the fail to deliver position has cleared and settled at a 
registered clearing agency. After making such determinations, the 
temporary rule requires that the participant notify such broker-dealer 
regarding this information.
    We estimate that such procedures will take a participant of a 
registered clearing

[[Page 61720]]

agency no more than approximately 0.16 hours (10 minutes) to 
complete.\116\ We base this estimate in part on the fact that most 
participants already notify broker-dealers for which they receive 
orders for clearance and settlement that the participant has a fail to 
deliver position in a threshold security that has not been closed out 
in order to comply with the borrow requirements of Rule 203(b)(3)(iv) 
of Regulation SHO for threshold securities; the fact that most 
participants already have the necessary communication mechanisms in 
place and are already familiar with notification processes and 
procedures to comply with the borrow requirements of Rule 203(b)(3)(iv) 
of Regulation SHO for threshold securities; and the fact that 
participants will be able to continue to use the same communication 
mechanisms, processes and procedures to notify any broker-dealers from 
which they receive trades for clearance and settlement of the 
information required by the temporary rule's notification requirement 
as they use for compliance with Regulation SHO.
---------------------------------------------------------------------------

    \116\ We base this estimate on information provided to our staff 
by three small, three medium, and three large registered clearing 
agency participants.
---------------------------------------------------------------------------

    If a participant of a registered clearing agency has a fail to 
deliver position in an equity security and after the beginning of 
regular trading hours on the Close-Out Date (or, in the case of a fail 
to deliver that resulted from a long sale, on the third consecutive 
settlement day following the settlement date), the participant has to 
determine whether or not the fail to deliver position was closed out in 
accordance with temporary Rule 204T(a), we estimate that a participant 
of a registered clearing agency will have to make such determination 
with respect to approximately 50 equity securities per day.\117\
---------------------------------------------------------------------------

    \117\ OEA estimates that there are approximately 9,809 fail to 
deliver positions per day. Across 197 broker-dealer participants of 
the NSCC, the number of securities per participant per day is 
approximately 50 equity securities. During the period from January 
to July 2008, approximately 4,321 new fail to deliver positions 
occurred per day. The NSCC data for this period includes only 
securities with at least 10,000 shares in fails to deliver. To 
account for securities with fails to deliver below 10,000 shares, 
the figure is grossed-up by a factor of 2.27. The factor is 
estimated from a more complete data set obtained from NSCC during 
the period from September 16, 2008 to September 22, 2008. It should 
be noted that these numbers include securities that were not subject 
to the close-out requirement of Rule 203(b)(3) of Regulation SHO.
---------------------------------------------------------------------------

    As of July 31, 2008, there were 197 participants of NSCC, the 
primary registered clearing agency responsible for clearing U.S. 
transactions that were registered as broker-dealers.\118\ We estimate a 
total of 2,482,200 notifications in accordance with temporary Rule 
204T(c) across all participants per year (197 participants notifying 
broker-dealers once per day on 50 securities, multiplied by 252 trading 
days in a year). The total estimated annual burden hours per year will 
be approximately 397,152 burden hours (2,482,200 @ 0.16 hours/
documentation). We estimate that the paperwork burden for the 
notification requirement for each participant will be approximately 
2,016 burden hours per year.
---------------------------------------------------------------------------

    \118\ Those participants not registered as broker-dealers 
include such entities as banks, U.S.-registered exchanges, and 
clearing agencies. Although these entities are participants of a 
registered clearing agency, generally these entities do not engage 
in the types of activities that will implicate the close-out 
requirements of the temporary rule. Such activities of these 
entities include creating and redeeming Exchange Traded Funds, 
trading in municipal securities, and using NSCC's Envelope 
Settlement Service or Inter-city Envelope Settlement Service. These 
activities rarely lead to fails to deliver and, if fails to deliver 
do occur, they are small in number and are usually closed out within 
a day. Thus, such fails to deliver will not trigger the close-out 
requirement of the temporary rule.
---------------------------------------------------------------------------

4. Certification Requirement
    The temporary rule includes an exception from the borrowing 
requirements for any broker-dealer that can demonstrate that it was not 
responsible for any part of the fail to deliver position of the 
participant. Specifically, temporary Rule 204T(b)(1) provides that a 
broker or dealer shall not be subject to the requirements of temporary 
Rule 204T(b) if the broker or dealer timely certifies to the 
participant that it has not incurred a fail to deliver position on 
settlement date for a long or short sale in an equity security for 
which the participant has a fail to deliver position at a registered 
clearing agency or that the broker or dealer is in compliance with the 
requirements of temporary Rule 204T(e) (the ``certification 
requirement'').\119\
---------------------------------------------------------------------------

    \119\ See temporary Rule 204T(b)(1).
---------------------------------------------------------------------------

    This certification requirement will allow a broker-dealer to avoid 
being subject to the temporary rule's borrowing requirements if it can 
demonstrate that it did not incur a fail to deliver position in the 
security on settlement date. Also, by requiring the broker-dealer to 
demonstrate that it was not responsible for any part of the fail to 
deliver position of the participant, the information collected will 
help ensure that broker-dealers are complying with the requirements of 
the temporary rule.
    This certification requirement will require a broker-dealer to 
determine that it has not incurred a fail to deliver position on 
settlement date in an equity security for which the participant has a 
fail to deliver position at a registered clearing agency or that the 
broker-dealer is in compliance with the requirements set forth in the 
Pre-Fail Credit provision of temporary Rule 204T(e). After making such 
determinations, the broker-dealer will have to certify this information 
to the participant. We estimate that such procedures will take a 
broker-dealer no more than approximately 0.16 hours (10 minutes) to 
complete.
    We base this estimate, in part, on the fact that, to comply with 
the close-out requirements of Rule 203(b) of Regulation SHO, current 
industry practice for some participants that are registered broker-
dealers is to document purchases made on settlement days 11, 12, and 13 
to demonstrate that such participants do not have a close-out 
obligation under Regulation SHO. On average, participants informed us 
that such documentation takes approximately 0.16 hours (10 
minutes).\120\
---------------------------------------------------------------------------

    \120\ We base this estimate on information provided to our staff 
by three small, three medium, and three large registered clearing 
agency participants.
---------------------------------------------------------------------------

    If the broker-dealer determines that it has not incurred a fail to 
deliver position on settlement date in an equity security for which the 
participant has a fail to deliver position at a registered clearing 
agency or has purchased securities in accordance with the conditions 
specified in temporary Rule 204T(e), we estimate that a broker-dealer 
will have to make such determinations with respect to approximately 
1.76 securities per day. As of December 31, 2007, there were 5,561 
registered broker-dealers. Each of these broker-dealers may clear 
trades through a participant of a registered clearing agency. We 
estimate that on average, a broker-dealer will have to certify to the 
participant that it has not incurred a fail to deliver position on 
settlement date in an equity security for which the participant has a 
fail to deliver position at a registered clearing agency or, 
alternatively, that it is in compliance with the requirements set forth 
in the Pre-Fail Credit provision of the temporary Rule 204T(e), 
2,466,415 times per year (5,561 broker-dealers certifying once per day 
on 1.76 securities, multiplied by 252 trading days in a year). The 
total approximate estimated annual burden hour per year will be 
approximately 394,626 burden hours (2,466,415 multiplied by 0.16 hours/
certification). We estimate that the paperwork burden for the 
certification provision for each broker-

[[Page 61721]]

dealer will be approximately 71.0 burden hours per year.
5. Pre-Fail Credit Demonstration Requirement
    To encourage close outs of fail to deliver positions prior to the 
Close-Out Date, temporary Rule 204T(e) provides that a broker-dealer 
can satisfy the temporary rule's close-out requirement by purchasing 
securities in accordance with the conditions of that provision (i.e., 
broker-dealers will receive ``pre-fail credit'' for the purchase), 
including a condition that the broker-dealer 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 or dealer is claiming credit (the 
``Pre-Fail Credit demonstration requirement'').
    Temporary Rule 204T(e) provides that even if a participant of a 
registered clearing agency has not closed out a fail to deliver 
position at a registered clearing agency in accordance with temporary 
Rule 204T(a), or has not allocated a fail to deliver position to a 
broker-dealer in accordance with temporary Rule 204T(d), a broker or 
dealer may receive credit for purchasing securities prior to the 
beginning of regular trading hours on the Close-Out Date if, among 
other things, the purchase is executed on, or after, trade date but by 
no later than the end of regular trading hours on settlement date and 
the broker or 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 or dealer is claiming credit.\121\
---------------------------------------------------------------------------

    \121\ See temporary Rule 204T(e).
---------------------------------------------------------------------------

    The Pre-Fail Credit provision is intended to encourage broker-
dealers to close out fail to deliver positions prior to the beginning 
of regular trading hours on the Close-Out Date. By requiring, among 
other things, that the broker-dealer 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 credit, the 
information collected will help ensure that broker-dealers purchase 
sufficient shares to close out their fail to deliver position prior to 
the beginning of regular trading hours on the Close-Out Date.
    Such demonstration requirement will require a broker-dealer that 
purchased securities in accordance with the conditions specified in 
temporary Rule 204T(e) to determine that it has a net long position or 
net flat position on the settlement day for which the broker-dealer is 
claiming credit. After making such determination, the temporary rule 
requires that the broker-dealer demonstrate such information on its 
books and records. We estimate that such procedures will take a broker-
dealer no more than approximately 0.16 hours (10 minutes) to complete.
    We base this estimate on the fact that, to comply with the close-
out requirement of Rule 203(b)(3) of Regulation SHO, current industry 
practice for some participants that are registered broker-dealers is to 
document purchases made on settlement days 11, 12, and 13 to 
demonstrate that such participants do not have a close-out obligation 
under Regulation SHO. On average, participants informed us that such 
documentation takes approximately 0.16 hours (10 minutes).\122\
---------------------------------------------------------------------------

