
[Federal Register: April 20, 2009 (Volume 74, Number 74)]
[Proposed Rules]               
[Page 18041-18113]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr20ap09-21]                         


[[Page 18041]]

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Part II





Securities and Exchange Commission





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17 CFR Part 242



Amendments to Regulation SHO; Proposed Rule


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 242

[Release No. 34-59748; File No. S7-08-09]
RIN 3235-AK35

 
Amendments to Regulation SHO

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
proposing amendments to Regulation SHO under the Securities Exchange 
Act of 1934 (``Exchange Act''). We are proposing two approaches to 
restrictions on short selling--one is a price test that would apply on 
a market wide and permanent basis (``short sale price test'' or ``short 
sale price test restriction'') and one that would apply only to a 
particular security during severe market declines in that security 
(``circuit breaker''). With respect to the first approach, we propose 
two alternative short sale price tests: One based on the national best 
bid and the second based on the last sale price. With respect to the 
second approach, we propose two basic alternatives: One alternative is 
a circuit breaker rule that would temporarily prohibit short selling in 
a particular security when there is a severe decline in the price of 
that security (a ``halt''), which could operate in place of, or in 
addition to, a short sale price test rule; and the second alternative 
is a circuit breaker rule that would trigger a short sale price test 
rule; we propose that such a short sale price test either be based on 
the national best bid for any security for which there has been a 
severe price decline or be based on the last sale price for any 
security for which there has been a severe price decline.
    Due to the extreme market conditions that we are currently facing 
and the resulting deterioration in investor confidence, we believe it 
is appropriate at this time to re-evaluate and seek comment on some 
form of short sale price test restriction, either in the form of a 
short sale price test such as the proposed modified uptick rule or 
proposed uptick rule, or a circuit breaker rule.
    For each of the proposed short sale price test restrictions and 
proposed circuit breaker rules, we are also proposing to amend 
Regulation SHO to require that a broker-dealer mark certain sell orders 
``short exempt.'' If the Commission adopts a short sale price test 
proposal or a circuit breaker proposal, and adopts a ``short exempt'' 
marking requirement, we are proposing that the implementation period 
for these amendments would be three months from the effective date of 
the amendments.

DATES: Comments should be received on or before June 19, 2009.

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/proposed.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number S7-08-09 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 Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number S7-08-09. 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). 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 am 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 Brigagliano, Deputy Director; Jo 
Anne Swindler, Acting Associate Director; Josephine Tao, Assistant 
Director; Victoria Crane, Branch Chief; Joan Collopy, Special Counsel; 
Christina Adams, Special Counsel; or Matthew Sparkes, Staff Attorney, 
Division of Trading and Markets, at (202) 551-5720, at the Commission, 
100 F Street, NE., Washington, DC 20549-6628.

SUPPLEMENTARY INFORMATION: The Commission is requesting public comment 
on proposed amendments to Rules 200(g) and 201 of Regulation SHO, 17 
CFR 242.200(g) and 17 CFR 242.201, under the Exchange Act. The 
Commission is soliciting comments on all aspects of the proposed 
amendments.

I. Executive Summary

    In July 2007, the Commission eliminated all short sale price test 
restrictions. At that time, short sale price test restrictions included 
Rule 10a-1 under the Exchange Act, also known as the ``uptick rule'' or 
``tick test'' (``former Rule 10a-1''), that applied to exchange-listed 
securities, and the National Association of Securities Dealers, Inc.'s 
(``NASD'') \1\ bid test, that applied to certain Nasdaq securities. The 
Commission's removal of short sale price test restrictions followed a 
careful, deliberative rulemaking process, carried out in multiple 
stages from 1999 through 2006, and was open to the public at every 
stage.\2\
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    \1\ NASD is now known as the Financial Industry Regulatory 
Authority, Inc. (``FINRA'').
    \2\ In 1999, the Commission published a concept release in which 
it sought comment regarding short sale price test regulation, 
including on whether to eliminate such regulation. See Securities 
Exchange Act Release No. 42037 (Oct. 20, 1999), 64 FR 57996 (Oct. 
28, 1999).
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    Prior to taking that action, the Commission took a number of steps, 
including seeking extensive public comment and staff study to consider 
removing short sale price test restrictions. For example, beginning in 
1999, the Commission published a concept release in which it sought 
comment regarding short sale price test regulation, including on 
whether to eliminate such regulation.\3\ In 2004, the Commission 
initiated a year-long pilot to study the removal of short sale price 
tests for approximately one-third of the largest stocks.\4\ Short sale 
data was made publicly available during this pilot to allow the public 
and Commission staff to study the effects of eliminating short sale 
price test restrictions. The findings of third party researchers were 
presented and discussed in a public Roundtable in September 2006.\5\ In 
addition, the results of the Commission staff study of the pilot data 
were made publicly available in draft form in September 2006 and in 
final form in February 2007.\6\
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    \3\ See Securities Exchange Act Release No. 42037 (Oct. 20, 
1999), 64 FR 57996 (Oct. 28, 1999).
    \4\ See Securities Exchange Act Release No. 50104 (July 28, 
2004), 69 FR 48032 (Aug. 6, 2004) (``Pilot Release'').
    \5\ See http://www.sec.gov/about/economic/
shopilottrans091506.pdf.
    \6\ See http://www.sec.gov/about/economic/shopilot091506/draft_
reg_sho_pilot_report.pdf and http://www.sec.gov/news/studies/
2007/regshopilot020607.pdf. See also discussion of findings of staff 
study, supra notes 25 to 41 and accompanying text.

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[[Page 18043]]

    As discussed in detail below,\7\ concurrent with the development of 
the subprime mortgage crisis and credit crisis in 2007, market 
volatility, including steep price declines, particularly in the stocks 
of certain financial services issuers, has increased markedly in the 
U.S. and in every major stock market around the world (including 
markets that continued to operate under short sale price test 
restrictions). As market conditions have continued to worsen, investor 
confidence has eroded, and the Commission has received requests from 
many commenters to consider imposing restrictions with respect to short 
selling, in part in the belief that such action would help restore 
investor confidence.
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    \7\ See infra Section II(C).
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    Due to the extreme market conditions that we are currently facing 
and the resulting deterioration in investor confidence, we believe it 
is appropriate at this time to re-examine and seek comment on whether 
to restore restrictions with respect to short selling. Thus, we are 
proposing two approaches to restrictions on short selling. One approach 
would apply a price test on a market wide and permanent basis. With 
respect to this approach, we propose two alternative price tests. The 
first alternative price test, in many ways similar to NASD's former bid 
test, would be based on the national best bid (the ``proposed modified 
uptick rule''). The second alternative price test, similar to former 
Rule 10a-1, would be based on the last sale price (the ``proposed 
uptick rule'').\8\
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    \8\ In 2003, the Commission proposed a short sale price test 
based on the national best bid (``uniform bid test''). See 
Securities Exchange Act Release No. 48709 (Oct. 28, 2003), 68 FR 
62972 (Nov. 6, 2003) (``2003 Regulation SHO Proposing Release''). 
The Commission determined not to proceed with the uniform bid test, 
but instead established a pilot program pursuant to which it could 
evaluate the overall effectiveness of short sale price test 
restrictions on short sales. See Securities Exchange Act Release No. 
50103 (July 28, 2004), 69 FR 48008, 48009 (Aug. 6, 2004) (``2004 
Regulation SHO Adopting Release''). See also infra Section II(B) 
(discussing the pilot program).
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    The other approach would apply only to a particular security during 
a severe market decline in that security (collectively, the ``proposed 
circuit breaker rules''). With respect to this second approach, we are 
proposing two basic alternatives. First, we propose a circuit breaker 
rule that, when triggered by a severe price decline in a particular 
security, would temporarily prohibit any person from selling short that 
security, subject to certain exceptions (``proposed circuit breaker 
halt rule''). The proposed circuit breaker halt rule could operate in 
place of, or in addition to, a short sale price test restriction. 
Second, we propose a circuit breaker rule that, when triggered by a 
severe price decline in a particular security, would trigger a 
temporary short sale price test for that security. In connection with 
this approach, we are proposing two price tests. One is the modified 
uptick rule--that is, we propose a circuit breaker rule that would, 
when triggered by a severe decline in a particular security, 
temporarily impose the proposed modified uptick rule for that security 
(``proposed circuit breaker modified uptick rule''). The other is the 
uptick rule--that is, we propose a circuit breaker rule that would, 
when triggered by a severe market decline in a particular security, 
temporarily impose the proposed uptick rule for that security 
(``proposed circuit breaker uptick rule''). A circuit breaker that 
triggers a short sale price test rule such as the proposed modified 
uptick rule or the proposed uptick rule would operate in place of a 
short sale price test rule (collectively, the ``circuit breaker price 
test rules'').
    As discussed in detail below, we preliminarily believe that of the 
short sale price test proposals, a price test based on the national 
best bid would have advantages over a test based on the last sale price 
in today's markets. Among other reasons, we believe that bids generally 
are a more accurate reflection of current prices for a security than 
last sale prices due to delays that can occur in the reporting of last 
sale price information and the manner in which last sale price 
information is published to the markets. For example, sale transactions 
may be reported manually up to 90 seconds after they occur. Even sale 
transactions that are reported automatically can be reported out-of-
sequence if trades are occurring in multiple trading venues. This may 
make the proposed uptick rule more difficult to implement. In addition, 
last sale price information is published to the markets in reporting 
sequence rather than in transaction sequence. Thus, we preliminarily 
believe that if we were to adopt a short sale price test restriction, 
whether as a full-time rule or as part of a circuit breaker rule, that 
it would be more appropriate for such short sale price test 
restrictions to be based on the national best bid rather than on the 
last sale price.
    A short sale price test similar to former Rule 10a-1 that is based 
on the last sale price, a short sale price test based on a national 
best bid, and a circuit breaker rule resulting in a short sale halt, 
should generally be familiar to investors and market participants. 
Former Rule 10a-1 was in place for almost 70 years. NASD adopted its 
bid test in 1994 and that rule was in place for over a decade. Various 
circuit breaker rules have been in place throughout the markets for 
many years.\9\ A circuit breaker rule resulting in a short sale price 
test for particular stocks that have suffered a severe price decline 
would be an amalgamation of these familiar rules.
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    \9\ See, e.g., infra note 239 and accompanying text.
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    To offer straight-forward alternatives, this release proposes a 
modified uptick rule based on the national best bid that would apply to 
trading centers \10\ and applies a policies and procedures approach 
that would require that trading centers have policies and procedures 
reasonably designed to prevent the execution or display of short sales 
at impermissible prices. As an alternative short sale price test, this 
release proposes an uptick rule based on the last sale price that, 
similar to former Rule 10a-1, applies a straight prohibition approach 
that would prohibit any person from effecting short sales at 
impermissible prices. However, either alternative could ultimately be 
implemented through a policies and procedures approach or through a 
prohibition approach or some combination thereof.\11\
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    \10\ A ``trading center'' means a national securities exchange 
or national securities association that operates an SRO trading 
facility, an alternative trading system, an exchange market maker, 
an OTC market maker, or any other broker or dealer that executes 
orders internally by trading as principal or crossing orders as 
agent. See infra note 111 and supporting text.
    \11\ For instance, the approaches could be combined so that 
persons are prohibited from selling short on a downbid and trading 
centers are also required to have reasonable policies and procedures 
to prevent the execution or display of a short sale on a downbid.
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    We are also proposing circuit breaker rules.\12\ As noted above, 
these are the proposed circuit breaker halt rule, the proposed circuit 
breaker modified uptick rule, and the proposed circuit breaker uptick 
rule. In addition, we are proposing that a broker-dealer be required to 
mark a sell order ``short exempt'' if the seller is relying on an 
exemption under the proposed short sale price test rules or proposed 
circuit breaker rules.
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    \12\ See Section III.C below discussing the proposed circuit 
breaker rules.
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II. Background on Short Sale Restrictions

    Short selling involves a sale of a security that the seller does 
not own or a sale that is consummated by the delivery of a security 
borrowed by, or for the account of, the seller.\13\ In order

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to deliver the security to the purchaser, the short seller will borrow 
the security, typically from a broker-dealer or an institutional 
investor. Typically, the short seller later closes out the position by 
purchasing equivalent securities on the open market and returning the 
security to the lender. In general, short selling is used to profit 
from an expected downward price movement, to provide liquidity in 
response to unanticipated demand, or to hedge the risk of an economic 
long position in the same security or in a related security.\14\
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    \13\ See 17 CFR 242.200(a).
    \14\ See, e.g., Securities Exchange Act Release No. 54891 (Dec. 
7, 2006), 71 FR 75068, 75069 (Dec. 13, 2006) (``2006 Price Test 
Elimination Proposing Release''); 2003 Regulation SHO Proposing 
Release, 68 FR at 62974.
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A. Short Selling and Its Market Impact

    The Commission has long held the view that short selling provides 
the market with important benefits, including market liquidity and 
pricing efficiency.\15\ Market liquidity is often provided through 
short selling by market professionals, such as market makers (including 
specialists) and block positioners, who offset temporary imbalances in 
the buying and selling interest for securities. Short sales effected in 
the market add to the selling interest of stock available to purchasers 
and reduce the risk that the price paid by investors is artificially 
high because of a temporary imbalance between buying and selling 
interest. Short sellers covering their sales also may add to the buying 
interest of stock available to sellers.\16\
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    \15\ See id. See also Securities Exchange Act Release No. 29278 
(June 7, 1991), 56 FR 27280 (June 13, 1991); 2004 Regulation SHO 
Adopting Release, 69 FR 48008, n. 6; Boehmer, Ekkehart and Wu, 
Julie, Short Selling and the Informational Efficiency of Prices 
(Jan. 8, 2009).
    \16\ See, e.g., 2006 Price Test Elimination Proposing Release, 
71 FR at 75069; 2003 Regulation SHO Proposing Release, 68 FR at 
62974.
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    Short selling also can contribute to the pricing efficiency of the 
equities markets.\17\ When a short seller speculates or hedges against 
a downward movement in a security, his transaction is a mirror image of 
the person who purchases the security in anticipation that the 
security's price will rise or to hedge against such an increase. Both 
the purchaser and the short seller hope to profit, or hedge against 
loss, by buying the security at one price and selling at a higher 
price. The strategies primarily differ in the sequence of transactions. 
Market participants who believe a stock is overvalued may engage in 
short sales in an attempt to profit from a perceived divergence of 
prices from true economic values. Such short sellers add to stock 
pricing efficiency because their transactions inform the market of 
their evaluation of future stock price performance. This evaluation is 
reflected in the resulting market price of the security.\18\
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    \17\ See id.
    \18\ See id. Arbitrageurs also contribute to pricing efficiency 
by utilizing short sales to profit from price disparities between a 
stock and a derivative security, such as a convertible security or 
an option on that stock. For example, an arbitrageur may purchase a 
convertible security and sell the underlying stock short to profit 
from a current price differential between two economically similar 
positions. See id.
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    We recognize that, to the extent that the proposed short sale price 
test restrictions would result in increased costs to short selling in 
equity securities, it may lessen some of the benefits of legitimate 
short selling. 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. Thus, we 
believe there may be potential costs associated with the proposed short 
sale price tests in terms of potential impact of such price tests on 
quote depths, spread widths, and market liquidity. We also believe 
costs may be incurred in terms of execution and pricing inefficiencies. 
For example, requiring all short sale orders to be executed or 
displayed above the best bid, or last sale price, in a declining market 
may slow the speed of executions and impose additional costs on market 
participants, including buyers. Also, by not allowing short sellers to 
sell at the bid, or last sale price, the proposed short sale price 
tests may impede trading and distort market pricing.
    Although short selling serves useful market purposes, it also may 
be used to illegally manipulate stock prices.\19\ One example is the 
``bear raid'' where an equity security is sold short in an effort to 
drive down the price of the security by creating an imbalance of sell-
side interest.\20\ This unrestricted short selling could exacerbate a 
declining market in a security by increasing pressure from the sell-
side, eliminating bids, and causing a further reduction in the price of 
a security by creating an appearance that the security price is falling 
for fundamental reasons, when the decline, or the speed of the decline, 
is being driven by other factors.\21\
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    \19\ See, e.g., 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); 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).
    \20\ Many people blamed ``bear raids'' for the 1929 stock market 
crash and the market's prolonged inability to recover from the 
crash. See 8 Louis Loss and Joel Seligman, Securities Regulation, 
section 8-B-3 (3d ed. 2006).
    \21\ See 2006 Price Test Elimination Proposing Release, 71 FR at 
75069; 2003 Regulation SHO Proposing Release, 68 FR at 62074.
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B. History of Short Sale Price Test Restrictions in the U.S.

    Section 10(a) of the Exchange Act \22\ gives the Commission plenary 
authority to regulate short sales of securities registered on a 
national securities exchange, as necessary or appropriate in the public 
interest or for the protection of investors.\23\ After conducting an 
inquiry into the effects of concentrated short selling during the 
market break of 1937,\24\ the Commission adopted former Rule 10a-1 
(also known as the ``tick test'' or ``uptick rule'') in 1938 to 
restrict short selling in a declining market.\25\
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    \22\ 15 U.S.C. 78j(a).
    \23\ See also 2006 Price Test Elimination Proposing Release, 71 
FR at 75068; 2003 Regulation SHO Proposing Release, 68 FR at 62973.
    \24\ The study covered two weekly periods, that of September 7-
13, 1937, and that of October 18-23, 1937. See Securities Exchange 
Act Release No. 1548 (Jan. 24, 1938), 3 FR 213 (Jan. 26, 1938) 
(``Former Rule 10a-1 Adopting Release'').
    \25\ See id. Former Rule 10a-1 provided that, subject to certain 
exceptions, a listed security could be sold short (i) at a price 
above the price at which the immediately preceding sale was effected 
(plus tick), or (ii) at the last sale price if it was higher than 
the last different price (zero plus tick).
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    The core provisions of former Rule 10a-1 remained virtually 
unchanged for almost 70 years. Over the years, however, in response to 
changes in the securities markets, including changes in trading 
strategies and systems used in the marketplace, the Commission added 
exceptions to former Rule 10a-1 and granted numerous written requests 
for relief from the rule's restrictions. These market changes included 
decimalization, the increased use of matching systems that execute 
trades at independently derived prices during random times within 
specific time intervals,\26\ and the spread of fully automated markets. 
In addition, market developments over the years led to the application 
of different price tests to securities trading in different 
markets.\27\
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    \26\ See, e.g., Letter from Larry E. Bergmann, Senior Associate 
Director, Division of Market Regulation, SEC, to Andre E. Owens, 
Schiff Hardin & Waite, dated April 23, 2003 (granting exemptive 
relief from former Rule 10a-1 for trades executed through an 
alternative trading system that matches buying and selling interest 
among institutional investors and broker-dealers at various set 
times during the day).
    \27\ See, e.g., Securities Exchange Act Release No. 55245 (Feb. 
5, 2007), 72 FR 6635 (Feb. 12, 2007). Former Rule 10a-1 applied only 
to short sale transactions in exchange-listed securities. In 1994, 
the Commission granted temporary approval to NASD to apply its own 
short sale rule, known as the ``bid test,'' on a pilot basis that 
was renewed annually until the Commission repealed short sale price 
tests. NASD's bid test prohibited short sales in Nasdaq Global 
Market securities (then known as Nasdaq National Market securities) 
at or below the current (inside) bid when the current best (inside) 
bid was below the previous best (inside) bid in a security. As a 
result, until the Commission eliminated former Rule 10a-1, and 
prohibited any self-regulatory organization (``SRO'') from having a 
short sale price test in July 2007, Nasdaq Global Market securities 
traded on Nasdaq or the OTC market and reported to a NASD facility 
were subject to a bid test. Other listed securities traded on an 
exchange, or otherwise, were subject to former Rule 10a-1. Nasdaq 
securities traded on exchanges other than Nasdaq were not subject to 
any price test. In addition, many thinly-traded securities, such as 
Nasdaq Capital Market securities, and securities quoted on the over-
the-counter (``OTC'') Bulletin Board and Pink Sheets, were not 
subject to any price test wherever traded. According to the 
Commission's Office of Economic Analysis (``OEA''), in 2005, prior 
to the start of the Pilot, NASD Rule 3350 applied to approximately 
2,800 securities, while former Rule 10a-1 applied to approximately 
4,000 securities.

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[[Page 18045]]

    In July 2004, the Commission adopted Rule 202T of Regulation 
SHO,\28\ which established procedures for the Commission to temporarily 
suspend short sale price tests for a prescribed set of securities so 
that the Commission could study the effectiveness of these tests.\29\ 
Pursuant to the process established in Rule 202T, the Commission issued 
an order creating a one year pilot (``Pilot'') temporarily suspending 
the tick test of former Rule 10a-1(a) and any price test of any 
exchange or national securities association for short sales of certain 
securities.\30\ The Pilot was designed to assist the Commission in 
assessing whether changes to current short sale price test regulation 
were appropriate at that time in light of then-current market practices 
and the purposes underlying short sale price test regulation.\31\
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    \28\ 17 CFR 242.202T.
    \29\ See 17 CFR 242.202T; see also 2004 Regulation SHO Adopting 
Release, 69 FR at 48012-48013.
    \30\ See Pilot Release, 69 FR 48032 (commencing the Pilot on 
January 3, 2005 and terminating the Pilot on December 31, 2005). On 
November 29, 2004, the Commission issued an order resetting the 
Pilot to commence on May 2, 2005 and end on April 28, 2006 to give 
market participants additional time to make systems changes 
necessary to comply with the Pilot. See Securities Exchange Act 
Release No. 50747 (Nov. 29, 2004), 69 FR 70480 (Dec. 6, 2004). On 
April 20, 2006, the Commission issued an order extending the 
termination date of the Pilot to August 6, 2007. See Securities 
Exchange Act Release No. 53684 (April 20, 2006), 71 FR 24765 (April 
26, 2006).
    \31\ See Pilot Release, 69 FR at 48032. In the 2004 Regulation 
SHO Adopting Release we noted that ``the purpose of the [P]ilot is 
to assist the Commission in considering alternatives, such as: (1) 
Eliminating a Commission-mandated price test for an appropriate 
group of securities, which may be all securities; (2) adopting a 
uniform bid test, and any exceptions, with the possibility of 
extending a uniform bid test to securities for which there is 
currently no price test; or (3) leaving in place the current price 
tests.'' 2004 Regulation SHO Adopting Release, 69 FR at 48010.
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    OEA gathered the data made public during the Pilot, analyzed the 
data and provided the Commission with a summary report on the Pilot 
(``OEA Staff's Summary Pilot Report'').\32\ The OEA Staff's Summary 
Pilot Report, which was made public, examined several aspects of market 
quality including the overall effect of price tests on short selling, 
liquidity, volatility and price efficiency.\33\ The Pilot was also 
designed to allow the Commission and members of the public to examine 
whether the effects of short sale price tests were similar across 
stocks.\34\
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    \32\ See supra note 6.
    \33\ OEA selected the securities to be included in the Pilot by 
sorting the 2004 Russell 3000, first by listing market and then by 
average daily dollar volume from June 2003 through May 2004, and 
then within each listing market, selecting every third company 
starting with the second. Because the selection process relied on 
average daily dollar volume, companies that had their Initial Public 
Offering (``IPO'') in May or June 2004, just prior to the Russell 
reconstitution, were not included. The securities in the control 
group came from the remainder of the 2004 Russell 3000 not included 
in the Pilot (excluding the IPOs in May or June 2004 and any 
securities added to the Russell 3000 after June 2004). See OEA 
Staff's Summary Pilot Report at 22 (discussing the selection of 
securities included in the Pilot and the control group).
    \34\ In the 2004 Regulation SHO Adopting Release, the Commission 
stated its expectation that data on trading during the Pilot would 
be made available to the public to encourage independent researchers 
to study the Pilot. See 2004 Regulation SHO Adopting Release, 69 FR 
at 48009, n.9. Accordingly, nine SROs began publicly releasing 
transactional short selling data on January 3, 2005. The nine SROs 
at that time were the Amex, ARCA, BSE, CHX, NASD, Nasdaq, National 
Stock Exchange, NYSE and Phlx. The SROs agreed to collect and make 
publicly available trading data on each executed short sale 
involving equity securities reported by the SRO to a securities 
information processor. The SROs published the information on a 
monthly basis on their Internet Web sites.
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    As set forth in the OEA Staff's Summary Pilot Report, OEA found 
little empirical justification at that time for maintaining short sale 
price test restrictions, especially for actively traded securities. 
Amongst its results, OEA found that short sale price tests did not have 
a significant impact on daily volatility. However, OEA also found some 
evidence that short sale price tests dampened intraday volatility for 
smaller stocks.\35\
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    \35\ See OEA Staff's Summary Pilot Report, at 55 n. 61-63 and 
supporting text.
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    OEA also found that the Pilot data provided limited evidence that 
price test restrictions distort a security's price.\36\ In addition, 
OEA found that price test restrictions resulted in an increase in quote 
depths.\37\ Realized liquidity levels, however, were unaffected by the 
removal of short sale price test restrictions.\38\ The Pilot data also 
provided evidence that short sale price test restrictions reduce the 
volume of executed short sales to total volume and, therefore, act as a 
constraint on short selling.\39\ OEA did not find, however, a 
significant difference in short interest positions between those 
securities subject to a short sale price test versus those securities 
that were not subject to such a test during the Pilot.\40\
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    \36\ On the day the Pilot went into effect, listed Pilot 
securities underperformed listed control group securities by 
approximately 24 basis points. The Pilot and control group 
securities, however, had similar returns over the first six months 
of the Pilot. See OEA Staff's Summary Pilot Report at 8.
    \37\ See OEA Staff's Summary Pilot Report, at 55 n. 61-63 and 
supporting text.
    \38\ This conclusion is based on the result that changes in 
effective spreads were not economically significant (less than a 
basis point) and that the changes in the bid and ask depth appear 
not to affect the transaction costs paid by investors. Arguably, the 
changes in bid and ask depth appeared to affect the intraday 
volatility. However, OEA concluded that overall, the Pilot data did 
not suggest a deleterious impact on market quality or liquidity. See 
OEA Staff's Summary Pilot Report at 42, 56.
    \39\ See OEA Staff's Summary Pilot Report at 35.
    \40\ See id.
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    In addition, the Commission encouraged outside researchers to 
examine the Pilot data. In response to this request, the Commission 
received four completed studies (the ``Academic Studies'') from outside 
researchers that specifically examined the Pilot data.\41\ The 
Commission also held a public roundtable (the ``Regulation SHO 
Roundtable'') that focused on the empirical evidence learned from the 
Pilot data (the OEA Staff's Summary Pilot Report, Academic Studies, and 
Regulation SHO Roundtable are referred to collectively herein as, the 
``Pilot Results'').\42\ The Pilot Results contained a variety of 
observations, which the Commission considered in determining whether or 
not to propose removal of then-current short sale price test 
restrictions and subsequently whether or not to eliminate such 
restrictions. Generally, the Pilot Results supported removal of short 
sale price test restrictions at that time.\43\ In addition to the Pilot 
Results, thirteen other analyses by SEC staff and various third party

[[Page 18046]]

researchers were conducted between 1963 and 2004 addressing price test 
restrictions.\44\ Among these were several studies that evaluated short 
sale price tests during times of severe market decline, including the 
market break of May 28, 1962, the market decline in September and 
October 1976, the market break of October 19, 1987, and the Nasdaq 
market decline of 2000-2001. The results of these studies were mixed, 
but generally they found that former Rule 10a-1 did not prevent short 
sales in extreme down markets and did limit short selling in up markets 
and provided additional support for the removal of short sale price 
restrictions.
---------------------------------------------------------------------------

    \41\ See Karl B. Diether, Kuan Hui Lee and Ingrid M. Werner, 
2009, It's SHO Time! Short-Sale Price-Tests and Market Quality, 
Journal of Finance 64:37-73; Gordon J. Alexander and Mark A. 
Peterson, 2008, The Effect of Price Tests on Trader Behavior and 
Market Quality: An Analysis of Reg. SHO, Journal of Financial 
Markets 11:84-111; J. Julie Wu, Uptick Rule, short selling and price 
efficiency, August 14, 2006; Lynn Bai, 2008, The Uptick Rule of 
Short Sale Regulation--Can it Alleviate Downward Price Pressure from 
Negative Earnings Shocks? Rutgers Business Law Journal 5:1-63 
(``Bai'').
    \42\ See supra note 5.
    \43\ See 2006 Price Test Elimination Proposing Release, 71 FR at 
75072-75075 (discussing the Pilot Results).
    \44\ See OEA Staff's Summary Pilot Report at 14, 17-22 
(discussing the thirteen studies).
---------------------------------------------------------------------------

    In December 2006, the Commission proposed to eliminate former Rule 
10a-1 by removing restrictions on the execution prices of short sales, 
as well as prohibiting any SRO from having a price test.\45\ The 
Commission received 27 comment letters in response to its proposal to 
eliminate former Rule 10a-1 and prohibit any SRO from having a short 
sale price test. The comments in response to the proposed amendments 
varied. Most commenters (including individual traders, academics, 
broker-dealers, SROs and trade associations) advocated removing all 
price test restrictions.\46\ Generally, these commenters believed that 
price test restrictions were no longer necessary due to increased 
market transparency and the existence of real-time regulatory 
surveillance that could monitor for and detect any potential short sale 
manipulation.\47\
---------------------------------------------------------------------------

    \45\ See 2006 Price Test Elimination Proposing Release, 71 FR 
75068.
    \46\ See, e.g., letter from Howard Teitelman, CSO, Trillium 
Trading (Feb. 6, 2007) (``Teitelman Letter''); letter from S. Kevin 
An, Deputy General Counsel, E*TRADE (Feb. 9, 2007) (``E*TRADE 
Letter''); letter from Carl Giannone (Feb. 11, 2007) (``Giannone 
Letter''); letter from David Schwarz (Feb. 12, 2007) (``Schwarz 
Letter''); letter from John G. Gaine, President, MFA (Feb. 12, 2007) 
(``MFA Letter''); letter from Lisa M. Utasi, Chairman of the Board 
and John C. Giesea, President and CEO, STA (Feb. 12, 2007) (``STA 
Letter''); letter from Gerard S. Citera, Executive Director, U.S. 
Equities, UBS (Feb. 14, 2007) (``UBS Letter''); letter from Mary 
Yeager, Assistant Secretary, NYSE (Feb. 14, 2007) (``NYSE Letter''); 
letter from James J. Angel, Ph.D., CFA, Associate Professor of 
Finance, McDonough School of Business, Georgetown University (Feb. 
14, 2007) (``Angel Letter''); letter from Ira D. Hammerman, SIFMA 
Managing Director and General Counsel (Feb. 16, 2007) (``SIFMA 
Letter''); see also Securities Exchange Act Release No. 55970 (June 
28, 2007), 72 FR 36348, 36350-36351 (July 3, 2007) (``2007 Price 
Test Adopting Release'') (discussing the comment letters).
    \47\ See, e.g., Giannone Letter; E*TRADE Letter; STA Letter; UBS 
Letter; see also Securities Exchange Act Release No. 55970 (June 28, 
2007), 72 FR 36348, 36350-36351 (July 3, 2007) (discussing the 
comment letters).
---------------------------------------------------------------------------

    Two commenters (both individual investors) opposed the proposed 
amendments noting the need for price tests to prevent ``bear raids.'' 
\48\ One commenter, although generally in support of removing all price 
test restrictions, stated the belief that at some level unrestricted 
short selling should be collared.\49\ This commenter supported having a 
10% circuit breaker to prevent panic in the event there is a major 
market collapse.\50\ The NYSE also noted its concern about unrestricted 
short selling during periods of unusually rapid and large market 
declines. The NYSE stated that the effects of an unusually rapid and 
large market decline could not be measured or analyzed during the Pilot 
because such decline did not occur during the period studied.\51\
---------------------------------------------------------------------------

    \48\ See, e.g., letter from Jim Ferguson (Dec. 19, 2006); 
letters from David Patch (Jan. 1, 2007; Jan. 12, 2007) (``Patch 
Letters'').
    \49\ See Giannone Letter.
    \50\ See id.
    \51\ See NYSE Letter.
---------------------------------------------------------------------------

    Effective July 3, 2007, the Commission eliminated former Rule 10a-1 
and added Rule 201 of Regulation SHO prohibiting any SRO from having a 
short sale price test.\52\ The Commission stated that it determined to 
eliminate all short sale price test restrictions after reviewing the 
comments received in response to its proposal to eliminate all short 
sale price test restrictions, the Pilot Results, and taking into 
account the market developments that had occurred in the securities 
industry since the Commission adopted former Rule 10a-1 in 1938.\53\ In 
addition, the Commission stated that it believed that the amendments 
would bring increased uniformity to short sale regulation, level the 
playing field for market participants, and remove an opportunity for 
regulatory arbitrage.\54\
---------------------------------------------------------------------------

    \52\ See 2007 Price Test Adopting Release, 72 FR 36348.
    \53\ See id at 36352.
    \54\ See id.
---------------------------------------------------------------------------

C. Changes in Market Conditions Since Elimination of Rule 10a-1

    Recently, market volatility has increased markedly in the U.S., as 
well as in every major stock market around the world. Although we are 
not aware of specific empirical evidence that the elimination of short 
sale price tests has contributed to the increased volatility in U.S. 
markets, many members of the public currently associate the removal of 
former Rule 10a-1 with the recent volatility, including steep declines 
in some securities' prices, and the loss of investor confidence in our 
markets.
    In addition, we have received numerous requests for reinstatement 
of short sale price test restrictions from a variety of individuals, 
including investors, issuers, academics, trade associations, and 
members of Congress.\55\ Most of these commenters have asked that we 
reinstate short sale price test restrictions because they believe that 
such a measure would help restore investor confidence.\56\
---------------------------------------------------------------------------

    \55\ See, e.g., letter to Mary Schapiro, Chairman, from Rep. 
Barney Frank and other Members of the House Financial Services 
Committee, dated March 11, 2009; letter to Mary Schapiro, Chairman, 
Commission, from Professor Constantine Katsoris (``Katsoris 
letter''), Fordham University School of Law, dated March 4, 2009; 
letter from Albert C. Roelse, dated Feb. 20, 2009; letter from 
Robert A. Lee, dated Feb. 10, 2009; letter from Giulio Liotine, 
dated Jan. 22, 2009 (``Liotine Letter''); letter from Edward L. 
Yingling, American Bankers Association, dated Dec. 16, 2008 
(``American Bankers Assn. 2008 Letter''); letter from Peter Brown, 
dated Dec. 12, 2008 (``Brown Letter''); letter to Christopher Cox, 
Chairman, Commission, from Peter T. King, Member of Congress, dated 
Oct. 7, 2008; letter to Christopher Cox, Chairman, Commission, from 
Bill Sali, Member of Congress, dated Oct. 1, 2008; letter to 
Christopher Cox, Chairman, Commission, from T.J. Rodgers, President 
and CEO, Cypress Semiconductor Corp., dated October 1, 2008; letter 
to Christopher Cox, Chairman, Commission, from Carl H. Tiedmann, 
General Partner, Tiedmann Investment Group, dated Sept. 22, 2008; 
letter to Christopher Cox, Chairman, Commission, from Hillary Rodham 
Clinton, Senator, dated Sept. 17, 2008 (``Clinton Letter''). The 
Commission's Office of Investor Education and Advocacy estimates 
that it has received over 4,000 requests (including duplicate 
requests) from individuals regarding reinstating a short sale price 
test.
    \56\ See, e.g., letter from Chris Baratta, dated March 9, 2009 
(``Baratta Letter''); letter from Paul Kent, dated March 7, 2009; 
letter from Troy Williams, dated March 6, 2009; letter from Briggs 
Diuguid, dated March 5, 2009 (``Diuguid Letter''); letter from Bob 
Young, dated March 5, 2009; letter from Kevin Girard, dated March 4, 
2009; letter from Mike Rogers, dated March 3, 2009; letter from 
George Flagg, dated March 3, 2009; letter from Arleen Golden, dated 
March 2, 2009; letter from Doug Cameron, dated March 2, 2009; letter 
from Dr. Bill Daniel, dated Feb. 26, 2009; letter from Glenn 
Webster, dated Feb. 26, 2009; letter from Robert Lounsbury, dated 
Feb. 25, 2009; letter from Karl Findorff, dated Feb. 19, 2009; 
letter from Robert Levine, dated Feb. 17, 2009; letter from Robert 
Lee, dated Feb. 10, 2009; American Bankers Assn. 2008 letter; letter 
from David Campbell and Natalie Win, dated Nov. 25, 2008; letter 
from Josh Dodson, dated Nov. 21, 2008; letter from J. Geddes 
Parsons, dated Nov. 21, 2008; letter from Charles Rudisill, dated 
Nov. 21, 2008; letter from Mike Ryan, dated Nov. 21, 2008; letter 
from Jeff Brower, dated Nov. 20, 2008; letter from Mike Abraham, 
dated Nov. 20, 2008; letter from Marvin Dingott, dated Nov. 20, 
2008; letter from W. Romain Spell, dated Nov. 19, 2008; letter from 
Phil Mason, dated Nov. 19, 2008; letter from David Sheridan, dated 
Nov. 18, 2008; letter from Lynn Miller, dated Nov. 13, 2008; letter 
from Patrick McQuaid, dated Oct. 29, 2008; letter from Scotland 
Settle, dated Oct. 27, 2008; letter from Jenna Spurrier, dated Oct. 
24, 2008; letter from Joe Garrett, dated Oct. 15, 2008; letter from 
Peter Eckle, dated Oct. 11, 2008; letter from Maureen Christensen, 
dated Oct. 9, 2008; letter from Richard Vulpi, dated Sept. 24, 2008; 
see also Katsoris Letter (stating that elimination of former Rule 
10a-1 ``* * * hardly generates confidence on the part of a true 
investor who is entrusting his or her life's savings * * * to the 
current market'').

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

[[Page 18047]]

    Some of these commenters have stated that a lack of price test 
restrictions makes them question whether they should invest in the 
stock market.\57\ Other commenters have stated that they believe a 
short sale price test would aid small investors.\58\ In addition, some 
commenters have asserted that restricting the prices at which 
securities may be sold short would help address recent steep declines 
in securities' prices. For example, the American Bankers Association 
(the ``ABA'') noted that its members, ``both large and small, are 
telling [the ABA] that short sellers are taking advantage of the uptick 
rule's absence and that their stock prices are experiencing excessive 
downward price pressure * * *.'' \59\ This commenter further noted that 
``its members strongly believe that reinstatement of the uptick rule in 
some format would help limit these downward stock spirals and restore 
investor confidence.'' \60\
---------------------------------------------------------------------------

    \57\ See, e.g., letter from Tim Zanni, dated Feb. 19, 2009; 
letter from Jeff Boyd, dated Feb. 10, 2009.
    \58\ See, e.g., Baratta Letter (noting that while price test 
restrictions could not reasonably be expected to prevent market 
downturns, they would, in his opinion, ``give the little investor a 
chance'' in the current conditions). See also Young Letter 
(suggesting that reinstatement of the uptick rule ``will not be a 
quick or total fix, but it will help''); letter to Mary Schapiro, 
Chairman, Commission, from Paul D. Mendelsohn, President of Windham 
Financial Services, Inc., dated March 6, 2009 (stating that he 
believes former Rule 10a-1 ``protected'' the markets and that 
``suspension of the uptick rule has opened a security hole into our 
financial system'').
    \59\ See American Bankers Assn. 2009 Letter.
    \60\ See id. See also letter to Christopher Cox, Chairman, 
Commission, from Paul Tudor Jones II, Tudor Investment Corporation, 
dated Oct. 10, 2008 (stating that he believes that one way to 
``immediately stem the decline'' in the stock market would be to 
reinstate the uptick rule); letter to Mary Schapiro, Chairman, 
Commission, from James F. Kane, Jr., dated Feb. 6, 2009 (stating 
that he believes that reinstating ``the Up-tick Rule will go a long 
way in preventing speculators from ganging up on a particular stock 
and forcing it down''); Diuguid Letter (stating that while short 
sellers ``make efficient markets,'' he is nonetheless concerned that 
short selling may be a tool of manipulators when short sales are 
``piled on'' a particular company).
---------------------------------------------------------------------------

    In commenting on the recent market volatility and the absence of a 
short sale price test, one member of Congress recently stated that 
``[o]ne of the simplest but most important and effective initiatives 
that the SEC could undertake immediately to combat market volatility is 
the reinstatement of a * * * `uptick rule'.'' \61\ A former U.S. 
Senator urged the Commission to ``* * * give close consideration to the 
many calls for the immediate restoration of the uptick rule whose 
repeal has been linked to the recent market volatility and 
proliferation of abusive short sale transactions.'' \62\ SRO 
representatives and others have also commented on the need for a short 
sale price test.\63\ Researchers have also indicated that they believe 
that they have collected data that establishes a possible association 
between the current market downturn and the elimination of former Rule 
10a-1.\64\ In addition, we note that recently there are reports of 
significant short selling in connection with credit default swaps, 
particularly in the securities of significant financial 
institutions.\65\ One commenter has suggested that the interaction 
between and amplifying effects of credit default swaps and short 
selling may be a reason to reinstate a short sale price test.\66\
---------------------------------------------------------------------------

    \61\ See letter to Mary Schapiro, Chairman, Commission, from 
Gary L. Ackerman, Member of Congress, dated Jan. 27, 2009.
    \62\ See Clinton Letter.
    \63\ See, e.g., Edgar Ortega, Short-Sale Rule Undermined as 
Bernanke Backs Review, Bloomberg News Service, March 4, 2009 (noting 
comments by Duncan Niederauer, CEO, The NYSE/Euronext Group, Inc., 
that imposing a measure such as former Rule 10a-1 ``would go a long 
way to adding confidence'' in our markets); Ben Stein, How to Deal 
with a 3 A.M. Fear, The New York Times, March 8, 2009; Charles R. 
Schwab, Restore the Uptick Rule, Restore Confidence, Wall Street 
Journal Online, December 9, 2008. The Federal Reserve Chairman also 
recently noted that, while the ``traditional literature on this 
doesn't seem to find much effect of the uptick rule,'' short sale 
price test restrictions are ``worth looking at'' and that the rule 
(i.e., former Rule 10a-1) ``might have had some benefit.'' Monetary 
Policy and the State of the Economy: Hearing Before the House 
Financial Services Comm., 111th Cong., 1st Sess. (Lexis Federal News 
Service at 33) (Feb. 25, 2009). See also letter from Duncan 
Niederauer, CEO, The NYSE/Euronext Group, Inc., Robert Greifeld, 
CEO, The NASDAQ OMX Group, Inc., Joe Ratterman, CEO, BATS Exchange, 
Inc., Joseph Rizzello, CEO, National Stock Exchange, dated March 24, 
2009 (``National Exchanges Letter'') (stating that the United States 
national securities exchanges welcome the announcement that the 
Commission will consider a proposal to adopt a rule to combat 
abusive short selling and suggesting that any such rule proposal 
include a circuit breaker in the form discussed therein).
    \64\ See D. Harmon and Y. Bar-Yam, 2008, Technical Report on the 
SEC Uptick Repeal Pilot, New England Complex Systems Institute; see 
also Robert C. Pozen and Dr. Yaneer Bar-Yam, There's a Better Way to 
Prevent Bear Raids, The Wall Street Journal, Opinion, November 18, 
2008 (stating that the ``uptick rule'' is an effective way to 
prevent ``bear raids''). But cf. John C. Bogle, Jr. and Howard 
Flinker, Uptick Rule Won't Prevent More Raids by the Bear, The Wall 
Street Journal, Opinion Section (November 26, 2008).
    \65\ See George Soros, The Game Changer, available at http://
www.ft.com/cms/s/0/49b1654a-ed60-11dd-bd60-0000779fd2ac.html.
    \66\ See id. (concluding that Lehman, AIG and other financial 
institutions were destroyed by ``bear raids'' in which the shorting 
of stocks and buying of CDS amplified and reinforced each other).
---------------------------------------------------------------------------

    Questions and comments have been raised about the role that short 
selling, and in particular potentially abusive short selling, may have 
in connection with the price fluctuations and disruption in our 
markets. As such, recently we took a number of short sale-related 
actions aimed at addressing these concerns. For example, due to our 
concerns that false rumors spread by short sellers regarding financial 
institutions of significance in the U.S. may have fueled market 
volatility in the securities of some of these institutions, on July 15, 
2008, we issued an emergency order (``July Emergency Order'') \67\ 
pursuant to Section 12(k)(2) of the Exchange Act \68\ which imposed 
borrowing and delivery requirements on short sales of the equity 
securities of certain financial institutions. We noted in the July 
Emergency Order that 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 well 
below the price level that would have resulted from the normal price 
discovery process.\69\ If significant financial institutions are 
involved, this chain of events can threaten disruption of our 
markets.\70\
---------------------------------------------------------------------------

    \67\ See Securities Exchange Act Release No. 58166 (July 15, 
2008), 73 FR 42379 (July 21, 2008).
    \68\ 15 U.S.C. 78l(k).
    \69\ See July Emergency Order, 73 FR 42379.
    \70\ See id.
---------------------------------------------------------------------------

    Due to our concerns regarding the impact of short selling on the 
prices of financial institution securities, on September 18, 2008, we 
issued another emergency order prohibiting short selling in the 
publicly traded securities of certain financial institutions.\71\ Our 
concerns, however, have not been limited to financial institutions 
given the importance of confidence in our markets and recent rapid and 
steep declines in the prices of securities generally.\72\ Such rapid 
and steep price declines can give rise to questions about the 
underlying financial condition of an institution, which in turn can 
erode confidence even without an underlying fundamental basis.\73\ This 
erosion of confidence can impair the liquidity and ultimate viability 
of an institution, with potentially broad market consequences.\74\
---------------------------------------------------------------------------

    \71\ See Securities Exchange Act Release No. 58592 (Sept. 18, 
2008), 73 FR 55169 (Sept. 24, 2008).
    \72\ See, e.g., July Emergency Order, 73 FR 42379; Securities 
Exchange Act Release No. 58592 (Sept. 18, 2008), 73 FR 55169 (Sept. 
24, 2008) (``Short Sale Ban Emergency Order''); Securities Exchange 
Act Release No. 58572 (Sept. 17, 2008), 73 FR 54875 (Sept. 23, 2008) 
(``September Emergency Order'').
    \73\ See Short Sale Ban Emergency Order, 73 FR 55169; September 
Emergency Order, 73 FR 54875.
    \74\ See id.
---------------------------------------------------------------------------

    These concerns resulted in our issuance on September 17, 2008 of an 
emergency order under Section 12(k)(2) of the Exchange Act, in part 
targeting

[[Page 18048]]

short selling in all equity securities.\75\ Pursuant to the September 
Emergency Order we imposed enhanced delivery requirements on sales of 
all equity securities under Rule 204T of Regulation SHO.\76\
---------------------------------------------------------------------------

    \75\ See September Emergency Order, 73 FR 54875.
    \76\ See id. We subsequently issued an interim final temporary 
rule imposing the delivery requirements of Rule 204T of Regulation 
SHO until July 31, 2009. See Securities Exchange Act Release No. 
58773 (Oct. 14, 2008), 73 FR 61706 (Oct. 17, 2008) (``Interim Final 
Temporary Rule 204T''). We and Commission staff are currently 
reviewing the comment letters received in response to that rule. In 
addition, we issued an emergency order, and subsequent interim final 
temporary rule, to require disclosure of short sales and short 
positions in certain securities. The temporary rule expires on 
August 1, 2009. We and Commission staff are currently reviewing 
comment letters received in response to the temporary rule. See 
Securities Exchange Act Release No. 58591 (Sept. 18, 2008). See also 
Securities Exchange Act Release No. 58785 (Oct. 15, 2008), 73 FR 
61678 (Oct. 17, 2008).
---------------------------------------------------------------------------

    The enhanced close-out requirements of Rule 204T of Regulation SHO 
in the September Emergency Order, which, among other things, require 
participants of a registered clearing agency to close-out fails to 
deliver resulting from short sales of any equity security by purchasing 
or borrowing the security by no later than the beginning of trading on 
the day after the fail to deliver occurs, appear to be having a 
positive effect toward achieving our goal of reducing fails to 
deliver.\77\ As we stated in the October 2008 release adopting Rule 
204T as an interim final temporary rule, we are concerned about the 
potentially negative market impact of large and persistent fails to 
deliver.\78\ Thus, our adoption of Rule 204T followed a series of other 
steps aimed at reducing such fails to deliver and addressing 
potentially abusive short selling. Such steps included eliminating the 
``grandfather'' and options market maker exceptions to Regulation SHO's 
close-out requirement,\79\ and proposing and subsequently adopting a 
``naked'' short selling anti-fraud rule, Rule 10b-21.\80\ Although we 
recognize that fails to deliver can occur for legitimate reasons, we 
are concerned about the impact of large and persistent fails to deliver 
on market confidence. Preliminary results from OEA indicate that our 
actions to further reduce fails to deliver and, thereby, address 
potentially abusive short selling are having their intended effect. For 
example, preliminary results from OEA indicate that fails to deliver in 
all equity securities have declined significantly since the adoption of 
Rule 204T.\81\
---------------------------------------------------------------------------

    \77\ See September Emergency Order, 73 FR 54875.
    \78\ See Interim Final Temporary Rule 204T, 73 FR at 61708.
    \79\ See Securities Exchange Act Release No. 56212 (Aug. 7, 
2007), 72 FR 45544 (Aug. 14, 2007) (eliminating the ``grandfather'' 
exception to Regulation SHO's close-out requirement); September 
Emergency Order, 73 FR 54875 (eliminating the options market maker 
exception to Regulation SHO's close-out requirement). Following the 
issuance of the September Emergency Order, we adopted amendments 
making permanent the elimination of the options market maker 
exception. See Securities Exchange Act Release No. 58775 (Oct. 14, 
2008), 73 FR 61690 (Oct. 17, 2008).
    \80\ See Securities Exchange Act Release No. 58774 (Oct. 14, 
2008), 73 FR 61666 (Oct. 17, 2008); Securities Exchange Act Release 
No. 57511 (March 17, 2008), 73 FR 15376 (March 21, 2008).
    \81\ See Memorandum from OEA Re: Impact of Recent SHO Rule 
Changes on Fails to Deliver, November 26, 2008 at http://
www.sec.gov/comments/s7-30-08/s73008-37.pdf; Memorandum from OEA Re: 
Impact of Recent SHO Rule Changes on Fails to Deliver, March 20, 
2009 at http://www.sec.gov/comments/s7-30-08/s73008-107.pdf 
(stating, among other things, that the average daily number of 
aggregate fails to deliver for all securities decreased from 1.1 
billion to 582 million for a total decline of 47.2% when comparing a 
pre-Rule to post-Rule period).
---------------------------------------------------------------------------

    Questions persist, however, about the rapid and steep declines in 
the prices of securities, and we recognize the concern over the 
continuing erosion of investor confidence in our markets. Thus, we have 
continued to examine whether there are other actions that the 
Commission might consider, including re-evaluating whether a short sale 
price test ought to be reintroduced or a circuit breaker rule should be 
imposed, in light of the extreme market declines and volatility, as 
well as the loss of investor confidence we continue to experience.
    We also note that when we eliminated all short sale price test 
restrictions in July 2007, we acknowledged that circumstances may 
develop that would warrant relief from the prohibition in Rule 201 of 
Regulation SHO for a short sale price test, including a short sale 
price test of an SRO, to apply to short sales in any security.\82\ 
Thus, in determining whether or not to propose a short sale price test 
rule or circuit breaker rule, we have considered the recent turmoil in 
the financial sector and steep declines and extreme volatility in 
securities prices. The turbulence in the financial markets has been 
underscored over the past 18 months by events such as the March 2008 
sale of Bear Stearns Corporation, and the crisis surrounding the 
collapse of Lehman Brothers in September 2008.
---------------------------------------------------------------------------

    \82\ See 2007 Price Test Adopting Release, 72 FR 36348.
---------------------------------------------------------------------------

    In addition, between July 2007 and March 2009, the Dow Jones 
Industrial Average (``DJIA'') lost roughly 50% of its value, while the 
Standard and Poor's 500 Index fell approximately 54%.\83\ The publicly 
traded securities of significant financial institutions have 
experienced large reductions in value in 2008 and early 2009.\84\ For 
example, one significant financial institution's stock price declined 
from approximately $49 per share in the beginning of July 2007, to 
approximately $1 per share in March 2009. Similarly, in July 2007, 
another significant financial institution's stock price declined from 
approximately $49 per share to approximately $3 per share in March 
2009. In addition, in 2008, a number of major banks became the subjects 
of federal seizure.\85\ A total of 25 banks failed in 2008, resulting 
in a $33.5 billion expenditure of the fund used by the Federal Deposit 
Insurance Corporation (``FDIC'') to protect individual depositors' 
savings.\86\ Put simply, market conditions have changed dramatically in 
recent months.\87\
---------------------------------------------------------------------------

    \83\ On July 3, 2007, the DJIA closed at 13,577, and on March 3, 
2009, the DJIA closed at 6,726. On July 3, 2007, the S&P 500 Index 
closed at 1524.87, and on March 3, 2009, the S&P 500 Index closed at 
700.82.
    \84\ We note that we have no empirical evidence that such 
falling prices are the result of short selling activity and the lack 
of short sale price test restrictions.
    \85\ See, e.g., Office of Thrift Supervision, Receivership Of A 
Federal Saving Association, dated Sept. 25, 2008 at http://
files.ots.treas.gov/680024.pdf; Office of Thrift Supervision, Pass-
Through Receivership Of A Federal Savings Association Into A De Novo 
Federal Savings Association That Is Placed Into Conservatorship With 
the FDIC, dated July 11, 2008 at http://files.ots.treas.gov/
680018.pdf.
    \86\ See Alison Vekshin, Bair Says Insurance Fund Could Be 
Insolvent This Year, http://www.bloomberg.com/apps/
news?pid=washingtonstory&sid=alsJZqIFuN3k, March 4, 2009.
    \87\ We note, however, that stock markets have incurred 
significant declines in value under former short sale price test 
restrictions, most notably the 1987 Market Crash and the 2000 Tech 
Bubble Burst.
---------------------------------------------------------------------------

    In addition, as noted above, in response to the proposed amendments 
to eliminate former Rule 10a-1, one commenter expressed its concern 
about unrestricted short selling during periods of unusually rapid and 
large market declines.\88\ This concern has been echoed in recent 
comment letters to the Commission.\89\ We note, however, that in the 
2007 Price Test Adopting Release, we noted that because of the 
Commission's stated objective when it adopted Rule 10a-1 and our 
concerns about the potential use of short sales to manipulate stock 
prices, OEA examined the Pilot data for any indication that there is an 
association between extreme price movements and price test

[[Page 18049]]

restrictions. OEA, however, did not find any such association.\90\
---------------------------------------------------------------------------

    \88\ See NYSE letter.
    \89\ See, e.g., Brown Letter (noting that ``the investigation 
performed before the uptick rule was rescinded was insufficient, 
particularly [because] it covered a period of relative market 
stability and studied the side effects of the rule rather than the 
primary effect of the rule which would only be seen in a sharply 
down market such as we have just suffered''); Liotine Letter 
(stating that ``[t]he research done prior to the [amendment] of rule 
10-A was far too short'' and that the study should have lasted 
longer to ``ensure at least one bear market was involved in the 
study'').
    \90\ See 2007 Price Test Adopting Release, 72 FR at 36351.
---------------------------------------------------------------------------

    Due to the extreme market conditions with which we are currently 
faced and the resulting deterioration in investor confidence, we 
believe it is appropriate at this time to propose amending Regulation 
SHO to add a short sale price test or a circuit breaker rule. In 
issuing this proposing release, we seek empirical data regarding the 
costs and benefits of reinstating short sale price test restrictions or 
imposing circuit breaker rules, including the potential impact on 
legitimate short selling. We note that although we have received 
numerous letters requesting reinstatement of short sale price test 
restrictions, such requests have not included empirical data, but 
rather focus on what such commenters believe might be the impact on the 
markets of reinstating such restrictions. In addition, such requests do 
not discuss the potential impact of short sale price test restrictions 
on the benefits of legitimate short selling.
    As discussed in this release, we remain mindful that there are 
benefits of short selling. For example, legitimate short selling can 
play an important and constructive functional role in the markets, 
providing liquidity and price efficiency. Short sellers also play an 
important role in correcting upward stock price manipulation.\91\ 
Because short sale price test restrictions may lessen some of these 
benefits, it is important that any short sale price test regulation be 
designed to limit any potentially unnecessary impact on legitimate 
short selling.
---------------------------------------------------------------------------

    \91\ See OEA Staff's Summary Pilot Report, at 9.
---------------------------------------------------------------------------

    We also recognize that some market participants may be advocating 
for a short sale price test because such participants may believe that 
it would put them at a competitive advantage over other participants 
who may be less able to implement or adjust their trading strategies to 
account for a short sale price test or may otherwise benefit at the 
expense of investors. Other market participants may favor a short sale 
price test due to concerns about the imposition of a greater 
restriction on short selling.
    We believe that all arguments, both for and against a short sale 
price test rule and a possible circuit breaker rule, should be 
considered and addressed in light of current market conditions and 
recent experience. Thus, we believe it is important at this time to 
propose and obtain informed public comment regarding restricting the 
prices at which securities can be sold short before determining whether 
or not to impose any such restrictions, and what any such restrictions 
should be, as well as the proposed circuit breaker rules.
    As discussed in detail below, we are proposing two alternative 
price tests. The first test would be the proposed modified uptick rule 
that would be based on the national best bid. The second test would be 
the proposed uptick rule that would be a modified version of the tick 
test under former Rule 10a-1. We are also proposing amendments to Rule 
200(g) of Regulation SHO that would require that a broker-dealer mark 
certain sell orders ``short exempt.''
    In considering whether to reinstitute short sale price test 
restrictions, it is important that the Commission take into account any 
extant empirical data and analyses that would shed light on the 
potential impact of such restrictions on capital markets. In that 
connection, we note that OEA has analyzed the impact that a short sale 
price test might have had during a thirteen day period in September of 
2008 \92\ as well as whether and the extent to which short selling 
drove prices downward during a volatile period in early September 
2008.\93\ The first of these studies noted that, although its data were 
limited to historical trade and quote data from a period when no price 
test was in place and the shape of order book and trading sequences 
might have differed had a price test been in place, a price test would 
likely have been most restrictive during periods of low volatility, 
with greatest impact on short selling in lower priced and more active 
stocks.\94\ The second study found that long sellers were primarily 
responsible for price declines during this period. It also found that, 
on average, short sale volume as a fraction of total volume was highest 
during periods of positive returns, noting, however, that it was also 
possible that there were instances in which short selling activity 
peaked during periods of extreme negative returns.\95\ The Commission 
looks forward to receiving additional analysis of relevant data and 
factors.
---------------------------------------------------------------------------

    \92\ See Office of Economic Analysis, Analysis of a short sale 
price test using intraday quote and trade data, Dec. 17, 2008.
    \93\ See Office of Economic Analysis, Analysis of Short Selling 
Activity during the First Weeks of September, 2008, Dec. 16, 2008.
    \94\ See OEA analysis (Dec. 17, 2008), supra note 92.
    \95\ See OEA analysis (Dec. 16, 2008), supra note 93.
---------------------------------------------------------------------------

    Similarly, it is important that the Commission take into account 
any extant empirical data and analyses that would shed light on the 
potential impact of such restrictions on capital markets, and it looks 
forward to receiving analysis of relevant data.

III. Discussion of Proposed Short Sale Restrictions

    We discuss below our price test approach, the alternatives 
contained therein and our circuit breaker approach. As noted above, we 
preliminarily believe that a price test based on the national best bid 
would have advantages over a test based on the last sale price in 
today's markets. In particular, we believe that bids generally are a 
more accurate reflection of current prices for a security than last 
sale prices due to delays that can occur in the reporting of last sale 
price information and because last sale price information is published 
to the markets in reporting rather than trade sequence.
    In adopting a final rule, we could take several different 
approaches, or a combination of approaches. For example, we could 
consider a straight prohibition approach prohibiting all persons from 
effecting short sales under a price test that references either the 
national best bid or the last sale price; a policies and procedures 
approach imposing obligations on market participants to adopt policies 
and procedures to guard against impermissible short selling; or a 
combination of a straight prohibition and a policies and procedures 
approach.
    We discuss below the proposed modified uptick rule which would 
require trading centers to have policies and procedures reasonably 
designed to prevent the execution or display of short sales at 
impermissible prices. As an alternative, in Section II.B, below, we 
discuss the proposed uptick rule that is based on the last sale price 
and that, similar to former Rule 10a-1, would apply a straight 
prohibition approach that would prohibit any person from effecting 
short sales at impermissible prices. However, either alternative could 
ultimately be implemented through a policies and procedures or through 
a straight prohibition approach or some combination thereof.
    We also discuss below our circuit breaker approach, which includes 
two basic alternatives--a halt and a price test. The proposed circuit 
breaker price test rule would temporarily result in either the proposed 
modified uptick rule or the proposed uptick rule applying to a specific 
security if there was a severe decline in the price of that security. 
As with the proposed short sale price test rules, the proposed circuit 
breaker price test rules could also be in the form of either a straight 
prohibition

[[Page 18050]]

or a policies and procedures approach. The proposed circuit breaker 
halt rule, which would temporarily halt short selling in a specific 
security if there is a severe price decline in that security, could 
operate either in addition to, or in place of, a proposed short sale 
price test rule.

A. Proposed Modified Uptick Rule

1. Operation of the Proposed Modified Uptick Rule
    We are proposing to amend Rule 201 of Regulation SHO to add a short 
sale price test that would use the national best bid as a reference 
point for short sale orders. Specifically, the proposed modified uptick 
rule would provide that ``[a] trading center shall establish, maintain, 
and enforce written policies and procedures reasonably designed to 
prevent the execution or display of a short sale order in a covered 
security at a down-bid price.'' \96\ The proposed modified uptick rule 
defines a ``down-bid price'' as ``a price that is less than the current 
national best bid or, if the last differently priced national best bid 
was greater than the current national best bid, a price that is less 
than or equal to the current national best bid.'' \97\
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    \96\ See Proposed Rule 201(b)(1).
    \97\ Proposed Rule 201(a)(2).
---------------------------------------------------------------------------

    Thus, under the proposed modified uptick rule, a trading center 
would be required to have policies and procedures reasonably designed 
to prevent it from executing or displaying any short sale order, absent 
an exception, at a price that is below the national best bid. If the 
current national best bid is below the last differently priced national 
best bid, a trading center would be required to have policies and 
procedures reasonably designed to prevent it from executing or 
displaying the order unless the order is priced above the current 
national best bid. Such a rule might help prevent short sellers from 
driving the market down. In addition, the proposed modified uptick rule 
might help prevent short sales from being used as a tool to accelerate 
a declining market.
    The following example demonstrates the operation of the proposed 
modified uptick rule. If the current national best bid in a security is 
$47.00, and the immediately preceding national best bid was $46.99 
(i.e., the current bid is above the previous bid), a trading center 
could immediately execute a short sale order at $47.00 or above. 
Similarly, a trading center could display a short sale order priced at 
$47.00 or above.\98\ If the current national best bid in a security is 
$47.00, and the immediately preceding bid was $47.01 (i.e., the current 
bid is below the previous bid), a trading center could execute or 
display a short sale order at a price above $47.00.\99\ If the current 
national best bid in a security is $47.00, and the immediately 
preceding national best bid was $47.00, but that bid was above the 
prior national best bid (i.e., the last differently priced national 
best bid), a trading center could execute a short sale order at $47.00 
or above. Similarly, a trading center could display a short sale order 
priced at $47.00 or above.\100\ If the current national best bid is 
$47.00, and the immediately preceding national best bid was $47.00, but 
that was below the prior national best bid (i.e., the last differently 
priced national best bid), a trading center could execute or display a 
short sale at a price above $47.00.\101\
---------------------------------------------------------------------------

    \98\ A trading center could display a short sale order priced at 
$47.00 provided such order would comply with the locking or crossing 
requirements of any Commission or SRO rule. See, e.g., 17 CFR 
242.610(d).
    \99\ Any such execution or display would also need to be in 
compliance with applicable rules regarding minimum pricing 
increments. See 17 CFR 242.612.
    \100\ A trading center could display a short sale order priced 
at $47.00 provided such order would comply with the locking or 
crossing requirements of any Commission or SRO rule. See, e.g., 17 
CFR 242.610(d).
    \101\ Any such execution or display would also need to be in 
compliance with applicable rules regarding minimum pricing 
increments. See 17 CFR 242.612.
---------------------------------------------------------------------------

    The proposed modified uptick rule would apply to any ``covered 
security,'' which is defined as an ``NMS stock'' under Rule 600(b)(47) 
of Regulation NMS.\102\ Rule 600(b)(47) of Regulation NMS defines an 
``NMS stock'' as ``any NMS security other than an option.'' \103\ Rule 
600(b)(46) of Regulation NMS defines an ``NMS security'' as ``any 
security or class of securities for which transaction reports are 
collected, processed, and made available pursuant to an effective 
transaction reporting plan, or an effective national market system plan 
for reporting transactions in listed options.'' \104\ Thus, the 
proposed modified uptick rule would apply to any security or class of 
securities, except options, for which transaction reports are 
collected, processed, and made available pursuant to an effective 
transaction reporting plan.\105\ As a result, the proposed modified 
uptick rule generally would cover all securities, except options, 
listed on a national securities exchange whether traded on an exchange 
or in the over-the-counter (``OTC'') market. It would not include non-
NMS stocks quoted on the OTC Bulletin Board or elsewhere in the OTC 
market. We are not proposing to apply the proposed modified uptick rule 
to non-NMS stocks quoted on the OTC Bulletin Board or elsewhere in the 
OTC market because a national best bid and offer currently is not 
required to be collected, consolidated, and disseminated for such 
securities. In addition, former Rule 10a-1 did not apply to non-
exchange listed securities quoted on the OTC Bulletin Board or 
elsewhere in the OTC market. We recognize, however, that issuers of 
securities quoted in the OTC market may believe that they are 
particularly vulnerable to abusive short selling. Thus, we seek 
specific comment regarding whether the proposed modified uptick rule or 
some other form of price test, or any other restrictions on short 
sales, should apply to these types of securities.
---------------------------------------------------------------------------

    \102\ See proposed Rule 201(a)(1).
    \103\ 17 CFR 242.600(b)(47).
    \104\ 17 CFR 242.600(b)(46).
    \105\ See proposed Rule 201(a)(1) (providing that a ``covered 
security'' shall mean all ``NMS stock'' as defined in Sec.  
242.600(b)(47) of Regulation NMS).
---------------------------------------------------------------------------

    The scope of securities covered by the proposed modified uptick 
rule would be similar to the scope of securities covered by former Rule 
10a-1. Former Rule 10a-1(a) applied to securities registered on, or 
admitted to unlisted trading privileges on, a national securities 
exchange, if trades of the security were reported pursuant to an 
effective transaction reporting plan and information regarding such 
trades was made available in accordance with such plan on a real-time 
basis to vendors of market transaction information. All securities that 
would have been subject to former Rule 10a-1 would also be subject to 
the proposed modified uptick rule. In addition, certain securities, 
i.e., securities traded on Nasdaq prior to its regulation as an 
exchange, that were not subject to former Rule 10a-1, would be subject 
to the proposed modified uptick rule.\106\
---------------------------------------------------------------------------

    \106\ When Nasdaq became a national securities exchange in 2006, 
absent an exemption from former Rule 10a-1, all Nasdaq securities 
would have been subject to former Rule 10a-1. The Commission 
provided Nasdaq with an exemption from the application of the 
provisions of former Rule 10a-1 to securities traded on Nasdaq 
because the Pilot was already in progress, and the Commission 
believed it was necessary and appropriate to maintain the status quo 
for short sale price tests during the Pilot, and to ensure that 
market participants would not be burdened with costs associated with 
implementing a price test that might be temporary. See letter to 
Marc Menchel, Executive Vice President and General Counsel, NASD, 
Inc., June 26, 2006.
---------------------------------------------------------------------------

    Market information for NMS stocks, including quotes, is 
disseminated pursuant to three different national market system 
plans.\107\ The national

[[Page 18051]]

securities exchanges and FINRA participate in these joint-industry 
plans (``Plans'').\108\ The Plans establish three separate networks to 
disseminate market information for NMS stocks.\109\ These networks are 
designed to ensure that, among other things, consolidated bids from the 
various trading centers that trade NMS stocks are continually collected 
and disseminated on a real-time basis, in a single stream of 
information. Thus, all trading centers would have access to the 
consolidated bids for all the securities that would be subject to the 
proposed modified uptick rule.\110\ As discussed in further detail 
below, however, we note that the national best bid can change rapidly 
and repeatedly and potentially there might be latencies in obtaining 
data regarding the national best bid.
---------------------------------------------------------------------------

    \107\ The three joint-industry plans are (1) the Consolidated 
Tape Association Plan (``CTA Plan''), which disseminates transaction 
information for securities primarily listed on an exchange other 
than Nasdaq, (2) the Consolidated Quotation Plan (``CQ Plan''), 
which disseminates consolidated quotation information for securities 
primarily listed on an exchange other than Nasdaq, and (3) the 
Nasdaq UTP Plan, which disseminates consolidated transaction and 
quotation information for securities primarily listed on Nasdaq.
    \108\ Rule 603(b) of Regulation NMS provides that every national 
securities exchange on which an NMS stock is traded and national 
securities association shall act jointly pursuant to one or more 
effective national market system plans to disseminate consolidated 
information, including a national best bid and national best offer, 
for NMS stocks. See 17 CFR 242.603(b).
    \109\ These networks can be categorized as follows: (1) Network 
A--securities primarily listed on the NYSE; (2) Network B--
securities listed on exchanges other than the NYSE and Nasdaq; and 
(3) Network C--securities primarily listed on Nasdaq.
    \110\ See Securities Exchange Act Release No. 51808 (June 9, 
2005), 70 FR 37496, 37503 (June 29, 2005) (``Regulation NMS Adopting 
Release'').
---------------------------------------------------------------------------

    The proposed modified uptick rule would apply to any trading center 
that executes or displays a short sale order in a covered security. It 
would define a ``trading center'' as ``a national securities exchange 
or national securities association that operates an SRO trading 
facility, an alternative trading system, an exchange market maker, an 
OTC market maker, or any other broker or dealer that executes orders 
internally by trading as principal or crossing orders as agent.'' \111\ 
The proposed definition encompasses all entities that may execute short 
sale orders. Thus, the proposed modified uptick rule would apply to any 
entity that executes short sale orders.
---------------------------------------------------------------------------

    \111\ See 17 CFR 242.600(b)(78); see also proposed Rule 
201(a)(7) (providing that the term ``trading center'' shall have the 
same meaning as in Sec.  242.600(b)(78) of Regulation NMS).
---------------------------------------------------------------------------

    Under the proposed modified uptick rule, a trading center would be 
required to have written policies and procedures reasonably designed to 
prevent the execution or display of short sale orders on a down-bid 
price. Thus, upon receipt of a short sale order, a trading center's 
policies and procedures would have to require that the trading center 
be able to determine whether or not the short sale order could be 
executed or displayed in accordance with the provisions of proposed 
Rule 201(b)(1). If the order is marketable at a permissible price, the 
trading center would be able to present the order for immediate 
execution or, if not immediately marketable, hold for execution later 
at its specified price.
    The proposed modified uptick rule would permit a trading center to 
display an order provided it is permissibly priced at the time the 
trading center displays the order. If an order is impermissibly priced, 
the trading center could, in accordance with policies and procedures 
reasonably designed to prevent the execution or display of a short sale 
order at a down-bid price, re-price the order at the lowest permissible 
price and hold it for later execution at its new price or better.\112\ 
As quoted prices change, the proposed rule would allow a trading center 
to repeatedly re-price and display an order at the lowest permissible 
price down to the order's original limit order price (or, if a market 
order, until the order is filled).
---------------------------------------------------------------------------

    \112\ For example, if a trading center receives a short sale 
order priced at $47.00 when the current national best bid in the 
security is $47.00, but the immediately preceding national best bid 
was $47.01 (i.e., the current bid is below the previous bid), the 
trading center could re-price the order at the permissible offer 
price of $47.01, and display the order for execution at this new 
limit price.
---------------------------------------------------------------------------

    In addition, paragraph (b)(1)(i) of the proposed rule would require 
a trading center's policies and procedures to be reasonably designed to 
permit a trading center to execute a displayed short sale order at a 
down-bid price provided that, at the time the order was displayed by 
the trading center it was permissibly priced, i.e., not on a down-bid 
price.\113\ This exception for properly displayed short sale orders 
would help avoid a conflict between the proposed modified uptick rule 
and the ``Quote Rule'' under Rule 602 of Regulation NMS. The Quote Rule 
requires that, subject to certain exceptions, the broker-dealer 
responsible for communicating a quotation shall be obligated to execute 
any order to buy or sell presented to him, other than an odd lot order, 
at a price at least as favorable to such buyer or seller as the 
responsible broker-dealer's published bid or published offer in any 
amount up to his published quotation size.\114\ Thus, pursuant to this 
exception, a trading center would be able to comply with the ``firm 
quote'' requirement of Rule 602 of Regulation NMS by executing a 
presented order to buy against its displayed offer to sell as long as 
the displayed offer to sell was permissibly priced under the proposed 
rule at the time it was first displayed, even if the execution of the 
transaction would be on a down-bid price at the time of execution.
---------------------------------------------------------------------------

    \113\ See proposed Rule 201(b)(1)(i).
    \114\ See 17 CFR 242.602(b)(2). We note that to the extent that 
a short sale order is undisplayed, the proposed modified uptick rule 
would prevent the trading center from executing the order unless at 
the time of execution, the execution price complies with the 
proposed modified uptick rule at the time of execution of the order.
---------------------------------------------------------------------------

    Because a trading center could re-price and display a previously 
impermissibly priced short sale order the proposed modified uptick rule 
potentially allows for the more efficient functioning of the markets 
than the proposed uptick rule because trading centers would not have to 
reject or cancel impermissibly priced orders unless instructed to do so 
by the trading center's customer submitting the short sale order. We 
recognize that some trading centers might not want to re-price an 
impermissibly priced short sale order. Thus, re-pricing would not be a 
requirement under the proposed modified uptick rule.
    In addition, the proposed modified uptick rule would provide 
trading centers and their customers with flexibility in determining how 
to handle orders that are not immediately executable or displayable by 
the trading center because the order is impermissibly priced. For 
example, trading centers could offer their customers various order 
types regarding the handling of impermissibly priced orders such that a 
trading center either could reject an impermissibly priced order or re-
price the order at the lowest permissible price until the order is 
filled.
    The proposed modified uptick rule would focus on a trading center's 
written policies and procedures as the mechanism through which to 
prevent the execution or display of short sale orders on a down-bid 
price. Under this approach, trading centers would be required to have 
policies and procedures reasonably designed to prevent the execution or 
display of short sale orders at impermissible prices and to surveil the 
effectiveness of the policies and procedures. Thus, short sale orders 
executed or displayed at impermissible prices would require the trading 
center that executed or displayed the short sales to take prompt action 
to remedy any deficiencies.
    We also note that the policies and procedures requirements of the 
proposed modified uptick rule are similar to those set forth under

[[Page 18052]]

Regulation NMS.\115\ In accordance with Regulation NMS, trading centers 
must have in place written policies and procedures in connection with 
that Regulation's order protection rule.\116\ Thus, trading centers are 
already familiar with establishing, maintaining, and enforcing trading-
related policies and procedures, including programming their trading 
systems in accordance with such policies and procedures. This 
familiarity should reduce the implementation costs of the proposed 
modified uptick rule on trading centers.
---------------------------------------------------------------------------

    \115\ See Regulation NMS Adopting Release, 70 FR 37496; see also 
17 CFR 242.611.
    \116\ See id.
---------------------------------------------------------------------------

    Similar to the requirements under Regulation NMS in connection with 
the order protection rule,\117\ at a minimum, a trading center's 
policies and procedures would need to enable a trading center to 
monitor, on a real-time basis, the national best bid, and whether the 
current national best bid is an up- or down-bid from the last 
differently priced national best bid, so as to determine the price at 
which the trading center may execute or display a short sale order. In 
addition, a trading center would need to have policies and procedures 
reasonably designed to permit the execution or display of a short sale 
order of a covered security marked ``short exempt'' without regard to 
whether the order is at a down-bid price.\118\ A trading center's 
policies and procedures would not, however, have to include mechanisms 
to determine on which provision a broker-dealer is relying in marking 
an order ``short exempt'' in accordance with paragraph (c) or (d) of 
the proposed modified uptick rule.\119\
---------------------------------------------------------------------------

    \117\ See id.
    \118\ See Section V below discussing short sale orders marked 
``short exempt.''
    \119\ See proposed Rules 201(c) and 201(d).
---------------------------------------------------------------------------

    A trading center would also need to take such steps as would be 
necessary to enable it to enforce its policies and procedures 
effectively. For example, trading centers could establish policies and 
procedures that could include regular exception reports to evaluate 
their trading practices. If a trading center's policies and procedures 
include exception reports, any such reports would need to be examined 
by the trading center to affirm that a trading center's policies and 
procedures have been followed by its personnel and properly coded into 
its automated systems and, if not, promptly identify the reasons and 
take remedial action.
    To help ensure compliance with the proposed modified uptick rule, 
trading centers could also have policies and procedures that would 
enable a trading center to have a record identifying the current 
national best bid at the time of execution or display of a short sale 
order, as well as the last differently priced national best bid. Such 
``snapshots'' of the market would aid SROs in evaluating a trading 
center's written policies and procedures and compliance with the 
proposed modified uptick rule. In addition, such snapshots would aid 
trading centers in verifying that a short sale order was priced in 
accordance with the provisions of proposed Rule 201(b)(1) if bid 
``flickering,'' i.e., rapid and repeated changes in the current 
national best bid during the period between identification of the 
current national best bid and the execution or display of the short 
sale order, creates confusion regarding whether or not the short sale 
order was executed or displayed at a permissible price. Snapshots of 
the market at the time of execution or display of an order would also 
aid trading centers in dealing with time lags in receiving data 
regarding the national best bid from different data sources. A trading 
center's policies and procedures would be required to address latencies 
in obtaining data regarding the national best bid. In addition, to the 
extent such latencies occur, a trading center's policies and procedures 
would need to implement reasonable steps to monitor such latencies on a 
continuing basis and take appropriate steps to address a problem should 
one develop.
    Trading centers would be required to conduct surveillance under the 
proposed modified uptick rule. Proposed Rule 201(b)(2) provides that a 
trading center must regularly surveil to ascertain the effectiveness of 
the policies and procedures required under the proposed modified uptick 
rule and must take prompt action to remedy deficiencies in such 
policies and procedures.\120\ This provision would reinforce the 
ongoing maintenance and enforcement requirements of proposed Rule 
201(b)(1) by explicitly assigning an affirmative responsibility to 
trading centers to surveil to ascertain the effectiveness of their 
policies and procedures.\121\ Thus, under the proposed modified uptick 
rule, trading centers would not be able to merely establish policies 
and procedures that may be reasonable when created and assume that such 
policies and procedures would continue to satisfy the requirements of 
proposed Rule 201(b). Rather, trading centers would be required to 
regularly assess the continuing effectiveness of their procedures and 
take prompt action when needed to remedy deficiencies. In particular, 
trading centers would need to engage in regular and periodic 
surveillance to determine whether executions or displays of short sale 
orders on impermissible bids are occurring without an applicable 
exception and whether the trading center has failed to implement and 
maintain policies and procedures that would have reasonably prevented 
such impermissible executions or displays of short sale orders.
---------------------------------------------------------------------------

    \120\ See proposed Rule 201(b)(2).
    \121\ We note that Rule 611(a)(2) of Regulation NMS contains a 
similar provision for trading centers. See 17 CFR 242.611(a)(2).
---------------------------------------------------------------------------

    The proposed modified uptick rule would differ from the tick test 
of former Rule 10a-1, and the alternative proposed uptick rule 
discussed below. Similar to former Rule 10a-1, the alternative proposed 
uptick rule would be based on the last sale price, rather than the 
national best bid, and it would not include an explicit policies and 
procedures requirement. The proposed uptick rule would prevent the 
execution of short sale orders below the last sale price, unless an 
exception applies. The proposed modified uptick rule would prevent the 
execution or display of short sale orders below the current national 
best bid, unless, among other things, the order is marked ``short 
exempt.'' Because the proposed modified uptick rule would use the 
national best bid as its reference point, short selling could occur 
below the last sale price.
    The two proposed alternative short sale price tests would operate 
similarly, however, in that they would be designed to achieve a similar 
purpose. In addition, to help limit the impact of the proposed 
alternative short sale price tests on legitimate short selling, both 
rules would permit short selling at an increment above the national 
best bid, or the last sale price, as applicable, in a declining market. 
As commenters have noted, the higher the increment the more restrictive 
such an increment could be on short selling and could even be 
tantamount to a ban on short selling.\122\
---------------------------------------------------------------------------

    \122\ See supra note 94; see also letter from Dan Mathisson, 
Managing Director, Credit Suisse Securities USA, LLC, dated March 
30, 2009 (``letter from Credit Suisse'') (stating that ``requiring 
an uptick of more than one cent would be tantamount to a total ban 
for any stock that trades actively'').
---------------------------------------------------------------------------

    In addition, the proposed modified uptick rule, similar to the 
proposed uptick rule, would not result in the type of disparate short 
sale regulation that existed under former Rule 10a-1.\123\ The proposed 
modified uptick rule would apply a uniform rule to trades in the same 
securities that can occur in

[[Page 18053]]

multiple, dispersed, and diverse markets. One of the reasons for the 
elimination of former Rule 10a-1 and the prohibition on any SRO from 
having a short sale price test in July 2007 was because the application 
of short sale price tests had become disjointed with different price 
tests applying to the same securities trading in different markets. 
Under the proposed modified uptick rule, all covered securities, 
wherever traded, would be subject to one short sale price test, the 
proposed modified uptick rule. To further this goal of having a uniform 
short sale price test, subsection (e) of proposed Rule 201 would 
provide that no SRO shall have any rule that is not in conformity with, 
or conflicts with proposed Rule 201.\124\ In addition, just as market 
participants would be familiar with the proposed uptick rule because it 
is a modified version of former Rule 10a-1 that was in existence for 
almost 70 years, market participants would also be familiar with using 
the current national best bid as a reference point because NASD's bid 
test, which was in existence from 1994 to mid-2007, was based on the 
current national best bid.\125\
---------------------------------------------------------------------------

    \123\ See proposed Rule 201(e).
    \124\ See proposed Rule 201(e).
    \125\ See supra note 27 (discussing NASD Rule 3350). Similar to 
the proposed modified uptick rule, NASD's bid test referenced the 
national best bid and was designed to help prevent short selling at 
or below the current national best bid in a declining market. NASD's 
bid test, however, took a straight prohibition approach, rather than 
a policies and procedures approach, and, by its terms, applied only 
to Nasdaq Global Market securities.
---------------------------------------------------------------------------

    We preliminarily believe that a short sale price test based on the 
national best bid would be more suitable to today's markets than a 
short sale price test based on the last sale price. Although we 
recognize that a quotation proposes a transaction, whereas the last 
trade price reflects an actual trade, we note that pursuant to 
Commission and SRO rules, quotations for all covered securities must be 
firm.\126\ By requiring that quotations are firm, the Commission 
intended to ensure that quotations provide reliable information to the 
marketplace so that broker-dealers are able to make best execution 
decisions for their customers' orders and customers are able to make 
informed investment decisions.\127\ Moreover, quotation information has 
significant value to the marketplace because it reflects the various 
factors affecting the market, including current levels of buying and 
selling interest.\128\ Both retail and institutional investors rely on 
quotation information to understand the market forces at work at a 
given time and to assist in the formulation of investment 
strategies.\129\
---------------------------------------------------------------------------

    \126\ See e.g., 17 CFR 242.602.
    \127\ See Securities Exchange Act Release No. 43085 (July 28, 
2000), 65 FR 47918 (Aug. 4, 2000).
    \128\ See id.
    \129\ See id.
---------------------------------------------------------------------------

    Further, we believe that bids generally are a more accurate 
reflection of current prices for a security because changes in the 
national best bid are sequenced across trading centers. In contrast, 
transactions may be reported within a 90 second window, which can 
easily result in out-of-sequence reports. Even transactions that are 
executed and reported automatically may be out of sequence if they 
occur in different trading centers. For example, trade reporting for 
covered securities can involve multiple trading centers reporting 
trades in the same stock from different locations using different means 
of reporting. In addition, trades are published in reporting sequence, 
not trade sequence.\130\ Thus, for those covered securities for which a 
significant amount of trading occurs manually, or in multiple trading 
centers, a price test based on the national best bid may be a fairer 
and more effective means of regulating short selling than a test based 
on the last sale price because the manner in which trades are reported 
may create up-ticks and down-ticks that may not accurately reflect 
actual price movements in the security for the purpose of a test based 
on the last sale price.
---------------------------------------------------------------------------

    \130\ See FINRA Rule 6380A.
---------------------------------------------------------------------------

    The proposed modified uptick rule would be designed to restrict 
short selling at successively lower prices and, thereby, might help 
prevent short selling, including potentially abusive or manipulative 
short selling, from being used as a tool to drive the markets down and 
from being used to accelerate a decline in the market by exhausting all 
remaining bids at one price level. By seeking to advance these goals, 
the proposed modified uptick rule might restore investor confidence in 
our securities markets.
    In addition, the proposed modified uptick rule would be designed to 
preserve instant execution and liquidity by allowing relatively 
unrestricted short selling in an advancing market. As discussed above, 
one of the benefits of legitimate short selling is that it provides 
market liquidity by, for example, adding to the selling interest of 
stock available to purchasers, and, when sellers are covering their 
short sales, adding to the buying interest of stock available to 
sellers.
    In addition, we believe the proposed modified uptick rule would 
accommodate trading systems and strategies used in the marketplace 
today, such as the automated trade matching systems that offer price 
improvement based on the national best bid and offer. These passive 
pricing systems often effect trades at an independently-derived price, 
such as at the mid-point of the bid-offer spread. Such pricing would 
often not satisfy the tick test of former Rule 10a-1 because matches 
could potentially occur at a price below the last reported sale price. 
Thus, we provided a limited exception from former Rule 10a-1 for these 
trading systems.\131\ The proposed modified uptick rule would 
accommodate matching systems that execute trades at an independently 
derived price because such systems are designed so that matches occur 
above the current national best bid.\132\ Thus, even in a declining 
market where a trading center could execute or display an order only if 
it is priced above the current national best bid at the time of 
execution or display, such matching system executions would comply with 
the proposed modified uptick rule.
---------------------------------------------------------------------------

    \131\ See, e.g., supra note 26.
    \132\ See id.; see e.g., letter from James A. Brigagliano, 
Acting Associate Director, Division of Market Regulation, to Alan J. 
Reed, Jr., First Vice President and Director of Compliance, Instinet 
Group, LLC. (June 15, 2006) (granting Instinet modified exemptive 
relief from Rule 10a-1 for certain transactions executed through 
Instinet's Intraday Crossing System); POSIT letter.
---------------------------------------------------------------------------

    If we were to adopt the proposed modified uptick rule, we are 
proposing that there would be a three month implementation period such 
that trading centers would have to comply with the proposed modified 
uptick rule three months following the effective date of the proposed 
modified uptick rule. We believe that a proposed three month 
implementation period would provide trading centers with sufficient 
time in which to modify their systems and procedures in order to comply 
with the requirements of the proposed modified uptick rule. Because the 
proposed modified uptick rule would require the implementation of 
policies and procedures similar to those required for trading centers 
under Regulation NMS, we believe that a three month implementation 
period would be reasonable. The addition of an implementation period 
should alleviate any potential disruptive effects of the proposal.
    We realize, however, that a shorter or longer implementation period 
may be manageable or preferable. In the Solicitation of Comment below, 
we seek specific comment as to what length of implementation period 
would be necessary or appropriate, and why, such that trading centers 
would be able to

[[Page 18054]]

meet the proposed short sale price test restrictions, if adopted.
2. ``Short Exempt'' Provision of Proposed Modified Uptick Rule
    Paragraph (b)(1)(ii) of the proposed modified uptick rule provides 
that a trading center's policies and procedures must be reasonably 
designed to permit the execution or display of a short sale order of a 
covered security marked ``short exempt'' without regard to whether the 
order is at a down-bid price.\133\ Thus, a trading center's policies 
and procedures must be reasonably designed to recognize when an order 
is marked ``short exempt'' so that the trading center's policies and 
procedures would not prevent the execution or display of such orders on 
a down-bid price.\134\
---------------------------------------------------------------------------

    \133\ See proposed Rule 201(b)(1)(ii).
    \134\ See proposed Rule 201(b)(1)(ii).
---------------------------------------------------------------------------

    As discussed in more detail below, proposed Rule 200(g)(2) of 
Regulation SHO provides that a sale order shall be marked ``short 
exempt'' only if the provisions of paragraph (c) or (d) of proposed 
Rule 201 are met.\135\ Paragraphs (c) and (d) of the proposed modified 
uptick rule set forth when a broker-dealer may mark a short sale order 
``short exempt.'' The provisions contained in paragraphs (c) and (d) of 
the proposed modified uptick rule are designed to promote the 
workability of the proposed modified uptick rule, while at the same 
time furthering the Commission's stated goals.
---------------------------------------------------------------------------

    \135\ See Section V below discussing proposed Rule 200(g)(2).
---------------------------------------------------------------------------

    In addition, we note that the provisions contained in paragraph (d) 
of proposed Rule 201 would parallel exceptions to former Rule 10a-1 and 
exemptive relief granted pursuant to that rule. These exceptions and 
exemptions from former Rule 10a-1, as applicable, had been in place 
under former Rule 10a-1 for several years. We are not aware of any 
reason that the rationales underlying these exceptions and exemptions 
from former Rule 10a-1 would not still hold true today. Moreover, due 
to the limited scope of these exceptions and exemptions to former Rule 
10a-1, we do not believe that including provisions that would parallel 
these exceptions and exemptions to former Rule 10a-1 would undermine 
the Commission's stated goals for proposing short sale price test 
restrictions.
    Thus, the provisions in proposed Rule 201(d) parallel exceptions to 
and exemptive relief granted under former Rule 10a-1, as 
applicable.\136\ As set forth in more detail below, however, we seek 
comment regarding each of these provisions, including whether or not 
these provisions would be appropriate or necessary under the proposed 
modified uptick rule.
---------------------------------------------------------------------------

    \136\ We note that NASD Rule 3350 contained exceptions to that 
rule similar to exceptions to former Rule 10a-1. In addition, we 
note NASD Rule 3350 included an exception related to bona fide 
market making activity. See infra note 190 and accompanying text 
(discussing our decision not to propose that a broker-dealer may 
mark an order ``short exempt'' in connection with bona fide market 
making activity). See also supra note 125.
---------------------------------------------------------------------------

a. Broker-Dealer Provision
    Proposed Rule 201(c) provides that a broker-dealer may mark a short 
sale order of a covered security ``short exempt'' if a broker-dealer 
that submits a short sale order to a trading center identifies that the 
short sale order is not on a down-bid price at the time of submission 
of the order to the trading center.\137\ The proposed rule would 
require any broker-dealer relying on this provision to establish, 
maintain, and enforce written policies and procedures that are 
reasonably designed to prevent the incorrect identification of orders 
as being priced in accordance with the requirements of proposed Rule 
201(c)(1).\138\
---------------------------------------------------------------------------

    \137\ See proposed Rule 201(c)(1).
    \138\ See proposed Rule 201(c)(1).
---------------------------------------------------------------------------

    We are proposing this provision to provide broker-dealers with the 
option to manage their order flow, rather than having to always rely on 
their trading centers to manage their order flow on their behalf. In 
addition, we note that this provision would not undermine the 
Commission's goals for short sale regulation because any broker-dealer 
marking an order ``short exempt'' in accordance with this provision 
would have to address whether its short sale order was not on a down-
bid price at the time of submission of the order to a trading center.
    As discussed in more detail below, we are proposing amendments to 
Rule 200(g) of Regulation SHO to require, in part, that a sale order 
shall be marked ``short exempt'' only if the provisions of paragraph 
(c) of proposed Rule 201 of the proposed modified uptick rule are 
met.\139\
---------------------------------------------------------------------------

    \139\ See proposed Rule 200(g)(2).
---------------------------------------------------------------------------

    To mark an order ``short exempt'' pursuant to paragraph (c) of the 
proposed modified uptick rule, the broker-dealer must have mechanisms 
in place to enable the broker-dealer to identify the short sale order 
as priced in accordance with the provisions of proposed Rule 201(c)(1). 
In accordance with proposed Rule 201(c)(1), these mechanisms must 
include written policies and procedures reasonably designed to prevent 
the incorrect identification of orders as being permissibly priced in 
accordance with the provisions of proposed Rule 201(c)(1).\140\ Thus, 
although a broker-dealer relying on this provision in marking an order 
``short exempt'' would not need to identify the order as permissibly 
priced to the trading center, it would need to have written policies 
and procedures in place reasonably designed to enable it to identify 
that an order was permissibly priced at the time of submission of the 
order to a trading center.\141\
---------------------------------------------------------------------------

    \140\ See proposed Rule 201(c)(1).
    \141\ Such policies and procedures would be similar to those 
required for trading centers complying with paragraph (b) of the 
proposed modified uptick rule.
---------------------------------------------------------------------------

    At a minimum, a broker-dealer's policies and procedures would need 
to be reasonably designed to enable a broker-dealer to monitor, on a 
real-time basis, the national best bid, and whether the current 
national best bid is an up- or down-bid from the last differently 
priced national best bid, so as to determine the price at which the 
broker-dealer may submit a short sale order to a trading center in 
compliance with the provisions of proposed Rule 201(c)(1).
    A broker-dealer would also need to take such steps as would be 
necessary to enable it to enforce its policies and procedures 
effectively.\142\ For example, broker-dealers could establish policies 
and procedures that could include regular exception reports to evaluate 
their trading practices. If a broker-dealer's policies and procedures 
include exception reports, any such reports would need to be examined 
to affirm that a broker-dealer's policies and procedures have been 
followed by its personnel and properly coded into its automated systems 
and, if not, promptly identify the reasons and take remedial action.
---------------------------------------------------------------------------