    \122\ We base this estimate on information provided to our staff 
by three small, three medium, and three large registered clearing 
agency participants.
---------------------------------------------------------------------------

    If a broker-dealer purchased securities in accordance with the 
conditions specified in temporary Rule 204T(e) and determined that it 
has a net long position or net flat position on the settlement day for 
which the broker-dealer is claiming credit, we estimate that a broker-
dealer will have to make such determination with respect to 
approximately 1.76 securities per day.\123\
---------------------------------------------------------------------------

    \123\ See supra, note 107.
---------------------------------------------------------------------------

    As of December 31, 2007, there were 5,561 registered broker-
dealers. We estimate that on average, a broker-dealer will have to 
demonstrate in its books and records that it has a net long position or 
net flat position on the settlement day for which the broker-dealer is 
claiming credit, 2,466,415 times per year (5,561 broker-dealers 
checking for compliance once per day on 1.76 securities, multiplied by 
252 trading days in a year). The total approximate estimated annual 
burden hour per year will be approximately 394,626 burden hours 
(2,466,415 multiplied by 0.16 hours/demonstration). We estimate that 
the paperwork burden for the temporary Pre-Fail Credit provision for 
each broker-dealer will be approximately 71.0 burden hours per year.
6. Market Maker Demonstration Requirement
    To allow market makers to facilitate customer orders in a fast 
moving market, the temporary rule includes a limited exception from the 
rule's close-out requirement for fails to deliver attributable to bona 
fide market making activities by registered market makers, options 
market makers, or other market makers obligated to quote in the over-
the-counter market (collectively, ``Market Makers''). Under this 
exception, a participant 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 for the transaction that resulted in the fail to 
deliver position. The borrowing requirements of the temporary rule do 
not apply to Market Makers provided the Market Maker can demonstrate 
that it does not have an open fail to deliver position at the time of 
any additional short sales (the ``Market Maker demonstration 
requirement'').
    By requiring a Market Maker to demonstrate that it does not have an 
open fail to deliver position at the time of any additional short sales 
and, thus, avoid being subject to the temporary rule's pre-borrow 
requirements, the information collected will help ensure that Market 
Makers are complying with the requirements of temporary Rule 
204T(b)(2).
    This requirement will require a Market Maker to determine whether 
it has an open fail to deliver position at the time of any additional 
short sales in the particular equity security in which there is a fail 
to deliver position at a registered clearing agency. After making such 
a determination, the temporary rule requires that the Market Maker 
demonstrate that it does not have an open fail to deliver position in 
that equity security. We estimate that such procedures will take a 
Market Maker no more than approximately 0.16 hours (10 minutes) to 
complete.\124\
---------------------------------------------------------------------------

    \124\ We base this estimate on information provided to our staff 
by three large, three medium, and three small firms that engage in 
market making activities currently complying with temporary Rule 
204T, pursuant to the September Emergency Order, which has similar 
requirements to temporary Rule 204(T)(b)(2) of this release.
---------------------------------------------------------------------------

    If a participant of a registered clearing agency has a fail to 
deliver position in an equity security at a registered clearing agency 
that is attributable to a Market Maker and the Market Maker, in seeking 
to avoid the borrowing requirements of temporary Rule 204T(b), has 
determined that it does not have an open fail to deliver position, we 
estimate that such Market Maker will have to make such determination 
with respect to approximately 15 securities per day.\125\
---------------------------------------------------------------------------

    \125\ OEA estimates that there are approximately 9,809 fail to 
deliver positions per day. An upper bound on the number of fail to 
deliver positions per day due to market makers is 9,809. Across 656 
market makers, the number of securities per market maker per day is 
approximately 15 equity securities. During the period from January 
to July 2008, approximately 4,321 new fail to deliver positions 
occurred per day. The NSCC data for this period includes only 
securities with at least 10,000 shares in fails to deliver. To 
account for securities with fails to deliver below 10,000 shares, 
the figure is grossed-up by a factor of 2.27. The factor is 
estimated from a more complete data set obtained from NSCC during 
the period from September 16, 2008 to September 22, 2008. It should 
be noted that these numbers include securities that were not subject 
to the close-out requirement of Rule 203(b)(3) of Regulation SHO.

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

[[Page 61722]]

    As of December 31, 2007, there were 656 Market Makers.\126\ We 
estimate a total of 2,479,680 written demonstrations in accordance with 
temporary Rule 204T(b)(1) across all Market Makers per year (656 Market 
Makers demonstrating once per day on 15 securities, multiplied by 252 
trading days in a year). The total estimated annual burden hour per 
year will be approximately 396,749 burden hours (2,479,680 multiplied 
by 0.16 hours/demonstration). We estimate that the paperwork burden for 
the Market Maker demonstration requirements for each Market Maker will 
be approximately 604.8 burden hours per year.
---------------------------------------------------------------------------

    \126\ These numbers are based on OEA's review of 2007 FOCUS 
Report filings reflecting registered broker-dealers. This number 
does not include broker-dealers that are delinquent on FOCUS Report 
filings.
---------------------------------------------------------------------------

B. Request for Comment

    We invite comment on these estimates and assumptions. Pursuant to 
44 U.S.C. 3506(c)(2)(B), we request comment in order to: (a) Evaluate 
whether the collection of information is necessary for the proper 
performance of our functions, including whether the information will 
have practical utility; (b) evaluate the accuracy of our estimate of 
the burden of the collection of information; (c) determine whether 
there are ways to enhance the quality, utility and clarity of the 
information to be collected; and (d) evaluate whether there are ways to 
minimize the burden of the collection of information on those who 
respond, including through the use of automated collection techniques 
or other forms of information technology.
    Persons submitting comments on the collection of information 
requirements should direct them to the Office of Management and Budget, 
Attention: Desk Officer for the Securities and Exchange Commission, 
Office of Information and Regulatory Affairs, Washington, DC 20503, and 
should also send a copy of their comments to Florence E. Harmon, Acting 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090, with reference to File No. S7-30-08. 
Requests for materials submitted to OMB by the Commission with regard 
to this collection of information should be in writing, with reference 
to File No. S7-30-08, and be submitted to the Securities and Exchange 
Commission, Records Management, Office of Filings and Information 
Services, 100 F Street, NE., Washington, DC 20549-1090. As OMB is 
required to make a decision concerning the collections of information 
between 30 and 60 days after publication, a comment to OMB is best 
assured of having its full effect if OMB receives it within 30 days of 
publication.

VIII. Cost-Benefit Analysis

 A. Summary

    The Commission is sensitive to the costs and benefits of its rules. 
Commenters should provide analysis and data to support their views on 
the costs and benefits associated with the temporary rule.
    We are adopting, as an interim final temporary rule, Rule 204T, 
under the Exchange Act. The temporary rule is intended to address 
abusive ``naked'' short selling in all equity securities by requiring 
that participants of a registered clearing agency deliver securities by 
settlement date, or if the participants have not delivered shares by 
settlement date, the participants must, by no later than the beginning 
of regular trading hours on the Close-Out Date, immediately close out 
the fail to deliver position by borrowing or purchasing securities of 
like kind and quantity.
    If a participant does not purchase or borrow shares, as applicable, 
to close out a fail to deliver position in accordance with temporary 
Rule 204T(a), the participant will have violated the temporary rule. In 
addition, the temporary rule imposes on the participant for its own 
trades and on all broker-dealers from which that participant receives 
trades for clearance and settlement (including introducing and 
executing brokers), a requirement to borrow or arrange to borrow 
securities prior to accepting or effecting further short sales in that 
security.\127\
---------------------------------------------------------------------------

    \127\ See temporary Rule 204T(b).
---------------------------------------------------------------------------

    To the extent that a participant becomes subject to the borrowing 
requirements of temporary Rule 204T(b), a broker-dealer that clears 
through the participant can avoid being subject to the borrowing 
requirements of temporary Rule 204T(b) if the broker-dealer can 
demonstrate that it was not responsible for any part of the fail to 
deliver position of the participant. Moreover, to allow Market Makers 
to facilitate customer orders in a fast moving market without possible 
delays associated with complying with the pre-borrow penalty provision 
of temporary Rule 204T(b), the borrowing requirements of the temporary 
rule do not apply to Market Makers 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.\128\
---------------------------------------------------------------------------

    \128\ See temporary Rule 204T(b)(2).
---------------------------------------------------------------------------

    Similar to Rule 203(b)(3)(vi) of Regulation SHO, temporary Rule 
204(d) provides that a participant may reasonably allocate its 
responsibility to close out a fail to deliver position to another 
broker-dealer for which the participant clears trades, or from which it 
receives trades for settlement.\129\ Unlike Rule 203(b)(3)(vi) of 
Regulation SHO, however, temporary Rule 204T(d) imposes a notification 
requirement on a broker-dealer that has been allocated responsibility 
for complying with the rule's requirements.\130\
---------------------------------------------------------------------------