    \142\ See proposed Rule 201(c)(1).
---------------------------------------------------------------------------

    To ensure compliance with proposed Rule 201(c)(1), a broker-dealer 
could also have policies and procedures that would enable it to have a 
record identifying the current national best bid at the time of 
submission of a short sale order, as well as the last differently 
priced national best bid. Such ``snapshots'' of the market would also 
aid SROs in evaluating a broker-dealer's written policies and 
procedures and compliance with proposed Rule 201(c). In addition, such 
snapshots would aid broker-dealers in verifying that a short sale order 
was priced in accordance with the provisions of proposed Rule 201(c)(1) 
if bid flickering during the period between identification of the 
current national best bid and the

[[Page 18055]]

submission of the short sale order to a trading center creates 
confusion regarding whether or not the short sale order was submitted 
at a permissible price. Snapshots of the market at the time of 
submission of an order would also aid broker-dealers in dealing with 
time lags in receiving data regarding the national best bid from 
different data sources. A broker-dealer's policies and procedures would 
be required to address any such latencies in obtaining data regarding 
the national best bid. In addition, to the extent such latencies occur, 
a broker-dealer's policies and procedures would need to implement 
reasonable steps to monitor such latencies on a continuing basis and 
take appropriate steps to address a problem should one develop.
    Surveillance would be a required part of a broker-dealer's 
satisfaction of its legal obligations. Proposed Rule 201(c)(1) provides 
that a broker-dealer must regularly surveil to ascertain the 
effectiveness of the policies and procedures required under proposed 
Rule 201(c)(2) and must take prompt action to remedy deficiencies in 
such policies and procedures.\143\ This provision would reinforce the 
ongoing maintenance and enforcement requirements of proposed Rule 
201(c)(2) by explicitly assigning an affirmative responsibility to 
broker-dealers to surveil to ascertain the effectiveness of their 
policies and procedures.\144\ Thus, under proposed Rule 201(c)(1) and 
(c)(2), broker-dealers would not be able to merely establish policies 
and procedures that may be reasonable when created and assume that such 
policies and procedures would continue to satisfy the requirements of 
the proposed rule. Rather, broker-dealers would be required to 
regularly assess the continuing effectiveness of their procedures and 
take prompt action when needed to remedy deficiencies. In particular, 
each broker-dealer would need to engage in regular and periodic 
surveillance to determine whether it is submitting short sale orders 
marked ``short exempt'' without complying with the requirements of 
proposed Rule 201(c)(1) and whether the broker-dealer has failed to 
implement and maintain policies and procedures that would have 
reasonably prevented such impermissible submissions.
---------------------------------------------------------------------------

    \143\ See proposed Rule 201(c)(2).
    \144\ We note that Rule 611(a)(2) of Regulation NMS contains a 
similar surveillance provision. See 17 CFR 242.611(a)(2).
---------------------------------------------------------------------------

b. Seller's Delay in Delivery
    The proposed modified uptick rule provides that a broker-dealer may 
mark an order ``short exempt'' if the broker-dealer has a reasonable 
basis to believe that the seller owns the security being sold and that 
the seller intends to deliver the security as soon as all restrictions 
on delivery have been removed.\145\ Specifically, proposed Rule 
201(d)(1) provides that a broker-dealer may mark a short sale order of 
a covered security ``short exempt'' if the broker-dealer has a 
reasonable basis to believe the short sale order of a covered security 
is by a person that is deemed to own the covered security pursuant to 
Rule 200 of Regulation SHO,\146\ provided that the person intends to 
deliver the security as soon as all restrictions on delivery have been 
removed.\147\
---------------------------------------------------------------------------

    \145\ Subsection (e)(1) of former Rule 10a-1 contained an 
exception relating to a seller's delay in the delivery of 
securities. The provision in proposed Rule 201(d)(1) parallels the 
exception contained in former Rule 10a-1(e)(1).
    \146\ 17 CFR 242.200.
    \147\ See proposed Rule 201(d)(1). This proposed provision is 
also consistent with Rule 203(b)(2)(ii) of Regulation SHO that 
provides an exception from the ``locate'' requirement of Rule 
203(b)(1) of Regulation SHO for ``[a]ny sale of a security that a 
person is deemed to own pursuant to Sec.  242.200, provided that the 
broker or dealer has been reasonably informed that the person 
intends to deliver such security as soon as all restrictions on 
delivery have been removed * * *'' 17 CFR 242.203(b)(2)(ii).
---------------------------------------------------------------------------

    Rule 200(g)(1) of Regulation SHO provides that a sale can be marked 
``long'' only if the seller is deemed to own the security being sold 
and either (i) the security is in the broker-dealer's physical 
possession or control, or (ii) it is reasonably expected that the 
security will be in the broker-dealer's physical possession or control 
by settlement of the transaction.\148\ Thus, even where a seller owns a 
security, if delivery will be delayed, such as in the sale of formerly 
restricted securities pursuant to Rule 144 of the Securities Act of 
1933, or where a convertible security, option, or warrant has been 
tendered for conversion or exchange, but the underlying security is not 
reasonably expected to be received by settlement date, such sales must 
be marked ``short.'' As a result, proposed Rule 201(d)(1) would be 
necessary to allow for sales of securities that although owned, are 
subject to the provisions of Regulation SHO governing short sales due 
solely to the seller being unable to deliver the security to its 
broker-dealer prior to settlement based on circumstances outside the 
seller's control.
---------------------------------------------------------------------------

    \148\ See 17 CFR 242.200(g)(1).
---------------------------------------------------------------------------

c. Odd Lot Transactions
    Proposed Rule 201(d)(2) would provide that a broker-dealer may mark 
a short sale order ``short exempt'' if the broker-dealer has a 
reasonable basis to believe that the short sale order is by a market 
maker to off-set a customer odd-lot \149\ order or liquidate an odd-lot 
position which changes such broker-dealer's position by no more than a 
unit of trading.\150\
---------------------------------------------------------------------------

    \149\ Proposed Rule 201(a)(5) provides that the term ``odd lot'' 
shall have the same meaning as in 17 CFR 242.600(b)(49). Rule 
600(b)(49) defines an ``odd lot'' as ``an order for the purchase or 
sale of an NMS stock in an amount less than a round lot.'' 17 CFR 
242.600(b)(49).
    \150\ See proposed Rule 201(d)(2). SRO rules define a ``unit of 
trading'' or ``normal unit of trading,'' and generally means 100 
shares, i.e., a round lot. For example, FINRA Rule 6320A(7) defines 
a ``normal unit of trading'' to mean ``100 shares of a security 
unless, with respect to a particular security, FINRA determines that 
a normal unit of trading shall constitute other than 100 shares.'' 
NYSE Rule 55 states that ``[t]he unit of trading in stocks shall be 
100 shares, except that in the case of certain stocks designated by 
the Exchange the unit of trading shall be such lesser number of 
shares as may be determined by the Exchange, with respect to each 
stock so designated * * *.''
---------------------------------------------------------------------------

    Under former Rule 10a-1, an exception for certain odd-lot 
transactions was created in an effort to reduce the burden and 
inconvenience that short sale restrictions would place on odd-lot 
transactions. In 1938, the Commission found that odd-lot transactions 
played a very minor role in potential manipulation by short selling. 
Initially, sales of odd-lots were not subject to the restrictions of 
Rule 10a-1.\151\ However, the Commission became concerned over the 
volume of odd-lot transactions, which possibly indicated that the 
exception was being used to circumvent the rule. As a result, the 
exception was changed to include the two odd lot exceptions described 
below.\152\
---------------------------------------------------------------------------

    \151\ The Commission initially adopted three exceptions for odd-
lot transactions. While the first one, excepting all odd-lot 
transactions, seemed to make other odd-lot exceptions unnecessary, 
the 1938 adopting release included all three exceptions without 
discussion. See supra note 24, Former Rule 10a-1 Adopting Release 3 
FR 213.
    \152\ See Securities Exchange Act Release No. 11030 (Sept. 27, 
1974), 39 FR 35570 (Oct. 2, 1974).
---------------------------------------------------------------------------

    Former Rule 10a-1(e)(3) contained a limited exception for odd-lot 
dealers registered in the security and third market makers. The 
exception allowed short sales by odd-lot dealers registered in the 
security and by third market makers of covered securities to fill 
customer odd lot orders. Former Rule 10a-1(e)(4) provided an exception 
under the rule for any sale to liquidate an odd-lot position by a 
single round lot sell order that changed the broker-dealer's position 
by no more than a unit of trading.
    We believe that a provision that would allow a broker-dealer to 
mark a short sale order ``short exempt'' if it has a reasonable basis 
to believe that the

[[Page 18056]]

short sale order is by a market maker to off-set a customer odd-lot 
order or liquidate an odd-lot position which changes such broker-
dealer's position by no more than a unit of trading would continue to 
be of utility under the proposed modified uptick rule because it would 
not be in conflict with the goals of the proposed rule.
    Thus, the provision in proposed Rule 201(d)(2) parallels the 
exceptions in subsections (e)(3) and (e)(4) of former Rule 10a-1. In 
addition, however, we propose extending the provision to cover all 
market makers acting in the capacity of an odd-lot dealer. When former 
Rule 10a-1 was adopted, odd-lot dealers dealt exclusively with odd-lot 
transactions, and were so registered. Today, market makers registered 
in a security typically also act as odd-lot dealers of the security. 
Thus, we propose to broaden the provision in proposed Rule 201(d)(2) to 
all broker-dealers acting as ``market makers'' in odd lots.\153\
---------------------------------------------------------------------------

    \153\ Section 3(a)(38) of the Exchange Act defines a ``market 
maker,'' and includes specialists. See 15 U.S.C. 78c(a)(38).
---------------------------------------------------------------------------

    We believe that this provision would be appropriate. Because odd-
lot transactions by market makers to facilitate customer orders are not 
of a size that could facilitate a downward movement in the market, we 
do not believe that proposed Rule 201(d)(2) would adversely affect the 
goals of short sale regulation that the proposed modified uptick rule 
seeks to advance. Thus, we believe that a broker-dealer should be able 
to mark such orders ``short exempt'' so that those acting in the 
capacity of a ``market maker,'' with the commensurate negative and 
positive obligations, would be able to off-set a customer odd-lot order 
and liquidate an odd-lot position without a trading center's policies 
and procedures preventing the execution or display of such orders at a 
down-bid price.
d. Domestic Arbitrage
    Proposed Rule 201(d)(3) would provide that a broker-dealer may mark 
``short exempt'' short sale orders associated with certain bona fide 
domestic arbitrage transactions. Subsection (e)(7) of former Rule 10a-1 
contained an exception related to domestic arbitrage.\154\ That 
exception applied to bona fide arbitrage undertaken to profit from a 
current difference in price between a convertible security and the 
underlying common stock.\155\ The term ``bona fide arbitrage'' 
describes an activity undertaken by market professionals in which 
essentially contemporaneous purchases and sales are effected in order 
to lock in a gross profit or spread resulting from a current 
differential in pricing of two related securities.\156\ For example, a 
person may sell short securities to profit from a current price 
differential based upon a convertible security that entitles him to 
acquire an equivalent number of securities of the securities sold 
short. We continue to believe that bona fide arbitrage activities are 
beneficial to the markets because they tend to reduce pricing 
disparities between related securities.\157\ Thus, bona fide arbitrage 
transactions promote market efficiency.
---------------------------------------------------------------------------

    \154\ See Securities Exchange Act Release No. 1645 (Apr. 8, 
1938).
    \155\ See Securities Exchange Act Release No. 42037 (Oct. 20, 
1999), 64 FR 57996 (Oct. 28, 1999) (``1999 Concept Release'').
    \156\ 1999 Concept Release, 64 FR at n.54 and accompanying text 
(discussing the domestic arbitrage exception under former Rule 10a-
1). See also Section 220.6(b) of Regulation T which states that the 
term ``bona fide arbitrage'' means: ``(1) A purchase or sale of a 
security in one market together with an offsetting sale or purchase 
of the same security in a different market at as nearly the same 
time as practicable for the purpose of taking advantage of a 
difference in prices in the two markets; or (2) A purchase of a 
security which is, without restriction other than the payment of 
money, exchangeable or convertible within 90 calendar days of the 
purchase into a second security together with an offsetting sale of 
the second security at or about the same time, for the purpose of 
taking advantage of a concurrent disparity in the prices of the two 
securities.'' 12 CFR 220.6(b). See also Securities Exchange Act 
Release No. 15533 (Jan. 29, 1979), 44 FR 6084 (Jan. 31, 1979) 
(interpretation concerning the application of Section 11(a)(1) to 
bona fide arbitrage).
    \157\ See Securities Exchange Act Release No. 15533 (Jan. 29, 
1979), 44 FR 6084 (Jan. 31, 1979) (interpretation concerning the 
application of Section 11(a)(1) to bona fide arbitrage).
---------------------------------------------------------------------------

    Proposed Rule 201(d)(3) would parallel the exception in former Rule 
10a-1(e)(7). Specifically, proposed Rule 201(d)(3) would provide that a 
broker-dealer may mark a short sale order of a covered security ``short 
exempt'' if the broker-dealer has a reasonable basis to believe that 
the short sale order is ``for a good faith account by a person who owns 
another security by virtue of which he is, or presently will be, 
entitled to acquire an equivalent number of securities of the same 
class as the securities sold, provided such sale, or the purchase which 
such sale offsets, is effected for the bona fide purpose of profiting 
from the difference between the price of the security sold and the 
security owned and that such right of acquisition was originally 
attached to or represented by another security or was issued to all the 
holders of any such securities of the issuer.'' \158\
---------------------------------------------------------------------------

    \158\ Proposed Rule 201(d)(3).
---------------------------------------------------------------------------

    The domestic arbitrage exception in former Rule 10a-1 was intended 
to be consistent with the arbitrage provision of Regulation T.\159\ 
Thus, consistent with that provision, former Rule 10a-1(e)(7) referred 
to a ``special arbitrage account'' and not a ``good faith account.'' 
\160\ The Federal Reserve Board amended Regulation T in 1998 to 
eliminate the ``special arbitrage account'' and allow the functions 
formerly effected in that account to be effected in a ``good faith 
account.'' Thus, proposed Rule 201(d)(3) also refers to a ``good faith 
account.'' We note, however, that we request specific comment regarding 
whether or not the use of a ``good faith account'' or any other 
separate account continues to be appropriate or necessary for purposes 
of this proposed Rule 201(d)(3).
---------------------------------------------------------------------------

    \159\ See 12 CFR 220.6.
    \160\ Section 220.3(b) of Regulation T, titled ``Separation of 
accounts,'' generally provides that requirements for an account may 
not be met by considering items in any other account. Further, 
Regulation T identifies three types of customer accounts--cash 
accounts, margin accounts and good faith accounts--in which customer 
transactions may be booked. A broker-dealer can extend credit to 
customers through a margin account or a good faith account. 
Generally, positions held in a good faith account are subject to 
good faith margin, whereas positions held in a margin account are 
subject to the margin requirements otherwise set forth in Regulation 
T and SRO margin requirements.
---------------------------------------------------------------------------

    Because allowing domestic arbitrage at a down-bid price would 
potentially promote market efficiency, the proposed modified uptick 
rule would include a limited provision to allow broker-dealers to mark 
short sale orders ``short exempt'' provided the broker-dealer has a 
reasonable basis to believe that the conditions in proposed Rule 
201(d)(3) have been met. Thus, the proposed rule is designed to permit 
the execution or display on a down-bid price of such orders in 
connection with bona fide arbitrage transactions involving convertible, 
exchangeable, and other rights to acquire the securities sold short, 
where such rights of acquisition were originally attached to, or 
represented by, another security, or were issued to all the holders of 
any such class of securities of the issuer.
e. International Arbitrage
    Proposed Rule 201(d)(4) would provide that a broker-dealer may mark 
``short exempt'' short sale orders associated with certain 
international arbitrage transactions. Former Rule 10a-1(e)(8) included 
an international arbitrage exception that was adopted in 1939.\161\ In 
adopting the exception, the Commission stated that it was necessary

[[Page 18057]]

to facilitate ``transactions which are of a true arbitrage nature, 
namely, transactions in which a position is taken on one exchange which 
is to be immediately covered on a foreign market.'' \162\ We believe 
likewise that such transactions would have utility under the proposed 
modified uptick rule. As discussed above in connection with domestic 
arbitrage, bona fide arbitrage transactions promote market efficiency 
because they equalize prices at an instant in time in different markets 
or between relatively equivalent securities. Thus, we do not believe 
that permitting broker-dealers to mark these orders ``short exempt'' 
would undermine the goals of short sale price test regulation.
---------------------------------------------------------------------------

    \161\ See Securities Exchange Act Release No. 2039 (Mar. 10, 
1939), 4 FR 1209 (Mar. 14, 1939).
    \162\ See id.
---------------------------------------------------------------------------

    Proposed Rule 201(d)(4) would parallel the exception contained in 
former Rule 10a-1(e)(8). Specifically, proposed Rule 201(d)(4) would 
provide that a broker-dealer may mark a short sale order of a covered 
security ``short exempt'' if the broker-dealer has a reasonable basis 
to believe that the short sale order is ``for a good faith account 
submitted to profit from a current price difference between a security 
on a foreign securities market and a security on a securities market 
subject to the jurisdiction of the United States, provided that the 
short seller has an offer to buy on a foreign market that allows the 
seller to immediately cover the short sale at the time it was made.'' 
\163\
---------------------------------------------------------------------------

    \163\ Proposed Rule 201(d)(4).
---------------------------------------------------------------------------

    In proposed Rule 201(d)(4), we have simplified the language of 
former Rule 10a-1(e)(8) to make it more understandable.\164\ In 
addition, we have changed the reference in former Rule 10a-1(e)(8) from 
a ``special international arbitrage account'' to a ``good faith 
account.'' As discussed above in connection with the domestic arbitrage 
provision of proposed Rule 201(d)(3), this revision is necessary to 
make the proposed provision consistent with the arbitrage provision in 
Regulation T. We note, however, that we request specific comment 
regarding whether or not the use of a ``good faith account'' or any 
other separate account continues to be appropriate or necessary for 
purposes of proposed Rule 201(d)(4).
---------------------------------------------------------------------------

    \164\ Former Rule 10a-1(e)(8) provided that the short sale price 
test restrictions of that rule shall not apply to: ``Any sale of a 
security registered on, or admitted to unlisted trading privileges 
on, a national securities exchange effected for a special 
international arbitrage account for the bona fide purpose of 
profiting [sic] from a current difference between the price of such 
security on a securities market not within or subject to the 
jurisdiction of the United States and on a securities market subject 
to the jurisdiction of the United States; provided the seller at the 
time of such sale knows or, by virtue of information currently 
received, has reasonable grounds to believe that an offer enabling 
him to cover such sale is then available to him such foreign 
securities market and intends to accept such offer immediately.''
---------------------------------------------------------------------------

    In addition, we have incorporated language from the exception in 
former Rule 10a-1(e)(12) that provided that, for purposes of the 
international arbitrage exception, a depository receipt for a security 
shall be deemed to be the same security represented by the receipt. 
This language was originally included in the Commission's 1939 release 
adopting the international arbitrage exception, but was incorporated 
separately in former Rule 10a-1(e)(12).\165\ We likewise believe this 
language is appropriate and should be incorporated into proposed Rule 
201(d)(4). We seek comment, however, regarding whether for purposes of 
the international arbitrage provision, a depository receipt for a 
security should be deemed to be the same security represented by the 
receipt.
---------------------------------------------------------------------------

    \165\ See supra note 161.
---------------------------------------------------------------------------

    As with the exception in former Rule 10a-1(e)(8), proposed Rule 
201(d)(4) would apply only to bona fide arbitrage transactions. Thus, 
this provision would only be applicable if at the time of the short 
sale there is a corresponding offer in a foreign securities market, so 
that the immediate covering purchase would have the effect of 
neutralizing the short sale. We believe proposed Rule 201(d)(4) would 
be necessary to facilitate arbitrage transactions in which a position 
is taken in a security in the U.S. market, and which is to be 
immediately covered in a foreign market.\166\
---------------------------------------------------------------------------

    \166\ We note that the requirement that the transaction be 
``immediately'' covered on a foreign market requires the foreign 
market to be open for trading at the time of the transaction. See 
2003 Regulation SHO Proposing Release, 68 FR at 62986.
---------------------------------------------------------------------------

f. Over-Allotments and Lay-Off Sales
    Proposed Rule 201(d)(5) would provide that a broker-dealer may mark 
``short exempt'' short sale orders by underwriters or syndicate members 
participating in a distribution in connection with an over-allotment, 
and any short sale orders with respect to lay-off sales by such persons 
in connection with a distribution of securities through a rights or 
standby underwriting commitment.
    Former Rule 10a-1(e)(10) contained an exception for over-allotment 
and lay-off sales.\167\ Although the exception was not adopted until 
1974, the Commission's approval of the concept of excepting over-
allotments and lay-off sales from short sale rules is long-
standing.\168\ In addition, we note that recently we excepted these 
sales from the July Emergency Order, which among other things required 
that short sellers borrow or arrange to borrow securities prior to 
effecting a short sale, stating that it was not necessary for the Order 
to cover such sales because such activity is covered by Regulation M 
under the Exchange Act,\169\ an anti-manipulation rule.\170\ In 
accordance with the long-standing Commission position regarding these 
sales, we are including through proposed Rule 201(d)(5) a provision for 
short sale orders in connection with over-allotment and lay-off sales 
that would parallel the exception in former Rule 10a-1(e)(10).
---------------------------------------------------------------------------

    \167\ See Securities Exchange Act Release No. 11030 (Sept. 7, 
1974), 39 FR 35570 (Oct. 2, 1974).
    \168\ See, e.g., Securities Exchange Act Release No. 3454 (July 
6, 1946), in which the Commission approved the NYSE's special 
offering plan, which permitted short sales in the form of over-
allotments to facilitate market stabilization.
    \169\ 17 CFR 242.100 et seq.
    \170\ See Securities Exchange Act Release No. 58190 (July 18, 
2008), 73 FR 42837 (July 23, 2008) (amending the July Emergency 
Order to include exceptions for certain short sales).
---------------------------------------------------------------------------

g. Riskless Principal Transactions
    Proposed Rule 201(d)(6) would provide that a broker-dealer may mark 
``short exempt'' short sale orders where broker-dealers are 
facilitating customer buy orders or sell orders where the customer is 
net long, and the broker-dealer is net short but is effecting the sale 
as riskless principal.\171\
---------------------------------------------------------------------------

    \171\ See proposed Rule 201(d)(6).
---------------------------------------------------------------------------

    In 2005, the Commission granted exemptive relief under former Rule 
10a-1 for any broker-dealer that facilitates a customer buy or long 
sell order on a riskless principal basis.\172\ In granting the relief, 
the Commission noted representations made in the letter requesting 
relief that in the situation where the amount of securities that the 
broker-dealer purchases for the customer may not be sufficient to give 
the broker-dealer an overall net ``long'' position, former Rule 10a-1 
would constrain the ability of the broker-dealer to fill the customer 
buy order. Further, the Commission noted representations in the letter 
requesting relief that because such short sales would be effected only 
in response to a customer buy order, this should vitiate any concerns 
about such sales having a depressing impact on the security's 
price.\173\
---------------------------------------------------------------------------

    \172\ See letter from James A. Brigagliano to Ira Hammerman, 
Senior Vice President and General Counsel, Securities Industry 
Association, dated July 18, 2005 (``Riskless Principal Letter'').
    \173\ See id.
---------------------------------------------------------------------------

    In addition, the Commission noted representations made in the 
letter

[[Page 18058]]

requesting relief that where a broker-dealer is facilitating a customer 
long sale order in a riskless principal transaction, because the 
ultimate seller is long the shares being sold, these transactions 
present none of the potential abuses that former Rule 10a-1 was 
designed to address.\174\ The Commission also noted representations 
that the application of former Rule 10a-1 to riskless principal 
transactions involving a customer long sale can inhibit the broker-
dealer's ability to provide timely (or any) execution to such customer 
long sale. Specifically, if the broker-dealer has a net short position, 
the broker-dealer will be restricted from executing its own principal 
trade to complete the first leg of the riskless principal 
transaction.\175\ Thus, compliance with former Rule 10a-1 would 
adversely affect a broker-dealer's ability to provide best execution to 
a customer order.\176\
---------------------------------------------------------------------------

    \174\ See id.
    \175\ See id.
    \176\ See id.
---------------------------------------------------------------------------

    Consistent with the relief granted in the Riskless Principal 
Letter, we believe that including a provision to permit a broker-dealer 
to mark ``short exempt'' short sale orders in connection with riskless 
principal transactions would be appropriate and would not undermine our 
goals in proposing short sale price test regulation. In particular, we 
note that such a provision would facilitate a broker-dealer's ability 
to provide best execution to customer orders. Accordingly, taken 
together proposed Rules 201(a)(6) and (d)(6) would parallel the 
conditions for relief in the Riskless Principal Letter.\177\
---------------------------------------------------------------------------

    \177\ These conditions are also consistent with the definition 
of ``riskless principal transactions'' under Rule 10b-18 of the 
Exchange Act. See 17 CFR 240.10b-18(a)(12).
---------------------------------------------------------------------------

    Specifically, proposed Rule 201(a)(6) would define the term 
``riskless principal'' to mean ``a transaction in which a broker or 
dealer, after having received an order to buy a security, purchases the 
security as principal at the same price to satisfy the order to buy or, 
after having received an order to sell, sells the security as principal 
at the same price to satisfy the order to sell.'' \178\ Proposed Rule 
201(d)(6) would provide that a broker-dealer may mark a short sale 
order ``short exempt'' if the broker-dealer has a reasonable basis to 
believe that the short sale order is to effect the execution of a 
customer purchase or the execution of a customer ``long'' sale on a 
riskless principal basis and provided the sell order is given the same 
per-share price at which the broker-dealer bought shares to satisfy the 
facilitated order, exclusive of any explicitly disclosed markup or 
markdown, commission equivalent or other fee.\179\ In addition, 
proposed Rule 201(d)(6) would require the broker-dealer, if it marks an 
order ``short exempt'' under this provision, to have policies and 
procedures in place to assure that, at a minimum: the customer order 
was received prior to the offsetting transaction; the offsetting 
transaction is allocated to a riskless principal or customer account 
within 60 seconds of execution; and that it has supervisory systems in 
place to produce records that enable the broker-dealer to accurately 
and readily reconstruct, in a time-sequenced manner, all orders on 
which the broker-dealer relies pursuant to this provision.\180\
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    \178\ In addition to being consistent with the conditions in the 
Riskless Principal Letter and Rule 10b-18 of the Exchange Act, this 
definition is consistent with the definition of ``riskless 
principal'' in FINRA Rule 6642.
    \179\ This requirement is also consistent with FINRA's trade 
reporting rules which require a riskless principal transaction in 
which both legs are executed at the same price to be reported once, 
in the same manner as an agency transaction, exclusive of any 
markup, markdown, commission equivalent, or other fee. See FINRA 
Rule 6380A(d)(3)(B).
    \180\ See proposed Rule 201(d)(6).
---------------------------------------------------------------------------

    We believe that proposed Rule 201(d)(6) would provide broker-
dealers with additional flexibility to facilitate customer orders and 
provide best execution. In addition, we believe that the conditions set 
forth in proposed Rule 201(d)(6) would provide a mechanism for the 
surveillance of the provision's use by linking it to specific incoming 
orders and executions, and by requiring broker-dealers to establish 
procedures for handling such transactions. These requirements would 
help ensure that broker-dealers are complying with proposed Rule 
201(d)(6).
h. Transactions on a Volume-Weighted Average Price Basis
    Proposed Rule 201(d)(7) would provide that a broker-dealer may mark 
``short exempt'' certain sale orders executed on a volume-weighted 
average price (``VWAP'') basis. Under former Rule 10a-1, the Commission 
granted limited relief from that rule in connection with short sales 
executed on a VWAP basis.\181\ The relief was limited to VWAP 
transactions that are arranged or ``matched'' before the market opens 
at 9:30 a.m., but are not assigned a price until after the close of 
trading when the VWAP value is calculated. The Commission granted the 
exemptions based, in part, on the fact that these VWAP short sale 
transactions appeared to pose little risk of facilitating the type of 
market effects that former Rule 10a-1 was designed to prevent.\182\ In 
particular, the Commission noted that the pre-opening VWAP short sale 
transactions do not participate in or affect the determination of the 
VWAP for a particular security.\183\ Moreover, the Commission stated 
that all trades used to calculate the day's VWAP would continue to be 
subject to former Rule 10a-1.\184\
---------------------------------------------------------------------------

    \181\ See e.g. letter from Larry E. Bergmann, Senior Associate 
Director, Division of Market Regulation, SEC, to Edith Hallahan, 
Counsel, Phlx, dated March 24, 1999; letter from Larry E. Bergmann, 
Senior Associate Director, Division of Market Regulation, SEC, to 
Soo J. Yim, Wilmer, Cutler & Pickering, dated December 7, 2000; 
letter from James Brigagliano, Assistant Director, Division of 
Market Regulation, SEC, to Andre E. Owens, Schiff Hardin & Waite, 
dated March 30, 2001; letter from James Brigagliano, Assistant 
Director, Division of Market Regulation, SEC, to Sam Scott Miller, 
Esq., Orrick, Herrington & Sutcliffe LLP, dated May 12, 2001; letter 
from James Brigagliano, Assistant Director, Division of Market 
Regulation, SEC, to William W. Uchimoto, Esq., Vie Institutional 
Services, dated February 12, 2003.
    \182\ See id.
    \183\ See id.
    \184\ See id.
---------------------------------------------------------------------------

    Consistent with the relief granted under former Rule 10a-1, we 
propose providing that a broker-dealer may mark ``short exempt'' 
certain short sale orders executed at the VWAP. Proposed Rule 201(d)(7) 
would differ from the relief granted under former Rule 10a-1, however, 
in that it would not be limited to VWAP transactions that are arranged 
or ``matched'' before the market opens at 9:30 a.m., or that are not 
assigned a price until after the close of trading when the VWAP value 
is calculated. We believe this restriction would not be necessary 
because VWAP short sale transactions appear to pose little risk of 
facilitating the type of market effects that a short sale price test 
restriction would be designed to prevent. In addition, in accordance 
with proposed Rule 201(d)(7), no short sale orders used to calculate 
the VWAP may be marked ``short exempt.'' \185\ This would help limit 
any potential for manipulation.
---------------------------------------------------------------------------

    \185\ See proposed Rule 201(b)(7).
---------------------------------------------------------------------------

    Thus, pursuant to proposed Rule 201(d)(7), a broker-dealer may mark 
a short sale order of a covered security ``short exempt'' if the 
broker-dealer has a reasonable basis to believe that the short sale 
order is for the sale of a covered security at the VWAP that meets the 
following conditions: \186\ (1) The VWAP for the covered security is 
calculated by: Calculating the values for every regular way trade 
reported in the consolidated system for the security during the regular 
trading session, by multiplying each such price by the total

[[Page 18059]]

number of shares traded at that price; compiling an aggregate sum of 
all values; and dividing the aggregate sum by the total number of 
reported shares for that day in the security; (2) the transactions are 
reported using a special VWAP trade modifier; (3) no short sales used 
to calculate the VWAP are marked ``short exempt''; (4) the VWAP matched 
security qualifies as an ``actively traded security'' (as defined under 
Rules 101(c)(1) and 102(d)(1) of Regulation M), or where the subject 
listed security is not an ``actively traded security,'' the proposed 
short sale transaction will be permitted only if it is conducted as 
part of a basket transaction of twenty or more securities in which the 
subject security does not comprise more than 5% of the value of the 
basket traded; (5) the transaction is not effected for the purpose of 
creating actual, or apparent, active trading in or otherwise affecting 
the price of any security; and (6) a broker or dealer will act as 
principal on the contra-side to fill customer short sale orders only if 
the broker-dealer's position in the subject security, as committed by 
the broker-dealer during the pre-opening period of a trading day and 
aggregated across all of its customers who propose to sell short the 
same security on a VWAP basis, does not exceed 10% of the covered 
security's relevant average daily trading volume, as defined in 
Regulation M.\187\
---------------------------------------------------------------------------

    \186\ See proposed Rule 201(d)(7).
    \187\ 17 CFR 242.100(b).
---------------------------------------------------------------------------

    Except as discussed above, the conditions set forth in proposed 
Rule 201(d)(7) parallel the conditions contained in the exemptive 
relief from former Rule 10a-1 granted for VWAP short sale transactions. 
We believe that these conditions worked well in restricting the 
exemptive relief to situations that generally would not raise the harms 
that short sale price tests are designed to prevent. We believe they 
would be similarly effective in serving that function today and, 
therefore, should be incorporated into proposed Rule 201(d)(7).
i. Decision Not To Propose That a Broker-Dealer May Mark an Order 
``Short Exempt'' in Connection With Bona Fide Market Making Activity
    Former Rule 10a-1(e)(5) provided a limited exception from the 
restrictions of that rule for ``[a]ny sale * * * by a registered 
specialist or registered exchange market maker for its own account on 
any exchange with which it is registered for such security, or by a 
third market maker for its own account over-the-counter, (i) Effected 
at a price equal to or above the last sale, regular way, reported for 
such security pursuant to an effective transaction reporting plan. * * 
* Provided, however, That any exchange, by rule, may prohibit its 
registered specialist and registered exchange market makers from 
availing themselves of the exemption afforded by this paragraph (e)(5) 
if that exchange determines that such action is necessary or 
appropriate in its market in the public interest or for the protection 
of investors.'' Unless prohibited by exchange rule, this exception was 
intended to permit registered specialists or market makers to protect 
customer orders against transactions in other markets in the 
consolidated system by allowing them to sell short at a price equal to 
the last trade price reported to the consolidated system, even if that 
sale was on a minus or zero-minus tick.\188\ Although former Rule 10a-1 
included this exception for market makers, exchanges adopted rules that 
prohibited their registered specialists and market makers from availing 
themselves of this exception.\189\ In addition, former Rule 10a-1 did 
not contain a general exception for short selling in connection with 
bona fide market making activities.\190\
---------------------------------------------------------------------------

    \188\ See Securities Exchange Act Release No. 11030 (Sept. 27, 
1974), 39 FR 35570 (Oct. 2, 1974). Former Rule 10a-1(a)(1)(i) 
referenced the last sale price reported to an effective transaction 
reporting plan, but former Rule 10a-1(a)(2) also permitted an 
exchange to make an election to use the last sale price reported in 
that exchange market. Certain exchanges, such as the NYSE, 
implemented short sale price test rules consistent with former Rule 
10a-1(a)(2). See, e.g., former NYSE Rule 440B.
    \189\ See id.
    \190\ We note, however, that NASD's bid test contained an 
exception for short sales executed by qualified market makers in 
connection with bona fide market making. When, however, the 
Commission approved NASD's bid test and the market maker exception 
to the bid test it noted concerns that the market maker exception 
could create opportunities for abusive short selling. See 1994 NASD 
Bid Test Approval, 59 FR 34885. See also supra notes 125 and 136 
(discussing NASD Rule 3350).
---------------------------------------------------------------------------

    Consistent with former Rule 10a-1, the proposed modified uptick 
rule would not permit a broker-dealer to mark a short sale order 
``short exempt'' if the broker-dealer is engaging in bona fide market 
making activity. By requiring trading centers to have policies and 
procedures reasonably designed to prevent the execution or display of a 
short sale order at a down-bid price, the proposed modified uptick rule 
might help prevent short selling, including potentially abusive or 
manipulative short selling, from being used as a tool to drive down a 
market and from being used to accelerate a declining market by 
exhausting all remaining bids at one price level, and causing 
successively lower prices to be established by long sellers. By seeking 
to advance these goals, the proposed modified uptick rule might help 
restore investor confidence.
    As set forth above, paragraphs (c) and (d) of proposed Rule 201 
would permit a broker-dealer to mark a short sale order ``short 
exempt'' under certain circumstances.\191\ Further, if an order is 
marked ``short exempt,'' proposed Rule 201(b)(1)(ii) provides that a 
trading center's policies and procedures must be reasonably designed to 
permit the execution or display of such order without regard to whether 
the order is at a down-bid price.\192\ We have proposed these 
provisions to facilitate the proposed modified uptick rule's 
workability, while at the same time, not undermine our goals in 
proposing short sale price test restrictions.
---------------------------------------------------------------------------

    \191\ See proposed Rule 201(c) and 201(d).
    \192\ See proposed Rule 201(b)(1)(ii).
---------------------------------------------------------------------------

    We believe that permitting broker-dealers to mark ``short exempt'' 
short sale orders in connection with bona fide market making activity 
may undermine the goals of our proposed short sale price test 
restrictions at this time. In particular, we believe that for the 
proposed modified uptick rule to have the effect of helping to prevent 
declines in securities prices and restore investor confidence, 
provisions relating to when a broker-dealer may mark an order ``short 
exempt'' should be limited in scope.
    In addition, we note that the proposed provision that would allow 
broker-dealers to mark short sale orders as ``short exempt'' in 
connection with riskless principal transactions would provide broker-
dealers with flexibility to facilitate customer orders. A trading 
center's policies and procedures would also be designed to permit the 
execution or display of short sale orders at the offer. Additionally, 
in an advancing market, in accordance with proposed Rule 201(b)(1), a 
trading center's policies and procedures would be reasonably designed 
to permit the execution or display of short sale orders at the current 
national best bid and, therefore, in an advancing market, market makers 
could provide liquidity to the markets and meet purchasing demand.\193\ 
For all these reasons, we do not believe it would be appropriate to 
provide that a broker-dealer may mark an order ``short exempt'' where 
the short

[[Page 18060]]

sale order is in connection with bona fide market making activity.
---------------------------------------------------------------------------

    \193\ See also McCormick, D. Timothy and Zeigler, Bram, 1997, 
The Nasdaq short sale rule: Analysis of market quality effects and 
the market maker exemption. Working paper, NASD Economic Research, 
p. 28 (finding that market makers' short sales at the bid or below 
on down-bids amounted to only 1.17% of their trading).
---------------------------------------------------------------------------

    We seek comment, however, on the importance of a market maker 
provision in the context of a market maker's role in providing 
liquidity, including the extent to which market makers would need to 
sell short at or below the current national best bid in their market 
making capacity. We also seek comment on the extent to which the 
proposed riskless principal provision, as well as any other proposed 
provisions, would address concerns regarding the need for a more 
general market maker provision. In addition, we seek comment regarding 
what conditions should apply if a general market maker provision were 
added to when a broker-dealer may mark an order ``short exempt'' under 
the proposed modified uptick rule. We also seek comment on whether a 
general market maker exception should be limited to registered market 
makers.
3. Proposed Modified Uptick Rule and After-Hours Trading
    Regular trading hours in the U.S. are from 9:30 a.m. to 4 p.m. 
Eastern Time (``ET'').\194\ A high volume of trading occurs, however, 
outside of these regular trading hours. Accordingly, the Commission 
interpreted former Rule 10a-1 to apply to all trades in covered 
securities, whenever they occurred.\195\ By its terms, former Rule 10a-
1 used as a reference point the last sale price reported to the 
consolidated tape. Thus, after the consolidated tape ceased to operate, 
the rule prevented any person from effecting a short sale in a listed 
security at a price lower than the last sale reported to the 
consolidated tape.\196\ Although former Rule 10a-1 applied in the 
after-hours market, we do not believe that the proposed modified uptick 
rule should apply to covered securities during periods that the 
national best bid is not collected, calculated and disseminated.
---------------------------------------------------------------------------

    \194\ See, e.g., Rule 600(64) of Regulation NMS, defining the 
term ``regular trading hours.''
    \195\ See 2003 Regulation SHO Proposing Release, 68 FR at 62997 
(stating that the Commission interprets former Rule 10a-1 to apply 
to all trades in listed securities whenever they occur).
    \196\ We note, however, that NASD did not extend its short sale 
price test rule to the after-hours market. See NASD Head Trader 
Alert 2000-55.
---------------------------------------------------------------------------

    As discussed above, market information for quotes in NMS stocks is 
disseminated pursuant to two different national market system plans, 
the CQ Plan, and Nasdaq UTP Plan.\197\ Quotation information is made 
available pursuant to the CQ Plan between 9 a.m. and 6:30 p.m. ET, 
while one or more participants is open for trading. In addition, 
quotation information is made available pursuant to the CQ Plan during 
any other period in which any one or more participants wish to furnish 
quotation information to the Plan.\198\ Quotation information is made 
available by the Nasdaq UTP Plan between 9:30 a.m. and 4 p.m. ET. The 
Nasdaq UTP Plan also collects, processes, and disseminates quotation 
information between 4 a.m. and 9:30 a.m. (ET), and after 4 p.m. when 
any participant is open for trading, until 8 p.m. ET.\199\
---------------------------------------------------------------------------

    \197\ See supra note 107. See also 17 CFR 242.603(b). Rule 603 
of Regulation NMS requires that every national securities exchange 
on which an NMS stock is traded and national securities association 
shall act jointly pursuant to one or more effective national market 
system plans to disseminate consolidated information, including a 
national best bid and national best offer, on quotations for and 
transactions in NMS stocks.
    \198\ See http://www.nyxdata.com/cta.
    \199\ See http://www.utpdata.com/docs/UTP_PlanAmendment.pdf.
---------------------------------------------------------------------------

    During the time periods in which these Plans do not operate, real-
time quote information is not collected, calculated and disseminated. 
We do not believe that it would further the goals of short sale price 
test regulation to apply the proposed modified uptick rule when the 
national best bid is not being collected, calculated and disseminated 
on a real-time basis. Thus, the proposed modified uptick rule would 
only apply at times when quotation information and, therefore, the 
national best bid, is collected, processed, and disseminated pursuant 
to a national market system plan. Thus, proposed Rule 201(f) limits 
application of the proposed modified uptick rule to times when ``a 
national best bid for [an] NMS stock is calculated and disseminated on 
a current and continuing basis by a plan processor pursuant to an 
effective national market system plan.'' \200\ However, we seek comment 
on these issues.
---------------------------------------------------------------------------

    \200\ See proposed Rule 201(e).
---------------------------------------------------------------------------

B. Proposed Uptick Rule

1. Operation of the Proposed Uptick Rule
    As an alternative to proposing a short sale price test based on the 
national best bid, we are proposing a modified version of former Rule 
10a-1 to provide the public with an opportunity to comment on the 
utility of such a price test, especially in light of the recent changes 
in market conditions.\201\ The proposed uptick rule would use the last 
sale price as the reference point for short sale orders.
---------------------------------------------------------------------------

    \201\ See supra Section II, discussing the history of short sale 
price test regulation in the United States and changes in market 
conditions and resulting erosion of investor confidence.
---------------------------------------------------------------------------

    Specifically, the proposed uptick rule would provide that ``[n]o 
person shall, for his own account or for the account of any other 
person, effect a short sale of any covered security, if trades in such 
security are reported pursuant to an effective transaction reporting 
plan \202\ and information as to such trades is made available in 
accordance with such plan on a real-time basis to vendors of market 
transaction information: (i) Below the price at which the last sale 
thereof, regular way, was reported pursuant to an effective transaction 
reporting plan; or (ii) At such price unless such price is above the 
next preceding different price at which a sale of such security, 
regular way, was reported pursuant to an effective transaction 
reporting plan.'' \203\ Thus, under the proposed uptick rule, no short 
sale order may be effected below the last sale price. Short sale orders 
may be effected at the last sale price only if the last sale price is 
above the last different price. Otherwise, all short sale orders must 
be effected above the last sale price.
---------------------------------------------------------------------------

    \202\ Proposed Rule 201(a)(3) provides that the term 
``transaction reporting plan'' shall have the same meaning as in 
Sec.  242.600(22) of Regulation NMS.
    \203\ Proposed Rule 201(b).
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    The following transactions illustrate the operation of the proposed 
uptick rule:
[GRAPHIC] [TIFF OMITTED] TP17AP09.008


[[Page 18061]]


    The first execution at 47.04 is a plus tick since it is higher than 
the previous last trade price of 47.00. The next transaction at 47.04 
is a zero-plus tick since there is no change in trade price but the 
last change was a plus tick. Short sales could be executed at 47.04 or 
above in both of these cases. The final two transactions at 47.00 are 
minus and zero-minus transactions, respectively. Short sales in these 
two circumstances would have to be effected at a price above 47.00 in 
order to comply with proposed uptick rule.
    Similar to the proposed modified uptick rule, the proposed uptick 
rule would apply to any ``covered security,'' which is defined as an 
``NMS stock'' under Rule 600(a)(47) of Regulation NMS. Rule 600(a)(47) 
of Regulation NMS defines an ``NMS stock'' as ``any NMS security other 
than an option.'' \204\ Rule 600(a)(46) of Regulation NMS defines an 
``NMS security'' as ``any security or class of securities for which 
transaction reports are collected, processed, and made available 
pursuant to an effective transaction reporting plan, or an effective 
national market system plan for reporting transactions in listed 
options.'' \205\ As a result, the proposed uptick rule would 
effectively cover all securities, other than options, listed on a 
national securities exchange whether traded on an exchange or in the 
OTC market. It would not include non-NMS stocks quoted on the OTC 
Bulletin Board or elsewhere in the OTC market.
---------------------------------------------------------------------------

    \204\ 17 CFR 242.600(a)(47).
    \205\ 17 CFR 242.600(a)(46).
---------------------------------------------------------------------------

    We are not proposing to apply the proposed uptick rule to non-NMS 
stocks quoted on the OTC Bulletin Board or elsewhere in the OTC market 
because these securities were not subject to former Rule 10a-1. We 
recognize, however, that issuers of non-NMS stocks, which often are 
less actively traded securities than NMS stocks, may believe that they 
are particularly vulnerable to abusive short selling. Thus, we seek 
specific comment regarding whether the proposed uptick rule or some 
other form of price test should apply to these types of securities.
    As discussed above in connection with the proposed modified uptick 
rule, the scope of securities covered by the proposed uptick rule would 
be similar to the scope of securities covered by former Rule 10a-1. 
Former Rule 10a-1(a) applied to securities registered on, or admitted 
to unlisted trading privileges on, a national securities exchange, if 
trades of the security were reported pursuant to an effective 
transaction reporting plan and information regarding such trades was 
made available in accordance with such plan on a real-time basis to 
vendors of market transaction information. All securities that would 
have been subject to former Rule 10a-1 would also be subject to the 
proposed uptick rule. In addition, certain securities, such as 
securities traded on Nasdaq, that were not subject to former Rule 10a-
1, would be subject to the proposed uptick rule.\206\
---------------------------------------------------------------------------