    \129\ See 17 CFR 242.203(b)(3)(vi). Rule 203(b)(3)(vi) provides 
that ``[i]f a participant of a registered clearing agency reasonably 
allocates a portion of a fail to deliver position to another 
registered broker or dealer for which it clears trades or for which 
it is responsible for settlement, based on such broker or dealer's 
short position, then the provisions of this paragraph (b)(3) 
relating to such fail to deliver position shall apply to the portion 
of such registered broker or dealer that was allocated the fail to 
deliver position, and not to the participant.''
    \130\ See temporary Rule 204T(d).
---------------------------------------------------------------------------

    In addition, the temporary rule provides that if a participant has 
a fail to deliver position at registered clearing agency in an equity 
security and can demonstrate on its books and records that such fail to 
deliver position resulted from a long sale, such participant has until 
no later than the beginning of regular trading hours on the third 
consecutive settlement day following the settlement date to immediately 
close out the fail to deliver position by purchasing securities of like 
kind and quantity.
    The temporary rule also extends the close-out requirement for fails 
to deliver attributable to bona fide market making activities by Market 
Makers by requiring a participant to close out the fail to deliver 
position attributable to a Market Maker by no later than the beginning 
of regular trading hours on the third settlement day after the 
settlement date for the transaction that resulted in the fail to 
deliver position.
    In addition, consistent with Rule 203(b)(3)(ii) of Regulation SHO, 
the temporary rule includes an exception for sales of securities 
pursuant to Rule 144 of the Securities Act.\131\

[[Page 61723]]

Specifically, temporary Rule 204T(a)(2) provides that if a participant 
of a registered clearing agency has a fail to deliver position at a 
registered clearing agency in any equity security sold pursuant to Rule 
144 for thirty-five consecutive settlement days after the settlement 
date for a sale in that equity security, the participant shall, by no 
later than the beginning of regular trading hours on the thirty-sixth 
consecutive settlement day following the settlement date for the 
transaction, immediately close out the fail to deliver position by 
purchasing securities of like kind and quantity.\132\
---------------------------------------------------------------------------

    \131\ See 17 CFR 242.203(b)(3)(ii).
    \132\ See temporary Rule 204T(a)(2).
---------------------------------------------------------------------------

    If, however, a fail to deliver position resulting from the sale of 
an equity security pursuant to Rule 144 is not closed out in accordance 
with temporary Rule 204T(a)(2), the participant is subject to the 
borrow requirements in temporary Rule 204T(b). Thus, if the fail to 
deliver position persists beyond thirty-five consecutive settlement 
days, the temporary rule prohibits a participant of a registered 
clearing agency, and any broker-dealer from which it receives trades 
for clearance and settlement, from accepting any short sale orders or 
effecting further short sales in the particular security without 
borrowing, or entering into a bona-fide arrangement to borrow, the 
security until the participant closes out the entire fail to deliver 
position by purchasing securities of like kind and quantity and that 
purchase has cleared and settled at a registered clearing agency.\133\
---------------------------------------------------------------------------

    \133\ See temporary Rule 204T(b).
---------------------------------------------------------------------------

    Although we recognize the temporary rule may impose increased 
borrowing costs to assure settlement in accordance with the 
requirements of the temporary rule, which may increase the costs of 
legitimate short selling, we believe that the requirements of the 
temporary rule are necessary to achieve our goal of further reducing 
fails to deliver and addressing abusive ``naked'' short selling.

B. Benefits

    The temporary rule will substantially restrict the practice of 
``naked'' short selling in all equity securities by strengthening the 
delivery requirements for such securities. By requiring that 
participants of a registered clearing agency deliver securities by 
settlement date, or if the participants have not delivered shares by 
settlement date, immediately close out the fail to deliver position by 
borrowing or purchasing securities of like kind and quantity, the 
temporary rule also furthers our goals of limiting fails to deliver and 
helping to reduce the possibility that abusive ``naked'' short selling 
may contribute to disruption in the securities markets. This, in turn, 
will help to ensure that investors remain confident that trading can be 
conducted without the influence of illegal manipulation. The temporary 
rule also furthers the goals of helping to maintain fair and orderly 
markets against the threat of sudden and excessive fluctuations of 
securities prices and substantial disruption in the functioning of the 
securities markets. The temporary rule also promotes the prompt and 
accurate clearance and settlement of transactions in equity securities.
    In addition, the temporary rule will help to further reduce the 
number of fails to deliver. These fails may create a misleading 
impression of the market for these securities. Large and persistent 
fails to deliver may have a negative effect on shareholders, 
potentially depriving them of the benefits of ownership, such as voting 
and lending. Thus, by facilitating the prompt receipt of shares, the 
temporary rule will help enable investors to receive the benefits 
associated with share ownership.
    Persistent fails to deliver in a security may also be perceived by 
potential investors negatively and may affect their decision about 
making a capital commitment. Thus, by providing greater assurance that 
securities will be delivered and, thereby, alleviating investor 
apprehension as they make investment decisions, the temporary rule will 
benefit issuers in that an increase in investor confidence in the 
market for their securities will facilitate investment in their 
securities.
1. Close-Out Requirements
    By requiring that participants of a registered clearing agency 
deliver securities by settlement date, or if the participants have not 
delivered shares by settlement date, immediately close out the fail to 
deliver position by borrowing or purchasing securities of like kind and 
quantity, the temporary rule will help restore, maintain, and enhance 
investor confidence in the securities markets. It will also help reduce 
manipulative schemes involving ``naked'' short selling in equity 
securities. Sellers that fail to deliver securities on settlement date 
may enjoy fewer restrictions than if they were required to deliver the 
securities within a reasonable period of time, and such sellers may 
attempt to use this additional freedom to engage in trading activities 
that deliberately depress the price of a security. Thus, the temporary 
rule's close-out requirements are expected to remove a potential means 
of manipulation, thereby decreasing the possibility of artificial 
market influences and contributing to price efficiency.
    Under temporary Rule 204T(a)(1), a participant that has a fail to 
deliver position at a registered clearing agency in an equity security 
and can demonstrate on its books and records that such fail to deliver 
position resulted from a long sale, will have until no later than the 
beginning of regular trading hours on the third consecutive settlement 
day following the settlement date to immediately close out the fail to 
deliver position by purchasing securities of like kind and quantity. 
This provision allows participants an additional two settlement days to 
close out fail to deliver positions that result from long sales, 
provided that the participant's books and records reflect the fact that 
the fail to deliver resulted from a long sale.\134\ We believe this 
exception to temporary Rule 204T(a)'s close-out requirement benefits 
participants because the two additional days to close-out these fail to 
deliver positions may reduce close-out costs for such participants.
---------------------------------------------------------------------------

    \134\ See temporary Rule 204T(a)(1).
---------------------------------------------------------------------------

    The temporary rule also extends temporary Rule 204T(a)'s close-out 
requirement for fails to deliver attributable to bona fide market 
making activities by Market Makers by requiring a participant to close 
out the fail to deliver position attributable to a Market Maker by no 
later than the beginning of regular trading hours on the third 
settlement day after the settlement date. We believe this exception to 
temporary Rule 204T(a)'s close-out requirement benefits participants 
because the two additional days to close-out these fail to deliver 
positions may reduce close-out costs for such participants.
    Similar to Rule 203(b)(3)(vi) of Regulation SHO, temporary Rule 
204(d) allows a participant to reasonably allocate its responsibility 
to close out a fail to deliver position to another broker-dealer for 
which the participant clears trades, or from which it receives trades 
for settlement. This allocation provision benefits participants because 
if a participant can identify the accounts of broker-dealers for which 
they clear or from which they receive trades for settlement, the 
participant can allocate the responsibility to close out the fail to 
deliver position to the particular broker-dealer account(s) whose 
trading activities caused the fail to deliver position provided the 
allocation is reasonable and, therefore, the allocated broker-dealer 
rather than the participant

[[Page 61724]]

will incur any costs associated with the temporary rule's close-out 
requirement.
    In addition, temporary Rule 204T(d) imposes a notification 
requirement on a broker-dealer that has been allocated responsibility 
for complying with the rule's requirements. Thus, under the temporary 
rule's allocation provision, if the broker-dealer does not comply with 
the provisions of temporary Rule 204T(a), it must immediately notify 
the participant that it has become subject to the borrowing 
requirements of temporary Rule 204T(b).\135\ This allocation 
notification requirement is intended to let participants know when a 
broker-dealer from which the participant receives trades for clearance 
and settlement has become subject to the temporary rule's borrowing 
requirements. The notification requirement furthers the Commission's 
goals of limiting fails to deliver and addressing abusive ``naked'' 
short selling by promoting the prompt and accurate clearance and 
settlement of transactions involving equity securities. The 
notification requirement will also help ensure that participants that 
receive trades for clearance and settlement from broker-dealers will be 
on notice that the broker-dealer is subject to the borrow requirements 
of temporary Rule 204T(b) until the fail to deliver position has been 
closed out.
---------------------------------------------------------------------------

    \135\ See temporary Rule 204T(d).
---------------------------------------------------------------------------