    \206\ See supra note 106. We note that former Rule 10a-1(b) 
applied the restrictions of former Rule 10a-1 to short sales on a 
national securities exchange in securities for which trades were not 
reported pursuant to an ``effective transaction reporting plan,'' as 
defined in Rule 600 of Regulation NMS, and for which information as 
to such trades was not made available in accordance with such plan 
on a real-time basis to vendors of market transaction information. 
Former Rule 10a-1(b) provided, in part: ``No person shall, for his 
own account or for the account of any other person, effect on a 
national securities exchange a short sale of any security not 
covered by paragraph (a) of this rule, 1. below the price at which 
the last sale thereof, regular way, was effected on such exchange, 
or 2. at such price unless such price is above the next preceding 
different price at which a sale of such security, regular way, was 
effected on such exchange.'' A similar provision would not be 
applicable to the proposed uptick rule because the proposed uptick 
rule applies to all NMS stocks, which, by definition, include only 
those stocks for which trades are collected, processed, and made 
available pursuant to an effective transaction reporting plan. See 
17 CFR 242.600(b)(47) and (b)(46).
---------------------------------------------------------------------------

    As discussed in more detail above, the Commission eliminated former 
Rule 10a-1 and prohibited any SRO from having a price test in an effort 
in part to modernize and simplify short sale regulation in light of 
current trading systems and strategies used in the marketplace. In 
supporting its elimination of former Rule 10a-1, the Commission noted 
that the increased demand for exemptions from the Rule, and the 
disjointed application of short sale price tests had limited the reach 
of short sale price test restrictions, created confusion and compliance 
difficulties as well as an un-level playing field among market 
participants. In addition, the Commission noted that decimal increments 
had resulted in a rule that was no longer suited to the wide variety of 
trading strategies and systems used in the marketplace. The Commission 
also discussed that following its study of the effects of removing 
short sale price tests, OEA had found little empirical justification 
for maintaining former Rule 10a-1 and that, on balance, elimination of 
short sale price test restrictions for pilot stocks had not had a 
deleterious effect on market quality based on the examination of 
transactions during the period covered by the Pilot.\207\
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    \207\ See 2006 Price Test Elimination Proposing Release, 71 FR 
at 75073.
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    Similar to the proposed modified uptick rule, the proposed uptick 
rule is designed to allow relatively unrestricted short selling in an 
advancing market. In addition, it is designed to restrict short selling 
at successively lower prices and, thereby, might help prevent short 
selling, including potentially abusive or manipulative short selling, 
from being used as a tool for driving the market down or from being 
used to accelerate a declining market by exhausting all remaining bids 
at one price level, causing successively lower prices to be established 
by long sellers. In addition, the proposed uptick rule, similar to the 
proposed modified uptick rule, would not result in the type of 
disparate short sale regulation that existed under former Rule 10a-1 
because proposed Rule 201(d) would include a requirement that no SRO 
shall have any rule that is not in conformity with, or conflicts with, 
the short sale price test requirements of the proposed uptick rule. 
Another potential advantage to the proposed uptick rule is that market 
participants would be familiar with the test because it would be based 
on former Rule 10a-1 which was in existence for almost 70 years, and 
was only recently eliminated.
    At the same time, some of the reasons cited by the Commission for 
eliminating former Rule 10a-1, which are unique to the proposed uptick 
rule as a price test based on the last sale price, remain today. For 
example, as discussed in more detail below, as a short sale price test 
that is based on the last sale price, the proposed uptick rule includes 
a number of exceptions necessary to accommodate the various trading 
strategies and systems used in today's marketplace. For example, the 
proposed uptick rule includes an exception for automated trading 
systems that utilize passive pricing and trading systems that offer 
price improvement based on the national best bid. The proposed uptick 
rule also includes an exception to allow market makers or specialists 
publishing two-sided quotes to sell short at the offer to facilitate 
customer market or marketable limit buy orders regardless of the last 
sale price.
    In addition, as noted above in connection with our discussion of 
the proposed modified uptick rule, we believe the spread of more fully 
automated markets may make a test based on the last sale price less 
effective at regulating short selling than a test based on the national 
best bid due to delays in reporting of last sale price information and 
because last sale price information is published in reporting sequence 
and not trade sequence. Such trade reporting may create up-ticks and 
down-ticks that may not accurately

[[Page 18062]]

reflect price movements in the security for purposes of the proposed 
uptick rule. Because last trade prices can be reported out of sequence, 
for various reasons, we believe bids may be a more accurate reflection 
of current prices for a security.
    Although former Rule 10a-1 was only recently eliminated, we 
recognize that due to the extensive systems changes that have occurred 
in the last couple of years in response to Regulation NMS, programming 
systems for the proposed uptick rule may be burdensome. For example, we 
note that at the same time that we proposed and subsequently adopted 
amendments to eliminate former Rule 10a-1, market participants were 
programming their systems to comply with Regulation NMS. It is our 
understanding that some market participants may not have included in 
their programming coding that would have allowed for the application of 
short sale price test restrictions at that time.\208\
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    \208\ In connection with the elimination of former Rule 10a-1 
and all short sale price test restrictions, we noted that commenters 
to the proposed amendments to eliminate all short sale price test 
restrictions discussed potential reprogramming costs that market 
participants may incur if the proposed amendments were not effective 
prior to the date for which all automated trading centers were 
required to have fully operational Regulation NMS-compliant trading 
systems, i.e., July 9, 2007 (the ``Regulation NMS Compliance 
Date''). For example, we noted that the Securities Industry 
Financial Markets Assn. (``SIFMA'') urged the Commission to take 
steps to eliminate price test restrictions prior to the Regulation 
NMS Compliance Date to alleviate the need for firms to, in the 
course of instituting programming changes to meet the new 
requirements of Regulation NMS, program systems to comply with price 
test restrictions, only to be required to reverse such programming 
costs shortly thereafter. After considering these comments, we made 
the elimination of short sale price test restrictions immediately 
effective to provide market participants with sufficient notice and 
time prior to the Regulation NMS Compliance Date to reprogram their 
systems without regard to the then-current short sale price test 
restrictions. See 2007 Price Test Adopting Release, 72 FR at 36356, 
36359.
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    Although the proposed uptick rule does not take a policies and 
procedures approach, it is likely that market participants would use a 
policies and procedures approach as part of their efforts to comply 
with the proposed prohibition. As such, for either proposed approach 
(prohibition or policies and procedures), market participants could 
consider whether to build off the policies and procedures they already 
have in place under Regulation NMS. As discussed above in connection 
with the proposed modified uptick rule, trading centers have been 
required to develop policies and procedures in accordance with 
Regulation NMS that would be similar to the types of policies and 
procedures that would be required under the proposed modified uptick 
rule.
    The proposed uptick rule may be more burdensome to apply than the 
proposed modified uptick rule, however, because the prohibition 
approach of the proposed uptick rule would not allow any short sale at 
an impermissible price, even if in error or inadvertent, unless an 
exception applies. If the Commission were to decide to provide an 
exception for inadvertent errors, that could reduce the differences 
between the two proposed approaches. In addition, the proposed uptick 
rule could follow a policies and procedures approach similar to the 
approach discussed in connection with the proposed modified uptick 
rule. Such a policies and procedures approach would require that market 
participants continuously surveil for compliance and take prompt 
remedial steps to limit the execution or display of short sales at 
impermissible prices.
    As discussed above, we are proposing a short sale price test based 
on the last sale price, and, in particular, we are proposing a 
modernized version of former Rule 10a-1 to provide the public with the 
opportunity to comment on this test in light of changes that have 
occurred in market conditions and investor confidence since the 
elimination of former Rule 10a-1 in mid-2007. Because we want to 
provide the public with the opportunity to comment on a short sale 
price test similar to former Rule 10a-1, we are not proposing a 
policies and procedures type of approach in connection with the 
proposed uptick rule because this would be a substantial change from 
how former Rule 10a-1 was applied. We note, however, that some 
commenters may believe that a policies and procedures approach similar 
to the approach discussed under the proposed modified uptick rule that 
references the last sale price, rather than the national best bid, 
might be preferable to either the proposed modified uptick rule or the 
proposed uptick rule. Thus, we seek specific comment regarding such an 
approach.
    If we were to adopt the proposed uptick rule, we are proposing that 
there would be a three month implementation period such that market 
participants would have to comply with the proposed uptick rule three 
months following the effective date of the proposed uptick rule. We 
believe that a proposed implementation period of three months after the 
effective date would provide market participants with sufficient time 
in which to modify their systems and procedures in order to comply with 
the requirements of the proposed uptick rule. Among other things, we 
believe this period would be a reasonable period because market 
participants would be familiar with the changes to their trading 
systems necessary to implement the proposed uptick rule as the proposed 
uptick rule would be similar to former Rule 10a-1. The addition of an 
implementation period should help alleviate potential disruptive 
effects of the proposal.
    We realize, however, that a shorter or longer implementation period 
may be manageable or preferable. Thus, we seek specific comment as to 
what length of implementation period would be necessary or appropriate, 
and why, such that market participants would be able to meet the 
proposed short sale price test restrictions, if adopted.
2. Exceptions to Proposed Uptick Rule
    Paragraph (c) of Rule 201 of the proposed uptick rule sets forth 
exceptions to the proposed rule to promote its workability. Rule 201(c) 
of the proposed uptick rule would include exceptions that parallel 
provision set forth in proposed Rule 201(d) of the proposed modified 
uptick rule pursuant to which a broker-dealer may mark an order ``short 
exempt'' for purposes of that proposed rule. Thus, proposed Rule 201(c) 
of the proposed uptick rule would also include exceptions for: (i) A 
seller's delay in delivery as set forth in Section III.A.2.b above; 
(ii) odd lots, as set forth in Section III.A.2.c. above; (iii) domestic 
arbitrage, as set forth in Section III.A.2.d. above; (iv) international 
arbitrage, as set forth in Section III.A.2.e. above; (v) over-
allotments and lay-off sales, as set forth in Section III.A.2.f. above; 
(vi) transactions on a VWAP basis, as set forth in Section III.A.2.h 
above; and (vii) riskless principal transactions as set forth in 
Section III.A.2.g. above. We believe that the rationale for these 
provisions under the proposed modified uptick rule would be equally 
applicable to the proposed uptick rule. Thus, we do not repeat the 
discussions of these provisions in connection with our discussion 
regarding the proposed uptick rule.
    The following discussion sets forth the rationale regarding 
exceptions that would be unique to the proposed uptick rule. The 
exceptions contained in paragraph (c) of proposed Rule 201 are based 
upon exceptions contained in former Rule 10a-1 and exemptive relief 
granted pursuant to that rule. These exceptions and exemptions, as 
applicable, had been in place under former Rule 10a-1 for several 
years. We are not aware of any reason that the

[[Page 18063]]

rationales underlying these exceptions and exemptions would not still 
hold true today. Moreover, due to the limited scope of the proposed 
exceptions and exemptions, we do not believe that they would undermine 
the Commission's stated goals for proposing short sale price test 
restrictions.
    Thus, the exceptions in proposed Rule 201(c) parallel exceptions to 
and exemptive relief granted under former Rule 10a-1. As set forth in 
more detail below, however, we seek comment regarding each of these 
exceptions, including whether or not these exceptions would be 
appropriate or necessary under the proposed modified uptick rule 
particularly in light of trading systems and strategies used in today's 
marketplace.
a. Error in Marking a Short Sale
    Proposed Rule 201(c)(2) would provide an exception from the 
proposed uptick rule where a broker-dealer effects a sale order marked 
``long'' by another broker-dealer, but the order was mis-marked such 
that it should have been marked as a ``short'' sale order. 
Specifically, proposed Rule 201(c)(2) provides that the proposed uptick 
rule shall not apply to ``[a]ny sale by a broker or dealer of a covered 
security for an account in which it has no interest, pursuant to an 
order marked long.'' \209\
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    \209\ Proposed Rule 201(c)(2).
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    The broker-dealer that marks the order ``long'' must comply with 
the order marking requirements of Rule 200(g) of Regulation SHO.\210\ 
Subsection (e)(2) of former Rule 10a-1 contained an exception for mis-
marked short sales. The exception was included in former Rule 10a-1 
when the rule was adopted in 1938 and was provided to ``avoid 
implicating in any violation of the rules a member whose participation 
in the violation [was] unwitting and unintentional.'' \211\ The 
exception in proposed Rule 201(c)(2) would avoid implicating the 
broker-dealer effecting the sale where the broker-dealer's 
participation in the violation was neither knowing nor reckless.\212\
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    \210\ See 17 CFR 242.200(g).
    \211\ See Former Rule 10a-1 Adopting Release, 3 FR 213.
    \212\ Knowledge may be inferred where a broker-dealer has 
previously accepted orders marked ``long'' from the same 
counterparty that required borrowed shares for delivery or that 
resulted in a ``fail to deliver.'' See 2004 Regulation SHO Adopting 
Release, 69 FR at 48019, n.111 (stating that ``[i]t may be 
unreasonable for a broker-dealer to treat a sale as long where 
orders marked `long' from the same customer repeatedly require 
borrowed shares for delivery or result in `fails to deliver.' A 
broker-dealer also may not treat a sale as long if the broker-dealer 
knows or has reason to know that the customer borrowed shares being 
sold.'').
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b. Electronic Trading Systems
    Proposed Rule 201(c)(8) would provide an exception from the 
proposed uptick rule for sales of securities in certain electronic 
trading systems that match and execute trades at various times and at 
independently-derived prices, such as at the mid-point of the NBBO. The 
Commission granted limited exemptive relief in connection with these 
systems under former Rule 10a-1 because matches could potentially occur 
at a price below the last sale price.\213\ Similarly, under the 
proposed uptick rule, matches could potentially occur at a price below 
the last sale price and, therefore, violate the provisions of proposed 
Rule 201(b) prohibiting short sales on a minus or zero-minus tick, 
absent an exception.
---------------------------------------------------------------------------

    \213\ See e.g., supra note 26.
---------------------------------------------------------------------------

    This exception provides that the proposed uptick rule shall not 
apply to any sale of a covered security in an electronic trading system 
that matches buying and selling interest at various times throughout 
the day if: (1) Matches occur at an externally derived price within the 
existing market and above the current national best bid; (2) sellers 
and purchasers are not assured of receiving a matching order; (3) 
sellers and purchasers do not know when a match will occur; (4) persons 
relying on the exception are not represented in the primary market 
offer or otherwise influence the primary market bid or offer at the 
time of the transaction; (5) transactions in the electronic trading 
system are not made for the purpose of creating actual, or apparent, 
active trading in, or depressing or otherwise manipulating the price 
of, any security; (6) the covered security qualifies as an ``actively-
traded security'' (as defined in Rules 101(c)(1) and 102(d)(1) of 
Regulation M), or where the subject listed security is not an 
``actively-traded security,'' the proposed short sale transaction will 
be permitted only if it is conducted as part of a basket transaction of 
twenty or more securities in which the subject security does not 
comprise more than 5% of the value of the basket traded; and (7) during 
the period of time in which the electronic trading system may match 
buying and selling interest, there is no solicitation of customer 
orders, or any communication with customers that the match has not yet 
occurred.\214\
---------------------------------------------------------------------------

    \214\ See Proposed Rule 201(c)(8).
---------------------------------------------------------------------------

    The conditions set forth in the exception in proposed Rule 
201(c)(8) parallel the conditions provided in the exemptive relief 
granted under former Rule 10a-1. Consistent with the relief granted 
under former Rule 10a-1 and the rationales provided in granting such 
relief, we believe it is appropriate to propose an exception to the 
proposed uptick rule for short sales submitted to these electronic 
trading systems because such rationales still hold true today. In 
particular, we note that due to the passive nature of pricing and the 
lack of price discovery, trades executed through these systems 
generally would not involve the types of abuses that the proposed 
uptick rule would be designed to prevent.
c. Trade-Throughs
    Proposed Rules 201(c)(10) and (11) would provide exceptions from 
the requirements of the proposed uptick rule that would help address 
any potential conflict between the proposed uptick rule and the Quote 
Rule under the Exchange Act.\215\ These exceptions parallel the 
exceptions contained in former Rule 10a-1(e)(5)(ii) and (e)(11), 
respectively.
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    \215\ See 17 CFR 242.602.
---------------------------------------------------------------------------

    Former Rule 10a-1(e)(5)(ii) was added to former Rule 10a-1 to 
address a potential conflict between the operation of former Rule 10a-1 
and the ``firm quote requirement'' of the Quote Rule \216\ in 
situations where execution of an offer quotation by a broker-dealer 
would be rendered unlawful because of a trade-through,\217\ even though 
the offer had been at a price permitted under former Rule 10a-1 at the 
time that the broker-dealer had communicated it to its exchange or 
association for inclusion in the consolidated quotation system.\218\
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    \216\ At the time the Commission adopted former Rule 10a-
1(e)(5)(ii), the Quote Rule was included in Rule 11Ac1-1 under the 
Exchange Act. The Quote Rule is now in Rule 602 of Regulation NMS. 
See 17 CFR 242.602.
    \217\ A ``trade-through'' generally means the purchase or sale 
of a security at a price that is lower than a protected bid or 
higher than a protected offer. See 17 CFR 242.600(a)(77) (defining 
the term ``trade-through'' for purposes of Regulation NMS).
    \218\ The following example from the release adopting the 
exception illustrates the potential conflict: A market maker who 
currently has a short position in XYZ stock communicates an offer 
which, if executed against at that time, would be in compliance with 
Rule 10a-1, e.g., at a price of 20\1/8\ when the last trade price 
reported in the consolidated system is also 20\1/8\. There is a 
``trade through'' of the market maker's offer on another trading 
venue that causes an up-tick to be reported in the consolidated 
system at 20\1/4\. Finally, a buy order is sent to the market maker 
after the trade through at 20\1/4\ has been reported. In order to 
ensure compliance with 10a-1, the market maker must refuse to 
execute the order at his offer of 20\1/8\ because doing so would 
result in a short sale being effected on an impermissible minus 
tick, however, in refusing to effect the trade, he would arguably 
violate the ``firm quote requirement'' of the Quote Rule. In 
addition, when a market maker ``backs away'' from an order, he may, 
in effect be revealing that he had a short position in the security, 
thus making it more difficult to liquidate that position at 
favorable prices. See Securities Exchange Act Release No. 17314 
(Nov. 20, 1980), 45 FR 79018 (Nov. 28, 1980).

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[[Page 18064]]

    To resolve this potential conflict, the Commission adopted the 
exception in subsection (e)(5)(ii) of former Rule 10a-1 to permit 
market makers to execute transactions at their offer following a trade-
through, and (e)(11) to permit non-market makers to effect a short sale 
at a price equal to the price associated with their most recently 
communicated offer up to the size of that offer \219\ provided the 
offer was at a price, when communicated, that was permissible under 
former Rule 10a-1. The (e)(11) exception was added in response to 
several comments that, in addition to orders for their own account, 
specialists and other floor members also often represent as part of 
their displayed quotation orders of other market participants (e.g., 
public agency orders or proprietary orders of non-market makers) that 
also might be ineligible for execution under former Rule 10a-1 
following a trade-through in another market.\220\
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    \219\ The Commission explained in the release that the scope of 
the exception in former Rule 10a-1(e)(11) was limited to the size of 
the broker-dealer's displayed offer because the need for the 
exception only arises to the extent that the broker-dealer's 
obligations under the Quote Rule may conflict with former Rule 10a-
1. Because the firm quote requirement of the Quote Rule only applies 
to a broker-dealer's displayed offer, it was deemed appropriate to 
limit the exception to the size of the displayed offer. See supra 
note 218 at n.20.
    \220\ This concern was illustrated in the release adopting the 
amendments with the following example: A specialist who is short XYZ 
stock quotes an offer for 1,000 shares at 20\1/8\ at a time when the 
last sale reported in the consolidated system was such that the 
offer, if executed at that time, would be in compliance with Rule 
10a-1. This offer for 1,000 shares consists of 300 shares offered by 
the specialist, a 400-share limit order in the specialist's book, 
and an offer from the crowd at the specialist's post for 300 shares, 
all at 20\1/8\. A trade through of this offer occurs on another 
exchange and an up-tick is reported in the consolidated system at 
20\1/4\. A buy order for 1,000 shares at 20\1/8\ is then sent to the 
exchange--after the trade through at 20\1/4\ is reported. Without 
(e)(11), filling the complete order for 1,000 shares would not be 
permissible, since (e)(5)(ii), by its terms, applied only to a sale 
by a market maker for its own account. See supra note 218 at n.18.
---------------------------------------------------------------------------

    We believe that the rationale for adopting the exceptions in former 
Rule 10a-1(e)(5)(ii) and (e)(11) and proposed in subsections (c)(10) 
and (c)(11) of the proposed uptick rule, namely resolving a conflict 
between a short sale price test based on the last sale price and the 
Quote Rule would exist under the proposed uptick rule. Thus, the 
proposed exceptions would parallel the exceptions in former Rule 10a-
1(e)(5)(ii) and (e)(11).\221\
---------------------------------------------------------------------------

    \221\ See Proposed Rule 201(c)(10) and (c)(11).
---------------------------------------------------------------------------

    Specifically, proposed Rule 201(c)(10) would provide that the 
restrictions of the proposed uptick rule shall not apply to: ``[A]ny 
sale of a covered security (except a sale to a stabilizing bid 
complying with Sec.  242.104 of Regulation M) by a registered 
specialist or registered exchange market maker for its own account on 
any exchange with which it is registered for such security, or by a 
third market maker for its own account over-the-counter, (i) Effected 
at a price equal to the most recent offer communicated for the security 
by such registered specialist, registered exchange market maker or 
third market maker to an exchange or a national securities association 
(``association'') pursuant to Sec.  242.602 of this chapter, if such 
offer, when communicated, was equal to or above the last sale, regular 
way, reported for such security pursuant to an effective transaction 
reporting plan. Provided, however, (ii) That any self-regulatory 
organization, by rule, may prohibit its registered specialist and 
registered exchange market makers from availing themselves of the 
exemption afforded by this paragraph (c)(10) if that self-regulatory 
organization determines that such action is necessary or appropriate in 
its market in the public interest or for the protection of investors.'' 
\222\
---------------------------------------------------------------------------

    \222\ See Proposed Rule 201(c)(10).
---------------------------------------------------------------------------

    We believe that the rationale for adopting former Rule 10a-
1(e)(5)(ii) still holds true today and, therefore, we have incorporated 
the language of that exception into proposed Rule 201(c)(10). 
Consistent with former Rule 10a-1(e)(5)(ii), the proposed exception 
would include language that would permit SROs to prohibit registered 
specialists and registered exchange market makers from availing 
themselves of this exception. We note that under former Rule 10a-1, 
SROs such as the NYSE prohibited registered specialists and registered 
exchange market makers from availing themselves of this exception.\223\ 
We believe it would be appropriate to continue to provide this option 
to SROs.
---------------------------------------------------------------------------

    \223\ See former NYSE Rule 440B.
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    Proposed Rule 201(c)(11) would provide that the restrictions of the 
proposed uptick rule shall not apply to: ``[A]ny sale of a covered 
security (except a sale to a stabilizing bid complying with Sec.  
242.104 of this chapter) by any broker or dealer, for his own account 
or for the account of any other person, effected at a price equal to 
the most recent offer communicated by such broker or dealer to an 
exchange or association pursuant to Sec.  242.602 of this chapter in an 
amount less than or equal to the quotation size associated with such 
offer, if such offer, when communicated, was: (i) Above the price at 
which the last sale, regular way, for such security was reported 
pursuant to an effective transaction reporting plan; or (ii) At such 
last sale price, if such last sale price is above the next preceding 
different price at which a sale of such security, regular way, was 
reported pursuant to an effective transaction reporting plan.'' We 
believe that the rationale for adopting former Rule 10a-1(e)(11) still 
holds true today and, therefore, we have incorporated the language of 
that exception into proposed Rule 201(c)(10).
d. Facilitation of Customer Buy Orders
    Proposed Rule 201(c)(12) would provide for an exception from the 
proposed uptick rule for short sales by registered market makers or 
specialists publishing two-sided quotes to sell short at the offer to 
facilitate customer market and marketable buy limit orders regardless 
of the last sale price.\224\ We believe that this exception would be 
necessary because some third market makers in exchange-listed 
securities offer trade execution for eligible customer orders at a 
price equal to or better than the national best offer. Under the 
proposed uptick rule, if the national best offer were below the 
previous last reported sale in a security and the third market maker or 
specialist has a short position, sales at the national best offer would 
violate the proposed uptick rule. The proposed exception would provide 
limited relief in a decimals environment to registered market makers 
and specialists so that they could provide liquidity in response to 
customer buy limit orders. Because this relief is limited to short 
selling only at the national best offer and only in response to 
customer buy limit orders we believe that it would not undermine the 
goals of short sale price test regulation, including helping to prevent 
short selling from being used as a tool to drive the market down.
---------------------------------------------------------------------------

    \224\ See proposed Rule 201(c)(12). This exception parallels 
exemptive relief provided by the Commission under former Rule 10a-1.
---------------------------------------------------------------------------

3. Proposed Uptick Rule and After-Hours Trading
    As discussed above in connection with the proposed modified uptick 
rule, the Commission interpreted former Rule 10a-1 to apply to all 
trades in covered securities, whenever they occurred. By its terms, 
former Rule 10a-1 used as a reference point the last sale price 
reported to the consolidated tape. Thus, after the consolidated tape 
ceased to operate, the rule prevented any person from effecting a short 
sale in a listed

[[Page 18065]]

security at a price lower than the last sale reported to the 
consolidated tape.\225\ Although former Rule 10a-1 applied in the 
after-hours market, similar to the proposed modified uptick rule, we do 
not believe that the proposed uptick rule should apply to covered 
securities while last sale price information is not collected, 
processed, and disseminated.\226\
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    \225\ We note, however, that NASD did not extend its short sale 
price test rule to the after-hours market. See NASD Head Trader 
Alert 2000-55.
    \226\ See supra Section III.A.2. (discussing our belief that the 
proposed modified uptick rule should not apply when the national 
best bid is not collected, processed, and disseminated on a real-
time basis).
---------------------------------------------------------------------------

    As discussed above, last sale price information for NMS stocks is 
disseminated pursuant to a national market system plan, the CTA 
Plan.\227\ The CTA Plan disseminates last sale price information during 
the hours in which any of its participants that regularly reports to 
the Plan is open for trading. In addition, the Plan disseminates last 
sale price information at other times during which any of its exchange 
participants is open for trading.\228\ During times in which the CTA 
Plan does not collect, process, and disseminate last sale price 
information, real-time last sale price information is not available. 
For the same reasons discussed in connection with the proposed modified 
uptick rule, we do not believe that it would further the goals of short 
sale price test regulation to apply the proposed uptick rule when last 
sale price information is not being collected and disseminated on a 
real-time basis. Thus, proposed Rule 201(e) limits application of the 
proposed uptick rule to times when ``a last sale price for [an] NMS 
stock is collected and disseminated on a current and continuing basis 
by a plan processor pursuant to an effective national market system 
plan.'' \229\
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    \227\ See 17 CFR 242.603(b). Rule 603 of Regulation NMS requires 
that every national securities exchange on which an NMS stock is 
traded and national securities association shall act jointly 
pursuant to one or more effective national market system plans to 
disseminate consolidated information, including a national best bid 
and national best offer, on quotations for and transactions in NMS 
stocks.
    \228\ See http://www.nyxdata.com/cta.
    \229\ See proposed Rule 201(e).
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C. The Proposed Circuit Breaker Rules

    We also are proposing for comment, as an alternative to the 
proposed price test restrictions, circuit breaker rules. The proposed 
circuit breaker halt rule would, when triggered by a specified decline 
in the price of a particular security, temporarily prohibit any person 
from selling short a particular NMS stock during severe market declines 
in that security, subject to certain exceptions. The proposed circuit 
breaker modified uptick rule would, when triggered by a specified 
decline in the price of a particular security, temporarily impose the 
proposed modified uptick rule for that security.
    As discussed above, questions persist about the reasons for the 
rapid speed of steep declines in the prices of securities. A short 
selling circuit breaker rule would be designed to target only those 
securities that experience rapid severe intraday declines and, 
therefore, might help to prevent short selling from being used to drive 
the price of a security down or to accelerate the decline in the price 
of those securities.
    In line with the Commission's position that market impediments 
should be minimized, a short selling circuit breaker when applied might 
benefit the market as a narrowly tailored response to extraordinary 
circumstances.\230\ Unlike the market wide circuit breakers that halt 
all trading, a short selling circuit breaker would apply only to those 
individual securities that are facing a severe intraday decline in 
share price. A short selling circuit breaker could be structured in a 
number of ways. We set forth below three forms of circuit breakers.
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    \230\ See Securities Exchange Act Release No. 39846 (Apr. 9, 
1998), 63 FR 18477 (Apr. 15, 1998) (order approving proposals by 
Amex, BSE, CHX, NASD, NYSE, and Phlx) (``1998 Release'').
---------------------------------------------------------------------------

1. Background on Circuit Breakers
    To protect investors and the markets, the Commission has approved 
proposals to restrict or halt trading if key market indexes fall by 
specified amounts. For example, the Commission approved such proposals 
from various exchanges (``SRO Circuit Breakers'') in response to the 
October 1987 market break. These measures were designed to permit 
brief, coordinated cross-market halts to provide opportunities during a 
severe market decline to re-establish equilibrium between buying and 
selling interests in an orderly fashion, and help to ensure that market 
participants have a reasonable opportunity to become aware of, and 
respond to, significant price movements.\231\
---------------------------------------------------------------------------

    \231\ See Securities Exchange Act Release No. 26198 (Oct. 19, 
1988), 53 FR 41637 (Oct. 24, 1988) (approving rules of the Amex, 
CBOE, NASD, NYSE).
---------------------------------------------------------------------------

    Currently, all stock exchanges and FINRA have rules or policies to 
implement coordinated circuit breaker halts.\232\ The options markets 
also have rules applying circuit breakers.\233\ The futures exchanges 
that trade index futures contracts have adopted circuit breaker halt 
procedures in conjunction with their price limit rules for index 
products.\234\ Finally, security futures products are required to have 
cross-market circuit breaker regulatory halt procedures in place.\235\ 
In addition, the Commission has authority under Section 12(k)(1) of the 
Exchange Act to suspend trading in the securities of individual 
issuers.\236\ Moreover, SROs have rules or policies in place to 
coordinate individual security trading halts corresponding to 
significant news events.\237\ Information on the securities subject to 
SRO regulatory trading halts is disseminated to market participants 
through the Common Messaging System (``CMS'') and other electronic 
media.\238\
---------------------------------------------------------------------------

    \232\ See 1998 Release supra note 230. See also NYSE Rule 80B. 
The circuit breaker procedures call for cross-market trading halts 
when the Dow Jones Industrial Average (DJIA) declines by 10 percent, 
20 percent, and 30 percent from the previous day's closing value. 
See e.g., BATS Exchange Rule 11.18.
    \233\ See Amex Rule 950 (applying Amex Rule 117, Trading Halts 
Due to Extraordinary Market Volatility, to options transactions); 
CBOE Rule 6.3B; ISE Rule 703; NYSE Arca Options Rule 7.5; and Phlx 
Rule 133.
    \234\ See, e.g., CME Rule 35102.I. The CME will implement a 
trading halt on S&P 500 Index futures contracts if a NYSE Rule 80B 
trading halt is imposed in the primary securities market. Trading of 
S&P 500 Index futures contracts will resume upon lifting of the NYSE 
Rule 80B trading halt.
    \235\ See Securities Exchange Act Release No. 45956 (May 17, 
2002), 67 FR 36740 (May 24, 2002).
    \236\ See 15 U.S.C. 78l(k)(1).
    \237\ See, e.g., FINRA Rule 6120.
    \238\ For example, in addition to disseminating news of trading 
halts through the CMS, Nasdaq publishes a daily list of securities 
subject to trading halts indicating the name of the issuer, the time 
the halt was initiated, and where applicable, the times at which 
quoting and trading may resume.
---------------------------------------------------------------------------

    The current SRO Circuit Breakers impose percentage based triggers 
that result in trading halts of varying lengths, dependent on the 
DJIA's rate of decline.\239\ Unlike the original SRO

[[Page 18066]]

Circuit Breakers, which used set point values to determine when a 
trading halt should be imposed, the current SRO Circuit Breakers are 
governed by percentage based declines tied to specific point values 
that are calculated at the beginning of each calendar quarter using the 
average daily DJIA closing for the previous month.\240\
---------------------------------------------------------------------------

    \239\ See 1998 Release 63 FR 18477 supra note 230 and 
accompanying text (The SRO Circuit Breakers, as adopted in 1988, 
called for a one-hour trading halt if the DJIA declined by 250 
points from the previous day's close, and a two-hour halt in the 
event of a 400 point decline.). See Securities Exchange Act Release 
No. 26198 (Oct. 19, 1988), 53 FR 41637 (Oct.24, 1988) (approving 
rules of the Amex, CBOE, NASD, NYSE). The original circuit breaker 
parameters were amended in 1996 to limit the duration of trading 
halts, and again in 1997 after it was determined that the 250 and 
400 point thresholds were too low given the substantial increase in 
the value of the DJIA in the years following implementation of 1988 
policies. The 1997 amendments increased the SRO Circuit Breakers' 
``trigger values'' to 350 and 500 points respectively for the one-
hour and two-hour trading halt scenarios. See Securities Exchange 
Act Release No. 38221 (Jan. 31, 1997) 62 FR 5871 (Feb. 7, 1997). The 
Commission approved the various Exchanges' circuit breaker revisions 
on a one year pilot basis. The SRO Circuit Breakers were revised 
again in 1998 to put into place circuit breakers triggered by 
certain percentage declines. See Securities Exchange Act Release No. 
39846 (Apr. 9, 1998) 63 FR 18477 (Apr. 15, 1998).
    \240\ See id.
---------------------------------------------------------------------------

    Under the current SRO Circuit Breakers, a 10% decline prior to 2 
p.m. will result in a one hour trading halt. Should the 10% decline 
occur after 2 p.m. but prior to 2:30 p.m., exchanges must halt trading 
for 30 minutes. If the 10% threshold is crossed after 2:30 p.m., 
trading will not be halted. A 20% decline in the DJIA will result in a 
two-hour trading halt, if the decline occurs prior to 1 p.m. and a one-
hour trading halt if the threshold is reached between 1 p.m., and 2 
p.m. If the DJIA declines by 20% after 2 p.m., under the current 
circuit breaker rules, trading will halt for the remainder of the day. 
Should the market decline by 30% at any point, trading will halt for 
the remainder of the day.\241\ The coordinated cross-market trading 
halts provided by the SRO Circuit Breakers operate only during 
significant market declines and are intended to substitute orderly, 
pre-planned halts for the ad hoc and destabilizing halts which can 
occur when market liquidity is exhausted.\242\
---------------------------------------------------------------------------

    \241\ See 1998 Release, 63 FR 18477 supra note 230.
    \242\ See Circuit Breaker Report by the Staff of the President's 
Working Group on Financial Markets (Aug. 18, 1998) (Circuit Breaker 
Report), n. 33.
---------------------------------------------------------------------------

    The SRO Circuit Breakers focus on market indexes rather than on the 
market for an individual security. The SRO Circuit Breakers apply a 
market-wide trading halt, rather than a halt in an individual security, 
or a short selling halt. The proposed circuit breaker rules, in 
contrast, would temporarily restrict only short selling (and only) in 
an individual NMS security that suffers a severe price decline.
    We believe that either a short sale price test restriction or a 
circuit breaker rule may be appropriate to address the recent change in 
market conditions and erosion of investor confidence. As discussed 
above, investors have become increasingly concerned about sudden and 
excessive declines in prices that appear to be unrelated to issuer 
fundamentals.\243\ Circuit breakers that are triggered by severe 
declines in the price of individual securities may be a targeted 
response to address these concerns.
---------------------------------------------------------------------------

    \243\ See supra Section II.C. (discussing investor confidence).
---------------------------------------------------------------------------

2. Proposed Circuit Breaker Halt Rule
    We are proposing a short selling circuit breaker that, when 
triggered by a severe price decline in a particular security, would 
prohibit any person from selling short that security, wherever it is 
traded, while the circuit breaker is in effect, subject to certain 
exceptions.
    While the Commission does not favor market closings as a general 
matter, the proposed circuit breaker halt rule would not be as broad as 
a market-wide trading halt. Furthermore, the Commission has recognized 
that circumstances may infrequently call for a trading pause that 
allows participants to reassess conditions.\244\ We believe that a 
pause in short selling resulting from a significant decline in the 
price of an individual equity security might provide a similar measure 
of stability.
---------------------------------------------------------------------------

    \244\ See 1998 Release, 63 FR 18477 supra note 230.
---------------------------------------------------------------------------

    We seek comment on whether it would be appropriate for the 
Commission to impose a circuit breaker that when triggered would halt 
all short selling in an individual equity security, wherever it is 
traded, for the remainder of the trading day if the price of the 
security has declined by at least 10% from the prior day's closing 
price for that security, as measured by the closing price of the 
security on the consolidated system. Like the proposed modified uptick 
rule and the proposed uptick rule, we propose that it would apply to 
all NMS stocks as that term is defined under Rule 600(a)(47) of 
Regulation NMS.\245\ We seek comment regarding the scope of a potential 
circuit breaker's application and to which securities it might most 
appropriately apply.
---------------------------------------------------------------------------

    \245\ See proposed Rule 201(a)(1).
---------------------------------------------------------------------------

    We preliminarily believe that a 10% decline in a security's price 
as measured from the prior day's closing price, as reported in the 
consolidated system, would be an appropriate level at which to trigger 
a circuit breaker that results in a short selling halt. As discussed 
above, such a percentage decline would be consistent with the current 
SRO Circuit Breakers.\246\ The 10% threshold for a circuit breaker 
that, when triggered, results in a short selling halt in an individual 
security would reflect the format of current SRO Circuit Breakers and 
use a trigger based on a fluctuating value, the share price, to strike 
a balance between the need to halt short selling in moments of severe 
decline in a security's price and the market participant's expectation 
that its short selling strategy will be available in an efficient and 
open marketplace. We note that a group of national securities exchanges 
recommended a 10% decline threshold in connection with a short selling 
circuit breaker combined with a short sale price test restriction.\247\ 
Another commenter supported a 10% minimum threshold, but also 
recommended a ``rolling'' circuit breaker that when triggered would 
impose short selling halts of varying lengths, depending on the level 
of decline in the price of an individual equity security.\248\ We 
recognize that a lesser or greater percentage decline or some other 
measure of decline may be appropriate, and seek comment on that 
question.
---------------------------------------------------------------------------

    \246\ See 1998 Release, 63 FR 18477 supra note 230 and 
accompanying text.
    \247\ See National Exchanges letter, supra note 63.
    \248\ See letter from Credit Suisse, supra note 122.
---------------------------------------------------------------------------

    As described in more detail below, the price decline would be based 
on the security's price during the trading day as reported in the 
consolidated system as compared to the prior day's closing price as 
reported in the consolidated system. The prior day's closing price 
would be the last price reported during regular trading hours \249\ the 
prior day.
---------------------------------------------------------------------------

    \249\ ``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).''
---------------------------------------------------------------------------

    The proposed circuit breaker halt rule would, once triggered by a 
10% decline in the price of a security from the prior day's closing 
price on any trading day, impose a short selling halt in the individual 
security at times when the last sale price is calculated and 
disseminated in the consolidated system. We based the time period on 
the calculation and dissemination of last sale price because the 
circuit breaker is triggered by a percentage decline in the security's 
intra-day last sale price relative to the prior day's last sale price 
at the end of regular trading hours on the prior day.
    In addition, to avoid market disruption that may occur if a circuit 
breaker is triggered late in the trading day, the proposed circuit 
breaker rules would not be triggered if the specified market decline 
threshold is reached in an NMS security within thirty minutes of the 
end of regular trading hours. Former NYSE Rules 80A(a) and 80A(b) 
provided that a circuit breaker would not trigger program trading 
restrictions after 3:25 p.m., or approximately thirty-five minutes 
before the close. We seek comment as to whether thirty minutes is an 
appropriate balance to ensure that

[[Page 18067]]

the goals of the proposed rule would be met while also reducing the 
potential for market disruption toward the close of regular trading 
hours.
    We believe that a short selling halt that persists at times when 
the last sale price is calculated and disseminated following a 10% 
decline in a security's price might be appropriate. We are concerned 
that a short selling halt for a lesser time might not provide 
sufficient time to re-establish equilibrium between buying and selling 
interest in the individual security in an orderly fashion. We also 
believe that a short selling halt for this length of time might be 
necessary to help ensure that market participants have a reasonable 
opportunity to become aware of, and respond to, a significant decline 
in a security's price. We seek comment below, however, regarding 
whether a longer or shorter short selling halt would be appropriate, or 
whether it would be appropriate to impose a short selling halt on a 
rolling basis as suggested by an industry commenter.\250\
---------------------------------------------------------------------------

    \250\ See letter from Credit Suisse supra note 122.
---------------------------------------------------------------------------

    We are also seeking comment on the potential costs and benefits of 
a short selling circuit breaker that when triggered results in a 
temporary halt on short selling. The Commission has previously noted 
that circuit breakers may benefit the market by allowing participants 
an opportunity to reevaluate circumstances and respond to 
volatility.\251\ Unlike the proposed modified uptick rule and the 
proposed uptick rule, this proposed circuit breaker halt rule would 
halt all short selling for an individual security for the specified 
period of time. In discussing a short selling circuit breaker, one 
commenter noted that such a measure could address the issue of ``bear 
raids'' while limiting the market impact that may arise from other 
forms of short sale price test restrictions.\252\ The Commission has 
long held the view that coordinated circuit breakers might restore 
investor confidence during times of substantial uncertainty.\253\ We 
believe the proposed circuit breaker halt rule might produce similar 
benefits.
---------------------------------------------------------------------------

    \251\ See 1998 Release, 63 FR 18477.
    \252\ See Brown Letter supra note 55.
    \253\ See 1998 Release, 63 FR 18477 supra note 230.
---------------------------------------------------------------------------

    We recognize, however, that there are potential costs associated 
with implementation of a short selling circuit breaker that when 
triggered results in a temporary short selling halt. As discussed 
below, we anticipate that market participants charged with 
implementation of such a short selling circuit breaker would have to 
invest human and financial resources to update systems as necessary for 
compliance. Furthermore, as discussed above, short selling is an 
important tool in price discovery and the provision of liquidity to the 
market, and we recognize that imposition of a short selling circuit 
breaker that when triggered imposes short selling halts could restrict 
otherwise legitimate short selling activity during periods of extreme 
volatility.
    We also understand there are concerns about a potential ``magnet 
effect'' that could arise as an unintended consequence of a circuit 
breaker that halts short selling and results in short sellers driving 
down the price of an equity security in a rush to execute short sales 
before the circuit breaker is triggered. One commenter noted that a 
short sale circuit breaker could exacerbate downward pressure on stocks 
as their value reached the threshold level.\254\ Another commenter, 
however, in discussing the issue of a ``magnet effect'' cited empirical 
studies that question whether a circuit breaker would result in 
artificial pressure on the price of individual securities.\255\ We are 
also concerned about another type of ``magnet effect'' in which short 
selling demand is built up until the circuit breaker is lifted.
---------------------------------------------------------------------------

    \254\ See letter to Mary Schapiro, Chairman, from Direct Edge, 
dated March 30, 2009.
    \255\ See letter from Credit Suisse supra note 122.
---------------------------------------------------------------------------

    Similar to the short sale price test restrictions, the proposed 
circuit breaker halt rule would apply to NMS securities other than 
options. However, we seek comment below on whether such a rule should 
also apply to non-NMS securities.
    The proposed circuit breaker halt rule would include exceptions 
substantially identical to exceptions that were included in the Short 
Sale Ban Emergency Order,\256\ as amended by the Commission on 
September 21, 2008 (``September 21, 2008 Amended Order'') 
(collectively, the ``Short Sale Ban'').\257\ We believe the proposed 
circuit breaker halt rule should include exceptions that mirror certain 
of the exceptions in the Short Sale Ban because the proposed rule 
shares the same goal of prohibiting short selling that might exacerbate 
a price decline during a period of sudden and excessive price declines, 
while being designed to maintain functions that, for example, would be 
necessary to help provide adequate liquidity. Short sales effected 
under these exceptions would be marked ``short exempt.''
---------------------------------------------------------------------------

    \256\ See Short Sale Ban Emergency Order, 73 FR 55169-02 (Sept. 
24, 2008).
    \257\ See September 21, 2008 Amendment, 73 FR 55556-01 (Sept. 
25, 2008).
---------------------------------------------------------------------------

    The proposed circuit breaker halt rule could operate in place of, 
or in addition to, a short sale price test restriction. For instance, 
in addition to the imposition of a permanent, market-wide price test 
restriction, a circuit breaker halt rule could also prohibit any person 
from selling short any security that suffers a severe price decline.
a. Market Makers and Options Market Makers Engaged in Bona Fide Market 
Making Activities
    The Short Sale Ban excepted registered market makers, block 
positioners, or other market makers obligated to quote in the over-the-
counter market, if they were selling short a publicly traded security 
covered by the Short Sale Ban as part of bona fide market making in 
such security.\258\ The purpose of the exception was to permit market 
makers to continue to provide liquidity to the markets, facilitate 
orders including customer buy orders, and otherwise comply with their 
obligations as market makers.
---------------------------------------------------------------------------

    \258\ See id.
---------------------------------------------------------------------------

    The term ``market maker'' includes any specialist permitted to act 
as a dealer, any dealer acting in the capacity of a block positioner, 
and any dealer who, with respect to a security, holds itself out (by 
entering quotations in an inter-dealer quotation system or otherwise) 
as being willing to buy and sell such security for its own account on a 
regular or continuous basis.\259\ As the Commission has stated 
previously, a market maker engaged in bona fide market making is a 
``broker-dealer that deals on a regular basis with other broker-
dealers, actively buying and selling the subject security as well as 
regularly and continuously placing quotations in a quotation medium on 
both the bid and ask side of the market.'' \260\ We recently provided 
guidance on bona fide market making for purposes of Regulation SHO Rule 
203(b), and believe that such guidance would also be appropriate with 
regard to a market maker exception for the proposed circuit breaker 
halt rule.\261\ We believe it is appropriate to include a market maker 
exception for this proposed alternative because a halt in short selling 
in a security would, during the period of the halt, have far greater 
effects on liquidity and legitimate price discovery activity than the 
proposed modified uptick rule or proposed uptick

[[Page 18068]]

rule, which, as discussed above, are each based on a trading unit 
increment.
---------------------------------------------------------------------------

    \259\ See 2004 Regulation SHO Adopting Release, 69 FR at 48015, 
n. 66 (citing to Section 3(a)(38) of the Exchange Act).
    \260\ See Exchange Act Release No. 32632 (July 14, 1993), 58 FR 
39072, 39074 (July 21, 1993).
    \261\ See Exchange Act Release No. 58775 (Oct. 14, 2008); 73 FR 
61690 (Oct. 17, 2008).
---------------------------------------------------------------------------

b. Bona Fide Market Making in Derivatives
    The Short Sale Ban also included an exception for any person that 
is a market maker that effects a short sale as part of bona fide market 
making and hedging activity related directly to bona fide market making 
in derivatives on the publicly traded securities of any security 
covered by the Short Sale Ban.\262\ Under the Short Sale Ban, this 
exception applied to all market makers, including over-the-counter 
market makers, and to bona fide market making and hedging activity 
related directly to bona fide market making in exchange traded funds 
and exchange traded notes of which securities included in the Short 
Sale Ban were a component. We stated that the purpose of the exception 
was to permit market makers to continue to provide liquidity to the 
markets.\263\ Similarly, we believe such an exception would be 
appropriate for the proposed circuit breaker halt rule.
---------------------------------------------------------------------------

    \262\ See Short Sale Ban Emergency Order, 73 FR 55169-02.
    \263\ See id.
---------------------------------------------------------------------------

    During the period that the Short Sale Ban was effective, to help 
ensure that the exception would not result in increased short exposure 
in securities covered by the Short Sale Ban, we limited the exception 
so that if a customer or counterparty position in a derivative security 
based on the security was established after the effectiveness of the 
September 21 Amended Order, a market maker could not effect the short 
sale if the market maker knew that the customer's or counterparty's 
transaction would result in the customer or counterparty establishing 
or increasing an economic net short position (i.e., through actual 
positions, derivatives, or otherwise) in the issued share capital of a 
firm covered by the Short Sale Ban. This provision was included to 
address potential circumvention of the Short Sale Ban during the 
several weeks that it was in effect.\264\ However, we do not believe 
such a provision is necessary for the proposed circuit breaker halt 
rule because the rule as proposed only contemplates a one-day (or less 
than one day depending on when during the day the circuit breaker is 
triggered) prohibition on short selling of any NMS security that 
becomes subject to the circuit breaker.
---------------------------------------------------------------------------

    \264\ See September 21, 2008 Amendment, 73 FR 55556-01.
---------------------------------------------------------------------------

c. Options and Futures Contract Expiration
    The Short Sale Ban included an exception to allow short sales that 
occurred as a result of automatic exercise or assignment of an equity 
option held prior to effectiveness of the Short Sale Ban due to 
expiration of the option.\265\ It also allowed short sales that 
occurred as a result of the expiration of futures contracts held prior 
to effectiveness of the Short Sale Ban.\266\
---------------------------------------------------------------------------

    \265\ See Short Sale Ban Emergency Order, 73 FR 55169-02.
    \266\ See id.
---------------------------------------------------------------------------

    We propose including a similar exception for the proposed circuit 
breaker halt rule for short sales that occur as a result of automatic 
exercise or assignment of an equity option held before a circuit 
breaker on a particular security is triggered and a short selling halt 
is imposed in that security due to expiration of the option. We are 
also proposing an exception to the proposed circuit breaker halt rule 
to allow short sales that occur as a result of the expiration of 
futures contracts held before a circuit breaker is triggered in a 
particular security.
    Persons that purchased or sold options prior to the effectiveness 
of a circuit breaker halt entered into such transactions with the 
expectation that they would be able to fulfill their contractual 
obligations and receive the benefits of their bargain in return. 
Generally, options contracts are purchased or sold prior to the day in 
which a circuit breaker might be triggered. Therefore, providing an 
exception to the proposed circuit breaker halt rule to allow such 
persons to continue to rely on their pre-existing transactions until 
completion does not raise the concerns that the proposed circuit 
breaker halt rule is intended to address. As with the Short Sale Ban, 
we propose to limit this exception to automatic exercises and 
assignments to prevent it from being abused by more discretionary 
options exercises.
d. Exception for Assignment To Call Writers Upon Exercise of an Option
    To allow for creation of long call options, the Short Sale Ban 
included an exception to permit short sales that occur as a result of 
assignment to call writers upon exercise.\267\ When options are 
exercised, call writers may be required to sell short in order to 
satisfy their obligations. Because call writers do not have discretion, 
and because the short sales are effected in order to fill buying 
demand, we believe that including this exception in the proposed 
circuit breaker halt rule would benefit the markets while not opening 
the door to the abuses that the proposed rule is intended to address.
---------------------------------------------------------------------------

    \267\ See September 21, 2008 Amendment, 73 FR 55556-01.
---------------------------------------------------------------------------

e. Owned Securities
    The Short Sale Ban provided that sales of Rule 144 securities were 
excepted from its requirements because Rule 144 securities are owned 
securities and do not raise the concerns that the Short Sale Ban was 
designed to address.\268\ We believe a similar exception for securities 
that a seller is deemed to own under Rule 200(b) should be included in 
the proposal.
---------------------------------------------------------------------------

    \268\ See id.
---------------------------------------------------------------------------

    Rule 200(g)(1) of Regulation SHO provides that a sale can be marked 
``long'' only if the seller is deemed to own the security being sold 
and either (i) the security is in the broker-dealer's physical 
possession or control, or (ii) it is reasonably expected that the 
security will be in the broker-dealer's physical possession or control 
by settlement of the transaction.\269\ Thus, even where a seller owns a 
security, if delivery will be delayed, such as in the sale of formerly 
restricted securities pursuant to Rule 144 of the Securities Act of 
1933, or where a convertible security, option, or warrant has been 
tendered for conversion or exchange, but the underlying security is not 
reasonably expected to be received by settlement date, such sales must 
be marked ``short.'' \270\ As a result, during a halt triggered by a 
circuit breaker, sellers would be permitted to sell securities that 
although owned, are subject to the provisions of Regulation SHO 
governing short sales due solely to the seller being unable to deliver 
the security to its broker-dealer prior to settlement based on 
circumstances outside the seller's control.
---------------------------------------------------------------------------

    \269\ See 17 CFR 242.200(g)(1).
    \270\ See id.
---------------------------------------------------------------------------

    Although the Short Sale Ban only excepted Rule 144 securities, we 
believe that other securities considered ``deemed to own'' for purposes 
of Rule 200(b) should also be excepted from the proposed circuit 
breaker halt rule because these are owned securities that do not raise 
the same concerns that the proposed rule is designed to address.
3. Proposed Circuit Breaker Price Test Rules
    We are also proposing a short selling circuit breaker that, when 
triggered by a severe decline in the price of a particular security, 
would impose short sale price restrictions for that security

[[Page 18069]]

wherever it is traded for the remainder of the trading day. Such a 
circuit breaker would be imposed in place of a permanent, market-wide 
short sale price test restriction.
    Similar to the reasons stated in the discussion above regarding the 
proposed circuit breaker halt rule, a circuit breaker price test rule 
would be triggered by a 10% intraday decline in the price of an 
individual equity security from the prior day's closing price as 
reported in the consolidated system. We preliminarily believe that a 
10% decline in a security's price as measured from the prior day's 
closing price, as reported in the consolidated system, would be an 
appropriate level at which to trigger a circuit breaker that results in 
a short sale price test restriction. As discussed above, such a 
percentage decline would be consistent with the current SRO Circuit 
Breakers.\271\ We recognize that a lesser or greater percentage decline 
or some other measure of decline may be appropriate.
---------------------------------------------------------------------------

    \271\ See 1998 Release, 63 FR 18477 supra note 230 and 
accompanying text.
---------------------------------------------------------------------------

    We also seek comment regarding the form of the short sale price 
test restrictions that could be imposed when the proposed circuit 
breaker is triggered. Such a circuit breaker when triggered could 
impose a short sale price test restriction in the form of the proposed 
modified uptick rule based on the national best bid, or in the form of 
the proposed uptick rule based on the last sale price of the individual 
security. This would include the same proposed short sale price test 
and provisions that would be used in the proposed modified uptick and 
proposed uptick rules, permitting certain sales to occur 
notwithstanding the price limitations otherwise applicable under the 
two proposed rules.\272\ We believe these provisions would be justified 
for the same reasons described regarding the proposed modified uptick 
rule and the proposed uptick rule, respectively.\273\
---------------------------------------------------------------------------

    \272\ See Section III.A. and III.B. (discussing the operation of 
the proposed modified uptick rule and the proposed uptick rule 
respectively).
    \273\ See Sections III.A.2. and III.B.2. (discussing the short 
exempt provisions of the proposed modified uptick rule and proposed 
uptick rule, respectively).
---------------------------------------------------------------------------

    As described in more detail below, the price decline would be based 
on the security's price during the trading day as reported in the 
consolidated system as compared to the prior day's closing price as 
reported in the consolidated system. The prior day's closing price 
would be the last price reported during regular trading hours \274\ the 
prior day.
---------------------------------------------------------------------------

    \274\ ``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).''
---------------------------------------------------------------------------

    The proposed circuit breaker modified uptick rule would, once 
triggered by a 10% decline in the price of a security from the prior 
day's closing price, impose the modified uptick rule in the individual 
security at times when the national best bid is calculated and 
disseminated in the consolidated system, for the remainder of the 
trading day. We based the time period on the calculation and 
dissemination of the national best bid in the consolidated system 
because the proposed modified uptick rule is based on the national best 
bid as calculated and disseminated in the consolidated system.
    Similarly, the proposed circuit breaker uptick rule would, once 
triggered by a 10% decline in the price of a security from the prior 
day's closing price on any trading day, impose the uptick rule in the 
individual security at times when the last sale price is calculated and 
disseminated in the consolidated system. We based the time period on 
the calculation and dissemination of the last sale price because the 
proposed uptick rule is based on the last sale price as calculated and 
disseminated in the consolidated system.
    To avoid market disruption that may occur if a circuit breaker is 
triggered late in the trading day, the proposed circuit breaker rules 
would not be triggered if the specified market decline threshold is 
reached in an NMS security within thirty minutes of the end of regular 
trading hours. Former NYSE Rules 80A(a) and 80A(b) provided that a 
circuit breaker would not trigger program trading restrictions after 
3:25 p.m., or approximately thirty-five minutes before the close of 
regular trading hours. As with the proposed circuit breaker halt rule, 
we seek comment as to whether thirty minutes is an appropriate balance 
to ensure that the goals of the proposed rule would be met while also 
reducing the potential for market disruption toward the close of 
regular trading hours.
    We believe that the temporary imposition of the proposed modified 
uptick rule, after a circuit breaker is triggered, that operates at 
times when the national best bid is disseminated following a 10% 
decline in a security's price might be appropriate. Similarly, we 
believe that the temporary imposition of the proposed uptick rule, 
after a circuit breaker is triggered, that operates at times when the 
last sale price is calculated and disseminated following a 10% decline 
in a security's price might be appropriate. We seek comment below, 
however, regarding whether longer or shorter time periods would be 
appropriate.
    We are seeking comment on the potential benefits and costs of the 
proposed circuit breaker price test rule. We believe that such a rule 
might be a narrowly tailored means to help restore investor confidence 
and stabilize the market for individual securities. Such a rule might 
also help prevent short selling, including potentially abusive or 
manipulative short selling, from being used as a tool for driving the 
market down or from being used to accelerate a declining market by 
exhausting all remaining bids at one price level, causing successively 
lower prices to be established by long sellers. Further, we note that 
allowing short selling to continue with price test restrictions once 
the circuit breaker is triggered might have a lesser impact on 
legitimate short selling and normal market activity including price 
discovery and the provision of liquidity than a circuit breaker that 
triggers a short selling halt. We also believe that a circuit breaker 
rule that triggers a price test restriction, because it is based on a 
trading increment of a penny as opposed to a short sale halt, may also 
alleviate some concerns over the possibility of artificial downward 
pressure that might arise from a ``magnet effect'' prior to reaching 
the trigger threshold.
    We recognize that a short selling circuit breaker that, when 
triggered, imposes short sale price test restrictions for the remainder 
of the trading day, would result in costs on market participants 
responsible for implementing and assuring compliance with the 
requirements of such restrictions. There might be significant 
operational costs associated with reprogramming systems to comply with 
short sale price test restrictions, and we anticipate that these costs 
might be greater than those required to comply with a short selling 
circuit breaker that, when triggered, imposes halts on short selling in 
individual securities. There might also be requirements for additional 
staff and costs associated with personnel hiring and training related 
to maintaining and ensuring compliance with any short sale price test 
restrictions.\275\
---------------------------------------------------------------------------

    \275\ See, e.g., Credit Suisse letter, supra note 122.
---------------------------------------------------------------------------

    Further, we recognize that short sale price test restrictions 
imposed as a result of a circuit breaker might result in many of the 
same costs discussed in detail in Section IX pertaining to the 
implementation of market-wide short

[[Page 18070]]

sale price test restrictions.\276\ Those costs might include a 
reduction of the benefit of legitimate short selling and a subsequent 
reduction in the quantity of short selling, which we have noted might 
lead to a decrease in market quality 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.\277\ We are seeking comment on the extent of these and other 
costs associated with a circuit breaker that when triggered imposes 
short sale price test restrictions.
---------------------------------------------------------------------------

    \276\ See Section IX (discussing costs and benefits of the 
proposed modified uptick rule and the proposed uptick rule).
    \277\ See Section IX.B.
---------------------------------------------------------------------------

    The proposed circuit breaker price test rule would result in either 
the proposed modified uptick rule or the proposed uptick rule, for the 
remainder of the trading day, as each proposed rule is described above. 
For instance, a circuit breaker resulting in the proposed modified 
uptick rule would require that trading centers establish, maintain, and 
enforce policies and procedures reasonably designed to prevent short 
selling on a downbid in a security where the circuit breaker has been 
triggered by a severe decline in the price of that NMS security. 
Broker-dealers could mark certain short sale orders ``short-exempt'' 
under the conditions set forth above. A circuit breaker that resulted 
in the proposed uptick rule would, when triggered by a decline in the 
price of a particular security, prohibit any person from selling short 
that security on a downtick. This would be a more limited approach than 
a short sale price test rule that is in place at all times and thus 
might result in fewer of the potential disadvantages that would result 
from a short sale price test that was in place at all times.
    Under the proposed circuit breaker price test rule, a price test 
would not be in place on a permanent and market-wide basis for all 
securities. Under the proposed circuit breaker that results in the 
proposed modified uptick rule, trading centers would need to establish 
and maintain reasonable policies and procedures in advance so that they 
are able to comply with the proposed circuit breaker rule whenever 
triggered. It would not be reasonable for a trading center to wait 
until the circuit breaker is triggered to begin establishing policies 
and procedures to prevent the execution or display of the particular 
security on a downbid. Thus, a circuit breaker that triggers the 
proposed modified uptick rule would result in some immediate upfront 
costs to trading centers.
    In the Solicitation of Comments, we seek comment on whether the 
short sale price test restrictions should remain in place for a longer 
or shorter period of time, whether a 10% decline would be an 
appropriate trigger for the circuit breaker proposals, or if for 
example, a 5% or 20% threshold might be more appropriate, and what 
additional costs may be associated with a proposed circuit breaker 
price test rule.

IV. Request for Comment

    In addition to the specific requests for comment found throughout 
this proposing release, we seek comment generally from all members of 
the public on all aspects of the proposed amendments to Rules 200(g) 
and 201 of Regulation SHO. We request that commenters provide empirical 
data to support their views and arguments related to these proposals. 
In addition to the questions set forth above, commenters are welcome to 
offer their views on any other matter raised by the proposed amendments 
to Regulation SHO. Specifically, are there any other possible 
restrictions on short selling that the Commission should consider, 
particularly ones that might be helpful in a severe market decline?
Questions Regarding Proposed Short Sale Price Tests Generally
    1. Should short sales be subject to a short sale price test 
restriction, or should we continue to rely on current short sale 
regulations and anti-fraud and anti-manipulation provisions of the 
securities laws to address potentially abusive short selling?
    2. We note that our decision to propose a short sale price test was 
based, in part, on the recent changes in market conditions and investor 
confidence.\278\ To what extent, if any, would a short sale price test, 
such as the proposed modified uptick rule or the proposed uptick rule, 
be necessary or appropriate in light of recent changes in market 
conditions? Please explain and provide empirical data in support of any 
arguments and/or analyses. How would the proposed modified uptick rule 
or the proposed uptick rule affect market conditions today? Please 
explain and provide empirical data in support of any arguments and/or 
analyses.
---------------------------------------------------------------------------

    \278\ See Section II.C.
---------------------------------------------------------------------------

    3. How effective would the proposed modified uptick rule or the 
proposed uptick rule be in allowing relatively unrestricted short 
selling in an advancing market? Please explain and provide empirical 
data in support of any arguments and/or analyses. How effective would 
the proposed modified uptick rule or proposed uptick rule be at helping 
to prevent short selling, including potentially abusive or manipulative 
short selling, from being used as a tool for driving the market down or 
from being used to accelerate a declining market by exhausting all 
remaining bids at one price level, causing successively lower prices to 
be established by long sellers? Please explain and provide empirical 
data in support of any arguments and/or analyses. Could the proposed 
modified uptick rule or proposed uptick rule be modified to better meet 
these goals? If so, how? Please explain and provide empirical data in 
support of any arguments and/or analyses.
    4. We also note our concern regarding investor confidence based on 
the numerous requests for reinstatement of short sale price test 
restrictions.\279\ Would reinstating a short sale price test 
restriction such as the proposed modified uptick rule or proposed 
uptick rule help restore investor confidence? If so, why? If not, why 
not? Please explain and provide empirical data or other specific 
information in support of any arguments and/or analyses.
---------------------------------------------------------------------------

    \279\ See id.
---------------------------------------------------------------------------

    5. In addition to investor confidence and market volatility, we 
have stated that we are concerned about potentially abusive short 
selling. Would the proposed modified uptick rule or proposed uptick 
rule help address potentially abusive short selling? If so, how? If 
not, why not? Please explain and provide empirical data in support of 
any arguments and/or analyses.
    6. We note that short selling provides the market with important 
benefits, including market liquidity and pricing efficiency.\280\ What 
effect, if any, would the proposed modified uptick rule or proposed 
uptick rule have on market liquidity? Please explain and provide 
empirical data in support of any arguments and/or analyses. What 
effect, if any, would the proposed modified uptick rule or proposed 
uptick rule have on pricing efficiency? Please provide empirical data 
in support of any arguments and/or analyses.
---------------------------------------------------------------------------

    \280\ See Section II.A.
---------------------------------------------------------------------------

    7. We also note that short selling may be used to illegally 
manipulate stock prices.\281\ What impact, if any, would the proposed 
modified uptick rule or proposed uptick rule have on ``bear raids''? 
Please explain and provide empirical data in support of any arguments 
and/or analyses. To what extent, if any, does unrestricted short

[[Page 18071]]

selling exacerbate a declining market? Please explain and provide 
empirical data in support of any arguments and/or analyses.
---------------------------------------------------------------------------

    \281\ See id.
---------------------------------------------------------------------------

    8. Is there a need for short sale price test restrictions? If there 
is a need for a short sale price test, would the proposed modified 
uptick rule be the best test? If so, why? If not, why not? Would the 
proposed uptick rule be the best test? If so, why? If not, why not? 
What are the costs and benefits of the proposed modified uptick rule 
versus the proposed uptick rule? What would be the general costs and 
benefits of short sales being subject to the proposed modified uptick 
rule? What would be the general costs and benefits of short sales being 
subject to the proposed uptick rule? Should we consider other forms of 
short sale price tests? If so, what forms? What would be the costs and 
benefits of any alternative forms of short sale price tests? Please 
explain and provide empirical data in support of any arguments and/or 
analyses.
    9. Would the proposed modified uptick rule or proposed uptick rule 
be an appropriate short sale price test in the current decimals 
environment? Would the proposed modified uptick rule or proposed uptick 
rule be more suitable in a decimals environment with multiple trading 
centers? Please explain and provide empirical data in support of any 
arguments and/or analyses.
    10. Should the proposed modified uptick rule or proposed uptick 
rule be limited to specific sectors or industries, such as financials, 
due to the unique harms or susceptibility to harms to those industries 
or sectors from the potential adverse effect of short selling in a 
declining market? If so, please describe the types of industries or 
sectors that should be covered and the unique harms or susceptibility 
to harm to which they are subject. Please also describe the mechanisms 
or criteria that should be used to determine which entities fall within 
these industries or sectors.
    11. One of the reasons for the elimination of former Rule 10a-1 and 
the prohibition on any SRO from having a short sale price test in July 
2007 was because the application of short sale price tests had become 
disjointed with different price tests applying to the same securities 
trading in different markets. Under both proposed rules, all covered 
securities, wherever traded, would be subject to one short sale price 
test. What are the advantages or disadvantages of having a uniform 
short sale price test in the covered securities across all markets? 
Please explain.
    12. How would trading systems and strategies used in today's 
marketplace be impacted by the proposed modified uptick rule or 
proposed uptick rule? How might market participants alter their trading 
systems and strategies in response to either proposed rule, if adopted? 
To further the goal of having a uniform short sale price test, both the 
proposed modified uptick rule and proposed uptick rule would provide 
that no SRO shall have any rule that is not in conformity with, or 
conflicts with either proposed rule. Is this prohibition necessary or 
appropriate? Would there ever be a need for an SRO to institute its own 
short sale price test? If so, why?
    13. One of the reasons for the elimination of former Rule 10a-1 was 
that the disjointed application of the rule resulted in an un-level 
playing field among market participants. Could implementation of a 
short sale price test through a policies and procedures approach 
applicable to a ``trading center'' lead to disproportionate burden 
among market participants? In what way? Would a straight prohibition 
implementation approach be preferable in this regard? To what extent 
could the proposed exceptions to either alternative rule contribute to 
a disproportionate burden on certain market participants? What effect 
might there be on relative competitive advantages of different market 
participants if the short sale price test were based on an increment 
larger than a penny?
    14. What impact, if any, would the trading requirements of 
Regulation NMS have on implementing the proposed modified uptick rule 
or proposed uptick rule?
    15. To what extent does the ability to obtain a short position 
through the use of derivative products such as options, futures, 
contracts for difference, warrants, credit default swaps or other swaps 
(so-called ``synthetic short sales'') or other instruments (such as 
inverse leveraged exchange traded funds) undermine the goals of short 
sale price test restrictions, such as the proposed modified uptick rule 
and the proposed uptick rule? Will synthetic short sales increase if 
the Commission adopts either alternative short sale price test? What 
effects might such an increase have on market liquidity and pricing 
efficiency? Please explain.
    16. Before determining whether to adopt a short sale price test 
restriction on a permanent basis, should we adopt a rule that would 
apply, on a pilot basis, the operation of a short sale price test 
restriction for specified securities? Such an approach would allow us 
to study the effects on, among other things, market volatility, price 
efficiency, and liquidity during the recent changes in market 
conditions. What would be other benefits of taking this approach? What 
would be the costs of taking this approach? Would the costs associated 
with programming systems to apply a short sale price test restriction 
on specified securities outweigh any benefits of having a pilot? If we 
were to take this approach, how long would it take to program systems 
to apply a short sale price test restriction to specified securities? 
Similar to the Pilot conducted immediately prior to the elimination of 
former Rule 10a-1, the securities that could be subject to the pilot 
could be comprised of a subset of the Russell 3000 index, or such other 
securities as necessary or appropriate in the public interest and 
consistent with the protection of investors after giving due 
consideration to the security's liquidity, volatility, market depth and 
trading market. Would it be appropriate for such a pilot to be 
comprised of a subset of the Russell 3000 index? How should the 
securities that would comprise a pilot be selected? Please explain the 
reasons for any suggested selection method. Such a pilot could remain 
in effect for one or two years. Would a one or two year pilot be an 
appropriate period of time? If so, why? If not, why not? Please provide 
specific reasons to support any views in favor of establishing another 
time period. Please provide any additional details regarding how a 
pilot could be structured in terms of the securities to be selected, 
the time-frame of the pilot, and the types of restrictions that could 
be placed on short selling of such securities.
    17. In connection with the Pilot conducted immediately prior to our 
elimination of former Rule 10a-1, SROs publicly released transactional 
short selling data so that data would be available to the public to 
encourage independent researchers to study the Pilot. If we were to 
adopt a rule that would apply, on a pilot basis, a short sale price 
test restriction on specified securities, we would expect to make 
information obtained during any such pilot publicly available. In 
addition, we would expect SROs to again make data available to the 
public during any such pilot. Would there be any costs associated with 
making short selling data available to the public during the period of 
a pilot? What would be the benefits of making such data available to 
the public?
    18. Commenters have stated that the Pilot conducted prior to the 
elimination of former Rule 10a-1 was insufficient, in part, because it 
only covered a period

[[Page 18072]]

of relative market stability \282\ and that the Pilot should have 
lasted longer to ``ensure at least one bear market was involved in the 
study.'' \283\ Did the Pilot cover a sufficient period of time?
---------------------------------------------------------------------------

    \282\ See Brown Letter supra note 55.
    \283\ See id.
---------------------------------------------------------------------------

    19. The proposed implementation period for both of the proposed 
rules would be three months from the effective date of the proposed 
rule, if adopted. Would a three month implementation period be 
appropriate for the proposed modified uptick rule? Would a three month 
implementation period be appropriate for the proposed uptick rule? 
Should there be a shorter or longer implementation period for either 
proposed rule? Please explain.
Questions Regarding Proposed Modified Uptick Rule
    1. The proposed modified uptick rule would define the term ``down-
bid price'' to mean a price that is less than the current national best 
bid or, if the last differently priced national best bid was greater 
than the current national best bid, a price that is less than or equal 
to the current national best bid. Should this definition be altered? If 
the last differently priced national best bid was greater than the 
current national best bid, should short selling be restricted to a cent 
above the current national best bid, or a higher or lower increment? If 
so, why? If a specific increment is suggested, please describe what 
impact such increment would have on short selling. What increment, if 
any, would be tantamount to a ban on short selling? Please provide 
empirical data in support of any arguments and/or analyses.
    2. The proposed modified uptick rule would allow short selling at 
the current national best bid in an advancing market. Should the 
proposed modified uptick rule instead require a trading center to have 
policies and procedures reasonably designed to permit short selling 
only at a price above the current national best bid such that short 
selling would occur only at a higher price than the current national 
best bid, and only on a passive basis? Would such an approach be more 
effective at preventing short selling, including potentially 
manipulative or abusive short selling, from being used as a tool to 
drive down the market or from being used to accelerate a declining 
market than the approach set forth in the proposed modified uptick rule 
or proposed uptick rule? If so, how? If not, why not? What effect would 
an approach that allows short selling only at a price above the current 
national best bid have on the benefits of short selling, such as 
providing price efficiency and liquidity? Would this approach be easier 
to program into trading and surveillance systems than the approach in 
the proposed modified uptick rule or proposed uptick rule? If so, why? 
If not, why not? Should an approach that allows short selling only at a 
price above the current national best bid be combined with a policies 
and procedures approach similar to that discussed under the proposed 
modified uptick rule or a prohibition approach similar to that 
discussed under the proposed uptick rule? What would be the advantages 
and disadvantages, including costs and benefits of each of these 
approaches as combined with a short sale price test that permits short 
selling only at a price above the current national best bid?
    3. The proposed modified uptick rule would apply to a ``covered 
security'' which is defined to mean an NMS stock as that term is 
defined in Regulation NMS. Is it appropriate for the proposed modified 
uptick rule to apply only to NMS stocks? Should the definition of a 
``covered security'' instead be a security that is registered on, or 
admitted to unlisted trading privileges on, a national securities 
exchange? If so, why? If not, why not? Should the definition of 
``covered security'' be expanded to include all NMS securities, 
including options? If so, why? If not, why not?
    4. Should the proposed modified uptick rule be extended to Non-NMS 
stocks, such as stocks quoted on the OTC Bulletin Board and Pink 
Sheets? How would a national best bid be determined for sales of such 
securities?
    5. The proposed modified uptick rule has as its reference point for 
a permissible short sale the current national best bid in relation to 
the last differently priced national best bid. To what extent would the 
sequence of bids play a role in determining when short sales can be 
executed or displayed by trading centers, or submitted by broker-
dealers relying on the exception to the proposed modified uptick rule 
in proposed Rule 201(c)? Are there any regulatory or operational 
reasons to allow markets to use their own bid information in regulating 
short sales under the proposed modified uptick rule? Would allowing 
markets to use their own bid information affect the operation or 
effectiveness of the proposed modified uptick rule? If so, how? If 
trading centers and broker-dealers marking orders ``short exempt'' 
pursuant to proposed Rule 201(c) take snapshots of the market at the 
time of execution, display, or submission of the short sale order, as 
applicable, would such snapshots address any concerns regarding the 
sequence of bids? If not, what other policies and procedures could 
trading centers and broker-dealers put in place to address these 
concerns?
    6. The proposed modified uptick rule would require trading centers 
to establish, maintain, and enforce written policies and procedures 
reasonably designed to prevent the execution or display by the trading 
center of impermissibly priced short sale orders. Are the proposed 
modified uptick rule's requirements for what trading centers' policies 
and procedures would be required to include appropriate? Please 
explain. Pursuant to proposed Rule 201(b)(1)(ii) a trading center's 
policies and procedures must be reasonably designed to permit the 
execution or display of a short sale order of a covered security marked 
``short exempt'' without regard to whether the order is at a down-bid 
price. Thus, a trading center's policies and procedures must be able to 
recognize an order marked ``short exempt.'' Is the inclusion of this 
requirement in a trading center's policies and procedures appropriate? 
Please explain.
    7. Proposed Rule 201(b)(2) would require that trading centers 
regularly surveil to ascertain the effectiveness of the policies and 
procedures required by proposed Rule 201(b)(1) and promptly take action 
to remedy deficiencies in such policies and procedures. Would all 
trading centers readily be able to monitor on a real-time basis the 
national best bid and the last differently priced national best bid? 
Are there other ways to surveil that would not be on a real-time basis 
that would be equally or more effective? Please explain. What systems 
and surveillance changes by trading centers would be necessary to meet 
the requirements of the proposed modified uptick rule? Should 
additional requirements be placed on trading centers that execute or 
display short sale orders in covered securities? If so, what should 
such requirements be? Is a policies and procedures approach preferable 
to a prohibition (as was the case under former Rule 10a-1) on any 
person executing a short sale on a down-bid price? What would be the 
costs and benefits of a policies and procedures approach as compared to 
such a prohibition? Should the Commission consider instead a 
prohibition with regard to some or all of the entities regulated by the 
Commission, rather than one on ``any person,'' as was the case under 
former Rule 10a-1? What about an approach that imposed a policies and 
procedures requirement on some or all of the entities regulated by the 
Commission and a prohibition on ``any person''?

[[Page 18073]]

What would be the costs and benefits of an approach that used both a 
prohibition and a policies and procedures requirement on some or all of 
the entities regulated by the Commission? What would be the costs and 
benefits of each of these approaches?
    8. Under the proposed modified uptick rule, a trading center or 
broker-dealer, as applicable, would need to take such steps as would be 
necessary to enable it to enforce its policies and procedures 
effectively. For example, trading centers and broker-dealers, as 
applicable, could establish policies and procedures that could include 
regular exception reports to evaluate their trading practices. Should 
the proposed modified uptick rule require trading centers and broker-
dealers subject to the policies and procedures requirements of the rule 
to have exception reports? Please explain. What would be the costs and 
benefits of such a requirement? Would such costs and benefits differ 
depending on the size of the trading center or broker-dealer?
    9. Under the proposed modified uptick rule, if an order is 
impermissibly priced, the trading center could re-price the order at 
the lowest permissible price and hold it for later execution at its new 
price or better. As quoted prices change, the proposed modified uptick 
rule would allow a trading center to repeatedly re-price and display an 
order at the lowest permissible price down to the order's original 
limit order price (or, if a market order, until the order is filled). 
In effect, what would be the consequences of the proposed modified 
uptick rule? What would be the impact of the proposed modified uptick 
rule on speed of executions, transaction costs, and order flow? In 
addition, if a trading center were not to re-price an order, what would 
be the impact on speed of executions, transaction costs, and order 
flow?
    10. Proposed Rule 201(b)(1)(i) provides that a trading center's 
policies and procedures must be reasonably designed to permit the 
execution of a displayed short sale order of a covered security if, at 
the time of display of the short sale order, the order was not at a 
down-bid price. Is it appropriate that the proposed modified uptick 
rule would not preclude execution of a short sale order that was not 
priced in accordance with proposed Rule 201(b)(1) provided that the 
short sale order complied with the requirements of proposed Rule 
201(b)(1) at the time it was displayed? If so, why? If not, why not? 
Please explain.
    11. Proposed Rule 201(c) provides that a broker-dealer may mark an 
order ``short exempt'' provided the broker-dealer complies with the 
requirements of that paragraph of the proposed rule. Would it be 
appropriate to permit a broker-dealer to mark a short sale order 
``short exempt'' if it complies with the requirements of paragraph (c) 
of the proposed rule? Should this provision apply to entities other 
than, or in addition to, broker-dealers? Would the determination of the 
down-bid price for certain orders at the time of submission and others 
at the time of execution or display cause unnecessary confusion in the 
market? What systems and surveillance changes by broker-dealers would 
be necessary to meet the requirements of this provision?
    12. The proposed modified uptick rule would not apply at times the 
national best bid is not collected, processed, and disseminated. Is 
this appropriate? Would this result in a substantial portion of short 
selling moving to times when the national best bid is not collected, 
processed, and disseminated? Would this undermine the effectiveness of 
the proposed modified uptick rule at helping to prevent short selling, 
including potentially abusive or manipulative short selling, from being 
used as a tool to drive down markets or to accelerate a price decline? 
Should the proposed modified uptick rule apply even at times the 
national best bid is not collected, processed, and disseminated? If so, 
why? If not, why not? If it were to apply during trading sessions when 
the national best bid is not collected, processed, and disseminated, 
how should it apply (e.g., using the national best bid at the end of 
the trading session)? What would be the costs and benefits of applying 
the proposed modified uptick rule at times the national best bid is not 
collected, processed, and disseminated, including the impact on 
liquidity and price efficiency? What would be the costs and benefits of 
applying the proposed modified uptick rule at times the national best 
bid is collected, processed, and disseminated, including the impact on 
liquidity and price efficiency?
    13. The proposed modified uptick rule includes a number of 
provisions that would permit a broker-dealer to mark a short sale order 
``short exempt.'' Pursuant to proposed Rule 201(b)(1)(ii) a trading 
center's policies and procedures must be reasonably designed to permit 
the execution or display of a short sale order marked ``short exempt'' 
without regard to whether the order is at a down-bid price. In addition 
to the provisions under paragraphs (c) and (d) of the proposed modified 
uptick rule regarding when a broker-dealer may mark an order ``short 
exempt,'' are there other provisions that the proposed modified uptick 
rule should include? Should the proposed modified uptick rule permit a 
broker-dealer to make a short sale order ``short exempt'' in connection 
with short selling activity and electronic trading systems that match 
and execute customer orders at random times within specific time 
intervals, and at independently derived prices? If so, please explain. 
If such a provision would be appropriate or necessary, what conditions 
should apply? Should such a provision include conditions similar to the 
conditions set forth in Rule 201(c)(8) of the proposed uptick rule? 
Should the proposed modified uptick rule permit a broker-dealer to mark 
a short sale order ``short exempt'' in connection with locked or 
crossed markets? If so, please explain how a conflict could arise in 
connection with the proposed modified uptick rule and locked or crossed 
markets and what should be the conditions of any such provision. Should 
the proposed modified uptick rule permit a broker-dealer to make a 
short sale order ``short exempt'' when the broker-dealer is fulfilling 
specific obligations? If so, please explain.
    14. Would any of the provisions under paragraph (c) or (d) under 
the proposed modified uptick rule be susceptible to abuse? If so, how? 
Are there conditions that would address this concern?
    15. Proposed Rule 201(d)(1) would permit a broker-dealer to mark a 
short sale order of a covered security ``short exempt'' if the seller 
owns the security sold and intends to deliver the security as soon as 
all restrictions on delivery have been removed. Would this provision be 
necessary or appropriate? Should any conditions or limitations apply? 
If so, why? If not, why not?
    16. Proposed Rule 201(d)(2) would permit a broker-dealer to mark a 
short sale order of a covered security ``short exempt'' in connection 
with certain odd lot transactions. Is this provision necessary or 
appropriate? Should proposed Rule 201(d)(2) apply to all market makers 
in odd-lots or should it be more limited? If so, why and how?
    17. Proposed Rule 201(d)(3) would permit a broker-dealer to mark a 
short sale order of a covered security ``short exempt'' in connection 
with certain bona fide domestic arbitrage transactions. Would this 
provision be necessary or appropriate? Should the provision be narrowed 
or broadened? If so, state specifically why, and how it should be 
restructured in relation to the purposes of the proposed modified 
uptick rule. Proposed Rule 201(d)(3)

[[Page 18074]]

parallels the exception in former Rule 10a-1(e)(7) which, consistent 
with Regulation T at the time, referred to a ``special arbitrage 
account.'' Because Regulation T no longer refers to a ``special 
arbitrage account'' but instead refers to a ``good faith account'', 
proposed Rule 201(d)(3) would also refer to a ``good faith account.'' 
Should proposed Rule 201(d)(3) refer to a ``special arbitrage account'' 
or a ``good faith account''? Please explain. Is a separate account, 
whether a ``special arbitrage account'' or ``good faith account,'' 
necessary or appropriate for this provision? If so, why? If not, why 
not?
    18. Proposed Rule 201(d)(4) would permit a broker-dealer to mark a 
short sale order of a covered security ``short exempt'' in connection 
with certain international arbitrage transactions. Would this provision 
be necessary or appropriate? Should the provision be narrowed or 
broadened? If so, state specifically why, and how it should be 
restructured in relation to the purposes of the proposed modified 
uptick rule. Proposed Rule 201(d)(4) parallels the exception in former 
Rule 10a-1(e)(8) which, consistent with Regulation T at the time, 
referred to a ``special international arbitrage account.'' Because 
Regulation T no longer refers to a ``special international arbitrage 
account'' but instead refers to a ``good faith account,'' proposed Rule 
201(d)(4) would also refer to a ``good faith account.'' Should proposed 
Rule 201(d)(4) refer to a ``special international arbitrage account'' 
or a ``good faith account''? Please explain. Is a separate account, 
whether a ``special arbitrage account'' or ``good faith account,'' 
necessary or appropriate for this provision? If so, why? If not, why 
not? Should proposed Rule 201(d)(4) be combined with proposed Rule 
201(d)(3)? If so, why? If not, why not? Should depository receipts of a 
security be deemed the same security as the security represented by 
such depository receipt? Why or why not?
    19. Proposed Rule 201(d)(5) would permit a broker-dealer to mark a 
short sale order of a covered security ``short exempt'' in connection 
with sales by underwriters or syndicate members participating in a 
distribution in connection with over-allotments, and lay-off sales by 
such persons in connection with a distribution of securities. Would 
this provision be necessary or appropriate for both and/or either over-
allotments and lay-off sales? Under what circumstances would an 
underwriter or syndicate member price an offering below the national 
best bid? What market impact, if any, would there be if the provision 
were extended to short sales below the national best bid?
    20. Proposed Rule 201(d)(6) would permit a broker-dealer to mark a 
short sale order of a covered security ``short exempt'' where a broker-
dealer is facilitating customer buy or long sale orders on a riskless 
principal basis. Would this provision be appropriate or necessary? Are 
the conditions set forth in proposed Rule 201(d)(6) appropriate? Should 
the conditions be narrowed or broadened in any way? Please explain.
    21. Proposed Rule 201(d)(7) would permit a broker-dealer to mark a 
short sale order of a covered security ``short exempt'' in connection 
with certain VWAP transactions. Would this provision be necessary or 
appropriate? Should the proposed provision be modified in any way? If 
so, please explain. Are all of the proposed conditions appropriate, or 
should any be eliminated or modified? Should any other conditions be 
added? In place of a provision limited to VWAP transactions, would it 
be more appropriate to permit a broker-dealer to mark a short sale 
order of a covered security ``short exempt'' in connection with ``any 
short sale at a price that is not based, directly or indirectly, on the 
quoted price of the covered security at the time of execution and for 
which the material terms were not reasonably determinable at the time 
the commitment to execute the order was made''? \284\ If this provision 
would be more appropriate, please explain why. What types of benchmark 
orders would such a provision capture? If we were to use this 
alternative language, how should we determine the ``material terms'' of 
the short sale? Should there be any conditions on the use of this 
alternative proposed provision?
---------------------------------------------------------------------------

    \284\ See also 17 CFR 242.611(7).
---------------------------------------------------------------------------

    22. Should the proposed modified uptick rule include a ``short 
exempt'' marking provision specific to the daily opening of trading at 
each trading center, particularly given that there are multiple trading 
centers with non-synchronous opening auctions? Please explain. Should 
there be a ``short exempt'' marking provision specific to the opening 
of trading after a trading halt? Please explain. Should there be a 
``short exempt'' marking provision specific to short selling at the 
closing of trading at each trading center? Please explain.
    23. Should the proposed modified uptick rule include a ``short 
exempt'' marking provision for transactions in exchange traded funds 
and similar products? If so, what should be the qualifications and/or 
conditions related to such provision? We note the Commission previously 
exempted ETFs from Rule 10a-1, subject to various conditions.\285\
---------------------------------------------------------------------------

    \285\ See, e.g., 2003 Proposing Release at 62988.
---------------------------------------------------------------------------

    24. Should the proposed modified uptick rule include a ``short 
exempt'' marking provision for short sale orders that are not pursuant 
to a ``regular way'' contract?
    25. The proposed modified uptick rule does not contain a ``short 
exempt'' marking provision in connection with market makers engaged in 
bona fide market making activity. Should there be such a provision to 
facilitate market making activity by broker-dealers? If so, why? What 
consequences would there be, if any, to the markets if broker-dealers 
are not permitted to mark such orders ``short exempt''? Please 
describe. If the proposed modified uptick rule were to permit broker-
dealers to mark short sale orders pursuant to bona fide market making 
activity as ``short exempt'' what qualifications and/or conditions 
should apply?
    26. When the Commission repealed short sale price tests in 2007, it 
also provided that no SRO could have or adopt its own short sale price 
test. One reason for removing short sale price tests was the existence 
of different types of prices tests (e.g., the tick test of Rule 10a-1 
and the NASD bid test). Should the proposed modified uptick rule be an 
SRO rule?
    27. Under a straight prohibition, any person is liable for an 
impermissible short sale, even if the sale is the product of an error. 
Should we include an exception for inadvertent errors, if the person 
can demonstrate that the error was inadvertent? When would an 
inadvertent error occur? How could a person demonstrate that the non-
compliant short sale was an inadvertent error?
    28. The short sales that qualify for the ``broker-dealer'' 
provision in proposed Rule 201(c) are still subject to the provisions 
of the proposed modified uptick rule and would be required to be marked 
as ``short exempt.'' Should these short sales be marked as ``short 
exempt'' or is another mark more appropriate? What effect, if any, 
would marking these short sales as ``short exempt'' have on compliance 
or surveillance relative to another mark? What would be the costs 
associated with implementing a mark especially for these short sales?
Questions Regarding Proposed Uptick Rule
    1. Should the proposed uptick rule have a policies and procedures 
approach for some or all of the entities

[[Page 18075]]

regulated by the Commission similar to the approach under the proposed 
modified uptick rule? If so, why? If not, why not? Or, should the 
Commission also adopt a prohibition on ``any person'' for the proposed 
uptick rule, in addition to a policies and procedures requirement on 
some or all of the entities regulated by the Commission? What would be 
the costs and benefits of a policies and procedures requirement, as 
compared to the proposed prohibition? What would be the costs and 
benefits of an approach that used both a prohibition and a policies and 
procedures requirement on some or all of the entities regulated by the 
Commission?
    2. The proposed uptick rule would apply to a ``covered security'' 
which is defined as an NMS security, other than an option, in which 
trades in such securities are reported pursuant to an effective 
transaction reporting plan and for which information as to such trades 
is made available in accordance with such plan on a real-time basis to 
vendors of market transaction information. Should the definition of a 
``covered security'' be changed to apply to a security registered on, 
or admitted to unlisted trading privileges on, a national securities 
exchange, if trades in such securities are reported pursuant to an 
effective transaction reporting plan and information as to such trades 
is made available in accordance with such plan on a real-time basis to 
vendors of market transaction information? If so, why? Would such a 
definition result in securities other than NMS stocks being subject to 
the proposed uptick rule? If so, please describe those types of 
securities and the costs and benefits of applying the proposed uptick 
rule to such securities. Should the definition of ``covered security'' 
be expanded to include all NMS securities, including options? If so, 
why? If not, why not?
    3. The proposed uptick rule would apply to NMS stocks quoted in the 
OTC market, but not to non-NMS stocks quoted in the OTC market. What 
form of price test, if any, should apply to non-NMS stocks quoted in 
the OTC market, and why? If a price test should apply to non-NMS 
stocks, to what types of non-NMS stocks should it apply? Please 
explain. How should such a price test be implemented? In addition, we 
seek comment regarding whether the market is structured in a manner 
that would make regulation of non-NMS stocks practical.
    4. Could any operational concerns regarding implementation of the 
proposed uptick rule be remedied by market participants taking 
snapshots of the market at the time of effecting a short sale? Such 
snapshots could provide a record of the last sale price and the 
direction of the market for a particular security at the time of 
effecting the short sale. Would any additional exceptions be necessary 
to address time lags in the receipt of last sale price information from 
data feeds? If so, please explain, including providing any suggested 
language for such an exception.
    5. The proposed uptick rule would not apply to short sales in 
covered securities while last sale price information is not collected, 
calculated and disseminated on a real-time basis. Would this result in 
a substantial portion of short selling moving to times when last price 
information is not collected, calculated, and disseminated on a real-
time basis? Would this undermine the effectiveness of the proposed 
modified uptick rule at helping to prevent short selling, including 
potentially abusive or manipulative short selling, from being used as a 
tool to drive down markets or to accelerate a price decline? Would it 
be appropriate to apply the proposed uptick rule while last sale price 
information is not collected, calculated and disseminated on a real-
time basis? Please explain. What would be the costs and benefits of 
applying the proposed uptick rule during after-hours trading sessions, 
including the impact on liquidity and price efficiency? Please explain. 
What would be the costs and benefits of not applying the proposed 
uptick rule during after-hours trading sessions, including the impact 
on liquidity and price efficiency? Please explain.
    6. Former Rule 10a-1 included a provision that permitted markets to 
use the last sale prices on their own markets as the reference point 
for measuring the permissibility of short sales. Specifically, former 
Rule 10a-1(a)(2) provided: ``* * * any exchange, by rule, may require 
that no person shall, for his own account or the account of any other 
person, effect a short sale of any such security on that exchange (i) 
below the price at which the last sale thereof, regular way, was 
effected on such exchange, or (ii) at such price unless such price is 
above the next preceding different price at which a sale of such 
securities, regular way, was effected on such exchange, if that 
exchange determines that such action is necessary or appropriate in its 
market in the public interest or for the protection of investors; and, 
if an exchange adopts such a rule, no person shall, for his own account 
or for the account of any other person, effect a short sale of any such 
security on such exchange otherwise than in accordance with such rule * 
* *.'' This provision was added to former Rule 10a-1 in response to 
certain SROs asserting that the last trade price on the consolidated 
system should not be the reference point for the tick test of former 
Rule 10a-1 because last trade price data was not available in a timely 
manner and because the principal exchanges did not have adequate 
information retrieval systems on their floors to ensure adherence with 
former Rule 10a-1.\286\ Should the proposed uptick rule include a 
similar provision? With the spread of fully automated markets and the 
advances in the dissemination of market information, is such a 
provision necessary or desirable in today's markets? Please explain the 
costs and benefits of permitting each market to use the last sale price 
in its market as the reference point under the proposed uptick rule.
---------------------------------------------------------------------------