    Moreover, under the temporary rule's Pre-Fail Credit provision, a 
broker or dealer may receive credit for purchasing securities prior to 
the beginning of regular trading hours on the Close-Out Date if, among 
other things, the purchase is executed on, or after, trade date but by 
no later than the end of regular trading hours on settlement date and 
the broker or 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 or dealer is claiming credit. The Pre-Fail Credit 
provision is intended to encourage earlier close out of fails to 
deliver in all equity securities and, therefore, to the extent used 
could result in a reduction of persistent fails to deliver.
2. Borrowing Requirements
    The borrowing requirements of temporary Rule 204T(b) are similar to 
the requirements of Rule 203(b)(3)(iv) of Regulation SHO for a 
participant that has not closed out a fail to deliver position in a 
threshold security that has persisted for thirteen consecutive 
settlement days.\136\ Similar to Regulation SHO, the temporary rule is 
aimed in part at addressing potentially abusive ``naked'' short selling 
in equity securities. To that end, we believe it is appropriate to 
include in the temporary rule borrowing requirements for broker-
dealers, including participants, that sell short a security that has a 
fail to deliver position that has not been closed out in accordance 
with the requirements of the temporary rule. We believe that the 
borrowing requirements of temporary Rule 204T(b) will further our goal 
of limiting fails to deliver and addressing abusive ``naked'' short 
selling by promoting the prompt and accurate clearance and settlement 
of transactions in equity securities. By requiring that participants 
and broker-dealers from which they receive trades for clearance and 
settlement borrow or arrange to borrow securities prior to accepting or 
effecting short sales in the security that has a fail to deliver 
position that has not been closed out, the temporary rule will help to 
ensure that shares will be available for delivery on the short sale by 
settlement date and, thereby, help to avoid additional fails to deliver 
occurring in the security.
---------------------------------------------------------------------------

    \136\ See 17 CFR 242.203(b)(3)(iv).
---------------------------------------------------------------------------

    Unlike the current borrow requirements of Rule 203(b)(3)(iv) of 
Regulation SHO, however, the borrow requirements of the temporary rule 
specify that participants must notify all broker-dealers from which 
they receive trades for clearance and settlement that a fail to deliver 
position in an equity security has not been closed out in accordance 
with temporary Rule 204T(a).\137\ This notification requirement in 
temporary Rule 204T(c) is intended to ensure that all broker-dealers 
that submit trades for clearance and settlement to a participant that 
has a fail to deliver position in an equity security that has not been 
closed out in accordance with temporary Rule 204T(a) are on notice that 
all short sales in that security will be subject to the borrowing 
requirements of temporary Rule 204T(b) until the fail to deliver 
position has been closed out.
---------------------------------------------------------------------------

    \137\ See temporary Rule 204T(c).
---------------------------------------------------------------------------

    However, if a participant becomes subject to the borrowing 
requirements of temporary Rule 204T(b) because it did not close out a 
fail to deliver position by no later than the beginning of regular 
trading hours on the settlement date for the transaction, a broker-
dealer that clears through the participant will not also be subject to 
the borrowing requirements of temporary Rule 204T(b) if the broker-
dealer can demonstrate that it was not responsible for any part of the 
fail to deliver position of the participant.\138\ This exception allows 
a broker-dealer to avoid being subject to the borrowing requirements of 
the temporary rule if the broker-dealer can demonstrate that it did not 
incur a fail to deliver position in the security on settlement date.
---------------------------------------------------------------------------

    \138\ See temporary Rule 204T(b)(1).
---------------------------------------------------------------------------

    Moreover, the borrowing requirements of the temporary rule will not 
apply to Market Makers, provided that the Market Maker can show that it 
does not have an open fail to deliver position at the time of any 
additional short sales.\139\ This provision is intended to allow Market 
Makers to facilitate customer orders in a fast moving market without 
possible delays associated with complying with the pre-borrow penalty 
provision of temporary Rule 204T(b).
---------------------------------------------------------------------------

    \139\ See temporary Rule 204T(b)(2).
---------------------------------------------------------------------------

3. Sales of Securities Pursuant to Rule 144
    Securities sold pursuant to Rule 144 of the Securities Act are 
formerly restricted securities that a seller is ``deemed to own,'' as 
defined by Rule 200(a) of Regulation SHO.\140\ The securities, however, 
may not be capable of being delivered on the settlement date due to 
processing delays related to removal of the restricted legend and, 
therefore, sales of these securities frequently result in fails to 
deliver. Consistent with our statements in connection with our recent 
amendments to Regulation SHO in connection with closing out fails to 
deliver in threshold securities sold pursuant to Rule 144,\141\ we 
believe that a close-out requirement of thirty-five consecutive 
settlement days from settlement date for fails to deliver resulting 
from sales of equity securities sold pursuant to Rule 144, will permit 
the orderly settlement of such sales without the risk of causing market 
disruption due to unnecessary purchasing activity (particularly if the 
purchases are for sizable quantities of stock). Because the Rule 144 
security sold will be received as soon as all processing delays have 
been removed, this additional time will allow participants to close out 
fails to deliver resulting from the sale of the security with the 
security sold, rather than having to close out such fail to deliver 
position by purchasing securities in the market. Thus, the amendments 
will

[[Page 61725]]

reduce costs to participants and, in turn, investors.
---------------------------------------------------------------------------

    \140\ See 17 CFR 242.200(a).
    \141\ As mentioned above, we recently adopted amendments to the 
close-out requirement of Regulation SHO to allow fails to deliver 
resulting from sales of threshold securities pursuant to Rule 144 to 
be closed out within 35 rather 13 consecutive settlement days. See 
2007 Regulation SHO Final Amendments, 72 FR at 45550-45551.
---------------------------------------------------------------------------

    Although the temporary rule allows fails to deliver resulting from 
sales of equity securities sold pursuant to Rule 144 of the Securities 
Act thirty-five consecutive settlement days after the settlement date 
before a participant must take action to close out the fail to deliver 
position, these fails to deliver must be closed out by no later than 
the beginning of regular trading hours on the thirty-sixth settlement 
day and, therefore, these fails to deliver cannot continue 
indefinitely. Thus, we believe that the temporary rule is consistent 
with our goal of further reducing fails to deliver in equity 
securities, while balancing the concerns associated with closing out 
fails to deliver resulting from sales of securities pursuant to Rule 
144 of the Securities Act.

C. Costs

    We recognize that the temporary rule may result in increased short 
selling costs for participants that may impact legitimate short selling 
activities; however, we believe such costs will be limited. For 
example, it might result in participants incurring borrowing costs 
where they borrow securities to close out a fail to deliver position 
that might have been closed out soon thereafter with shares received 
from the customer. Such actions might result in added demand in the 
lending market which in turn might exert upward pressure on securities 
lending rates, potentially making short selling more expensive for all 
market participants. For example, it is estimated that about $700 
billion in U.S. equity securities are lent out per year. Preliminary 
input from industry participants suggests that lending rates increased 
significantly after the September Emergency Order for stocks not 
covered by the ban on short selling. While results from the period 
after the September Emergency Order may be confounded by the unusual 
circumstances of the continued credit crisis, an increase of 10 basis 
points in lending rates would result in an annual cost increase to 
securities borrowers of $700 million and the new revenue for securities 
lenders increasing by the corresponding amount of $700 million. 
Therefore, if lending increased by 10 basis points, the annual impact 
on the securities lending market would be about $1,400 million (or 
$1,050 million for nine months).
    To the extent that the requirements of the temporary rule will 
result in increased costs to short selling in equity securities, it may 
lessen some of the benefits of legitimate short selling and, thereby, 
result in a reduction in short selling generally. Such a reduction may 
lead to a decrease in market efficiency and price discovery, less 
protection against upward stock price manipulations, a less efficient 
allocation of capital, an increase in trading costs, and a decrease in 
liquidity. We also recognize that requiring that participants purchase 
securities to close out fails to deliver in equity securities in 
accordance with the temporary rule, may potentially impact the 
willingness of participants to provide liquidity.
    As a likely result of the temporary rule as contained in the 
September Emergency Order, bid-ask spreads on equity securities have 
increased. Preliminary input from industry participants suggests that 
bid-ask spreads have increased after the September Emergency Order for 
stocks not covered by the ban on short selling. While results from the 
period after the September Emergency Order may be confounded by the 
unusual circumstances of the continued credit crisis, an increase of 1 
basis point in bid-ask spreads would result in an annual cost to 
investors of about $6,048 million. To calculate the annual cost, we 
assume that 12 billion shares trade on a daily basis. At an average 
share price of approximately $20, this constitutes $240 billion in 
dollar volume per day. Based on this total, an increase in transaction 
costs of one basis point would result in a daily increase in realized 
transaction costs of approximately $24 million a day. At this rate, 
investors would experience increased total transaction costs of over 
$100 million within the first five trading days of the rule or about 
$6,048 million annually ($24 million times 252 trading days) (or $4,536 
million for nine months).
    We believe, however, that strengthening rules against potentially 
abusive ``naked'' short selling will provide increased confidence in 
the securities markets. Thus, although we recognize that the temporary 
rule may result in increased short selling costs, we believe such costs 
are justified by the fact that the temporary rule may help restore, 
maintain, and enhance investor confidence in the markets by preventing 
potentially abusive ``naked'' short selling.
1. Close-Out Requirements
    We also recognize that requiring that participants purchase 
securities to close-out fails to deliver in any equity security in 
accordance with the temporary rule, may potentially impact the 
willingness of participants to provide liquidity. However, we believe 
that any such potential effect will be minimal because participants 
will still have some flexibility by having two additional settlement 
days in which to purchase securities to close-out their fail to deliver 
positions that either result from long sales or are attributable to 
bona fide market making activities by Market Makers.
    In addition, we recognize that the temporary rule's close-out 
requirement may result in some additional costs for participants of a 
registered clearing agency in terms of systems and surveillance 
modifications, as well as changes to processes and procedures. However, 
we believe any additional costs incurred in implementing temporary Rule 
204T's close-out requirement in terms of these modifications will be 
minimal. The close-out requirement of the temporary rule is consistent 
with the current settlement practices and procedures and with the 
close-out requirement of Regulation SHO. For example, because most 
transactions settle by T+3, participants should already have in place 
policies and procedures to help ensure that delivery is being made by 
settlement date. Nevertheless, participants will incur costs for each 
close-out and these costs could accumulate to significant amounts over 
time and across participants.
    Moreover, similar to the existing close-out requirement of Rule 
203(b)(3) of Regulation SHO, the temporary rule is based on a 
participant's fail to deliver position at a registered clearing agency. 
As noted above, the NSCC clears and settles the majority of equity 
securities trades conducted on the exchanges and in the over-the-
counter markets. The NSCC clears and settles trades through the CNS 
system, which nets the securities delivery and payment obligations of 
all of its members. The NSCC notifies its members of their securities 
delivery and payment obligations daily. Thus, because the temporary 
rule is based on a participant's fail to deliver position at a 
registered clearing agency, it is consistent with current settlement 
practices and procedures and with the Regulation SHO framework 
regarding delivery of securities.\142\ As such, we anticipate that most 
participants will already have systems, processes and procedures in 
place in order to comply with the temporary rule's close-out 
requirements and, therefore, that any additional implementation costs 
associated with the temporary rule will be minimal.
---------------------------------------------------------------------------

    \142\ See 17 CFR 242.203(b)(3).
---------------------------------------------------------------------------

    In addition, to comply with Regulation SHO's close-out requirement

[[Page 61726]]

when it became effective in January 2005, participants needed to modify 
their recordkeeping systems and surveillance mechanisms. Participants 
also should have retained and trained the necessary personnel to ensure 
compliance with the rule's close-out requirements. Thus, most of the 
infrastructure necessary to comply with the temporary rule's close-out 
requirement should already be in place. Thus, we believe that any 
changes to personnel, computer hardware and software, recordkeeping or 
surveillance costs will be minimal.
    We recognize that the requirements of temporary Rule 204T(a)(1) may 
also impose additional costs on participants of a registered clearing 
agency. As discussed above, under temporary Rule 204T(a)(1), a 
participant of a registered clearing agency that has a fail to deliver 
position at a registered clearing agency in an equity security and can 
demonstrate on its books and records that the fail to deliver position 
resulted from a long sale, will have until no later than the beginning 
of regular trading hours on the third consecutive settlement day 
following the settlement date to immediately close out the fail to 
deliver position by purchasing securities of like kind and quantity. 
Thus, to qualify for this additional time to close out a fail to 
deliver position, the temporary rule requires the participant to 
demonstrate on their books and records that the fail to deliver 
position resulted from a long sale.
    This demonstration requirement may result in participants incurring 
costs related to personnel, recordkeeping, systems, and surveillance 
mechanisms. For example, as discussed in detail in section VII above, 
for purposes of the Paperwork Reduction Act, we estimate that it will 
take each participant of a registered clearing agency no more than 
approximately 0.16 hours (10 minutes) to comply with the demonstration 
requirement of the temporary Rule 204T(a)(1). In addition, we estimate 
that the total annual hour burden per year for each participant subject 
to the documentation requirement will be 1,371 hours.
    The allocation notification requirement of temporary Rule 204T(d) 
will impose costs on broker-dealers that have been allocated 
responsibility for the close-out requirement under the temporary rule. 
As discussed above, temporary Rule 204T(d) requires a broker or dealer 
that has been allocated a portion of a fail to deliver position that 
has not complied with the close-out provisions under the temporary rule 
to notify the participant that it has become subject to the borrowing 
requirements of temporary Rule 204T(b). This notification requirement 
may result in broker-dealers incurring costs related to personnel, 
recordkeeping, systems, and surveillance mechanisms. For example, as 
discussed in detail in section VII, above, for purposes of the 
Paperwork Reduction Act, we estimate that it will take each broker-
dealer no more than approximately 0.16 hours (10 minutes) to comply 
with the notification requirements of temporary Rule 204T(d). In 
addition, we estimate that the total annual hour burden per year for 
each broker-dealer subject to the notification requirement will be 71.0 
hours.
    We also recognize that the requirements of temporary Rule 204T(e) 
may impose additional costs on broker-dealers. As discussed above, 
temporary Rule 204T(e) allows a broker-dealer to obtain pre-fail credit 
if it purchases securities in accordance with the conditions specified 
in the temporary rule. To receive pre-fail credit, the temporary rule 
requires, among other things, that a broker-dealer 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 or dealer is claiming 
credit.
    This demonstration requirement may result in participants incurring 
costs related to personnel, recordkeeping, systems, and surveillance 
mechanisms. For example, as discussed in detail in section VII above, 
for purposes of the Paperwork Reduction Act, we estimate that it will 
take each broker-dealer no more than approximately 0.16 hours (10 
minutes) to comply with the demonstration requirements of the temporary 
rule. In addition, we estimate that the total annual hour burden per 
year for each broker-dealer subject to the demonstration requirement 
will be 71.0 hours.
2. Borrowing Requirements
    We believe that temporary Rule 204T's borrow requirements for fail 
to deliver positions that are not closed out in accordance with the 
temporary rule will result in limited, if any, implementation costs to 
participants of a registered clearing agency, and broker-dealers from 
which they receive trades for clearance and settlement. These entities 
must already comply with the borrow requirements of Rule 203(b)(3)(iv) 
of Regulation SHO if a fail to deliver position has not been closed out 
in accordance with Regulation SHO's mandatory close-out requirement. 
Accordingly, these entities should already have in place the personnel, 
recordkeeping, systems, and surveillance mechanisms necessary to comply 
with the temporary rule's borrow requirements. Nevertheless, we 
recognize that each pre-borrow will impose costs on participants, 
broker-dealers, and investors and these costs can accumulate to 
significant amounts if the borrow requirement is imposed often.
    The pre-borrow notification requirement of temporary Rule 204T(c) 
will impose costs on participants of a registered clearing agency. 
Temporary Rule 204T(c) requires a participant to notify any broker or 
dealer from which it receives trades for clearance and settlement, 
including any market maker that would otherwise be entitled to rely on 
the exception provided in Rule 203(b)(2)(iii) of Regulation SHO,\143\ 
(1) that the participant has a fail to deliver position in an equity 
security at a registered clearing agency that has not been closed out 
in accordance with the requirements of temporary Rule 204T(a), and (2) 
when the purchase that the participant has made to close out the fail 
to deliver position has cleared and settled at a registered clearing 
agency.\144\ This notification requirement may result in participants 
incurring costs related to personnel, recordkeeping, systems, and 
surveillance mechanisms. For example, as discussed in detail in section 
VII, above, for purposes of the Paperwork Reduction Act, we estimate 
that it will take each participant of a registered clearing agency no 
more than approximately 0.16 hours (10 minutes) to comply with the pre-
borrow notification requirements of temporary Rule 204T(b). In 
addition, we estimate that the total annual hour burden per year for 
each participant subject to the notification requirement will be 2,016 
hours.
---------------------------------------------------------------------------

    \143\ See 17 CFR 203(b)(2)(iii) (providing for an exception from 
the ``locate'' requirement for market makers engaged in bona fide 
market making in that security at the time of the short sale).
    \144\ See temporary Rule 204T(c).
---------------------------------------------------------------------------

    Moreover, we believe any additional costs incurred in connection 
with the borrowing requirements of temporary Rule 204T(b) will be 
limited by the fact that if a participant becomes subject to the 
borrowing requirements of temporary Rule 204T(b), a broker-dealer that 
clears through the participant will not also be subject to the 
borrowing requirements of temporary Rule 204T(b) if the broker-dealer 
can demonstrate that it was not responsible for any part of the fail to 
deliver position of the participant. This provision allows a broker-
dealer to avoid the costs of being subject to the temporary rule's 
borrowing requirements, provided that the broker-dealer can demonstrate 
that it

[[Page 61727]]

did not incur a fail to deliver position in the security on settlement 
date.
    The certification requirement of temporary Rule 204T(b)(1) may 
impose some costs on broker-dealers having to demonstrate that it was 
not responsible for any part of the fail to deliver position of the 
participant. As discussed above, temporary Rule 204T(b)(1) requires the 
broker-dealer to timely certify to the participant that it has not 
incurred a fail to deliver position on settlement date in an equity 
security for which the participant has a fail to deliver position at a 
registered clearing agency or the broker-dealer is in compliance with 
the requirements set forth in the temporary rule's Pre-Fail Credit 
provision. This certification requirement may result in broker-dealers 
incurring costs related to personnel, recordkeeping, systems, and 
surveillance mechanisms. For example, as discussed in detail in section 
VII, above, for purposes of the Paperwork Reduction Act, we estimate 
that it will take each broker-dealer no more than approximately 0.16 
hours (10 minutes) to comply with the certification requirement of 
temporary Rule 204T(b)(1). In addition, we estimate that the total 
annual hour burden per year for each broker-dealer subject to the 
certification requirement will be 71.0 hours.
    Any potential additional costs associated with the temporary 
borrowing requirements will be limited by the fact that the temporary 
rule's borrowing requirements will not apply to Market Makers, provided 
that the Market Maker can demonstrate that it does not have an open 
fail to deliver position at the time of any additional short sales. 
This allows Market Makers to facilitate customer orders in a fast 
moving market without possible delays and added costs associated with 
complying with the pre-borrow penalty provision of temporary Rule 
204T(b).
    The demonstration requirement of temporary Rule 204T(b)(2) may 
impose costs on Market Makers. This demonstration requirement may 
result in Market Makers incurring costs related to personnel, 
recordkeeping, systems, and surveillance mechanisms. For example, as 
discussed in detail in section VII, above, for purposes of the 
Paperwork Reduction Act, we estimate that it will take each Market 
Maker no more than approximately 0.16 hours (10 minutes) to comply with 
the demonstration requirement of temporary Rule 204T(b)(2). In 
addition, we estimate that the total annual hour burden per year for 
each Market Maker subject to this demonstration requirement will be 
604.8 hours.
3. Sales of Securities Pursuant to Rule 144
    Consistent with our statements in connection with our recent 
amendments to Regulation SHO in connection with closing out fails to 
deliver in threshold securities sold pursuant to Rule 144,\145\ we do 
not believe the temporary rule's close-out requirement will impose any 
significant burden or cost on market participants. We believe that a 
close-out requirement of thirty-five consecutive settlement days from 
settlement date for fails to deliver resulting from sales of equity 
securities sold pursuant to Rule 144 will reduce costs by allowing 
participants of a registered clearing agency with a fail to deliver 
position additional time for delivery of these securities.
---------------------------------------------------------------------------