    \286\ See Securities Exchange Act Release No. 11276 (Mar. 5, 
1975), 54 FR 12522 (Mar. 19, 1975) (release proposing subparagraph 
(a)(2) in response to stated operational and other difficulties 
associated with complying with Rule 10a-1); see also Securities 
Exchange Act Release No. 11468 (June 12, 1975), 40 FR 25442 (June 
16, 1975) (adoption of proposed changes adding subparagraph (a)(2)).
---------------------------------------------------------------------------

    7. Former Rule 10a-1(a)(3) included a provision that allowed for an 
adjustment to the sale price of a security after the security went ex-
dividend, ex-right, or ex any other distribution when determining the 
price at which a short sale may be effected. Specifically, former Rule 
10a-1(a)(3) provided: ``In determining the price at which a short sale 
may be effected after a security goes ex-dividend, ex-right, or ex-any 
other distribution, all sale prices prior to the ``ex'' date may be 
reduced by the value of such distribution.'' Would this provision be 
necessary under the proposed uptick rule? Please explain.
    8. Former Rule 10a-1(e)(6) contained an ``equalizing exception'' 
that applied to securities registered on, or admitted to unlisted 
trading privileges on, a national securities exchange, for which trades 
in such securities were not reported to an effective transaction 
reporting plan and for which information as to such trades was not made 
available in accordance with such plan on a real-time basis to vendors 
of market transaction information. For such securities, it allowed 
short sales to be effected on a national securities exchange (provided 
the exchange approved the sale), if such sale was necessary to equal 
the price of the security on that exchange with the price of the 
security on the principal exchange for the security. The Commission 
stated that this exception

[[Page 18076]]

was afforded to persons on regional exchanges to enhance the liquidity 
on those exchanges with respect to orders naturally flowing to those 
exchanges.\287\ The Commission also noted, however, that the exception 
may have resulted in providing an incentive to divert orders from the 
principal exchange market to avoid the impact of former Rule 10a-1, 
because it allowed short sales to be effected on regional exchanges at 
prices below the last sale price on the principal exchange.\288\ We 
have determined not to include this exception in the proposed uptick 
rule because we believe it would not make sense in light of the 
proposed reference point (the last sale reference point in the 
consolidated system). The exception in former Rule 10a-1(e)(6) was 
originally adopted in 1938 when the permissibility of short sales under 
former Rule 10a-1 was determined for each particular exchange by 
comparing the price of the proposed short sale to the immediately 
preceding price of the security to be sold short on that exchange. The 
exception was modified, but retained, following amendments to former 
Rule 10a-1 to reference the last trade price reported to the 
consolidated system or in a particular exchange market. The proposed 
uptick rule uses as the reference price the last sale price reported 
pursuant to an effective transaction reporting plan only. Thus, we 
believe a similar exception to the exception contained in former Rule 
10a-1(e)(6) would not be necessary. Are there any reasons to include in 
the proposed uptick rule a similar exception to that contained in 
former Rule 10a-1(e)(6)? Please explain.
---------------------------------------------------------------------------

    \287\ See Securities Exchange Act Release No. 11468 (June 12, 
1975), 40 FR 25442 (June 16, 1975) (adopting amendments to Rule 10a-
1 and discussing the operation of Rule 10a-1(e)(6) as in effect 
prior to and after amendment).
    \288\ See id.
---------------------------------------------------------------------------

    9. As discussed in detail above under Section III.B.2.c. we have 
incorporated into proposed Rule 201(c)(10) and (c)(11), proposed 
exceptions to address any potential conflict between the proposed 
uptick rule and the Quote Rule arising from a trade-through. These 
exceptions are substantially in the form in which they were included in 
subsections (e)(5)(ii) and (e)(11) of former Rule 10a-1. Are these 
exceptions appropriate or necessary? Should these exceptions be revised 
in any way? If so, please provide suggested language. Proposed Rule 
201(c)(10) would allow an SRO, by rule, to prohibit its registered 
specialists and registered exchange market makers from availing 
themselves of the exemption afforded by paragraph (c)(10) if that SRO 
determines that such action is necessary or appropriate in its market 
in the public interest or for the protection of investors. Is this 
provision appropriate or necessary? Would any SRO avail itself of this 
provision? If not, why not? If so, why and how?
    10. Former Rule 10a-1 contained an exception in paragraph (e)(5)(i) 
that permitted market makers to effect short sales at the same price as 
the last sale price even if the last sale price was on a zero-minus 
tick. Specifically, former Rule 10a-1(e)(5)(i) provided an exception 
for: ``Any sale of a security * * * (except a sale to a stabilizing bid 
complying within Rule 104 of Regulation M) by a registered specialist 
or registered exchange market maker for its own account on any exchange 
with which it is registered for such security, or by a third market 
maker for its own account over-the-counter, i. Effected at a price 
equal to or above the last sale, regular way, reported for such 
security pursuant to an effective transaction reporting plan * * * 
Provided, however, That any exchange, by rule, may prohibit its 
registered specialist and registered exchange market makers from 
availing themselves of the exemption afforded by this paragraph (e)(5) 
if that exchange determines that such action is necessary or 
appropriate in its market in the public interest or for the protection 
of investors.'' Unless prohibited by exchange rule, this exception was 
intended to permit registered specialists or market makers to protect 
customer orders against transactions in other markets in the 
consolidated system by allowing them to sell short at a price equal to 
the last trade price reported to the consolidated system, even if that 
sale was on a minus or zero-minus tick.\289\ Although former Rule 10a-1 
included this exception for market makers, exchanges adopted rules that 
prohibited their registered specialists and market makers from availing 
themselves of this exception.\290\ Thus, we have determined not to 
include a similar exception in the proposed uptick rule.\291\ Would a 
similar exception under the proposed uptick rule for registered market 
makers be appropriate or necessary? If the proposed uptick rule were to 
include a similar exception, should the exception be substantially in 
the form in which it was included in former Rule 10a-1(e)(5)(i)? If so, 
why? If not, why not? Please explain any recommended changes.
---------------------------------------------------------------------------

    \289\ See supra note 188. Former Rule 10a-1(a)(1)(i) referenced 
the last sale price reported to an effective transaction reporting 
plan, but former Rule 10a-1(a)(2) also permitted an exchange to make 
an election to use the last sale price reported in that exchange 
market. Certain exchanges, such as the NYSE, implemented short sale 
price test rules consistent with former Rule 10a-1(a)(2). See, e.g., 
former NYSE Rule 440B.
    \290\ See former NYSE Rule 440B.
    \291\ See supra Section III.A.2.i. (discussing our decision not 
to propose that a broker dealer may mark an order ``short exempt'' 
in connection with bona fide market making activity).
---------------------------------------------------------------------------

    11. The proposed uptick rule would include a number of exceptions. 
In addition to the exceptions contained in the proposed uptick rule, 
are there other exceptions that should be included? For example, should 
the Commission provide an exception from the proposed uptick rule for 
transactions in exchange traded funds? If so, what should be the 
qualifications and/or conditions for relief? If not, please explain why 
not. In addition, we note that under former Rule 10a-1 the Commission 
granted conditional relief to allow requesting exchanges \292\ and 
broker-dealers \293\ to execute short sales in after-hours crossing 
sessions at a price equal to the closing price of the security.\294\ 
Absent relief, such short sales could have violated former Rule 10a-1 
in that the matching price (the closing price) of a security could have 
been on a minus or zero-minus tick with respect to the last sale in the 
consolidated transaction reporting system. In granting this conditional 
relief, the Commission noted that short sale transactions executed at 
the closing price generally do not represent the type of abusive 
practices that former Rule 10a-1 was designed to prevent. In 
particular, the Commission stated that short sale orders entered in the 
after-hours crossing sessions cannot influence the matching price, but 
rather are priced by unrelated order flow and transactions occurring 
during the primary trading session, which are subject to former Rule 
10a-1. Should we codify the exemptive

[[Page 18077]]

relief granted under former Rule 10a-1 as an exception from the 
proposed uptick rule? Under current market conditions, do closing price 
transactions create potentially manipulative incentives for broker-
dealers, such that they should not be granted an exception?
---------------------------------------------------------------------------

    \292\ See, e.g., letter re: Off-Hours Trading by the Amex, 
[1991] Fed. Sec. L. Rep. (CCH) ] 79,802 (Aug. 5, 1991); letter re: 
Operation of Off-Hours Trading by the NYSE, [1991] Fed. Sec. L. Rep. 
(CCH) ] 79,736 (June 13, 1991).
    \293\ See, e.g., letter re: Burlington Capital Markets (July 1, 
2003); letter re: Bear, Stearns & Co., Inc. (Jan. 19, 1996); Letter 
re: AZX, Inc. (Nov. 15, 1995); letter re: Instinet Corporation 
Crossing Network, [1992] Fed. Sec. L. Rep. (CCH) ] 76,290 (July 1, 
1992); letter re: Portfolio System for Institutional Trading, [1991-
1992] Fed. Sec. L. Rep. (CCH) ] 76,097 (Dec. 31, 1991).
    \294\ The relief was generally subject to the conditions that: 
(1) Short sales of a security in the after-hours matching session 
shall not be effected at prices lower than the closing price of the 
security on its primary exchange; (2) persons relying on these 
exemptions shall not directly or indirectly effect any transactions 
designed to affect the closing price on the primary exchange for any 
security traded in the after-hours matching session; and (3) 
transactions effected in the after-hours matching session shall not 
be made for the purpose of creating actual, or apparent, active 
trading in or otherwise affecting the price of any security.
---------------------------------------------------------------------------

    12. Proposed Rule 201(c)(1) would provide an exception to allow 
short sales to be submitted without regard to the proposed uptick rule 
if the seller owns the security sold and the seller intends to deliver 
the security as soon as all restrictions on delivery have been removed. 
Would this exception be necessary or appropriate? Should any conditions 
or limitations apply to the exception? If so, why? If not, why not?
    13. Proposed Rule 201(c)(2) would provide an exception for any sale 
by a broker-dealer of a covered security for an account in which it has 
no interest pursuant to an order marked ``long.'' Would this exception 
be appropriate or necessary? Should any conditions or limitations apply 
to the exception? If so, why? If not, why not?
    14. Proposed Rule 201(c)(3) would provide a limited exception for 
odd lot transactions. Would this exception be appropriate or necessary? 
Should the proposed exception apply to all market makers in odd-lots or 
should the exception be more limited? Would this exception be 
susceptible to abuse? If so, how? Should all odd-lot transactions have 
an exception from the proposed uptick rule? Would providing an 
exception for all odd-lot transactions result in a risk of increased 
short sale manipulation, e.g., would traders break up trades into 99 
share odd-lots in order to avoid the proposed uptick rule?
    15. Proposed Rule 201(c)(4) would provide an exception from the 
proposed uptick rule for certain bona fide domestic arbitrage 
transactions. Should the exception be narrowed or broadened? If so, 
state specifically why, and how it should be restructured in relation 
to the purposes of the proposed uptick rule. Proposed Rule 201(c)(4) 
parallels the exception in former Rule 10a-1(e)(7) which, consistent 
with Regulation T at the time, referred to a ``special arbitrage 
account.'' Because Regulation T no longer refers to a ``special 
arbitrage account'' but instead refers to a ``good faith account'', 
proposed Rule 201(c)(4) would also refer to a ``good faith account.'' 
Should proposed Rule 201(c)(4) refer to a ``special arbitrage account'' 
or a ``good faith account''? Please explain.
    16. Proposed Rule 201(c)(5) would provide an exception from the 
proposed uptick rule for certain international arbitrage transactions. 
Should the proposed exception be narrowed or broadened? If so, state 
specifically why, and how it should be restructured in relation to the 
purposes of the proposed uptick rule. Proposed Rule 201(c)(5) parallels 
the exception in former Rule 10a-1(e)(8) which, consistent with 
Regulation T at the time, referred to a ``special international 
arbitrage account.'' Because Regulation T no longer refers to a 
``special international arbitrage account'' but instead refers to a 
``good faith account'', proposed Rule 201(c)(5) would also refer to a 
``good faith account.'' Should proposed Rule 201(c)(5) refer to a 
``special international arbitrage account'' or a ``good faith 
account''? Please explain. Should proposed Rule 201(c)(4) be combined 
with proposed Rule 201(c)(5)? If so, why? If not, why not? Should 
depository receipts of a security be deemed the same security as the 
security represented by such depository receipt? Why or why not?
    17. Proposed Rule 201(c)(6) would provide an exception from the 
proposed uptick rule for sales by underwriters or syndicate members 
participating in a distribution in connection with over-allotments and 
lay-off sales by such persons in connection with a distribution of 
securities. Under what circumstances would an underwriter or syndicate 
member price an offering below the last sale? What market impact, if 
any, would there be if the exception were extended to short sales below 
the last sale?
    18. Would the exception for VWAP transactions contained in proposed 
Rule 201(c)(7) be appropriate or necessary? Are all of the proposed 
conditions appropriate, or should any be eliminated or modified? Should 
any other conditions be added? Should the proposed exception be 
modified in any way? If so, please explain. Would the following 
exception be more appropriate for excepting transactions such as short 
sale orders on a VWAP basis: The provisions of the proposed uptick rule 
shall not apply to ``any short sale at a price that was not based, 
directly or indirectly, on the quoted price of the covered security at 
the time of execution and for which the material terms were not 
reasonably determinable at the time the commitment to execute the order 
was made''? \295\ If this exception would be more appropriate, please 
explain why. What types of benchmark orders would such an exception 
capture? If we were to use this alternative language, how should we 
determine the ``material terms'' of the short sale? Should there be any 
conditions on the use of this alternative proposed exception?
---------------------------------------------------------------------------

    \295\ See also 17 CFR 242.611(a)(7).
---------------------------------------------------------------------------

    19. Would the exception for transactions pursuant to certain 
electronic trading systems that match buying and selling interest in 
proposed Rule 201(c)(8) be appropriate? Should the proposed exception 
be modified in any way? If so, please explain.
    20. Proposed Rule 201(c)(9) would provide an exception from the 
proposed uptick rule for broker-dealers facilitating customer buy or 
long sale orders on a riskless principal basis. Are the conditions set 
forth in proposed Rule 201(c)(9) in connection with the ``riskless 
principal'' exception appropriate? Should the conditions be narrowed or 
broadened in any way? Please explain.
    21. Proposed Rule 201(c)(12) would provide for an exception from 
the proposed uptick rule for short sales by registered market makers or 
specialists publishing two-sided quotes to sell short to facilitate 
customer market and marketable limit orders regardless of the last sale 
price. Would this proposed exception be appropriate? Should additional 
qualifications and/or conditions be placed on such a proposed 
exception? If so, please describe any such qualifications and/or 
conditions including the purpose of such qualifications and/or 
conditions. Is this proposed exception necessary in highly liquid 
securities where there is likely to be sufficient selling interest 
without the specialist's or market maker's quote? Should this proposed 
exception be limited in some way? Please explain.
    22. Should there be an exception specific to the daily opening of 
trading at each trading center, particularly given that there are 
multiple trading centers with non-synchronous opening auctions? Please 
explain. Should there be an exception specific to the opening of 
trading after a trading halt? Please explain. Should there be an 
exception specific to short selling at the closing of trading at each 
trading center? Please explain.
    23. Under the proposed uptick rule, short sales could not be 
executed at a price below the last sale price of a security. In 
addition, short sale orders could be executed at the last sale price 
only if it is higher than the last different price for the security. Is 
a one-cent trading increment appropriate for the proposed uptick rule? 
Why or why not? If a higher increment is suggested, please describe 
what impact such increment would have on short selling. What increment, 
if any, would be tantamount to a ban on short selling?

[[Page 18078]]

Please provide empirical data in support of any arguments and/or 
analyses.
    24. When the Commission repealed short sale price tests in 2007, it 
also provided that no SRO could have or adopt its own short sale price 
test. One reason for removing short sale price tests was the existence 
of different types of prices tests (e.g., the tick test of Rule 10a-1 
and the NASD bid test). Should the proposed uptick rule be an SRO rule?
Questions Regarding Circuit Breakers Generally
    1. The Commission believes that the erosion of investor confidence 
and questions concerning the volatility in the securities markets 
necessitate review of various alternatives with respect to short 
selling restrictions. Would a short selling circuit breaker be more 
appropriate than a market-wide short sale price test restriction in 
current market conditions? If so, why? If not, why not? Would a short 
selling circuit breaker provide more potential benefit to the market 
than a market-wide short sale price test restriction? Please explain. 
For example, would a short selling circuit breaker be a more 
appropriate means for the Commission to achieve the objective of 
helping to prevent short selling from being used as a tool to drive 
down the market? Please explain. Would a short selling circuit breaker 
rule help to address the Commission's concerns regarding investor 
confidence? If so, why and how? If not, why not?
    2. Would implementation of a circuit breaker be less or more costly 
than the implementation of a market-wide short sale price test 
restriction? The proposed circuit breaker rules would, when triggered, 
impose short selling restrictions for the trading day on which the 
circuit breaker is triggered. Should the circuit breaker rules instead 
impose short sale price tests for multiple days? How many days? Would 
there be any additional costs associated with a circuit breaker that 
persisted for multiple trading days? Would a circuit breaker that when 
triggered imposed a temporary halt on short selling be more or less 
costly than one that resulted in a short sale price test restriction? 
Please explain. Would a short selling circuit breaker be generally 
easier to implement in a Regulation NMS environment than a market-wide 
short sale price test restriction such as the proposed modified uptick 
rule, or the proposed uptick rule.
    3. To which securities should a short selling circuit breaker 
apply? Should a short selling circuit breaker apply to all NMS stocks? 
If so, why? If not, why not and to which securities should a short 
selling circuit breaker apply? Should a short selling circuit breaker 
also apply to securities traded over-the-counter?
    4. The Commission is seeking comment on the potential impacts of a 
short selling circuit breaker on market function and efficiency. What 
would be the impact of a short selling circuit breaker when triggered 
on the liquidity of individual securities? What would be the impact of 
a short selling circuit breaker on capital formation? What would be the 
impact of a short selling circuit breaker on price discovery? Would 
different circuit breaker alternatives have different impacts on 
liquidity, capital formation and price discovery? Would a multiple day 
circuit breaker pose any unique costs? Please explain.
    5. Would circuit breakers pose any unique issues related to the 
daily opening of trading, the opening of trading after a trading halt, 
or the closing of trading? Please explain.
    6. Should a short selling circuit breaker be limited in its 
application to specific industry sectors that are historically 
susceptible to extreme volatility or disproportionately high levels of 
short selling? If so, why? If not, why not? If a circuit breaker should 
be limited to apply only to certain sectors, what sectors should be 
included? Please explain. For example, should a circuit breaker apply 
only to the financial sector? If so, how should the financial sector be 
defined for purposes of determining which issuers' securities are 
subject to the circuit breaker thresholds? Please explain.
    7. Currently, the marketwide circuit breaker rules are SRO rules. 
Should a short selling circuit breaker be a SRO rule or a Commission 
rule? Who should be responsible for implementing a short selling 
circuit breaker? Should trading centers be responsible for implementing 
a short selling circuit breaker when triggered? Should any person 
effecting a short sale be responsible for implementing a short selling 
circuit breaker? Should market participants be responsible for 
programming their own systems to prevent submission of a short sale 
order in violation of the circuit breaker? Please explain.
    8. Who should be responsible for monitoring the price declines of 
individual securities that may trigger the short selling circuit 
breaker (e.g., broker-dealers, SROs)? Please explain. How should 
information about the triggering of a circuit breaker in an individual 
security be disseminated to the market? Who should be responsible for 
disseminating that information? For example, the CMS is the primary 
means of dissemination for the current SRO Circuit Breakers and 
regulatory halts. Should the CMS be the primary means by which 
participants are made aware that a short selling circuit breaker has 
been triggered with respect to an individual security? Please explain. 
Should the exchanges be responsible for publishing daily lists of the 
individual securities subject to the restrictions of a short selling 
circuit breaker? What cost would be associated with dissemination of 
circuit breaker notifications and what entities would bear expense in 
upgrading systems to ensure compliance with a short selling circuit 
breaker? Please explain.
    9. What would be the advantages and disadvantages of a short 
selling circuit breaker combined with a short selling halt versus those 
of a short selling circuit breaker combined with short sale price test 
restrictions? Please explain.
    10. What would be the advantages and disadvantages of short selling 
circuit breakers in general? Please explain.
    11. To what extent would market participants' ability to create 
short positions through the use of derivatives or other instruments 
undermine the effectiveness of a short selling circuit breaker? If this 
would occur, would it be more or less significant in the context of a 
short selling circuit breaker as compared to a short sale price test 
restriction? What effects would any increase in ``synthetic short 
sales'' after a circuit breaker is reached during a rapid market 
decline have on market volatility, liquidity, and price efficiency? 
Would a short selling circuit breaker create an unlinking of equity 
markets from derivatives market prices?
    12. Would a short selling circuit breaker result in exacerbated 
downward pressure as the trigger was approached, creating a ``magnet 
effect''? Would any such ``magnet effect'' differ between a circuit 
breaker that when triggered imposed a short selling halt, and a circuit 
breaker that when triggered imposed a short sale price test 
restriction? Please explain and provide empirical data and analysis 
where appropriate to support the explanation.
    13. Before determining whether to adopt a short selling circuit 
breaker on a permanent basis, should we adopt a rule that would apply, 
on a pilot basis, the operation of a short selling circuit breaker on 
individual securities? If so, what variation of a short selling circuit 
breaker should be applied on a pilot basis? Should the pilot circuit 
breaker when triggered result in short selling halts in individual 
securities, or rather should such a pilot circuit breaker impose short 
sale price test restrictions

[[Page 18079]]

on individual securities? Please explain. Such an approach would allow 
us to study the effects on, among other things, market volatility, 
price efficiency, and liquidity during the recent changes in market 
conditions. What would be other benefits of taking this approach? What 
would be the costs of taking this approach? Would the costs associated 
with programming systems to apply a short selling circuit breaker on 
specified individual securities outweigh any benefits of having a 
pilot? If we were to take this approach, how long would it take to 
program systems to apply a short selling circuit breaker in specified 
individual securities? Would it take longer or be more difficult to 
implement a short selling circuit breaker that when triggered imposed 
short selling halts? Would it take longer or be more difficult to 
implement a short selling circuit breaker that when triggered imposed 
short sale price test restrictions? Please explain. Similar to the 
Pilot conducted immediately prior to the elimination of former Rule 
10a-1, the securities that could be subject to the pilot could be 
comprised of a subset of the Russell 3000 index, or such other 
securities as necessary or appropriate in the public interest and 
consistent with the protection of investors after giving due 
consideration to the security's liquidity, volatility, market depth and 
trading market. Would it be appropriate for such a pilot to be 
comprised of a subset of the Russell 3000 index? How should the 
securities that would comprise a pilot be selected? Please explain the 
reasons for any suggested selection method. Such a pilot could remain 
in effect for one or two years. Would a one or two year pilot be an 
appropriate period of time? If so, why? If not, why not? Please provide 
specific reasons to support any views in favor of establishing another 
time period.
    14. In connection with the Pilot conducted immediately prior to our 
elimination of former Rule 10a-1, SROs publicly released transactional 
short selling data so that data would be available to the public to 
encourage independent researchers to study the Pilot. If we were to 
adopt a rule that would apply, on a pilot basis, a short selling 
circuit breaker on individual securities, we would expect to make 
information obtained during any such pilot publicly available. In 
addition, we would expect SROs to again make data available to the 
public during any such pilot. Would there be any costs associated with 
making short selling data available to the public during the period of 
a pilot? What would be the benefits of making such data available to 
the public?
    15. The proposed circuit breaker rules would not be triggered if 
there is a severe decline in the price of any NMS security within 30 
minutes of the end of regular trading hours on any trading day. As 
noted above, former NYSE Rule 80A provided that a circuit breaker would 
not trigger program trading restrictions after 3:25 p.m., or 
approximately 35 minutes before the close. Is 30 minutes an appropriate 
time to limit the proposed circuit breaker rules? Is 35 minutes more 
appropriate? At what point during the trading day would it be too 
disruptive to implement a circuit breaker rule? Is a 30 minute period 
sufficient to avoid major disruptions to the markets? Do thinly traded 
NMS securities raise additional concerns? If a circuit breaker would 
otherwise be triggered toward the end of the trading day, what 
alternative short sale restriction would be helpful in addressing a 
severe market decline in the price of a particular NMS security? Please 
provide any data if available.
    16. Should a circuit breaker be based on an intra-day decline from 
that day's opening price? For instance, should the circuit breaker be 
triggered by a 10% decline from the opening price during regular 
trading hours?
    17. As proposed, the proposed circuit breaker rules, once 
triggered, would impose a short selling halt or a short sale price test 
restriction in the individual security until the close of the 
consolidated system.\296\ Should the short selling halt or short sale 
price test restriction conclude at the end of regular trading hours 
(which are from 9:30 a.m. until 4 p.m. EST)? \297\ Should we consider 
extending the short selling halt or short sale price test, when 
triggered, for a longer period of time? Should the halt be extended 
until the opening of regular trading hours on the next trading day? 
Please explain.
---------------------------------------------------------------------------

    \296\ See Sections III.A.3 and III.B.3. discussing the after-
hours trading with regard to the proposed modified uptick rule and 
the proposed uptick rule, respectively.
    \297\ See supra note 274.
---------------------------------------------------------------------------

Questions Regarding Proposed Circuit Breaker Halt Rule
    1. If a short selling circuit breaker was to be imposed, should 
short selling in individual securities be halted entirely during a 
period of severe decline in the price of the security? If so, why? If 
not, why not? Please explain.
    2. If short selling should be halted during periods of severe 
decline in the price of an individual security, how should the decline 
be measured? Should the decline be tied to a market index or the price 
of an individual security? Should illiquidity in the market for an 
individual security be a factor in measuring a decline in the price of 
a security for purposes of determining whether to halt short selling in 
a particular security? Please explain.
    3. If short selling should be halted during periods of severe 
decline in the price of an individual security, on what price should 
the decline be based? Should the decline be based on the previous day's 
closing price? If the decline is measured by the prior day's closing 
price at the end of regular trading hours, should it be based on the 
closing price reported in the consolidated system, or some other widely 
disseminated price? Please explain.
    4. The proposed circuit breaker rules would impose a short sale 
halt on any security that declines in price 10% or more relative to the 
prior day's closing price for that security. We note that a low trigger 
level may result in more securities becoming subject to a halt or some 
securities becoming subject to a halt more frequently, resulting in 
potential increases in costs, decreases in liquidity, and decreases in 
market quality for the affected security. Also, the impact of a lower 
trigger level may be greater for thinly traded securities and higher 
volatility securities than for other securities. However, if a high 
level is established, more securities may face severe price declines 
for longer periods before a halt is imposed. This also may affect 
thinly traded securities more than other securities. Is 10% an 
appropriate trigger for a circuit breaker rule that results in short 
sale halt? If not, at what level should a halt take place? Should the 
trigger be different for thinly traded or higher volatility securities? 
Should the halt take place after a 10% decline, or a higher/lower 
level? Should the initial halt take place after a 5% decline, or a 15% 
decline, or a 20% decline, or some other decline? Please explain. 
Should the decline be measured as a percentage of the individual 
security's price or should another value be used? Please explain. For 
example, should the decline measurement for the circuit breaker 
threshold be based on the dollar amount of the decline, i.e., $5? If 
so, how should the thresholds be determined in relation to the price 
level of the individual stock? Should the percentage decline be linked 
to the stock's price level such that stocks with lower prices must 
experience a greater percentage decline before the circuit breaker is 
triggered? If so, what thresholds are appropriate? Please explain. If 
the percentage decline is linked to price level, what additional

[[Page 18080]]

operational burdens would be experienced if stock values were required 
to be continuously monitored due to frequent fluctuation? Please 
explain. What costs and benefits may accrue from having the decline 
based on a dollar amount rather than a value derived from a percentage 
of the share value? What potential problems or benefits may arise from 
pegging a short selling circuit breaker threshold to a decline in a 
stock's dollar amount? Please explain.
    5. The proposed circuit breaker halt rule would impose a short 
selling halt for the trading day following the triggering of the 
circuit breaker. Is this an appropriate length of time? If so, why? If 
not, why not, and how long should the halt persist? Should the length 
of the halt vary depending on the time during the day that the circuit 
breaker is triggered? \298\ We note that increasing the length of a 
halt to an additional day or multiple additional days may increase 
costs, reduce market quality, and reduce liquidity in that security. 
This may affect thinly traded securities and higher volatility 
securities more than other securities. However, decreasing the period 
of time to less than a trading day, such as limiting the halt to an 
hour or a few hours following the trigger, may reduce the effectiveness 
of the halt. Would it be more beneficial for a 10% intraday decline to 
trigger a periodic halt in short selling rather than a halt for the 
trading day? Should it result in a multiple day halt in short selling? 
Please explain. How disruptive to normal trading would a multiple day 
halt be compared to a halt for one trading day? If short selling is 
halted after the circuit breaker is triggered in the wake of a 10% 
intraday decline, and the value of the stock continues to decline 
throughout the day to the point where it is down 20% at closing, should 
short selling be allowed to resume the following trading day? If so, 
why? If not, why not? Please explain. Should a 20% or greater intraday 
decline result in a halt on short selling for multiple trading days? 
For example, would it be appropriate for a 20% intraday decline on the 
day the circuit breaker is triggered to result in a 3-day halt in short 
selling, a 5-day halt in short selling, or a 10-day halt in short 
selling? Specifically, what length of a short selling halt would be 
appropriate for the various levels of decline in excess of 10%? Should 
volatility of the individual security be considered? Please explain.
---------------------------------------------------------------------------

    \298\ See 1998 Release supra note 230 and accompanying text 
(discussing that SRO Circuit Breaker rules vary the length of the 
trading halt depending on the time of day the halt is triggered and 
the amount of the decline triggering the halt).
---------------------------------------------------------------------------

    6. Should different stocks be subject to different levels of 
decline before the circuit breaker is triggered? For example, should a 
higher trigger level apply to more liquid stocks than to less liquid 
stocks? Should different trigger levels be based on market 
capitalization or volatility of individual securities? If so, what 
parameters should apply and what criteria should be used to determine 
those parameters? Please explain.
    7. Would a circuit breaker that when triggered halts short selling 
in a particular security result in increased selling pressure by short 
sellers in anticipation of the halt for securities experiencing large 
price declines? Please explain and provide data and analysis to support 
the explanation. What provisions, if any, would facilitate an orderly 
re-entry of a security after a halt on short selling? Please explain.
    8. What benefits would be associated with a short selling circuit 
breaker that when triggered imposes short selling halts? Could such a 
short selling halt help stabilize the market for the individual 
security? If so, why? If not, why not? Could the short selling halt 
benefit investors by allowing the market to ``cool off'' with respect 
to that individual security? Please explain. Could a temporary short 
selling halt imposed by a circuit breaker result in an increase in 
investor confidence? Please explain.
    9. What costs would be associated with implementing a short selling 
circuit breaker for individual securities that when triggered imposed a 
halt on short selling? Please explain. What would it cost to update 
systems in a manner necessary to ensure compliance with such a circuit 
breaker? Would the expenditure necessary to ensure compliance be 
primarily an ``up-front'' cost? Would the expenditure necessary to 
ensure compliance require long-term investment? Please explain. What 
technological challenges would be encountered in updating systems to 
ensure compliance with a short selling circuit breaker that applied to 
individual securities and when triggered imposed halts on short 
selling? Please explain. How long would it take to update systems in a 
manner that ensured compliance with such a short selling circuit 
breaker? Please explain.
    10. Should a short selling circuit breaker that when triggered 
imposed a halt on short selling contain exceptions? If so, why? If not, 
why not? Please explain. Should the circuit breaker contain an 
exception for bona fide market making? If so, why? If not, why not? 
Should such an exception apply to: Registered market makers, block 
positioners, other market makers obligated to quote in the over-the-
counter market, in each case that are selling short the individual 
securities subject to the short selling halt? If so, why? If not, why 
not, and what entities should be excepted under a bona fide market 
making exception? Should the circuit breaker provide an exception that 
would allow short sales that occur as a result of automatic exercise or 
assignment of an equity option held prior to the effectiveness of the 
short selling halt due to expiration of the option? If so, why? If not, 
why not? Please explain. Should the circuit breaker contain an 
exception for options market makers selling short as part of bona fide 
market making and hedging activities related directly to bona fide 
market making in derivatives on the individual security subject to the 
halt? If so, why? If not, why not? Please explain. The circuit breaker 
halt rule as proposed includes an exception for hedging activity by 
market makers engaged in bona fide market making, but it does not 
provide an exception for hedging of convertible securities or for 
convertible arbitrage activities by persons who are not market makers 
engaged in bona fide market making activities at the time of the short 
sale. Should we consider exceptions for convertible arbitrage and/or 
the hedging of convertible securities by persons who are not market 
makers engaged in bona fide market making? Would such exceptions reduce 
the effectiveness of the rule? How often would this exception be used? 
Please explain and provide empirical data to support explanations/
analyses.
    11. What other exceptions should be considered or included in such 
a circuit breaker? Please explain.
    12. What would be an appropriate implementation period for the 
circuit breaker? Would a three-month implementation period be 
appropriate for a circuit breaker that when triggered imposed short 
selling halts on individual securities? Is more or less time necessary? 
Please explain.
    13. Should the exception for owned securities be limited to Rule 
144 securities, similar to the Short Sale Ban, or expanded to include 
other securities that a seller is deemed to own but are not included 
under Rule 200(b) of Regulation SHO?
    14. We are proposing to include an exception for marker makers, 
including over-the-counter market makers, that sell short as part of 
bona fide market making and hedging activity directly related to bona 
fide market making in

[[Page 18081]]

derivative securities based on covered securities or exchange traded 
funds and exchange traded notes of which covered securities are a 
component. Similar to the Short Sale Ban, should we also provide that 
this exception would not apply to any market maker that knows that the 
customer's or counterparty's transaction would result in the customer 
or counterparty establishing or increasing an economic net short 
position (i.e., through actual positions, derivatives, or otherwise) in 
a covered security? Do the same concerns apply for a short sale halt 
that would only be in place for one trading day? What if the proposed 
circuit breaker halt rule prohibits short selling in a particular 
security for longer than one trading day when triggered? How long of a 
period would necessitate including such a provision?
    15. Should the proposed circuit breaker halt rule be adopted in 
addition to a permanent, marketwide short sale price test restriction 
rule? Thus, while a short sale price test restriction rule would be in 
place as a permanent, marketwide rule, a circuit breaker would also 
trigger a short selling halt in any security that suffers a severe 
price decline.
    16. Should the proposed circuit breaker halt rule apply to non-NMS 
securities? Would a 10% trigger level cause some non-NMS securities to 
be halted too frequently? Should we consider a different trigger for 
non-NMS securities?
    17. As an alternative to a circuit breaker rule that prohibits 
short selling at any price after the trigger price is reached, should 
we consider instead a price limit rule that would prohibit short 
selling in a particular NMS security at a price lower than 10% below 
the prior day's close? Unlike a circuit breaker rule, a price limit 
rule would continue to allow short selling at prices above the limit 
price after the limit has been reached. Would 10% be the appropriate 
limit? Should it be higher or lower? Please explain.
    18. We propose including an exception for sales of securities that 
the seller is deemed to own pursuant to Rule 200(b) of Regulation SHO 
because these are sales of owned securities. Are broker-dealers able to 
identify short sales as sales of Rule 200(b) owned securities on an 
intra-day basis so that the exception would be useful when a circuit 
breaker is triggered?
Questions Regarding Circuit Breaker Price Test Rule
    1. Should a short selling circuit breaker impose a short sale price 
test restriction on individual equity securities, rather than halt 
short selling for individual securities when triggered? For example, 
following a 10% decline in a security's price, as measured from the 
prior day's closing price, should a circuit breaker result in a 
temporary short sale price test restriction in the form of the proposed 
modified uptick rule or the proposed uptick rule? Please explain.
    2. Should we consider a circuit breaker rule that, when triggered, 
would prohibit short selling in a particular NMS security on a downbid 
unless the short sale is effected at a price that is more than 10% 
greater than the prior day's closing price? Would 10% be an appropriate 
requirement? Should it be higher or lower? Should we have different 
percentages for different types of securities (e.g., based on 
volatility, market capitalization, volume traded)? Please explain.
    3. The proposed circuit breaker rules would impose a short sale 
price test on any security that suffers a decline in price of 10% or 
more relative to the prior day's closing price for that security. We 
note that a low trigger level may result in more securities becoming 
subject to a short sale price test or some securities becoming subject 
to a short sale price test more frequently, resulting in potential 
increases in costs, decreases in liquidity, and decreases in market 
quality for the affected security. Also, the impact of a lower trigger 
level may be greater for thinly traded securities or higher volatility 
securities than for other securities. However, if a high level is 
established, more securities may face severe price declines for longer 
periods before the short sale price test is imposed. This also may 
affect thinly traded securities more than other securities. Unlike a 
circuit breaker that results in a halt, however, a circuit breaker that 
results in a short sale price test would not prohibit short selling but 
would restrict short selling to a rising market. Also, the short sale 
price test would be limited to a trading unit increment, which may 
result in fewer costs and reduced loss of liquidity than a short sale 
halt. Is 10% an appropriate trigger for a circuit breaker rule that 
results in short sale price test? If not, at what percentage trigger 
level should short sale price test restrictions be imposed? Would a 10% 
trigger level be appropriate? Would a higher or lower trigger level be 
appropriate? Should the trigger be different for thinly traded or 
higher volatility stocks? Should we consider market capitalization in 
determining different trigger levels?
    4. What short sale price test restrictions would be most 
appropriate in combination with a short selling circuit breaker? Should 
the circuit breaker when triggered result in a short sale price test 
based on the national best bid, similar to the proposed modified uptick 
rule? Please explain. Should the circuit breaker when triggered result 
in a short sale price test based on the last sale price, similar to the 
proposed uptick rule? Please explain. Should the circuit breaker when 
triggered result in a short sale price test that requires short sale 
orders to be initiated only at a price above the highest prevailing 
national best bid by posting a quote for a short sale order above the 
national bid? If so, why? If not, why not? If the circuit breaker when 
triggered results in a short sale price test restriction based on the 
national best bid (the proposed modified uptick rule), should short 
selling be restricted to a specific increment above the current 
national best bid, such as one cent above the national best bid? Or 
should a higher or lower increment apply? Please explain. If a specific 
increment is suggested, what impact would such an increment have on 
short selling in the individual security? Please explain. What 
increment, if any, would be tantamount to a halt on short selling 
during the period in which the circuit breaker is in effect? Please 
explain and provide empirical data and analysis in support of any 
arguments and/or analyses.
    5. The proposed circuit breaker halt rule would impose a short sale 
price test for the trading day following the triggering of the circuit 
breaker. Is this an appropriate length of time? If so, why? If not, why 
not, and how long should the short sale price test persist? We note 
that increasing the length of a halt to an additional days or multiple 
additional days may increase costs, reduce market quality, and reduce 
liquidity in that security. This may affect thinly traded securities or 
higher volatility securities more than other securities. However, 
decreasing the period of time to less than the trading day, such as 
limiting the short sale price test to an hour or a few hours following 
the trigger, may reduce the effectiveness of the short sale price test. 
Would it be more beneficial for a 10% intraday decline to trigger a 
short sale price test in short selling for a few hours rather than for 
the trading day? Should it result in a multiple day short sale price 
test? Please explain. How disruptive to normal trading would a multiple 
day short sale price test be compared to a halt for one trading day? If 
short selling is restricted by a price test after the circuit breaker 
is triggered in the wake of a 10% intraday decline, and the value of 
the stock continues to decline

[[Page 18082]]

throughout the day to the point where it is down 20% at closing, should 
short selling be allowed to resume the following trading day? If so, 
why? If not, why not? Please explain. Should a 20% or greater intraday 
decline result in a short sale price test for multiple trading days? 
For example, would it be appropriate for a 20% intraday decline on the 
day the circuit breaker is triggered to result in a 3-day price test 
restriction in short selling, a 5-day restriction on short selling, or 
a 10-day restriction on short selling? Specifically, what length of a 
restriction would be appropriate for the various levels of decline in 
excess of 10%? Should we consider a different period for higher 
volatility stocks? Should we consider market capitalization in 
determining different trigger levels? Please explain.
    6. What benefits would be associated with a short selling circuit 
breaker that when triggered imposed short sale price test restrictions? 
Could the short sale price test restrictions help stabilize the market 
for the individual security? If so, why? If not, why not? Could the 
short sale price test restrictions benefit investors by allowing the 
market to ``cool off'' with respect to that individual security? Please 
explain. Could a circuit breaker that when triggered imposes short sale 
price test restrictions result in an increase in investor confidence? 
Please explain.
    7. What are the benefits, if any, of a circuit breaker that when 
triggered imposes short sale price test restrictions, versus a 
permanent, market-wide short sale price test such as the modified 
uptick rule or the proposed uptick rule? Please explain and support 
explanations with data and analysis where appropriate.
    8. What costs would be associated with implementing a short selling 
circuit breaker that when triggered imposed short sale price test 
restrictions? Please explain. What would be the degree of financial 
expenditure involved in updating systems in a manner necessary to 
ensure compliance with such a circuit breaker? Would the expenditure 
necessary to ensure compliance be primarily an ``up-front'' cost? Would 
the expenditure necessary to ensure compliance require long-term 
investment? Please explain. How would the costs of a circuit breaker 
that when triggered imposes short sale price test restrictions compare 
with the costs of a permanent short sale price test such as the 
proposed modified uptick rule or the proposed uptick rule? Please 
explain.
    9. What technological challenges would be encountered in updating 
systems to ensure compliance with a short selling circuit breaker that 
when triggered imposed short sale price test restrictions on individual 
securities? Please explain. How long would it take to update systems in 
a manner that ensured compliance? Please explain. Would a short selling 
circuit breaker that when triggered imposed short sale price test 
restrictions impede the efficient functioning of the equity markets? If 
so, why? If not, why not? Please explain. Are there any other 
operational challenges that may arise from implementing a short selling 
circuit breaker that when triggered imposed short sale price test 
restrictions? Please explain. Would the operational challenges 
presented impede the effectiveness of such a short selling circuit 
breaker? Please explain.
    10. Are there other short sale price test restrictions that should 
be considered in combination with a short selling circuit breaker? 
Please explain.
    11. Should a circuit breaker that when triggered imposed short sale 
price test restrictions include exceptions? Please explain. If such a 
circuit breaker is based on the proposed modified uptick rule, should 
it contain the same exceptions as those contemplated in the proposed 
modified uptick rule? If so, why? If not, why not? If other or 
different exceptions are warranted for such a circuit breaker, what 
should they be? Please explain. If a circuit breaker is based on the 
proposed uptick rule, should it contain the same exceptions as those 
contemplated in the proposed uptick rule? If so, why? If not, why not? 
If other or different exceptions are warranted for such a circuit 
breaker, what should they be? Please explain.
    12. Should a circuit breaker that when triggered imposed short sale 
price test restrictions contain a general market maker exception? If 
so, why? If not, why not? If so, should the market maker exemption be 
limited to registered market makers, exchange-based market makers, or 
apply to over-the-counter market makers as well? Should upstairs 
customer facilitation be exempted from a short selling circuit breaker? 
Should parties involved in delta neutral hedging be excepted from a 
short selling circuit breaker? Should parties involved with index 
arbitrage be excepted from a short selling circuit breaker that when 
triggered imposed short sale price test restrictions? What other 
exceptions may be appropriate? Please explain.
    13. What implementation period would be necessary for the circuit 
breaker? Would a three month implementation period be appropriate for a 
circuit breaker that when triggered imposed short sale price test 
restrictions on individual securities? Is more or less time necessary? 
Please explain.
    14. One commenter suggested a circuit breaker that, when triggered, 
would prohibit any person from selling short except at an upbid.\299\ 
Should a circuit breaker that triggers a bid-based price restriction 
for a particular security be expanded to prohibit short sales both on a 
downbid and at the bid? Thus, once triggered, short sales in the 
particular security could only be executed or displayed, or effected, 
at an upbid. We note that such a rule would be stricter than the 
proposed circuit breaker modified uptick rule, which would permit short 
sales at the bid unless the bid is on a downbid. As a result, this 
proposal may result in additional costs, reduce liquidity, and reduce 
market quality. However, this proposed rule may also establish a longer 
``break'' before short selling resumes. Would it be appropriate to 
change the proposed circuit breaker modified uptick rule to require 
that, following the trigger of the circuit breaker, short sales could 
only be effected at an upbid? Please explain why this may be more 
appropriate.
---------------------------------------------------------------------------

    \299\ See National Exchanges Letter, supra note 63.
---------------------------------------------------------------------------

    15. Would it be more appropriate for the resulting price test to be 
based on a policies and procedures rule or a straight prohibition? For 
instance, a circuit breaker that triggers a policies and procedures 
rule would require trading centers to incur immediate upfront costs to 
establish policies and procedures that would be implemented and 
enforced once a circuit breaker is triggered for a particular security. 
Would a circuit breaker that triggers a straight prohibition incur 
fewer costs? Please explain.

V. Marking

    Rule 200(g) of Regulation SHO provides that a broker-dealer must 
mark all sell orders of any security as ``long'' or ``short.'' \300\ As 
initially adopted, Regulation SHO included an additional marking 
requirement of ``short exempt'' applicable to short sale orders if the 
seller was ``relying on an exception from the tick test of 17 CFR 
240.10a-1, or any short sale price test of any exchange or national 
securities association.'' \301\ We adopted amendments to Rule 200(g) of 
Regulation SHO to remove the ``short exempt'' marking requirement in 
conjunction with our elimination of former Rule 10a-1.\302\
---------------------------------------------------------------------------

    \300\ See 17 CFR 242.200(g).
    \301\ See 2004 Regulation SHO Adopting Release, 69 FR 48008.
    \302\ See 2007 Price Test Adopting Release, 72 FR 36348.