    \145\ See 2007 Regulation SHO Final Amendments, 72 FR at 45550-
45551.
---------------------------------------------------------------------------

    Participants may incur, however, some added costs for minor changes 
to their current systems to reflect the application of the temporary 
rule's close-out requirement to fails to deliver resulting from sales 
of all equity securities, rather than just threshold securities, sold 
pursuant to Rule 144 of the Securities Act.

D. Request for Comment

    The Commission is sensitive to the costs and benefits of the 
temporary rule, and encourages commenters to discuss any additional 
costs or benefits beyond those discussed herein, as well as any 
reduction in costs. Commenters should provide analysis and data to 
support their views of the costs and benefits associated with the 
temporary rule.
     What, if any, additional benefits are involved in 
complying with the temporary rule? Should the temporary rule be 
modified in any way to increase the benefits of the temporary rule? If 
so, how?
     What, if any, additional costs are involved in complying 
with the temporary rule? What are the types of costs, and what are the 
amounts? Should the temporary rule be modified in any way to mitigate 
costs? If so, how?
     The temporary rule requires that participants of a 
registered clearing agency deliver securities by settlement date, or if 
the participants have not delivered shares by settlement date, borrow 
or purchase securities to close out the fail to deliver position by no 
later than the beginning of regular trading hours on the settlement day 
following the day the participant incurred the fail to deliver 
position. What are the costs and benefits associated with purchasing 
versus borrowing securities to close out a fail to deliver position?
     What impact will the temporary rule have on borrowing 
costs? Please explain. What effect will the temporary rule have on the 
availability of equity securities for lending and borrowing?
     The temporary rule will allow a participant that has a 
fail to deliver position at a registered clearing agency in an equity 
security and can demonstrate that such fail to deliver position 
resulted from a long sale, two additional settlement days in which to 
close out that fail to deliver position by purchasing securities of 
like kind and quantity. What costs and benefits are associated with the 
long sale documentation requirement? Are there any operational or 
compliance concerns associated with this provision of the temporary 
rule?
     The temporary rule will allow a participant of a 
registered clearing agency two additional settlement days to close out 
any fail to deliver positions attributable to a Market Maker. What are 
the costs and benefits of allowing this additional time to close-out 
fails to deliver attributable to Market Makers? Are there any 
operational or compliance concerns associated with this provision of 
the temporary rule?
     Will the temporary rule create any additional 
implementation or operational costs associated with systems (including 
computer hardware and software), surveillance, procedural, 
recordkeeping, or personnel modifications?
     To comply with the temporary rule, will broker-dealers be 
required to purchase new systems or implement changes to existing 
systems? Will changes to existing systems be significant? What are the 
costs and benefits associated with acquiring new systems or making 
changes to existing systems? What, if any, changes will need to be made 
to existing records? What are the costs and benefits associated with 
any changes?
     Will there be any increases in staffing and associated 
overhead costs? What are the costs and benefits associated with hiring 
new staff or retraining existing staff? Will other resources need to be 
re-dedicated to comply with the temporary rule?
     How much, if any, will the temporary rule affect 
compliance costs for small, medium, and large broker-dealers (e.g., 
personnel or system changes)? We seek comment on the costs of 
compliance that may arise.
     We solicit comment on whether the costs will be incurred 
on a one-time or ongoing basis, as well as cost estimates. In addition, 
we seek comment as to

[[Page 61728]]

whether the temporary rule will decrease any costs for any market 
participants. We seek comment about any other costs and cost reductions 
associated with the temporary rule.
     We recognize that the temporary rule may increase the 
costs of legitimate short selling and lessen some of the benefits of 
legitimate short selling, which, in turn, could result in a reduction 
of short selling. To what extent, if any, will the temporary rule 
impact legitimate short selling and market efficiency?
     The temporary rule does not allow any exceptions for fails 
to deliver due to mechanical aspects of corporate events, such as 
equity offers, including initial public offerings, and tender offers. 
Will the temporary rule cause any disruption to these corporate events? 
Can the costs of any disruption be quantified?
     What, if any, additional costs are involved in complying 
with the borrowing requirements under temporary Rule 204T(b)? What are 
the types of costs, and what are the amounts? Should the temporary rule 
be modified in any way to mitigate costs? If so, how? Are there any 
operational or compliance concerns associated with the borrowing 
requirements under temporary Rule 204T(b)?
     The temporary rule will allow a broker-dealer that clears 
through a participant that becomes subject to the borrowing 
requirements of temporary Rule 204T(b) to avoid being subject to the 
temporary rule's borrowing requirements if the broker-dealer can 
demonstrate that it was not responsible for any part of the fail to 
deliver position of the participant. What costs and benefits are 
associated with the certification requirement? Are there any 
operational or compliance concerns associated with this provision of 
the temporary rule?
     Temporary Rule 204T(c) imposes a pre-borrow notification 
requirement on participants. Will such a notification requirement 
impose operational or systems costs on participants? What types of 
communication mechanisms do participants use to comply with this 
requirement of the temporary rule? What are the costs and benefits of 
this notification requirement?
     What, if any, additional costs are associated with 
extending the close-out requirement for Rule 144 securities? What are 
the types of costs, and what are the amounts? Who bears these costs? 
Should the exception be modified in any way to mitigate costs? If so, 
how?
     Please identify any other costs, including reductions in 
costs, associated with sales of Rule 144 restricted securities not 
already discussed.

IX. Consideration of Burden on Competition and Promotion of Efficiency, 
Competition, and Capital Formation

    Section 3(f) of the Exchange Act requires the Commission, whenever 
it engages in rulemaking and whenever it is required to consider or 
determine if an action is necessary or appropriate in the public 
interest, to consider whether the action would promote efficiency, 
competition, and capital formation.\146 \In addition, section 23(a)(2) 
of the Exchange Act requires the Commission, when adopting rules under 
the Exchange Act, to consider the impact such rules would have on 
competition.\147\ Exchange Act section 23(a)(2) prohibits the 
Commission from adopting any rule that would impose a burden on 
competition not necessary or appropriate in furtherance of the purposes 
of the Exchange Act.
---------------------------------------------------------------------------

    \146\ 15 U.S.C. 78c(f).
    \147\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    We believe the temporary rule will have minimal impact on the 
promotion of efficiency. The temporary rule is intended to further 
reduce fails to deliver and address abusive ``naked'' short selling in 
equity securities by requiring that participants of a registered 
clearing agency deliver securities by settlement date, or if the 
participants have not delivered shares by settlement date, the 
participants must, by no later than the beginning of regular trading 
hours on the Close-Out Date, immediately close out the fail to deliver 
position by borrowing or purchasing securities of like kind and 
quantity. A participant that does not comply with this close-out 
requirement, and any broker-dealer from which it receives trades for 
clearance and settlement, will not be able to short sell the security 
either for itself or for the account of another, unless it has first 
arranged to borrow the security, until the fail to deliver position is 
closed out.
    The temporary rule is designed to ensure that buyers of equity 
securities receive delivery of their shares, thereby helping to reduce 
persistent fails to deliver, which may have a negative effect on the 
securities markets and investors and also may be used to facilitate 
some manipulative strategies. By requiring that participants of a 
registered clearing agency deliver securities by settlement date and to 
the extent that participants have not delivered shares by settlement 
date, borrow or purchase securities to close out the fail to deliver 
position by no later than the beginning of regular trading hours on the 
Close-Out Date, the temporary rule will promote the prompt clearance 
and settlement of securities transactions. By doing so, the temporary 
rule will further our goals of helping to eliminate any possibility 
that abusive ``naked'' short selling, as well as persistent fails to 
deliver, will contribute to the disruption of markets in equity 
securities and, thereby, will help ensure that investors remain 
confident that trading can be conducted without the illegal influence 
of manipulation. A loss of confidence in the market for these 
securities can lead to panic selling, which may be further exacerbated 
by potentially abusive ``naked'' short selling. As a result, prices of 
these securities may artificially and unnecessarily decline below the 
price level that would have resulted from the normal price discovery 
process, threatening the disruption of the markets for these 
securities. We seek comment regarding whether the temporary rule may 
adversely impact liquidity, disrupt markets, or unnecessarily increase 
risks or costs to participants of a registered clearing agency.
    In addition, we believe that the temporary rule will have minimal 
impact on the promotion of capital formation. Issuers and investors 
have repeatedly expressed concerns about fails to deliver in connection 
with manipulative ``naked'' short selling.\148\ The perception that 
abusive ``naked'' short selling is occurring in securities could 
undermine the confidence of investors. These investors, in turn, may be 
reluctant to commit capital to an issuer they believe to be subject to 
such manipulative conduct.\149\ To the extent that ``naked'' short 
selling and fails to deliver result in an unwarranted decline in 
investor confidence about a security, the temporary rule will improve 
investor confidence about the security. In addition, the temporary rule 
may lead to a greater certainty in the settlement of these securities 
which should

[[Page 61729]]

strengthen investor confidence in the settlement process.
---------------------------------------------------------------------------

    \148\ See, e.g., 2008 Regulation SHO Final Amendments, supra 
note 19.
    \149\ In connection with prior proposed amendments to Regulation 
SHO aimed at reducing fails to deliver and addressing potentially 
abusive ``naked'' short selling, such as the 2007 Regulation SHO 
Proposed Amendments, we sought comment on whether such proposed 
amendments would promote capital formation, including whether the 
proposed increased short sale restrictions would affect investors' 
decisions to invest in certain equity securities. In response, 
commenters expressed concern about the potential impact of ``naked'' 
short selling on capital formation claiming that ``naked'' short 
selling causes a drop in an issuer's stock price that may limit the 
issuer's ability to access the capital markets. See, e.g., letter 
from Robert K. Lifton, Chairman and CEO, Medis Technologies, Inc., 
dated Sept. 12, 2007; letter from NCANS.
---------------------------------------------------------------------------

    We also believe that the temporary rule will not impose any burden 
on competition not necessary or appropriate in furtherance of the 
purposes of the Exchange Act. By requiring that participants of a 
registered clearing agency deliver securities by settlement date, and 
to the extent that participants have not delivered shares by settlement 
date, borrow or purchase securities to close out the fail to deliver 
position by no later than the beginning of regular trading hours on the 
Close-Out Date, we believe the temporary rule will promote competition 
by requiring similarly situated participants of a registered clearing 
agency, including broker-dealers from which they receive trades for 
clearance and settlement, to close out fail to deliver positions in any 
equity securities within similar time-frames. Moreover, the 
requirements of the temporary rule will help to eliminate any 
possibility that abusive ``naked'' short selling may contribute to the 
disruption of markets in equity securities and, therefore, will help 
ensure that all investors remain confident that trading in these 
securities can be conducted without the influence of illegal 
manipulation. We also believe that the temporary rule will promote 
competition by protecting and enhancing the operation, integrity, and 
stability of the markets. At the same time, the temporary rule will 
help to maintain fair and orderly markets without unduly restricting 
legitimate short selling.
    In addition, by providing a close-out requirement of 35 consecutive 
settlement days from settlement date for fails to deliver resulting 
from sales of equity securities sold pursuant to Rule 144 of the 
Securities Act, we believe the temporary rule will promote competition 
by requiring similarly situated participants to close out fail to 
deliver positions in any equity securities resulting from sales of Rule 
144 securities within the same time-frame.
    Similarly, an extended close-out requirement for fails to deliver 
resulting from long sales that are attributable to a Market Maker, will 
promote competition by requiring similarly situated participants to 
close out these fail to deliver positions within the same time-frame.
    We request comment on whether the temporary rule is likely to 
promote efficiency, capital formation, and competition.

X. Final Regulatory Flexibility Analysis

    The Final Regulatory Flexibility Analysis (``FRFA'') has been 
prepared in accordance with 5 U.S.C. 604. This FRFA relates to the 
amendments that add temporary Rule 204T to Regulation SHO, which we are 
adopting in this release.\150\
---------------------------------------------------------------------------

    \150\ Although the requirements of the Regulatory Flexibility 
Act are not applicable to rules adopted under the Administrative 
Procedure Act's ``good cause'' exception, see 5 U.S.C. 601(2) 
(defining ``rule'' and notice requirements under the Administrative 
Procedures Act), we nevertheless prepared a FRFA.
---------------------------------------------------------------------------

A. Need for and Objectives of the Rule

    Sections I through VI of this release describe the reasons for and 
objectives of temporary Rule 204T. As we discuss in detail above, we 
have become concerned that there is a substantial threat of sudden and 
excessive fluctuations of securities prices and disruption in the 
functioning of the securities markets that could threaten fair and 
orderly markets.

B. Small Entities Affected by the Rule

    The entities covered by the temporary rule will include small 
entities that are participants of a registered clearing agency and 
small broker-dealers from which participants receive trades for 
clearance and settlement. In addition, the entities covered by the 
temporary rule will include small entities that are market participants 
that effect sales subject to the requirements of Regulation SHO. 
Although it is impossible to quantify every type of small entity 
covered by the temporary rule, Paragraph (c)(1) of Rule 0-10 under the 
Exchange Act \151\ states that the term ``small business'' or ``small 
organization,'' when referring to a broker-dealer, means a broker or 
dealer that had total capital (net worth plus subordinated liabilities) 
of less than $500,000 on the date in the prior fiscal year as of which 
its audited financial statements were prepared pursuant to Sec.  
240.17a-5(d); and is not affiliated with any person (other than a 
natural person) that is not a small business or small organization. We 
estimate that as of 2007 there were approximately 896 broker-dealers 
that qualified as small entities as defined above.\152\
---------------------------------------------------------------------------

    \151\ 17 CFR 240.0-10(c)(1).
    \152\ These numbers are based on OEA's review of 2007 FOCUS 
Report filings reflecting registered broker-dealers. This number 
does not include broker-dealers that are delinquent on FOCUS Report 
filings.
---------------------------------------------------------------------------

    As noted above, the entities covered by the temporary rule will 
include small entities that are participants of a registered clearing 
agency. As of July 31, 2008, approximately 91% of participants of the 
NSCC, the primary registered clearing agency responsible for clearing 
U.S. transactions, were registered as broker-dealers. Participants not 
registered as broker-dealers include such entities as banks, U.S.-
registered exchanges, and clearing agencies. Although these entities 
are participants of a registered clearing agency, generally these 
entities do not engage in the types of activities that would implicate 
the close-out requirements of Regulation SHO. Such activities of these 
entities include creating and redeeming Exchange Traded Funds, trading 
in municipal securities, and using NSCC's Envelope Settlement Service 
or Inter-city Envelope Settlement Service. These activities rarely lead 
to fails to deliver and, if fails to deliver do occur, they are small 
in number and are usually cleaned up within a day. Thus, such fails to 
deliver would not trigger the close-out provisions of Regulation SHO.
    The federal securities laws do not define what is a ``small 
business'' or ``small organization'' when referring to a bank. The 
Small Business Administration regulations define ``small entities'' to 
include banks and savings associations with total assets of $165 
million or less.\153\ As of July 31, 2008, no bank that was a 
participant of the NSCC was a small entity because none met these 
criteria.
---------------------------------------------------------------------------

    \153\ See 13 CFR 121.201.
---------------------------------------------------------------------------

    Paragraph (e) of Rule 0-10 under the Exchange Act \154\ states that 
the term ``small business'' or ``small organization,'' when referring 
to an exchange, means any exchange that: (1) Has been exempted from the 
reporting requirements of Rule 11Aa3-1 under the Exchange Act; and (2) 
is not affiliated with any person (other than a natural person) that is 
not a small business or small organization, as defined by Rule 0-10. No 
U.S. registered exchange is a small entity because none meets these 
criteria.
---------------------------------------------------------------------------

    \154\ 17 CFR 240.0-10(e).
---------------------------------------------------------------------------

    Paragraph (d) of Rule 0-10 under the Exchange Act \155\ states that 
the term ``small business'' or ``small organization,'' when referring 
to a clearing agency, means a clearing agency that: (1) Compared, 
cleared and settled less than $500 million in securities transactions 
during the preceding fiscal year (or in the time that it has been in 
business, if shorter); (2) had less than $200 million in funds and 
securities in its custody or control at all times during the preceding 
fiscal year (or in the time that it has been in business, if shorter); 
and (3) is not affiliated with any person (other than a

[[Page 61730]]

natural person) that is not a small business or small organization as 
defined by Rule 0-10. No clearing agency that is subject to the 
requirements of Regulation SHO is a small entity because none meets 
these criteria.
---------------------------------------------------------------------------

    \155\ 17 CFR 240.0-10(d).
---------------------------------------------------------------------------

C. Projected Reporting, Recordkeeping and Other Compliance Requirements

    The temporary rule may impose some new or additional reporting, 
recordkeeping, or compliance costs on small entities that are 
participants of a clearing agency registered with the Commission and 
small broker-dealers from which the participant receives trades for 
clearance and settlement. We do not believe, at this time, that any 
specialized professional skills will be necessary to comply with the 
temporary rule.

D. Agency Action To Minimize Effect on Small Entities

    As required by the Regulatory Flexibility Act, we have considered 
alternatives that would accomplish our stated objectives, while 
minimizing any significant adverse impact on small entities. Temporary 
Rule 204T should not adversely affect small entities because it imposes 
minimal new reporting, recordkeeping, or compliance requirements. 
Moreover, it is not appropriate to develop separate requirements for 
small entities because we think all small entities that are broker-
dealers should be subject to the enhanced delivery requirements imposed 
by the temporary rule.

E. Duplicative, Overlapping, or Conflicting Federal Rules

    The Commission believes that there are no rules that duplicate, 
overlap, or conflict with temporary Rule 204T. The Commission has 
designed the temporary rule so that it is consistent with the close-out 
requirements of Rule 203(b)(3) of Regulation SHO.