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

[[Page 18083]]

    In conjunction with the proposed amendments to Rule 201 of 
Regulation SHO to add a short sale price test or a circuit breaker 
rule, we are proposing to amend Rule 200(g) of Regulation SHO to again 
impose a ``short exempt'' marking requirement. Specifically, proposed 
Rule 200(g) would provide that ``[a] broker or dealer must mark all 
sell orders of any equity security as ``long,'' ``short,'' or ``short 
exempt.'' \303\
---------------------------------------------------------------------------

    \303\ See proposed Rule 200(g) of the proposed modified uptick 
rule and of the proposed uptick rule.
---------------------------------------------------------------------------

    In addition, proposed Rule 200(g)(2) of the proposed modified 
uptick rule would provide that a sale order shall be marked ``short 
exempt'' only if the provisions of paragraph (c) or (d) of proposed 
Rule 201 are met.\304\ This ``short exempt'' marking requirement would 
provide a record that a broker-dealer is availing itself of the 
provisions of paragraph (c) or (d) of the proposed modified uptick 
rule.
---------------------------------------------------------------------------

    \304\ See proposed Rule 200(g)(2) of the proposed modified 
uptick rule.
---------------------------------------------------------------------------

    Proposed Rule 200(g)(2) of the proposed uptick rule or the proposed 
circuit breaker rules would provide that a sale order shall be marked 
``short exempt'' only if the seller is relying on an exception from the 
price test of Sec.  242.201.\305\ This ``short exempt'' marking 
requirement would provide a record that short sellers are availing 
themselves of the various exceptions to the application of the 
restrictions of the proposed uptick rule.\306\
---------------------------------------------------------------------------

    \305\ See Proposed Rule 200(g)(2).
    \306\ The improper marking of a short sale order as ``short 
exempt'' by the broker-dealer would be a violation of proposed Rule 
200(g)(2) and Exchange Act Section 10(a). In addition, the improper 
marking of a short sale order as ``short exempt'' could, in some 
circumstances, result in liability under the antifraud provisions of 
the federal securities laws; the liability of the broker-dealer that 
marked the order, and of the trading center that displayed or 
executed the order, would turn on whether those entities acted with 
the mental state required under the applicable antifraud provisions.
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    The records provided pursuant to the ``short exempt'' marking 
requirements of proposed Rule 200(g) of the proposed short sale price 
test rules and the proposed circuit breaker rules would aid 
surveillance by SROs and the Commission for compliance with the 
provisions of either of those short sale price test restrictions. In 
addition, if the Commission were to adopt a policies and procedures 
approach, such as is proposed in conjunction with the proposed modified 
uptick rule, the proposed ``short exempt'' marking requirement would 
provide an indication to a trading center regarding whether it must 
execute or display a short sale order with regard to whether the short 
sale order is at a down-bid price.
    If we were to adopt the proposed ``short exempt'' marking 
requirement of proposed Rule 200(g) of the proposed short sale price 
test rules or the proposed circuit breaker rules, we are proposing an 
implementation period under which market participants would have to 
comply with this requirement three months following the effective date 
of the proposed marking requirement. We believe that this proposed 
implementation period would provide market participants with sufficient 
time in which to modify their systems and procedures in order to comply 
with the proposed marking requirements. We realize, however, that a 
shorter or longer implementation period may be manageable or 
preferable. Thus, we seek specific comment as to what length of 
implementation period would be necessary or appropriate, and why, such 
that market participants would be able to meet the proposed marking 
requirements, if adopted.

Request for Comment

    We seek comment generally on all aspects of the proposed amendment 
to Rule 200(g) of Regulation SHO. In addition, we seek comment on the 
following:
    1. What type of costs, if any, would be associated with requiring 
sell orders to be marked ``short exempt'' when relying on an exception 
under proposed Rule 201? What types of costs, if any, would be 
associated with not requiring sell orders to be marked ``short exempt'' 
when relying on an exception under proposed Rule 201?
    2. Should the proposed rule require a broker-dealer marking a sell 
order ``short exempt'' to identify the specific provision on which the 
broker-dealer is relying in marking the order ``short exempt''? If not, 
why not?
    3. What would be a sufficient implementation period for making any 
systems changes necessary to allow sell orders to be marked ``short 
exempt''?
    4. Please describe any anticipated difficulties in complying with a 
``short exempt'' marking requirement.
    5. The ``short exempt'' marking has historically been used only for 
short sales that are excepted from a short sale price test. For 
instance, the ``short exempt'' marking was not available for short 
sales that were excepted from the Regulation SHO locate requirement of 
Rule 203(b). We are, however, proposing to require short sales that are 
excepted from the proposed circuit breaker halt rule, when triggered, 
to be marked ``short exempt.'' Would a ``short exempt'' marking be 
needed for the proposed circuit break rules if circuit breakers operate 
in place of short sale price test restrictions?

VI. Overseas Transactions

    In connection with former Rule 10a-1, the Commission consistently 
took the position that the rule applied to trades in securities subject 
to that rule where the trade was ``agreed to'' in the U.S., but booked 
overseas.\307\ In addition, in the 2004 Regulation SHO Adopting Release 
we stated that any broker-dealer using the United States jurisdictional 
means to effect short sales in securities traded in the United States 
would be subject to Regulation SHO, regardless of whether the broker-
dealer is registered with the Commission or relying on an exemption 
from registration.\308\ For example, a U.S. money manager decides to 
sell a block of 500,000 shares in an NMS stock. The money manager 
negotiates a price with a U.S. broker-dealer, who sends the order 
ticket to its foreign trading desk for execution. In our view, this 
trade occurred in the United States as much as if the trade had been 
executed by the broker-dealer

[[Page 18084]]

at a U.S. trading desk. Under either the proposed short sale price test 
rules or the proposed circuit breaker rules, if the short sale is 
agreed to in the U.S., it must be effected in accordance with the 
requirements of those proposed rules, unless otherwise excepted.
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    \307\ See Securities Exchange Act Release No. 27938 (Apr. 23, 
1990), 55 FR 17949 (Apr. 30, 1990) (stating that the no-action 
position exempting certain index arbitrage sales from former Rule 
10a-1 would not apply to an index arbitrage position that was 
established in an offshore transaction unless the holder acquired 
the securities from a seller that acted in compliance with former 
Rule 10a-1 or other comparable provision of foreign law). See also 
Securities Exchange Act Release No. 21958 (Apr. 18, 1985), 50 FR 
16302 (Apr. 25, 1985) at n. 48 (stating that, ``Rule 10a-1 does not 
contain any exemption for short sales effected in international 
markets.''). The question of whether a particular transaction 
negotiated in the U.S. but nominally executed abroad by a foreign 
affiliate is a domestic trade for U.S. regulatory purposes was also 
addressed in the Commission's Order concerning Wunsch Auction 
Systems, Inc. (WASI). The Commission stated its belief that ``trades 
negotiated in the U.S. on a U.S. exchange are domestic, not foreign 
trades. The fact that the trade may be time-stamped in London for 
purposes of avoiding an SRO rule does not in our view affect the 
obligation of WASI and BT Brokerage to maintain a complete record of 
such trades and report them as U.S. trades to U.S. regulatory and 
self-regulatory authorities and, where applicable, to U.S. reporting 
systems.'' See Securities Exchange Act Release No. 28899 (Feb. 20, 
1991), 56 FR 8377 (Feb. 28, 1991). In what is commonly referred to 
as the ``fax market,'' a U.S. broker-dealer acting as principal for 
its customer negotiates and agrees to the terms of a trade in the 
U.S., but transmits or faxes the terms overseas to be ``printed'' on 
the books of a foreign office. This practice of ``booking'' trades 
overseas was analyzed in depth in the Division of Market 
Regulation's Market 2000 Report. In the Report, the Division 
estimated that at that time approximately 7 million shares a day in 
NYSE stocks were faxed overseas, and many of these trades were 
nominally ``executed'' in the London over-the-counter market. See 
Division of Market Regulation, SEC, Market 2000: An Examination of 
Current Equity Market Developments (Jan. 1994), Study VII, p. 2.
    \308\ See 2004 Regulation SHO Adopting Release, 69 FR at 48104, 
n. 54.
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Request for Comment

    1. Would the proposed modified uptick rule, proposed uptick rule, 
or circuit breaker rules, if adopted, result in sellers transacting 
short sales in foreign markets where they would not be subject to a 
short sale price test rather than in U.S. markets? If so, please 
explain.
    2. For short sales agreed to in the United States and executed 
overseas, would the time the short sale is agreed to in the U.S. be the 
appropriate time to be used to establish the price against which the 
proposed uptick rule, proposed modified uptick rule, or circuit breaker 
rule, would be determined?
    3. Please identify any challenges or difficulties that could arise 
in applying the proposed modified uptick rule or proposed uptick rule 
to short sales agreed to in the United States and executed overseas?
    4. Would the proposed modified uptick rule, proposed uptick rule, 
circuit breaker proposals, or any other restriction on short sales, be 
easier to implement and enforce for short sales agreed to in the United 
States but executed overseas? Please explain.
    5. What would be the costs and benefits of applying the proposed 
modified uptick rule, proposed uptick rule, the alternative circuit 
breaker rules, or any other restriction on short sales to short sales 
agreed to in the United States and executed overseas?

VII. Exemptive Procedures

    The proposed alternative short sale price test rules and the 
alternative circuit breaker rules would establish procedures for the 
Commission, upon written request or its own motion, to grant an 
exemption from the rules' provisions, either unconditionally or on 
specified terms and conditions, if the Commission determines that such 
exemption is necessary or appropriate in the public interest and is 
consistent with the protection of investors.\309\ Pursuant to this 
provision, we would consider and act upon appropriate requests for 
relief from the proposed short sale price tests' provisions and the 
proposed short sale circuit breakers' provisions, if adopted, and would 
consider the particular facts and circumstances relevant to each such 
request and any appropriate conditions to be imposed as part of the 
exemption. We solicit comment regarding including a provision for 
exemptive procedures in the proposed short sale price test rules and 
the proposed circuit breaker rules.
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    \309\ See proposed Rule 201(e) of the proposed uptick rule; 
proposed Rule 201(f) of the proposed modified uptick rule; proposed 
Rule 201(g) of the proposed circuit breaker halt rule and proposed 
circuit breaker uptick rule; and proposed Rule 201(h) of the 
proposed circuit breaker modified uptick rule.
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VIII. Paperwork Reduction Act

A. Background

    Certain provisions of the proposed amendments to Regulation SHO 
would impose new ``collection of information'' requirements within the 
meaning of the Paperwork Reduction Act of 1995 (``PRA'').\310\ 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. 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. OMB has not yet assigned a control number to the new 
collection of information.
---------------------------------------------------------------------------

    \310\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

    We are proposing amendments to Rules 201 and 200(g) of Regulation 
SHO under the Exchange Act. The proposed amendments to Rule 201 include 
two alternative price tests that would impose restrictions on the 
prices at which certain securities would be able to be sold short.\311\ 
The first alternative short sale price test would be a proposed 
modified uptick rule. The second alternative short sale price test 
would be a proposed uptick rule. We are also proposing alternative 
circuit breaker rules that would establish limitations on short selling 
in a particular security during severe market declines in the price of 
that security.\312\ The first alternative circuit breaker rule would be 
the proposed circuit breaker halt rule. The second alternative circuit 
breaker rule would be the proposed circuit breaker modified uptick 
rule. The third alternative circuit breaker rule would be the proposed 
circuit breaker uptick rule. In addition, we are proposing to amend 
Rule 200(g) of Regulation SHO to impose a ``short exempt'' marking 
requirement and to also require that a broker-dealer mark a sell order 
``short exempt'' only if the provisions in proposed Rule 201(c) or (d) 
of the proposed modified uptick rule (or the proposed circuit breaker 
modified uptick rule) are met, or if a seller is relying on an 
exception in proposed Rule 201(c) of the proposed uptick rule (or the 
proposed circuit breaker uptick rule), or if a seller is relying on an 
exception in proposed Rule 201(c) of the proposed circuit breaker halt 
rule.\313\
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    \311\ See proposed Rule 201.
    \312\ See proposed Rule 201.
    \313\ See proposed Rules 200(g) and 200(g)(2).
---------------------------------------------------------------------------

B. Summary

    As detailed below, several provisions under the proposed amendments 
to Regulation SHO would impose a new ``collection of information'' 
within the meaning of the PRA.
1. Policies and Procedures Requirement Under Proposed Modified Uptick 
Rule
    The proposed modified uptick rule would impose a new ``collection 
of information'' within the meaning of the PRA.\314\ Under the proposed 
modified uptick rule, a trading center would be required to have 
written policies and procedures reasonably designed to prevent the 
execution or display of a short sale order of a covered security at a 
down-bid price.\315\ In addition, a trading center would be required to 
have policies and procedures reasonably designed to permit the 
execution or display of a short sale order of a covered security marked 
``short exempt'' without regard to whether the order is at a down-bid 
price.\316\ Thus, upon acceptance of a short sale order, a trading 
center's policies and procedures would have to be reasonably designed 
to permit the trading center to be able to determine whether or not the 
short sale order is priced in accordance with the provisions of 
proposed Rule 201(b)(1) and to recognize when an order is marked 
``short exempt'' such that the trading center's policies and procedures 
do not prevent the execution or display of such orders on a down-bid 
price.\317\
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    \314\ The discussion of the PRA as it applies to the proposed 
modified uptick rule applies equally to the proposed circuit breaker 
modified uptick rule.
    \315\ Proposed Rule 201(b)(1). A ``down bid'' is defined as ``a 
price that is less than the current national best bid or, if the 
last differently priced national best bid was greater than the 
current national best bid, a price that is less than or equal to the 
current national best bid.'' Proposed Rule 201(a)(2).
    \316\ See proposed Rule 201(b)(1)(ii). See also Section V, 
above, regarding the proposed ``short exempt'' marking requirement.
    \317\ See proposed Rule 200(g)(2). The broker-dealer marking the 
order ``short exempt'' would have responsibility for being able to 
identify on which provision to the proposed modified uptick rule it 
was relying in marking the order ``short exempt.''
---------------------------------------------------------------------------

    At a minimum, a trading center's policies and procedures would need 
to enable a trading center to monitor, on a real-time basis, the 
national best bid,

[[Page 18085]]

and whether the current national best bid is an up- or down-bid from 
the last differently priced national best bid, so as to determine the 
price at which the trading center may execute or display a short sale 
order. As mentioned above, a trading center would need to have policies 
and procedures governing how to recognize and handle orders that a 
trading center receives as marked ``short exempt'' pursuant to proposed 
Rule 200(g)(2).\318\ A trading center's policies and procedures also 
would be required to address latencies in obtaining data regarding the 
national best bid. In addition, to the extent such latencies occur, a 
trading center would be required to implement reasonable steps in its 
policies and procedures to monitor such latencies on a continuing basis 
and take appropriate steps to address a problem should one develop.
---------------------------------------------------------------------------

    \318\ Id.
---------------------------------------------------------------------------

    A trading center would also need to take such steps as would be 
necessary to enable it to enforce its policies and procedures 
effectively. As part of its written policies and procedures, a trading 
center also would be required to regularly surveil to ascertain the 
effectiveness of its policies and procedures and take prompt remedial 
steps.\319\ The nature and extent of the policies and procedures that a 
trading center would be required to establish to comply with these 
requirements would depend upon the type, size, and nature of the 
trading center.
---------------------------------------------------------------------------

    \319\ This provision would reinforce the ongoing maintenance and 
enforcement requirements of proposed Rule 201(b)(1) by explicitly 
assigning an affirmative responsibility to trading centers to 
surveil to ascertain the effectiveness of their policies and 
procedures. See proposed Rule 201(b)(2). We note that Rule 611(a)(2) 
of Regulation NMS contains a similar provision for trading centers. 
See 17 CFR 242.611(a)(2).
---------------------------------------------------------------------------

2. Identification of Short Sale Orders and Policies and Procedures 
Requirement Under the Proposed ``Broker-Dealer'' and ``Riskless 
Principal'' Provisions
    The proposed modified uptick rule contains a ``broker-dealer'' 
provision that would require a new ``collection of information'' under 
the PRA. Proposed Rule 201(c)(1) provides that a broker dealer may mark 
a short sale order of a covered security ``short exempt'' if a broker-
dealer that submits a short sale order to a trading center has 
identified that the short sale order is not on a down-bid price at the 
time of submission of the order to the trading center.\320\ This 
provision would require a new ``collection of information'' in that a 
broker-dealer marking an order ``short exempt'' under proposed Rule 
201(c)(1) must identify both a short sale order as priced in accordance 
with the requirements of proposed Rule 201(c)(1) and establish, 
maintain, and enforce written policies and procedures reasonably 
designed to prevent the incorrect identification of orders as being 
priced in accordance with the requirements of proposed Rule 
201(c)(1).\321\
---------------------------------------------------------------------------

    \320\ See proposed Rule 201(c)(1).
    \321\ See proposed Rule 201(c)(1). As part of its written 
policies and procedures, a broker-dealer also would be required to 
regularly surveil to ascertain the effectiveness of its policies and 
procedures and take prompt remedial steps. See proposed Rule 
201(c)(2). This provision is intended to reinforce the ongoing 
maintenance and enforcement requirements of the provision contained 
in proposed Rule 201(c)(1) by explicitly assigning an affirmative 
responsibility to broker-dealers to surveil to ascertain the 
effectiveness of their policies and procedures. See id.
---------------------------------------------------------------------------

    While the proposed uptick rule itself does not contain a 
``collection of information'' requirement within the meaning of the 
PRA, the proposed uptick rule does contain a ``riskless principal'' 
exception that would require a new ``collection of information'' under 
the PRA.\322\ The proposed modified uptick rule also contains a 
``riskless principal'' provision that would require a new ``collection 
of information'' under the PRA. Specifically, proposed Rule 201(d)(6) 
of the proposed modified uptick rule and Rule 201(c)(9) of the proposed 
uptick rule would allow a broker-dealer to mark short sale orders of a 
covered security ``short exempt'' where a broker-dealer is facilitating 
customer buy orders or sell orders where the customer is net long, and 
the broker-dealer is net short but is effecting the sale as riskless 
principal, provided certain conditions are satisfied.\323\
---------------------------------------------------------------------------

    \322\ The discussion of the PRA as it applies to the proposed 
uptick rule applies equally to the proposed circuit breaker uptick 
rule.
    \323\ See proposed Rule 201(d)(6). As a result, a trading 
center's policies and procedures would need to be reasonably 
designed to permit the execution or display of such orders without 
regard to whether the order is at a down-bid price. See proposed 
Rule 201(b)(1)(ii).
---------------------------------------------------------------------------

    Proposed Rules 201(d)(6) of the proposed modified uptick rule and 
201(c)(9) of the proposed uptick rule would require a new ``collection 
of information'' in that each would require a broker-dealer marking an 
order ``short exempt'' under these provisions to have written policies 
and procedures in place to assure that, at a minimum, the customer 
order was received prior to the offsetting transaction; the offsetting 
transaction is allocated to a riskless principal account within 60 
seconds of execution; and that it has supervisory systems in place to 
produce records that enable the broker-dealer to accurately and readily 
reconstruct, in a time-sequenced manner, all orders on which the 
broker-dealer relies pursuant to this provision.\324\
---------------------------------------------------------------------------

    \324\ See proposed Rule 201(c)(9) of the proposed uptick rule 
and Rule 201(d)(6) of the proposed modified uptick rule.
---------------------------------------------------------------------------

3. Proposed Marking Requirements
    While the current marking requirements in Rule 200(g) of Regulation 
SHO, which require broker-dealers to mark all sell orders of any equity 
security as either ``long'' or ``short,'' \325\ would remain in effect, 
proposed Rule 200(g) would add a new marking requirement of ``short 
exempt.'' \326\ In addition, the proposed amendments to Rule 200(g)(2) 
would require that a broker-dealer mark a sell order ``short exempt'' 
only if the provisions in paragraph (c) or (d) of the proposed modified 
uptick rule (or paragraph (c) or (d) of the proposed circuit breaker 
modified uptick rule) are met, or if the seller is relying on an 
exception in paragraph (c) of the proposed uptick rule (or paragraph 
(c) of the proposed circuit breaker uptick rule), or if the seller is 
relying on an exception in paragraph (c) of the proposed circuit 
breaker halt rule.\327\ The proposed ``short exempt'' marking 
requirements would impose a new ``collection of information.''
---------------------------------------------------------------------------

    \325\ 17 CFR 242.200(g).
    \326\ See proposed Rule 200(g). See also Section V above 
discussing proposed Rule 200(g).
    \327\ See proposed Rule 200(g)(2).
---------------------------------------------------------------------------

C. Proposed Use of Information

1. Policies and Procedures Requirement Under Proposed Modified Uptick 
Rule
    The information that would be collected under the proposed modified 
uptick rule's written policies and procedures requirement would help 
ensure that the trading center does not execute or display any 
impermissibly priced short sale orders, unless an order is marked 
``short exempt'' in accordance with the rule's requirements. This 
written policies and procedures requirement would also provide trading 
centers with flexibility in determining how to comply with the 
requirements of the proposed modified uptick rule. The information 
collected also would aid the Commission and SROs that regulate trading 
centers in monitoring compliance with the price test's requirements. It 
also would aid trading centers and broker-dealers in complying with the 
rule's requirements.

[[Page 18086]]

2. Identification of Short Sale Orders and Policies and Procedures 
Requirement Under the Proposed ``Broker-Dealer'' and ``Riskless 
Principal'' Provisions
    Proposed Rule 201(c)(1) of the proposed modified uptick rule would 
include a ``broker-dealer'' provision that would permit a broker-dealer 
to mark a short sale order in a covered security ``short exempt'' if 
the broker-dealer has identified the order as not being at a down-bid 
price at the time of submission of the order to the trading center. 
This provision would include a policies and procedures requirement that 
would be designed to help prevent incorrect identification of orders 
for purposes of the proposed modified uptick rule's broker-dealer 
provision.
    Moreover, the information collection under the written policies and 
procedures requirement in the ``riskless principal'' exception in 
proposed Rule 201(c)(9) of the proposed uptick rule and the ``riskless 
principal'' provision in proposed Rule 201(d)(6) of the proposed 
modified uptick rule would help assure that broker-dealers comply with 
the requirements of these proposed provisions. The information 
collected would also enable the Commission and SROs to examine for 
compliance with the requirements of these proposed provisions.
3. Proposed Marking Requirements
    Proposed Rule 200(g) would impose a ``short exempt'' marking 
requirement.\328\ In addition, proposed Rule 200(g)(2) would require 
that a sale order be marked ``short exempt'' only if the provisions in 
paragraph (c) or (d) of the proposed modified uptick rule (or paragraph 
(c) or (d) of the proposed circuit breaker modified uptick rule) are 
met,\329\ or if the seller is relying on an exception in paragraph (c) 
of the proposed uptick rule (or paragraph (c) of the proposed circuit 
breaker uptick rule),\330\ or if the seller is relying on an exception 
in paragraph (c) of the proposed circuit breaker halt rule.\331\ The 
purpose of the information collected would be to enable the Commission 
and SROs to monitor whether a person entering a sell order covered by 
the proposed amendments to Rule 201 is acting in accordance with one of 
the provisions contained in paragraph (c) or (d) of the proposed 
modified uptick rule (or paragraph (c) or (d) of the proposed circuit 
breaker modified uptick rule), or if the seller is relying on an 
exception in paragraph (c) of the proposed uptick rule (or paragraph 
(c) of the proposed circuit breaker uptick rule), or if the seller is 
relying on an exception in paragraph (c) of the proposed circuit 
breaker halt rule. In particular, the ``short exempt'' marking 
requirement would provide a record that would aid in surveillance for 
compliance with the provisions of proposed Rule 201. It also would 
provide an indication to a trading center regarding whether or not it 
must execute or display a short sale order in accordance with the price 
test restrictions of the proposed modified uptick rule (or the proposed 
circuit breaker modified uptick rule). It also would help a trading 
center determine whether its policies and procedures were reasonable 
and whether its surveillance was effective.
---------------------------------------------------------------------------

    \328\ See proposed Rule 200(g).
    \329\ See proposed Rule 200(g)(2) of the proposed modified 
uptick rule (and the proposed circuit breaker modified uptick rule). 
Paragraphs (c) and (d) of the proposed modified uptick rule (and the 
proposed circuit breaker modified uptick rule) set forth when a 
broker-dealer may mark a short sale order ``short exempt.'' See 
proposed Rules 201(c) and (d).
    \330\ See proposed Rule 200(g)(2) of the proposed uptick rule 
(and the proposed circuit breaker uptick rule). Paragraph (c) of the 
proposed uptick rule (and paragraph (c) of the proposed circuit 
breaker uptick rule) sets forth when a broker-dealer may mark a 
short sale order ``short exempt'' in accordance with the proposed 
uptick rule (or the proposed circuit breaker uptick rule). See 
proposed Rule 201(c).
    \331\ See proposed Rule 200(g)(2) of the proposed circuit 
breaker halt rule. Paragraph (c) of the proposed circuit breaker 
halt rule sets forth when a broker-dealer may mark a short sale 
order ``short exempt'' in accordance with the proposed circuit 
breaker halt rule. See proposed Rule 201(c).
---------------------------------------------------------------------------

D. Respondents

    As discussed below, the Commission has considered each of the 
following respondents for the purposes of calculating the reporting 
burdens under the proposed amendments to Rules 200(g) and 201 of 
Regulation SHO. The Commission requests comment on the accuracy of 
these figures.
1. Policies and Procedures Requirement Under Proposed Modified Uptick 
Rule
    The proposed modified uptick rule would require each trading center 
to establish, maintain, and enforce written policies and procedures 
reasonably designed to prevent the execution or display of a short sale 
order at a down-bid price.\332\ A ``trading center'' is defined as ``a 
national securities exchange or national securities association that 
operates an SRO trading facility, an alternative trading system, an 
exchange market maker, an OTC market maker, or any other broker-dealer 
that executes orders internally by trading as principal or crossing 
orders as agent.'' \333\ Because the proposed modified uptick rule 
would apply to any trading center that executes or displays a short 
sale order in a covered security, the proposed modified uptick rule 
would apply to 10 registered national securities exchanges that trade 
NMS stocks and one national securities association (or ``SRO trading 
centers''),\334\ and approximately 372 broker-dealers (including ATSs) 
registered with the Commission (or ``non-SRO trading centers'').\335\
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    \332\ See proposed Rule 201(b)(1).
    \333\ See 17 CFR 242.600(b)(78).
    \334\ There are 10 national securities exchanges (BX, BATS, 
CBOE, CHX, ISE, NASDAQ, NSX, NYSE, NYSE Amex, and NYSE Arca) and one 
national securities association (FINRA) that operate an SRO trading 
facility for NMS stocks and thus would be subject to the Rule.
    \335\ This number includes the approximately 325 firms that were 
registered equity market makers or specialists at year-end 2007 
(this number was derived from annual FOCUS reports and discussion 
with SRO staff), as well as the 47 ATSs that operate trading systems 
that trade NMS stocks. The Commission believes it is reasonable to 
estimate that in general, firms that are block positioners--i.e., 
firms that are in the business of executing orders internally--are 
the same firms that are registered market makers (for instance, they 
may be registered as a market maker in one or more Nasdaq stocks and 
carry on a block positioner business in exchange-listed stocks), 
especially given the amount of capital necessary to carry on such a 
business.
---------------------------------------------------------------------------

2. Identification of Short Sale Orders and Policies and Procedures 
Requirements Under the Proposed ``Broker-Dealer'' and ``Riskless 
Principal'' Provisions
    The collection of information that would be required in the 
proposed ``broker-dealer'' provision in proposed Rule 201(c)(1) of the 
proposed modified uptick rule, the ``riskless principal'' provision in 
proposed Rule 201(d)(6) of the proposed modified uptick rule, and the 
``riskless principal'' exception in proposed Rule 201(c)(9) of the 
proposed uptick rule would apply to all the 5,561 \336\ registered 
brokers-dealers submitting short sale orders in reliance on these 
proposed provisions.
---------------------------------------------------------------------------

    \336\ This number is based on OEA's review of 2007 FOCUS Report 
filings reflecting registered broker-dealers, including introducing 
broker-dealers. This number does not include broker-dealers that are 
delinquent on FOCUS Report filings.
---------------------------------------------------------------------------

3. Proposed Marking Requirements
    The collection of information that would be required pursuant to 
the proposed ``short exempt'' marking requirements would apply to all 
the 5,561 \337\ registered brokers-dealers submitting short sale orders 
marked ``short exempt'' in accordance with the provisions contained in 
paragraph (c) or (d) of the proposed modified uptick rule (or paragraph 
(c) or (d) of the proposed

[[Page 18087]]

circuit breaker modified uptick rule), or in reliance on an exception 
contained in paragraph (c) of the proposed uptick rule (or paragraph 
(c) of the proposed circuit breaker uptick rule), or in reliance on an 
exception contained in paragraph (c) of the proposed circuit breaker 
halt rule.
---------------------------------------------------------------------------

    \337\ See id.
---------------------------------------------------------------------------

E. Total Annual Reporting and Recordkeeping Burdens

1. Policies and Procedures Requirement under Proposed Modified Uptick 
Rule
    The proposed modified uptick rule would require each trading center 
to establish, maintain, and enforce written policies and procedures 
reasonably designed to prevent the execution or display of a short sale 
order of a covered security at a down-bid price.\338\ In addition, a 
trading center would need to have policies and procedures reasonably 
designed to permit the execution or display of a short sale order of a 
covered security marked ``short exempt'' without regard to whether the 
order is at a down-bid price.\339\ Thus, trading centers would be 
required to develop written policies and procedures reasonably designed 
to permit the trading center to be able to determine whether or not the 
short sale order is priced in accordance with the provisions of 
proposed Rule 201(b)(1) and to recognize when an order is marked 
``short exempt'' such that the trading center's policies and procedures 
do not prevent the execution or display of such orders on a down-bid 
price in accordance with proposed Rule 201(b)(1)(ii).\340\ A trading 
center's policies and procedures would not, however, have to include 
mechanisms to determine on which provision a broker-dealer is relying 
in marking an order ``short exempt'' in accordance with paragraph (c) 
or (d) of the proposed modified uptick rule.
---------------------------------------------------------------------------

    \338\ See proposed Rule 201(b)(1). This would include a trading 
center taking such steps as would be necessary to enable it to 
enforce its policies and procedures effectively, including the 
proposed requirement to regularly surveil to ascertain the 
effectiveness of its policies and procedures and taking prompt 
remedial steps. See proposed Rule 201(b)(2).
    \339\ See proposed Rule 201(b)(1)(ii). See also Sections III.A. 
and V, above, discussing short sale orders marked ``short exempt.''
    \340\ See proposed Rule 201(b)(1)(ii).
---------------------------------------------------------------------------

    Although the exact nature and extent of the policies and procedures 
that a trading center would be required to establish likely would vary 
depending upon the nature of the trading center (e.g., SRO vs. non-SRO, 
full service broker-dealer vs. market maker), we preliminarily estimate 
that it initially would take an SRO trading center approximately 220 
hours \341\ of legal, compliance, information technology and business 
operations personnel time,\342\ and a non-SRO trading center 
approximately 160 hours of legal, compliance, information technology 
and business operations personnel time,\343\ to develop the required 
policies and procedures.
---------------------------------------------------------------------------

    \341\ For purposes of this Release, we are basing our estimates 
on the burden hour estimates provided in connection with the 
adoption of Regulation NMS because the policies and procedures 
developed in connection with that Regulation's order protection rule 
are in many ways similar to what a trading center would need to do 
to comply with the proposed modified uptick rule. See Securities 
Exchange Act Release No. 51808 (June 9, 2005), 70 FR 37496 (June 29, 
2005). We note, however, that these estimates may be on the high end 
because trading centers have already had to establish similar 
policies and procedures to comply with Regulation NMS.
    \342\ Based on experience and estimates provided in connection 
with Regulation NMS, we anticipate that of the 220 hours we 
preliminarily estimate would be spent to establish the required 
policies and procedures, 70 hours would be spent by legal personnel, 
105 hours would be spent by compliance personnel, 20 hours would be 
spent by information technology personnel and 25 hours would be 
spent by business operations personnel of the SRO trading center.
    \343\ Based on experience and the estimates provided in 
connection with Regulation NMS, we anticipate that of the 160 hours 
we preliminarily estimate would be spent to establish policies and 
procedures, 37 hours would be spent by legal personnel, 77 hours 
would be spent by compliance personnel, 23 hours would be spent by 
information technology personnel and 23 hours would be spent by 
business operations personnel of the non-SRO trading center.
---------------------------------------------------------------------------

    In addition to this estimate (of 220 hours for SRO respondents and 
160 hours for non-SRO respondents), we expect that SRO and non-SRO 
respondents may incur one-time external costs for outsourced legal 
services. While we recognize that the amount of legal outsourcing 
utilized to help establish written policies and procedures may vary 
widely from entity to entity, we preliminarily estimate that on 
average, each trading center would outsource 50 hours of legal time in 
order to establish policies and procedures in accordance with the 
proposed amendments.\344\
---------------------------------------------------------------------------

    \344\ As discussed above, we base our burden estimate of 50 
hours of outsourced legal time on the burden estimate used for 
Regulation NMS because the policies and procedures developed in 
connection with that Regulation's order protection rule are in many 
ways similar to what a trading center would need to do to comply 
with the proposed modified uptick rule.
---------------------------------------------------------------------------

    We estimate that there would be an initial one-time burden of 220 
(not including the outsourced 50 hours of legal time) burden hours per 
SRO trading center or 2,420 hours,\345\ and 160 (not including the 
outsourced 50 hours of legal time) burden hours per non-SRO trading 
center \346\ or 59,520 hours, for a total of 61,940 burden hours to 
establish the required written policies and procedures.\347\ We 
estimate a cost of approximately $7,660,000 for both SRO and non-SRO 
trading centers resulting from outsourced legal work.\348\
---------------------------------------------------------------------------

    \345\ The estimated 2,420 burden hours necessary for SRO trading 
centers to establish policies and procedures are calculated by 
multiplying 11 times 220 hours (11 x 220 hours = 2,420 hours).
    \346\ The estimated 59,520 burden hours necessary for non-SRO 
trading centers to establish policies and procedures are calculated 
by multiplying 372 times 160 hours (372 x 160 hours = 59,520 hours).
    \347\ Proposed Rule 201(b)(1). Proposed Rule 201(b)(1) requires 
that ``A trading center shall establish, maintain, and enforce 
written policies and procedures reasonably designed to prevent the 
execution or display of a short sale order at a down-bid price.''
    \348\ This figure was calculated as follows: (50 legal hours x 
$400 x 11 SRO trading centers) + (50 legal hours x $400 x 372 non-
SRO trading centers) = $7,660,000. Based on industry sources, OEA 
estimates that the average hourly rate for outsourced legal services 
in the securities industry is $400.
---------------------------------------------------------------------------

    Once a trading center has established the required written policies 
and procedures, we preliminarily estimate that it would take the 
average SRO and non-SRO trading center each approximately two hours per 
month of ongoing internal legal time and three hours of ongoing 
internal compliance time to ensure that its written policies and 
procedures are up-to-date and remain in compliance with the proposed 
amendments to Rule 201, or a total of 60 hours annually per 
respondent.\349\ In addition, we preliminarily estimate that it would 
take the average SRO and non-SRO trading center each approximately 16 
hours per month of ongoing compliance time, 8 hours per month of 
ongoing information technology time, and 4 hours per month of ongoing 
legal time associated with ongoing monitoring and surveillance for and 
enforcement of trading in compliance with the proposed modified uptick 
rule, or a total of 336 hours annually per respondent.\350\
---------------------------------------------------------------------------

    \349\ This figure was calculated as follows: (2 legal hours x 12 
months) + (3 compliance hours x 12 months) = 60 hours annually per 
respondent. As discussed above, this burden estimate of 60 hours is 
based on experience and what was estimated for Regulation NMS to 
ensure that written policies and procedures were up-to-date and 
remained in compliance.
    \350\ This figure was calculated as follows: (16 compliance 
hours x 12 months) + (8 information technology hours x 12 months) + 
(4 legal hours x 12 months) = 336 hours annually per respondent. As 
discussed above, this preliminary burden estimate of 336 hours is 
based on experience and what was estimated for Regulation NMS 
regarding similarly required ongoing monitoring and surveillance for 
and enforcement of trading in compliance with that regulation's 
policies and procedures requirement.
---------------------------------------------------------------------------

    As mentioned above, we realize that the exact nature and extent of 
the policies and procedures that a trading

[[Page 18088]]

center would be required to establish likely would vary depending upon 
the type, size, and nature of the trading center. Thus, while we have 
based our burden estimates, in part, on the burden estimates provided 
in connection with the adoption of Regulation NMS, we note that these 
estimates may be on the high end because trading centers have already 
had to establish policies and procedures in connection with that 
Regulation's order protection rule, which could help form the basis for 
the policies and procedures for the proposed modified uptick rule. We 
realize, however, that these estimates may be on the low end for 
smaller trading centers with less familiarity with having had to 
establish policies and procedures in connection with Regulation NMS's 
order protection rule. Thus, we seek specific comment as to whether the 
proposed burden estimates are appropriate or whether such estimates 
should be increased or reduced, and for which entities. If they should 
be increased or decreased, please address by how much, in order to be 
able to comply with the proposed modified uptick rule's required 
policies and procedures, if adopted.
2. Identification of Short Sale Orders and Policies and Procedures 
Requirements Under the Proposed ``Broker-Dealer'' and ``Riskless 
Principal'' Provisions
    To rely on the proposed modified uptick rule's Rule 201(c)(1) 
``broker-dealer'' provision, a broker-dealer marking a short sale order 
in a covered security ``short exempt'' under proposed Rule 201(c)(1) 
must identify the order as not being a down-bid price at the time the 
order is submitted to the trading center and must establish, maintain, 
and enforce written policies and procedures that are reasonably 
designed to prevent the incorrect identification of orders as not being 
submitted to the trading center at a down-bid price.\351\ At a minimum, 
the broker-dealer's policies and procedures would need to be reasonably 
designed to enable a broker-dealer to monitor, on a real-time basis, 
the national best bid, and whether the current national best bid is an 
up- or down-bid from the last differently priced national best bid, so 
as to determine the price at which the broker-dealer may submit a short 
sale order to a trading center in compliance with the requirements of 
proposed Rule 201(c)(1). In addition, a broker-dealer would also need 
to take such steps as would be necessary to enable it to enforce its 
policies and procedures effectively.\352\
---------------------------------------------------------------------------

    \351\ See proposed Rule 201(c)(1).
    \352\ This would include the proposed requirement that broker-
dealer regularly surveil to ascertain the effectiveness of its 
policies and procedures and taking prompt remedial steps. See 
proposed Rule 201(c)(2).
---------------------------------------------------------------------------

    To rely on proposed Rule 201(d)(6)'s ``riskless principal'' 
provision under the proposed modified uptick rule or Rule 201(c)(9)'s 
``riskless principal'' exception to the proposed uptick rule, a broker-
dealer would be required to have written policies and procedures in 
place to assure that, at a minimum, the customer order was received 
prior to the offsetting transaction and that it has supervisory systems 
in place to produce records that enable the broker-dealer to accurately 
and readily reconstruct, in a time-sequenced manner, all orders on 
which a broker-dealer relies pursuant to these provisions.
    Although the exact nature and extent of the required policies and 
procedures that a broker-dealer would be required to establish under 
the ``broker-dealer'' or the ``riskless principal'' provisions likely 
would vary depending upon the nature of the broker-dealer (e.g., full 
service broker-dealer vs. market maker), we preliminarily estimate that 
it initially would take a broker-dealer approximately 160 hours \353\ 
of legal, compliance, information technology and business operations 
personnel time,\354\ to develop the required policies and procedures. 
In addition to this estimate of 160 hours, we expect that broker-
dealers may incur one-time external costs for outsourced legal 
services. While we recognize that the amount of legal outsourcing 
utilized to help establish written policies and procedures may vary 
widely from entity to entity, we preliminarily estimate that on 
average, each broker-dealer would outsource 50 hours \355\ of legal 
time in order to establish policies and procedures in accordance with 
the ``broker-dealer'' provision in proposed Rule 201(c)(1) of the 
proposed modified uptick rule, the ``riskless principal'' exception in 
201(c)(9) of the proposed uptick rule, and the ``riskless principal'' 
provision in 201(d)(6) of the proposed modified uptick rule.
---------------------------------------------------------------------------

    \353\ We base this estimate of 160 hours on the estimated burden 
hours we preliminarily believe it would take a non-SRO trading 
center (which would include broker-dealers) to develop similarly 
required policies and procedures, since the policies and procedures 
required under the proposed broker-dealer provisions would be 
similar to those required for non-SRO trading centers in complying 
with paragraph (b) of the proposed modified uptick rule.
    \354\ Based on experience and the estimates provided in 
connection with Regulation NMS, we anticipate that of the 160 hours 
we estimate would be spent to establish policies and procedures; 37 
hours would be spent by legal personnel, 77 hours would be spent by 
compliance personnel, 23 hours would be spent by information 
technology personnel and 23 hours would be spent by business 
operations personnel of the broker-dealer.
    \355\ As discussed above, we base our burden estimate of 50 
hours of outsourced legal time on the burden estimate used for 
Regulation NMS because the policies and procedures developed in 
connection with that Regulation's order protection rule are in many 
ways similar to what a broker-dealer would need to do to comply with 
the policies and procedures required under the proposed broker-
dealer provision of the proposed modified uptick rule.
---------------------------------------------------------------------------

    We preliminarily estimate that there would be an initial one-time 
burden of 160 burden hours per broker-dealer or 889,760 hours \356\ to 
establish policies and procedures that would be required to rely on the 
proposed modified uptick rule's ``broker-dealer'' provision in proposed 
Rule 201(c)(1), the ``riskless principal'' exception in Rule 201(c)(9) 
of the proposed uptick rule, or the ``riskless principal'' provision in 
201(d)(6) of the proposed modified uptick rule. We preliminarily 
estimate a cost of approximately $111,220,000 for broker-dealers 
resulting from outsourced legal work.\357\
---------------------------------------------------------------------------

    \356\ As discussed above, we base this estimate of 160 hours on 
the estimated burden hours we preliminarily believe it would take a 
non-SRO trading center (which would include broker-dealers) to 
develop similarly required policies and procedures since the 
policies and procedures required under the proposed broker-dealer 
provisions would be similar to those required for non-SRO trading 
centers in complying with paragraph (b) of the proposed modified 
uptick rule.
     The estimated 889,760 burden hours necessary for a broker-
dealer to establish policies and procedures are calculated by 
multiplying 5,561 times 160 hours (5,561 x 160 hours = 889,760 
hours).
    \357\ This figure was calculated as follows: (50 legal hours x 
$400 x 5,561 broker-dealers) = $111,220,000. Based on industry 
sources, OEA estimates that the average hourly rate for outsourced 
legal services in the securities industry is $400.
---------------------------------------------------------------------------

    Once a broker-dealer has established written policies and 
procedures that would be required so that it could rely on proposed 
201(c)(1) of the proposed modified uptick rule, 201(c)(9) of the 
proposed uptick rule, or 201(d)(6) of the proposed modified uptick 
rule, we preliminarily estimate that it would take the average broker-
dealer approximately two hours per month of internal legal time and 
three hours of internal compliance time to ensure that its written 
policies and procedures are up-to-date and remain in compliance with 
proposed 201(c)(1) of the proposed modified uptick rule, 201(c)(9) of 
the proposed uptick rule, or 201(d)(6) of the proposed modified uptick 
rule, or a total of 60 hours annually per respondent.\358\

[[Page 18089]]

In addition, we preliminarily estimate that it would take the average 
broker-dealer each approximately 16 hours per month of ongoing 
compliance time, 8 hours per month of ongoing information technology 
time, and 4 hours per month of ongoing legal time associated with 
ongoing monitoring and surveillance for and enforcement of trading in 
compliance with the proposed modified uptick rule, or a total of 336 
hours annually per respondent.\359\
---------------------------------------------------------------------------

    \358\ This figure was calculated as follows: (2 legal hours x 12 
months) + (3 compliance hours x 12 months). As discussed above, this 
burden estimate of 60 hours is based on experience and what was 
estimated for a Regulation NMS respondent to ensure that its written 
policies and procedures were up-to-date and remained in compliance.
    \359\ This figure was calculated as follows: (16 compliance 
hours x 12 months) + (8 information technology hours x 12 months) + 
(4 legal hours x 12 months) = 336 hours annually per respondent. As 
discussed above, this preliminary burden estimate of 336 hours is 
based on experience and what was estimated for Regulation NMS for 
similarly required ongoing monitoring and surveillance for and 
enforcement of trading in compliance with that regulation's policies 
and procedures requirement.
---------------------------------------------------------------------------

    As mentioned above, we realize that the exact nature and extent of 
the policies and procedures that a broker-dealer would be required to 
establish likely would vary depending upon the type, size, and nature 
of the broker-dealer. Thus, while we have based our burden estimates on 
the burden estimates provided in connection with the adoption of 
Regulation NMS with respect to non-SRO trading centers (which includes 
broker-dealers), we note that these estimates may be on the high end 
for those broker-dealers that have already had to establish policies 
and procedures in connection with that Regulation's order protection 
rule, which could help form the basis for the policies and procedures 
for the proposed broker-dealer provision of the modified uptick rule, 
or the riskless principal provisions under the proposed modified uptick 
rule and the proposed uptick rule. We realize, however, that these 
estimates may be on the low end for some broker-dealers with less 
familiarity with having had to establish policies and procedures in 
connection with Regulation NMS's order protection rule. Thus, we seek 
specific comment as to whether the proposed burden estimates are 
appropriate or whether such estimates should be increased or reduced, 
and for which broker-dealers. If they should be increased or decreased, 
please address by how much, in order to be able to comply with the 
proposed provisions' required policies and procedures, if adopted.
3. Proposed Marking Requirements
    Proposed Rule 200(g) would impose a ``short exempt'' marking 
requirement.\360\ In addition, proposed Rule 200(g)(2) would require a 
broker-dealer to mark all sell orders of a covered security ``short 
exempt'' only if the provisions contained in paragraph (c) or (d) of 
the proposed modified uptick rule (or paragraph (c) or (d) of the 
proposed circuit breaker modified uptick rule) are met, or if the 
seller is relying on one of the exceptions contained in paragraph (c) 
of the proposed uptick rule (or paragraph (c) of the proposed circuit 
breaker uptick rule), or if the seller is relying on one of the 
exceptions contained in paragraph (c) of the proposed circuit breaker 
halt rule.\361\ While not all broker-dealers likely would enter sell 
orders in securities covered by the proposed amendments to Rules 200(g) 
and 201 in a manner that would subject them to this collection of 
information, we estimate, for purposes of the PRA, that all of the 
approximately 5,561 registered broker-dealers would do so.\362\ For 
purposes of the PRA, the Commission staff has estimated that a total of 
approximately 12.9 billion ``short exempt'' orders would be entered 
annually.\363\
---------------------------------------------------------------------------

    \360\ See proposed Rule 200(g).
    \361\ See proposed Rule 200(g)(2).
    \362\ We also note that, because the proposed circuit breaker 
halt rule, if adopted, would not be in place at all times or for all 
securities and because there would be fewer exceptions that would be 
available and they would apply only when the restrictions of the 
proposed circuit breaker halt rule are triggered, the frequency and, 
therefore, the estimate burden of marking ``short exempt'' would be 
expected to be lower under the proposed circuit breaker halt rule.
    \363\ There are approximately 45.4 billion short sale orders 
entered annually. OEA calculates that there were about 263 million 
short sale trades during August 2008 for Amex, FINRA, Nasdaq, 
NYSEArca, and NYSE market centers. We gross up 263 million by 14.4 
which is the ratio of orders to trades. The ratio is derived from 
Rule 605 reports from the three largest market centers during August 
2008. This yields 3.8 billion short sale orders during August 2008 
or an annualized figure of 45.4 billion. OEA believes that August 
2008 data is representative of a normal month of trading. We 
estimate that approximately 28.5% of short sale orders are short 
exempt using Nasdaq short sale data from January to April 2005. We 
multiply 45.4 billion times 0.285 to obtain our estimate of 12.9 
billion short exempt orders.
---------------------------------------------------------------------------

    This would be an average of approximately 2,319,727 annual 
responses by each respondent.\364\ Each response of marking sell orders 
``short exempt'' would take approximately .000139 hours (.5 seconds) to 
complete.\365\ We base this estimate on the fact that, in accordance 
with the current marking requirements of Rule 200(g) of Regulation SHO, 
broker-dealers are already required to mark a sell order either 
``long'' or short''; the fact that most broker-dealers already have the 
necessary mechanisms and procedures in place and are already familiar 
with processes and procedures to comply with the marking requirements 
of Rule 200(g) of Regulation SHO; and the fact that broker-dealers 
would be able to continue to use the same mechanisms, processes and 
procedures to comply with proposed Rules 200(g) and 200(g)(2).
---------------------------------------------------------------------------

    \364\ This figure was calculated as follows: 12.9 billion 
``short exempt'' orders divided by 5,561 broker-dealers.
    \365\ This estimate is based on the same time estimate for 
marking sell orders ``long'' or ``short'' under current Rule 200(g) 
under Regulation SHO. See 2004 Regulation SHO Adopting Release, 69 
FR at 48023; see also 2003 Regulation SHO Proposing Release, 68 FR 
at 63000 n. 232.
---------------------------------------------------------------------------

    Thus, the total approximate estimated annual hour burden per year 
would be 1,793,100 burden hours (12,900,000,000 orders marked ``short 
exempt'' @ 0.000139 hours/order marked ``short exempt''). Our estimate 
for the paperwork compliance for the proposed amendments order marking 
requirement for each broker-dealer would be approximately 322 burden 
hours (2,319,727 responses @ 0.000139 hours/responses) or (a total of 
1,793,100 burden hours/5,561 respondents).