F. Significant Alternatives

    The Regulatory Flexibility Act directs us to consider significant 
alternatives that would accomplish our stated objective, while 
minimizing any significant adverse impact on small entities.\156\ In 
connection with the temporary rule, we considered the following 
alternatives: (1) Establishing different compliance or reporting 
standards or timetable that take into account the resources available 
to small entities; (2) clarifying, consolidating, or simplifying 
compliance requirements under the rule for small entities; (3) using 
performance rather than design standards; and (4) exempting small 
entities from coverage of the rule, or any part of the rule.
---------------------------------------------------------------------------

    \156\ See 5 U.S.C. 603(c).
---------------------------------------------------------------------------

    The temporary rule furthers the Commission's stated goal of helping 
to eliminate any possibility that abusive ``naked'' short selling may 
contribute to the substantial disruption in the securities markets and, 
therefore, to help ensure that investors remain confident that trading 
in equity securities can be conducted without the illegal influence of 
manipulation. The temporary rule also furthers the goals of helping to 
maintain fair and orderly markets against the threat of sudden and 
excessive fluctuations of securities prices generally and disruption in 
the functioning of the securities markets.
    The temporary rule should not adversely affect small entities 
because the rule may impose only minimal new compliance requirements. 
Moreover, it is not appropriate to develop different compliance 
requirements for small entities with respect to the temporary rule 
because we think all entities, including small entities, should be 
subject to the requirements of the temporary rule. We believe that 
imposing different compliance requirements, and possibly a different 
timetable for implementing compliance requirements, for small entities 
would undermine the Commission's goal of addressing abusive ``naked'' 
short selling. We have concluded similarly that it is not consistent 
with the goal of the temporary rule to further clarify, consolidate or 
simplify the temporary rule for small entities. The Commission also 
believes that it is inconsistent with the purposes of the Exchange Act 
to use performance standards to specify different requirements for 
small entities or to exempt small entities from having to comply with 
the temporary rule.

G. General Request for Comments

    We solicit written comments regarding our analysis. We request 
comment on whether the temporary rule will have any effects that we 
have not discussed. We request that commenters describe the nature of 
any impact on small entities and provide empirical data to support the 
extent of the impact.

XI. Statutory Authority

    Pursuant to the Exchange Act and, particularly, Sections 2, 3(b), 
6, 9(h), 10, 11A, 15, 15A, 17, 17A, 19 and 23(a) thereof, 15 U.S.C. 
78b, 78c(b), 78f, 78i(h), 78j, 78k-1, 78o, 78o-3, 78q, 78q-1, 78s and 
78w(a), the Commission is adopting, as an interim final temporary rule, 
Rule 204T, amendments to Regulation SHO.

XII. Text of the Amendments to Regulation SHO

List of Subjects in 17 CFR Part 242

    Brokers, Fraud, Reporting and recordkeeping requirements, 
Securities.

0
For the reasons set out in the preamble, Title 17, Chapter II, Part 
242, of the Code of Federal Regulations is amended as follows.

PART 242--REGULATIONS M, SHO, ATS, AC, AND NMS, AND CUSTOMER MARGIN 
REQUIREMENTS FOR SECURITY FUTURES

0
1. The authority citation for part 242 continues to read as follows:

    Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2), 
78i(a), 78j, 78k-1(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g), 
78q(a), 78q(b), 78q(h), 78w(a), 78dd-1, 78mm, 80a-23, 80a-29, and 
80a-37.

0
2. Section 242.204T is added to read as follows:


Sec.  242.204T  Short sales.

    (a) A participant of a registered clearing agency must deliver 
securities to a registered clearing agency for clearance and settlement 
on a long or short sale in any equity security by settlement date, or 
if a participant of a registered clearing agency has a fail to deliver 
position at a registered clearing agency in any equity security for a 
long or short sale transaction in that equity security, the participant 
shall, by no later than the beginning of regular trading hours on the 
settlement day following the settlement date, immediately close out its 
fail to deliver position by borrowing or purchasing securities of like 
kind and quantity; Provided, however:
    (1) If a participant of a registered clearing agency has a fail to 
deliver position at a registered clearing agency in any equity security 
and the participant can demonstrate on its books and records that such 
fail to deliver position resulted from a long sale, the participant 
shall by no later than the beginning of regular trading hours on the 
third consecutive settlement day following the settlement date, 
immediately close out the fail to deliver position by purchasing 
securities of like kind and quantity;
    (2) If a participant of a registered clearing agency has a fail to 
deliver position at a registered clearing agency in any equity security 
sold pursuant to Sec.  230.144 of this chapter for thirty-five 
consecutive settlement days after the settlement date for a sale in 
that equity security, the participant shall, by no later than the 
beginning of regular trading hours on the thirty-sixth

[[Page 61731]]

consecutive settlement day following the settlement date for the 
transaction, immediately close out the fail to deliver position by 
purchasing securities of like kind and quantity; or
    (3) If a participant of a registered clearing agency has a fail to 
deliver position at a registered clearing agency in any equity security 
that is attributable to bona fide market making activities by a 
registered market maker, options market maker, or other market maker 
obligated to quote in the over-the-counter market (individually a 
``Market Maker,'' collectively ``Market Makers''), the participant 
shall by no later than the beginning of regular trading hours on the 
third consecutive settlement day following the settlement date, 
immediately close out the fail to deliver position by purchasing 
securities of like kind and quantity.
    (b) If a participant of a registered clearing agency has a fail to 
deliver position in any equity security at a registered clearing agency 
and does not close out such fail to deliver position in accordance with 
the requirements of paragraph (a) of this section, the participant and 
any broker or dealer from which it receives trades for clearance and 
settlement, including any market maker that would otherwise be entitled 
to rely on the exception provided in Sec.  242.203(b)(2)(iii), may not 
accept a short sale order in the equity security from another person, 
or effect a short sale in the equity security for its own account, to 
the extent that the broker or dealer submits its short sales to that 
participant for clearance and settlement, without first borrowing the 
security, or entering into a bona fide arrangement to borrow the 
security, until the participant closes out the fail to deliver position 
by purchasing securities of like kind and quantity and that purchase 
has cleared and settled at a registered clearing agency; Provided, 
however:
    (1) A broker or dealer shall not be subject to the requirements of 
paragraph (b) of this section if the broker or dealer timely certifies 
to the participant of a registered clearing agency that it has not 
incurred a fail to deliver position on settlement date for a long or 
short sale in an equity security for which the participant has a fail 
to deliver position at a registered clearing agency or that the broker 
or dealer is in compliance with paragraph (e) of this section.
    (2) The requirements of paragraph (b) of this section shall not 
apply to Market Makers provided the Market Maker can demonstrate that 
it does not have an open short position in the equity security at the 
time of any additional short sales.
    (c) The participant must notify any broker or dealer from which it 
receives trades for clearance and settlement, including any market 
maker that would otherwise be entitled to rely on the exception 
provided in Sec.  242.203(b)(2)(iii):
    (1) That the participant has a fail to deliver position in an 
equity security at a registered clearing agency that has not been 
closed out in accordance with the requirements of paragraph (a) of this 
section; and
    (2) When the purchase that the participant has made to close out 
the fail to deliver position has cleared and settled at a registered 
clearing agency.
    (d) If a participant of a registered clearing agency reasonably 
allocates a portion of a fail to deliver position to another registered 
broker or dealer for which it clears trades or from which it receives 
trades for settlement, based on such broker's or dealer's short 
position, the provisions of paragraphs (a) and (b) of this section 
relating to such fail to deliver position shall apply to such 
registered broker or dealer that was allocated the fail to deliver 
position, and not to the participant. A broker or dealer that has been 
allocated a portion of a fail to deliver position that does not comply 
with the provisions of paragraph (a) of this section must immediately 
notify the participant that it has become subject to the requirements 
of paragraph (b) of this section.
    (e) Even if a participant of a registered clearing agency has not 
closed out a fail to deliver position at a registered clearing agency 
in accordance with paragraph (a) of this section, or has not allocated 
a fail to deliver position to a broker or dealer in accordance with 
paragraph (d) of this section, a broker or dealer shall not be subject 
to the requirements of paragraph (a) or (b) of this section if the 
broker or dealer purchases securities prior to the beginning of regular 
trading hours on the settlement day after the settlement date for a 
long or short sale to close out an open short position, and if:
    (1) The purchase is bona fide;
    (2) The purchase is executed on, or after, trade date but by no 
later than the end of regular trading hours on settlement date for the 
transaction;
    (3) The purchase is of a quantity of securities sufficient to cover 
the entire amount of the open short position; and
    (4) The broker or 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 or dealer is seeking to demonstrate 
that it has purchased shares to close out its open short position.
    (f) Definitions. (1) For purposes of this section, the term 
settlement date shall mean the business day on which delivery of a 
security and payment of money is to be made through the facilities of a 
registered clearing agency in connection with the sale of a security.
    (2) For purposes of this section, the term regular trading hours 
has the same meaning as in Rule 600(b)(64) of Regulation NMS (17 CFR 
242.600(b)(64)).
    (g) This temporary section will expire and no longer be effective 
on July 31, 2009.

    By the Commission.

    Dated: October 14, 2008.
Florence E. Harmon,
Acting Secretary.
[FR Doc. E8-24785 Filed 10-16-08; 8:45 am]

BILLING CODE 8011-01-P