F. Collection of Information Is Mandatory

1. Proposed Policies and Procedures Requirements
    The collection of information that would be required under the 
proposed modified uptick rule's (and proposed circuit breaker modified 
uptick rule's) policies and procedures requirement in proposed Rule 
201(b)(1) would be mandatory for trading centers executing and 
displaying short sale orders in covered securities. The collection of 
information that would be required under the proposed modified uptick 
rule's (and proposed circuit breaker modified uptick rule's) policies 
and procedures requirements in connection with the proposed broker-
dealer provision in proposed Rule 201(c)(1) and the ``riskless 
principal'' provision in proposed Rule 201(d)(6), and the collection of 
information that would be required under the proposed uptick rule's 
(and proposed circuit breaker uptick rule's) policies and procedure 
requirement in connection with the proposed ``riskless principal'' 
exception in proposed Rule 201(c)(9) would be mandatory for broker-
dealers relying on these provisions.
2. Proposed Marking Requirements
    The collection of information would be mandatory for all broker-
dealers submitting sell orders marked ``short exempt'' in reliance on 
one of the proposed provisions contained in paragraph (c) or (d) of the 
proposed modified uptick rule (or paragraph (c) or

[[Page 18090]]

(d) of the proposed circuit breaker modified uptick rule), or in 
reliance on an exception in paragraph (c) of the proposed uptick rule 
(or paragraph (c) of the proposed circuit breaker uptick rule), or in 
reliance on an exception in paragraph (c) of the proposed circuit 
breaker halt rule.

G. Confidentiality

1. Proposed Policies and Procedures Requirements
    We expect that the information collected pursuant to the proposed 
modified uptick rule's (and the proposed circuit breaker modified 
uptick rule's) required policies and procedures would be communicated 
to the members, subscribers, and employees (as applicable) of all 
trading centers. To the extent this information is made available to 
the Commission, it would not be kept confidential. The information 
collected pursuant to the proposed modified uptick rule's (or proposed 
circuit breaker modified uptick rule's) ``broker-dealer'' provision and 
the ``riskless principal'' provisions under the proposed short sale 
price tests (or under the proposed circuit breaker price tests) would 
be retained and would be available to the Commission and SRO examiners 
upon request, but not subject to public availability.
2. Proposed Marking Requirements
    The information collected pursuant to the ``short exempt'' marking 
requirements in proposed Rules 200(g) and 200(g)(2) would be submitted 
to trading centers and would be available to the Commission and SRO 
examiners upon request.

H. Record Retention Period

1. Proposed Policies and Procedures Requirements
    Any records generated in connection with the proposed short sale 
price tests' requirements to establish written policies and procedures 
and the proposed circuit breaker rules would be required to be 
preserved in accordance with, and for the periods specified in, 
Exchange Act Rules 17a-1 for SRO trading centers and 17a-4(e)(7) for 
non-SRO trading centers.
2. Proposed Marking Requirements
    The proposed amendments to Rule 200(g) and 200(g)(2) do not contain 
any new record retention requirements. All registered broker-dealers 
that would be subject to the proposed amendments are currently required 
to retain records in accordance with Rule 17a-4(e)(7) of the Exchange 
Act.\366\
---------------------------------------------------------------------------

    \366\ 17 CFR 240.17a-4.
---------------------------------------------------------------------------

I. Request for Comment

    We invite comment on these estimates. 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 Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090, with reference to File No. [S7-08-09]. 
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. [S7-08-09], and be submitted to the Securities and Exchange 
Commission, Records Management, 100 F Street, NE., Washington, DC 
20549. 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.

IX. Cost-Benefit Analysis

    We are sensitive to the costs and benefits of our rules. We request 
comment on the costs and benefits associated with the proposed 
amendments. In particular, we request comment on the potential costs 
for any modification to both computer systems and surveillance 
mechanisms and for information gathering, management, and recordkeeping 
systems or procedures, as well as any potential benefits resulting from 
the proposed amendments for registrants, issuers, investors, brokers or 
dealers, other securities industry professionals, regulators, and 
others. We also request comment as to the extent to which placing price 
restrictions on short selling could impact or lessen some of the 
benefits of legitimate short selling or could lead to a decrease in 
market efficiency, price discovery, or liquidity. Commenters should 
provide analysis and data to support their views on the costs and 
benefits associated with the proposed amendments to Rules 200(g) and 
201.

A. Benefits

    As discussed above, we believe it is appropriate at this time to 
examine and seek comment on whether to restore short sale price test 
restrictions or adopt circuit breaker rules in light of the extreme 
market conditions that we are currently facing and the resulting 
deterioration in investor confidence.
    The proposed amendments to Rule 201 include two alternative price 
tests that would place restrictions on the prices at which certain 
securities would be able to be sold short.\367\ The first test would be 
the proposed modified uptick rule that would be based on the national 
best bid and would require trading centers to have policies and 
procedures reasonably designed to prevent the execution or display of 
short sales at impermissible prices. The second test would be the 
proposed uptick rule that would be based on the last sale price, 
similar to the tick test under former Rule 10a-1, and would prohibit 
any person from effecting short sales at impermissible prices.
---------------------------------------------------------------------------

    \367\ See proposed Rule 201.
---------------------------------------------------------------------------

    We are also proposing circuit breaker rules that would establish 
limitations on short selling in a particular security during severe 
market declines in the price of that security.\368\ The proposed 
circuit breaker halt rule, when triggered by a severe price decline in 
a particular security, would temporarily prohibit any person from 
selling short that security during the effectiveness of the circuit 
breaker.\369\ The proposed circuit breaker modified uptick rule, when 
triggered by a severe market decline in a particular security, would 
temporarily impose the proposed modified uptick rule, as described in 
detail above, for that security. The proposed circuit breaker uptick 
rule, when triggered by a severe market decline in a particular 
security, would temporarily impose the

[[Page 18091]]

proposed uptick rule, as described in detail above, for that 
security.\370\
---------------------------------------------------------------------------

    \368\ See proposed Rule 201.
    \369\ The proposed circuit breaker halt rule could be imposed in 
place of, or in addition to, a short sale price rule.
    \370\ A circuit breaker that triggers a short sale price test 
rule would be adopted in place of a short sale price test rule.
---------------------------------------------------------------------------

    In addition, we are proposing amendments to Rule 200(g) of 
Regulation SHO to impose a ``short exempt'' marking requirement and to 
Rule 200(g)(2) of Regulation SHO to require broker-dealers to mark a 
sell order ``short exempt'' only if the provisions in paragraph (c) or 
(d) of the proposed modified uptick rule (or paragraph (c) or (d) of 
the proposed circuit breaker modified uptick rule) are met, or if the 
seller is relying on an exception in paragraph (c) of the proposed 
uptick rule (or paragraph (c) of the proposed circuit breaker uptick 
rule), or if the seller is relying on an exception in paragraph (c) of 
the proposed circuit breaker halt rule.
1. Proposed Short Sale Price Tests
    The two alternative short sale price tests proposed would be 
designed to allow relatively unrestricted short selling in an advancing 
market. In addition, the proposed short sale price tests would be 
designed to restrict short selling at successively lower prices and, 
thereby, help prevent short selling, including potentially abusive or 
manipulative short selling, from being used as a tool for driving the 
market down or from being used to accelerate a declining market by 
exhausting all remaining bids at one price level, causing successively 
lower prices to be established by long sellers. Further, the two 
alternative short sale price tests would be designed to help restore 
investor confidence in the securities markets.\371\
---------------------------------------------------------------------------

    \371\ See, e.g., supra note 56 (citing comment letters 
suggesting that reinstatement of short price test restrictions in 
some format would help restore investor confidence in the market).
---------------------------------------------------------------------------

    In particular, by requiring trading centers to have policies and 
procedures reasonably designed to prevent the execution or display of 
short sale orders at a down-bid price, unless the order is marked 
``short exempt,'' and by requiring them to regularly surveil to 
ascertain the effectiveness of the policies and procedures and to take 
prompt remedial action to remedy deficiencies in such policies and 
procedures, the proposed modified uptick rule might help to prevent 
short selling, including potentially abusive or manipulative short 
selling, from driving the market down and from being used as a tool to 
accelerate a declining market. Similarly, for the proposed uptick rule, 
by prohibiting the execution of short sale orders below the last sale 
price, unless an exception applies, the alternative proposed uptick 
rule might also help to prevent short selling, including potentially 
abusive or manipulative short selling, from being used as a tool to 
drive the market down and accelerate a declining market.
    At the same time, the proposed short sale price tests might help to 
preserve instant execution and liquidity, by allowing relatively 
unrestricted short selling in an advancing market. As discussed above, 
one of the benefits of legitimate short selling is that it may provide 
market liquidity by, for example, adding to the selling interest of 
stock available to purchasers, and, when sellers are covering their 
short sales, adding to the buying interest of stock available to 
sellers.
    In seeking to advance these goals, the proposed short sale price 
tests might help address the erosion of investor confidence in our 
markets. Bolstering investor confidence in the markets should help to 
encourage investors to be more willing to invest in the market, thus 
adding depth and liquidity to the markets. Moreover, as discussed 
above, prior research on the uptick rule indicates that price test 
restrictions might help improve market depth, especially at the offer, 
and could also dampen intraday volatility.\372\ For example, as 
discussed above, OEA found that price test restrictions resulted in an 
increase in the quote depths.\373\
---------------------------------------------------------------------------

    \372\ See supra note 35 (referencing OEA Staff's Summary Pilot 
Report, at 55 n. 61-63 and supporting text).
    \373\ See supra note 37 (referencing OEA Staff's Summary Pilot 
Report, at 55 n. 61-63 and supporting text).
---------------------------------------------------------------------------

2. Proposed Circuit Breaker Halt Rule
    The proposed circuit breaker halt rule, when triggered by a severe 
price decline in a particular security, would temporarily prohibit any 
person from selling short a particular NMS stock during a severe 
decline in the price of that security.\374\ By targeting only those 
securities that experience severe intraday declines, the proposed 
circuit breaker halt rule would be designed to help prevent short 
selling, including potentially abusive or manipulative short selling, 
from being used to drive the price of a security down, or to accelerate 
the decline in the price of those securities when needed most. By 
applying only to those individual securities that are facing a severe 
intraday decline in share price, the proposed circuit breaker halt rule 
might benefit the market as a narrowly tailored response to 
extraordinary circumstances.\375\ It also might benefit the market by 
allowing participants an opportunity to reevaluate circumstances and 
respond to volatility.\376\
---------------------------------------------------------------------------

    \374\ See proposed Rule 201.
    \375\ See 1998 Release, 63 FR 18477 (April 15, 1998) supra note 
230.
    \376\ See id.
---------------------------------------------------------------------------

    We believe that the proposed circuit breaker halt rule also would 
be narrowly tailored to help restore investor confidence and stabilize 
the market for individual securities during times of substantial 
uncertainty.\377\ By halting short selling for the remainder of the 
trading day following a significant decline in a security's price, we 
believe the proposed circuit breaker halt rule might provide sufficient 
time to re-establish equilibrium between buying and selling interests 
in the individual security in an orderly fashion. It might also help to 
ensure that market participants have a reasonable opportunity to become 
aware of, and respond to, a significant decline in a security's price. 
By providing a pause in short selling resulting from a significant 
decline in the price of an individual equity security, we believe the 
proposed circuit breaker halt rule might provide a measure of stability 
to the markets. We believe that the proposed circuit breaker halt rule 
might help to restore investor confidence during times of substantial 
uncertainty.
---------------------------------------------------------------------------

    \377\ See id.
---------------------------------------------------------------------------

    Moreover, unlike the proposed short sale price test restrictions, 
the proposed circuit breaker halt rule would halt all short selling for 
an individual security only for a specified period of time. Thus, the 
proposed circuit breaker halt rule would also be narrowly tailored to 
help address the issue of ``bear raids'' while limiting the potential 
negative market quality impact that may arise from the proposed short 
sale price test restrictions.\378\
---------------------------------------------------------------------------

    \378\ See 1998 Release, 63 FR 18477.
---------------------------------------------------------------------------

3. Proposed Circuit Breaker Price Test Rules
    The alternative proposed circuit breaker price test rules, when 
triggered by a severe market decline in a particular security, would 
temporarily impose either the proposed circuit breaker modified uptick 
rule or the proposed circuit breaker uptick rule, as each rule is 
described above, for a particular NMS stock during a severe market 
decline in that security, and would remain in place for the remainder 
of the trading day.\379\
---------------------------------------------------------------------------

    \379\ For instance, a circuit breaker resulting in the proposed 
modified uptick rule would require that trading centers implement 
and enforce policies and procedures reasonably designed to prevent 
short selling at a down-bid price in a particular security, when 
triggered by a decline in the price of that security. Broker-dealer 
could mark certain short sale orders ``short-exempt'' under the 
conditions set forth above. A circuit breaker resulting in the 
proposed uptick rule would, once triggered by a decline in the price 
of a particular security, prohibit any person from selling short on 
a downtick.

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

[[Page 18092]]

    We believe that the proposed circuit breaker price test rules would 
be narrowly tailored to help restore investor confidence and stabilize 
the market for individual securities. The proposed circuit breaker 
price test rules might also help prevent short selling, including 
potentially abusive or manipulative short selling, from being used as a 
tool for driving the market down or from being used to accelerate a 
declining market by exhausting all remaining bids at one price level, 
causing successively lower prices to be established by long sellers. 
Further, we also believe that allowing short selling to continue with 
price test restrictions once a circuit breaker is triggered might also 
have less impact on legitimate short selling and normal market activity 
including price discovery and the provision of liquidity than a circuit 
breaker that halts short selling. To that end, we believe that the 
proposed circuit breaker price test rules might also alleviate some 
concerns over the possibility of artificial downward pressure that 
might arise from a ``magnet effect'' prior to reaching the trigger 
threshold.\380\
---------------------------------------------------------------------------

    \380\ See, e.g., letter from Credit Suisse (discussing ``magnet 
effect'').
---------------------------------------------------------------------------

4. Proposed Marking Requirements
    In addition, the ``short exempt'' marking requirements under Rule 
200(g)(2) would provide a record that a broker-dealer is availing 
itself of the provisions of paragraph (c) or (d) of the proposed 
modified uptick rule (or paragraphs (c) or (d) of the proposed circuit 
breaker modified uptick rule), or that short sellers are availing 
themselves of the various exceptions to the application of the 
restrictions of the proposed uptick rule (or the proposed circuit 
breaker uptick rule), or that short sellers are availing themselves of 
the various exceptions to the application of the proposed circuit 
breaker halt rule. Thus, the records created pursuant to the ``short 
exempt'' marking requirements of proposed Rule 200(g) of the proposed 
short sale price test rules or the proposed circuit breaker rules would 
aid surveillance by SROs and the Commission for compliance with the 
provisions of those short sale price tests or circuit breaker rules. In 
addition, if the Commission were to adopt a policies and procedures 
approach, such as is proposed in conjunction with the proposed modified 
uptick rule (or proposed circuit breaker modified uptick rule), the 
proposed ``short exempt'' marking requirement would provide an 
indication to a trading center regarding whether it must execute or 
display a short sale order with regard to whether the short sale order 
is at a down-bid price.

B. Costs

1. Proposed Short Sale Price Test Restrictions
    We recognize that the proposed amendments, if adopted, would impose 
costs on market participants to implement and assure compliance with 
the proposed short sale price test requirements. These costs could, in 
sum, increase the costs of legitimate short selling. We believe, 
however, that such costs might be justified by the design of the 
proposed short sale price tests to restrict short selling at 
successively lower prices and, thereby, help prevent short selling, 
including potentially abusive or manipulative short selling, from being 
used as a tool for driving the market down or from being used to 
accelerate a declining market by exhausting all remaining bids at one 
price level, causing successively lower prices to be established by 
long sellers. Further, by seeking to advance these goals, the proposed 
price test restrictions might help restore investor confidence in the 
securities markets.
    We recognize that, to the extent that the proposed short sale price 
test restrictions could result in increased costs of short selling in 
NMS stocks, it might lessen some of the benefits of legitimate short 
selling and, thereby, could result in a reduction in short selling 
generally. Such a reduction might 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. Restricting 
short selling may also reduce ``long'' activity where it is part of the 
same strategy, thus adversely affecting liquidity. Thus, we believe 
there might be potential costs associated with the proposed short sale 
price tests in terms of potential impact of such price tests on quote 
depths, spread widths, and market liquidity.
    We also believe costs might be incurred in terms of execution and 
pricing inefficiencies. For example, allowing all short sales to be 
executed or displayed at or above the best bid (or last sale price) in 
an advancing market, and above the best bid (or last sale price) in a 
declining market might slow the speed of executions and impose 
additional costs on market participants, including buyers.\381\
---------------------------------------------------------------------------

    \381\ As discussed above, on the day the Pilot went into effect, 
listed Pilot securities underperformed listed control group 
securities by approximately 24 basis points. The Pilot and control 
group securities, however, had similar returns over the first six 
months of the Pilot. See supra note 36 (referencing OEA Staff's 
Summary Pilot Report at 8).
---------------------------------------------------------------------------

    In addition, we recognize that imposing short sale price 
restrictions when, currently, there is an absence of any short sale 
price test restrictions may result in costs in terms of modifications 
to systems and surveillance mechanisms, as well as changes to processes 
and procedures. We anticipate that these changes would likely result in 
immediate implementation costs for trading centers and SROs and other 
market participants associated with reprogramming trading and 
surveillance systems to now account for price test restrictions based 
on either last sale or best bid information, as discussed in more 
detail below. We also believe the proposed amendments may impose costs 
to trading centers and SROs and other market participants related to 
systems changes to computer hardware and software, reprogramming costs, 
and surveillance and compliance costs, as well as staff time and 
technology resources, associated with monitoring compliance with the 
proposed short sale price test restrictions, as discussed below.
    Moreover, imposing price test restrictions when there are currently 
no short sale price restrictions in place also could mean that staff 
(compliance personnel, associated persons, etc.) might need to be 
trained or re-trained regarding rules related to price test 
restrictions. Also, trading centers and SROs and other market 
participants could be required to hire additional staff (and train or 
re-train them) to comply with the proposed rules related to short sale 
price test restrictions. As such, we believe the proposed amendments, 
if adopted, might impose training and compliance costs for trading 
centers, SROs, and other market participants.
a. Proposed Modified Uptick Rule
    The proposed modified uptick rule, in particular, would require 
each trading center to establish, maintain, and enforce written 
policies and procedures reasonably designed to prevent the execution or 
display of a short sale order at a down-bid price.\382\ In addition, a 
trading center would be required to have policies and procedures 
reasonably designed to

[[Page 18093]]

permit the execution or display of a short sale order of a covered 
security marked ``short exempt'' without regard to whether the order is 
at a down-bid price.\383\ A trading center's policies and procedures 
would not, however, have to include mechanisms to determine on which 
provision a broker-dealer is relying in marking an order ``short 
exempt'' in accordance with paragraph (c) or (d) of the proposed 
modified uptick rule. In addition, trading centers also would be 
required to surveil the effectiveness of their written policies and 
procedures and take prompt action to remedy any deficiencies in their 
policies and procedures.
---------------------------------------------------------------------------

    \382\ See proposed Rule 201(b)(1).
    \383\ See proposed Rule 201(b)(1)(ii). See also Sections 
III.A.2. and V, above, discussing short sale orders marked ``short 
exempt.''
---------------------------------------------------------------------------

    As detailed in the PRA section, VIII, above, although the exact 
nature and extent of the required policies and procedures that a 
trading center would be required to establish likely would vary 
depending upon the nature of the trading center (e.g., SRO vs. non-SRO, 
full service broker-dealer vs. market maker), we preliminarily estimate 
a total one-time initial cost of $26,393,412 \384\ for all trading 
centers subject to the proposed modified uptick rule to establish the 
written policies and procedures reasonably designed to help prevent the 
execution or display of short sale orders not priced in accordance with 
the provisions of proposed Rule 201(b)(1).
---------------------------------------------------------------------------

    \384\ This figure was calculated by adding $18,733,412 and 
$7,660,000 (for outsourced legal work). The $18,733,412 figure was 
calculated as follows: (70 legal hours x $305) + (105 compliance 
hours x $313) + (20 information technology hours x $292) + (25 
business operation hours x $273) = $66,880 per SRO x 11 SROs = 
$735,680 total cost for SROs; (37 legal hours x $305) + (77 
compliance hours x $313) + (23 information technology hours x $292) 
+ (23 business operation hours x $273) = $48,381 per broker-dealer x 
372 broker-dealers = $17,997,732 total cost for broker-dealers; 
$735,680 + $17,997,732 = $18,733,412. The $7,660,000 figure for 
outsourced legal work was calculated as follows: (50 legal hours x 
$400 x 11 SROs) + (50 legal hours x $400 x 372 broker-dealers) = 
$7,660,000.
    Based on industry sources, OEA estimates that the average hourly 
rate for outsourced legal services in the securities industry is 
$400. For in-house legal services, we estimate that the average 
hourly rate for an attorney in the securities industry is 
approximately $305 per hour. The $305/hour figure for an attorney is 
from SIFMA's Management & Professional Earnings in the Securities 
Industry 2008, modified by Commission staff to account for an 1800-
hour work-year and multiplied by 5.35 to account for bonuses, firm 
size, employee benefits and overhead. In addition, OEA estimates 
that the average hourly rate for an assistant compliance director, a 
senior computer programmer, a senior operations manager, in the 
securities industry is approximately $313, $292, and $273 per hour, 
respectively. These figures are from SIFMA's Management & 
Professional Earnings in the Securities Industry 2008, modified by 
Commission staff to account for an 1800-hour work-year and 
multiplied by 5.35 to account for bonuses, firm size, employee 
benefits and overhead.
---------------------------------------------------------------------------

    Once a trading center has established written policies and 
procedures reasonably designed to help prevent the execution or display 
of a short sale order at a down-bid price, we preliminarily estimate a 
total annual ongoing cost of $7,119,204 \385\ for all trading centers 
subject to the proposed modified uptick rule to ensure that their 
written policies and procedures are up-to-date and remain in compliance 
with the proposed amendments to Rule 201. In addition, with regard to 
ongoing monitoring for and enforcement of trading in compliance with 
the proposed modified uptick rule, as detailed in the PRA section, 
VIII, above, we preliminary believe that, once the tools necessary to 
carry out on-going monitoring have been put in place, a trading center 
would be able to incorporate ongoing monitoring and enforcement within 
the scope of its existing surveillance and enforcement policies and 
procedures without a substantial additional burden. We recognize, 
however, that this ongoing compliance would not be cost-free, and that 
trading centers would incur some additional annual costs associated 
with ongoing compliance, including compliance costs of reviewing 
transactions. We preliminarily estimate that each trading center would 
incur an average annual ongoing compliance cost of $102,768, for a 
total annual cost of $39,360,144 for all trading centers.\386\
---------------------------------------------------------------------------

    \385\ This figure was calculated as follows: (2 legal hours x 12 
months x $305) x (11 + 372) + (3 compliance hours x 12 months x 
$313) x (11 + 372) = $7,119,204.
    \386\ We preliminarily estimate that each trading center would 
incur an average annual ongoing compliance cost of $102,768 for a 
total annual cost of $39,360,144 for all trading centers. This 
figure was calculated as follows: (16 compliance hours x $313) + (8 
information technology hours x $292) + (4 legal hours x $305) x 12 
months = $102,768 per trading center x 383 trading centers = 
$39,360,144. As discussed above, we base our burden hour estimates 
on the estimates used for Regulation NMS because it requires similar 
ongoing monitoring and surveillance for and enforcement of trading 
in compliance with that regulation's policies and procedures 
requirement.
    For in-house legal services, we estimate that the average hourly 
rate for an attorney in the securities industry is approximately 
$305 per hour. The $305/hour figure for an attorney is from SIFMA's 
Management & Professional Earnings in the Securities Industry 2008, 
modified by Commission staff to account for an 1800-hour work-year 
and multiplied by 5.35 to account for bonuses, firm size, employee 
benefits and overhead. In addition, OEA estimates that the average 
hourly rate for an assistant compliance director, a senior computer 
programmer, a senior operations manager, in the securities industry 
is approximately $313, $292, $273 per hour, respectively. These 
figures are from SIFMA's Management & Professional Earnings in the 
Securities Industry 2008, modified by Commission staff to account 
for an 1800-hour work-year and multiplied by 5.35 to account for 
bonuses, firm size, employee benefits and overhead.
---------------------------------------------------------------------------

    As detailed in the PRA section, VIII, above, we realize that the 
exact nature and extent of the policies and procedures that a trading 
center would be required to establish would likely vary depending upon 
the type, size, and nature of the trading center. Thus, while we have 
based our estimates on the burden estimates provided in connection with 
the adoption of Regulation NMS, we note that these estimates may be on 
the high end because trading centers have already had to establish 
policies and procedures in connection with that Regulation's order 
protection rule, which could help form the basis for the policies and 
procedures for the proposed modified uptick rule. We realize, however, 
that these estimates may be on the low end for some trading centers. 
Thus, we seek specific comment as to whether these estimates are 
appropriate or whether such estimates should be increased or reduced 
and for which entities. If they should be increased or decreased, 
please address by how much, in order to be able to comply with the 
proposed modified uptick rule's required policies and procedures, if 
adopted.
    As detailed in the PRA section, VIII, above, although the exact 
nature and extent of the required policies and procedures that a 
broker-dealer would be required to establish under the ``broker-
dealer'' provision in proposed Rule 201(c)(1) of the proposed modified 
uptick rule, as well as under the ``riskless principal'' provision in 
proposed Rule 201(d)(6) of the proposed modified uptick rule and the 
``riskless principal'' exception in proposed Rule 201(c)(9) of the 
proposed uptick rule, likely would vary depending upon the nature of 
the broker-dealer (e.g., full service broker-dealer vs. market maker), 
we preliminarily estimate a total one-time initial cost of $380,266,741 
for all broker-dealers relying on the broker-dealer provision in 
proposed Rule 201(c)(1) of the proposed modified uptick rule; the 
``riskless principal'' provisions in proposed Rules 201(d)(6) of the 
proposed modified uptick rule; or 201(c)(9) of the proposed uptick 
rule, to establish the written policies and procedures reasonably 
designed to prevent the incorrect identification of orders as being 
priced in accordance with the broker-dealer provision or, in the case 
of the ``riskless principal'' provisions, to assure that, at a minimum, 
the customer order was received prior to the offsetting transaction and 
to assure the broker-dealer has supervisory systems in place

[[Page 18094]]

to produce records that enable the broker-dealer to accurately and 
readily reconstruct, in a time-sequenced manner, all orders on which a 
broker-dealer relies pursuant to these provisions of the proposed price 
tests.\387\
---------------------------------------------------------------------------

    \387\ This figure was calculated by adding $269,046,741 and 
$111,220,000 (for outsourced legal work). The $269,046,741 figure 
was calculated as follows: (37 legal hours x $305) + (77 compliance 
hours x $313) + (23 information technology hours x $292) + (23 
business operation hours x $273) = $48,381 per broker-dealer x 5,561 
broker-dealers = $ 269,046,741 total cost for broker-dealers. The 
$111,220,000 figure was calculated as follows: (50 legal hours x 
$400 x 5,561) = $111,220,000.
    Based on industry sources, OEA estimates that the average hourly 
rate for outsourced legal services in the securities industry is 
$400. For in-house legal services, we estimate that the average 
hourly rate for an attorney in the securities industry is 
approximately $305 per hour.
    The $305/hour figure for an attorney is from SIFMA's Management 
& Professional Earnings in the Securities Industry 2008, modified by 
Commission staff to account for an 1800-hour work-year and 
multiplied by 5.35 to account for bonuses, firm size, employee 
benefits and overhead. In addition, OEA estimates that the average 
hourly rate for an assistant compliance director, a senior computer 
programmer, a senior operations manager, in the securities industry 
is approximately $313, $292, $273 per hour, respectively. These 
figures are from SIFMA's Management & Professional Earnings in the 
Securities Industry 2008, modified by Commission staff to account 
for an 1800-hour work-year and multiplied by 5.35 to account for 
bonuses, firm size, employee benefits and overhead.
---------------------------------------------------------------------------

    Once a broker-dealer has established written policies and 
procedures that would be required so that it could rely on the proposed 
modified uptick rule's ``broker-dealer provision'' in proposed Rule 
201(c)(1); the ``riskless principal'' exception in proposed Rule 
201(c)(9) of the proposed uptick rule; or the ``riskless principal'' 
provision in proposed Rule 201(d)(6) of the proposed uptick rule, we 
estimate a total annual on-going cost of $103,367,868 for all broker-
dealers relying on any of these three provisions to ensure that its 
written policies and procedures are up-to-date and remain in compliance 
with the proposed amendments to Rule 201.\388\ In addition, with regard 
to ongoing monitoring for and enforcement of trading in compliance with 
the proposed modified uptick rule's ``broker-dealer'' provision in 
proposed Rule 201(c)(1), as detailed in the PRA section, VIII, above, 
we preliminary believe that, once the tools necessary to carry out on-
going monitoring would have been put in place, a broker-dealer would be 
able to incorporate ongoing monitoring and enforcement within the scope 
of its existing surveillance and enforcement policies and procedures 
without a substantial additional burden. We recognize, however, that 
this ongoing compliance would not be cost-free, and that broker-dealers 
would incur some additional annual costs associated with ongoing 
compliance, including compliance costs of reviewing transactions. We 
estimate that each broker-dealer would incur an average annual ongoing 
compliance cost of $102,768, for a total annual cost of $571,492,848 
for all broker-dealers.\389\
---------------------------------------------------------------------------

    \388\ This figure was calculated as follows: (2 legal hours x 12 
months x $305) x 5,561 + (3 compliance hours x 12 months x $313) x 
5,561 = $103,367,868.
    \389\ We estimate that each broker-dealer would incur an average 
annual ongoing compliance cost of $102,768 for a total annual cost 
of $571,492,848 for all broker-dealers. This figure was calculated 
as follows: (16 compliance hours x $313) + (8 information technology 
hours x $292) + (4 legal hours x $305) x 12 months = $102,768 per 
broker-dealer x 5,561 broker-dealers = $571,492,848. As discussed 
above, we base our estimate of burden hours on the estimates used 
for Regulation NMS because it requires similar ongoing monitoring 
and surveillance for and enforcement of trading in compliance with 
that regulation's policies and procedures requirement.
    For in-house legal services, we estimate that the average hourly 
rate for an attorney in the securities industry is approximately 
$305 per hour. The $305/hour figure for an attorney is from SIFMA's 
Management & Professional Earnings in the Securities Industry 2008, 
modified by Commission staff to account for an 1800-hour work-year 
and multiplied by 5.35 to account for bonuses, firm size, employee 
benefits and overhead. In addition, OEA estimates that the average 
hourly rate for an assistant compliance director, a senior computer 
programmer, a senior operations manager, in the securities industry 
is approximately $313, $292, $273 per hour, respectively. These 
figures are from SIFMA's Management & Professional Earnings in the 
Securities Industry 2008, modified by Commission staff to account 
for an 1800-hour work-year and multiplied by 5.35 to account for 
bonuses, firm size, employee benefits and overhead.
---------------------------------------------------------------------------

    As discussed above in connection with the PRA, we realize that the 
exact nature and extent of the policies and procedures that a broker-
dealer would be required to establish likely would vary depending upon 
the type, size, and nature of the broker-dealer. Thus, while we have 
based our estimates on the burden estimates provided in connection with 
the adoption of Regulation NMS, we note that these estimates may be on 
the high end because broker-dealers have already had to establish 
policies and procedures in connection with that Regulation's order 
protection rule, which could help form the basis for the policies and 
procedures for the proposed modified uptick rule's ``broker-dealer'' 
provision's policies and procedures requirement in proposed Rule 
201(c)(1). We realize, however, that these estimates may be on the low 
end for some broker-dealers that may have less familiarity with a 
policies and procedures approach. Thus, we seek specific comment as to 
whether these estimates are appropriate or whether such estimates 
should be increased or reduced. If they should be increased or 
decreased, please address by how much, in order to be able to comply 
with the proposed modified uptick rule's required policies and 
procedures, if adopted.
    In addition, we anticipate that each trading center would incur 
initial up-front costs associated with taking action necessary to 
implement the written policies and procedures it has developed, which 
would include surveillance and reprogramming costs for enforcing, 
monitoring, and updating their trading, execution management, and 
surveillance systems under the proposed modified uptick rule, systems 
changes to computer hardware and software, as well as staff time and 
technology resources.\390\ However, we note that the policies and 
procedures that would be required to be implemented are similar to 
those that are required under Regulation NMS.\391\ In accordance with 
Regulation NMS, trading centers must have in place written policies and 
procedures in connection with that Regulation's order protection rule, 
which could help form the basis for the policies and procedures

[[Page 18095]]

for the proposed modified uptick rule.\392\ Thus, we believe trading 
centers may already be familiar with establishing, maintaining, and 
enforcing trading-related policies and procedures, including 
programming their trading systems in accordance with such policies and 
procedures.
---------------------------------------------------------------------------

    \390\ For instance, to implement the proposed modified uptick 
rule would require that each ATS reprogram their trading engine, as 
would any broker-dealer who executes trades as an OTC market maker. 
Moreover, one commenter indicated that programming costs across 
sell-side firms could range from $200,000 to $2 million. See, e.g., 
2007 Price Test Adopting Release, 72 FR at 36350 n. 113 (citing 
comment letter from SIFMA stating that cost estimates for firms to 
program for the changes that were necessary to meet the policies and 
procedures requirements of Regulation NMS varied, from as low as 
approximately $200,000 for some firms to as high as $2 million for 
others. See also supra note 46 (citing to 2007 SIFMA letter) and 
text accompanying note 208. Additionally, because they might require 
trading centers and other market participants a significant amount 
of time in which to reprogram and test their systems to comply with 
the proposed amendments, these systems and programming costs might 
be higher without a sufficient implementation period. For example, 
this same commenter indicated that it would take six to nine months 
to implement a new version of the bid test. See id.
    See letter from Credit Suisse (discussing need for a longer 
implementation period, particularly for smaller broker-dealers, in 
terms of having to build systems to be able to track upticks or 
upbids in their smart order routers in accordance with any new rules 
and then preserve this history so that regulators can audit it). 
According to this commenter, ``[b]uilding such systems would likely 
be as expensive and challenging as Reg NMS implementation was from 
2005-2007, and would likely take more than a year to implement * * * 
It is also likely that the compliance costs would disproportionately 
burden smaller BDs, who would likely be forced to route their order 
flow through a handful of larger brokers, impeding competition and 
adding to systemic risk as flow is consolidated among fewer 
players''. Id.
    We also recognize that the proposed amendments, if adopted, 
would require the commitment of resources associated with compliance 
oversight, market surveillance, and enforcement, with attendant 
opportunity costs.
    \391\ See Regulation NMS Adopting Release, 70 FR 37496. See also 
17 CFR 242.611.
    \392\ See id.
---------------------------------------------------------------------------

    We believe this familiarity may reduce the implementation costs of 
the proposed modified uptick rule on trading centers and may make the 
proposed modified uptick rule less burdensome to implement. Moreover, 
because trading centers have already developed or modified their 
surveillance mechanisms in order to comply with Regulation NMS's 
policies and procedures requirement, trading centers may already have 
retained and trained the necessary personnel to ensure compliance with 
that Regulation's policies and procedures requirements and, therefore, 
may already have in place most of the infrastructure and potential 
policies and procedures necessary to comply with the proposed modified 
uptick rule.\393\
---------------------------------------------------------------------------

    \393\ We also believe some trading centers may have retained 
personnel familiar with the former SRO bid tests, which may make the 
proposed modified uptick rule less burdensome to implement. See, 
e.g., supra note 125 and accompanying text.
---------------------------------------------------------------------------

    Thus, while we believe there would be costs associated with systems 
modifications and training staff that would be affected by these 
systems modifications, because most trading centers would already have 
in place systems, written policies and procedures in order to comply 
with Regulation NMS's order protection rule, we believe trading centers 
would already be familiar with establishing, maintaining, and enforcing 
trading-related policies and procedures, including programming their 
trading and surveillance systems in accordance with such policies and 
procedures.
    Moreover, the proposed modified uptick rule's written policies and 
procedures requirement are designed to provide trading centers with 
significant flexibility in determining how to comply with the 
requirements of the proposed modified uptick rule. For example, the 
proposed modified uptick rule is designed to provide trading centers 
and their customers with flexibility in determining how to handle 
orders that are not immediately executable or displayable by the 
trading center because the order is impermissibly priced. Thus, if an 
order were impermissibly priced, the trading center could, in 
accordance with policies and procedures reasonably designed to prevent 
the execution or display of a short sale at a down-bid price, re-price 
the order at the lowest permissible price and hold it for later 
execution at its new price or better.\394\ As quoted prices change, the 
proposed modified uptick rule would allow a trading center to 
repeatedly re-price and display an order at the lowest permissible 
price down to the order's original limit order price (or, if a market 
order, until the order is filled). Because a trading center could re-
price and display a previously impermissibly priced short sale order, 
the proposed modified uptick rule may allow for the more efficient 
functioning of the markets because trading centers would not have to 
reject or cancel impermissibly priced orders unless instructed to do so 
by the trading center's customer submitting the short sale order.
---------------------------------------------------------------------------

    \394\ For example, if a trading center received a short sale 
order priced at $47.00 when the current national best bid in the 
security is $47.00, but the immediately preceding national best bid 
was $47.01 (i.e., the current bid is below the previous bid), the 
trading center could re-price the order at the permissible offer 
price of $47.01, and display the order for execution at this new 
limit price.
---------------------------------------------------------------------------

    Moreover, while latencies in obtaining data regarding the national 
best bid from consolidated market data feeds, as discussed in detail 
above, could impact implementation costs associated with the proposed 
modified uptick rule, a trading center could have policies and 
procedures that could provide a snapshot of the market to identify the 
current national best bid at the time of execution or display of a 
short sale order. Such snapshots may cause a reduction in costs for 
trading centers by helping to verify whether a short sale order was 
executed or displayed at a permissible price.
b. Proposed Uptick Rule
    The alternative proposed uptick rule would be based on the last 
sale price, rather than the national best bid, as the reference point 
for short sale orders, similar to former Rule 10a-1. However, the 
proposed uptick rule would not include an explicit policies and 
procedures requirement. Instead, the proposed uptick rule would 
prohibit any person from effecting a short sale below the last sale 
price, unless an exception applies. Because the proposed uptick rule 
would be a modernized version of the former Rule 10a-1, it would also 
provide the public with an opportunity to comment on the utility of 
such a price test, especially in light of recent changes in market 
conditions.\395\
---------------------------------------------------------------------------

    \395\ See supra Section II discussing the history of short sale 
price test regulation in the United States and the changes in market 
conditions and resulting erosion of investor confidence.
---------------------------------------------------------------------------

    We recognize that due to the extensive systems changes that have 
occurred in the last couple of years in response to Regulation NMS, 
programming systems for the proposed uptick rule could be 
burdensome.\396\ In particular, because the proposed uptick rule does 
not take a policies and procedures approach, market participants would 
not be able to rely to the same extent on the policies and procedures 
they already have in place under Regulation NMS. Instead, the proposed 
uptick rule would prohibit any person from effecting a short sale in 
contravention of the rule's limitations. However, because the proposed 
uptick rule would apply to any person effecting a short sale, rather 
than just to trading centers, the proposed uptick rule might impose 
costs on more market participants than the proposed modified uptick 
rule. However, the proposed uptick rule, which is similar to the price 
test of former Rule 10a-1, would be familiar to many market 
participants because it would be based on a rule which was in existence 
for almost 70 years, and was only recently eliminated. We believe this 
familiarity may help to reduce the implementation costs of the proposed 
uptick rule on market participants and, therefore, should decrease the 
costs of implementation of the proposed uptick. For example, we believe 
some market participants may have retained personnel familiar with 
former Rule 10a-1,\397\ and may also have in place some of the systems 
and surveillance mechanisms used in connection with former Rule 10a-1 
that could be used to comply with the proposed uptick rule. We believe, 
however, that most market participants would incur costs associated 
with having to implement or modify their trading systems and 
surveillance

[[Page 18096]]

mechanisms in order to comply with the proposed uptick rule, including 
a period of time in which to make such changes.\398\ However, we 
believe familiarity with a price test that would be based on a 
modernized version of former Rule 10a-1 might more readily help address 
investor confidence in our markets.
---------------------------------------------------------------------------

    \396\ See, e.g., 2007 Price Test Adopting Release, 72 FR at 
36350 n. 113 (citing to comment letter from SIFMA stating that cost 
estimates for firms to program for the changes that were necessary 
to meet the policies and procedures requirements of Regulation NMS 
varied, from as low as approximately $200,000 for some firms to as 
high as $2 million for others. See SIFMA Letter. Additionally, 
because they might require trading centers, SROs, and other market 
participants a significant amount of time in which to reprogram and 
test their systems to comply with a price test restriction, these 
systems and programming costs might be higher without a sufficient 
implementation period. For example, one commenter indicated that it 
would take six to nine months to implement a new version of the 
price test. See id. (discussing SIFMA comment letter) and see also 
supra note 208.
    \397\ Likewise, we believe some market participants may have 
retained personnel familiar with former SRO bid tests. See, e.g., 
supra note 125 and accompanying text.
    \398\ See, e.g., supra note 346.
---------------------------------------------------------------------------

c. Additional Mitigating Price Test Costs Features
    While we recognize that either proposed price test alternatives 
would create costs for trading centers that execute or display short 
sale orders in covered securities, as well as other market participants 
that engage in short selling, we believe there are several additional 
mitigating costs features that might help to reduce costs associated 
with a proposed price test if adopted.
    First, we believe that the fact that either proposed price test 
alternative, if adopted, would apply a uniform price test \399\ might 
help to reduce compliance costs for market participants. For example, 
by applying a uniform price test, the proposed short sale price test 
restrictions would be designed so as to not result in the type of 
disparate short sale regulation that existed under former Rule 10a-1, 
in which different price tests were applied in different markets, 
resulting in confusion, compliance difficulties, regulatory arbitrage, 
and an un-level playing field among market participants.\400\ Moreover, 
subsection (e) of proposed Rule 201 of the proposed modified uptick 
rule and subsection (d) of proposed Rule 201 of the proposed uptick 
rule, if adopted, would include a requirement that no SRO may have any 
rule that is not in conformity with, or conflicts with, the proposed 
short sale price test requirements.\401\ Thus, we believe a uniform 
rule might reduce compliance costs, and also could reduce regulatory 
arbitrage. Also, there might be a reduction in costs associated with 
systems and surveillance mechanisms that would have to be programmed to 
consider only a single test based on the national best bid (or on the 
last sale price if the proposed uptick rule is adopted) instead of 
different tests for different markets.
---------------------------------------------------------------------------

    \399\ As discussed above, unlike the former Rule 10a-1, the 
proposed short sale price test restrictions, if adopted, would apply 
a uniform rule to trades in the same securities that occur in 
multiple, dispersed, and diverse markets. Under the proposed short 
sale price test restrictions, all covered securities, wherever 
traded, would be subject to the same short sale price test.
    \400\ See supra note 27 (discussing the different tests under 
former Rule 10a-1).
    \401\ See proposed Rule 201(e) of the proposed modified uptick 
rule, and proposed Rule 201(d) of the proposed uptick rule.
---------------------------------------------------------------------------

    Second, the proposed three month implementation period would be 
designed to provide trading centers and market participants with a 
sufficient amount of time in which to modify their systems and 
procedures in order to comply with the requirements of a proposed short 
sale price test if adopted and, thus, might help reduce some of the 
costs and help to alleviate some of the potential disruptions that 
might be associated with implementing either proposed price test. We 
recognize, however, that a longer implementation period may be more 
manageable or preferable, particularly to smaller broker-dealers that 
might be disproportionately burdened by any implementation and 
compliance costs associated with the proposed short sale price test 
restrictions, as well as competitively disadvantaged in terms of 
reduced order flow as a result.\402\ Thus, we seek comment as to what 
length of implementation period would be necessary or appropriate, and 
why, such that trading centers would be able to meet the proposed short 
sale price test restrictions, if adopted.
---------------------------------------------------------------------------

    \402\ See supra note 390 and accompanying text (discussing 
letters from SIFMA and Credit Suisse, respectively, regarding cost 
estimates and the need for a longer implementation period, 
particularly for smaller broker-dealers).
---------------------------------------------------------------------------

    Third, as described below, we believe the ``broker-dealer'' 
provision in proposed Rule 201(c)(1) of the proposed modified uptick 
rule and the provisions contained in paragraph (d) of the proposed 
modified uptick rule, as well as the exceptions contained in paragraph 
(c) of the proposed uptick rule might also help to minimize any 
potential price distortions or costs associated with the proposed short 
sale price restrictions. These provisions also would be designed to 
help promote the workability of the proposed price tests, while at the 
same time furthering the Commission's stated goals of short sale price 
test regulation.
    For example, as discussed above, proposed Rule 201(c)(1) of the 
proposed modified uptick rule would provide that a broker-dealer may 
mark a short sale order in a covered security ``short exempt'' and send 
it to a trading center if the broker-dealer has identified the order as 
not being at a down-bid price at the time of submission of the order to 
the trading center. This provision would provide broker-dealers with 
the option to manage their order flow, rather than having to always 
rely on their trading centers to manage their order flow on their 
behalf. In addition, we note that this provision would not undermine 
the Commission's goals for short sale regulation because any broker-
dealer marking an order ``short exempt'' in accordance with this 
provision would have to ensure that its short sale order was not on a 
down-bid price at the time of submission of the order to a trading 
center. We believe that this provision also might help to preserve 
instant execution and liquidity by allowing relatively unrestricted 
short selling in an advancing market.
    Proposed Rule 201(d)(1) of the proposed modified uptick rule would 
provide an exception if the seller owns a security and would provide 
that a short sale order of a covered security may be marked ``short 
exempt,'' thereby allowing it to be displayed or executed at a down-bid 
price, if the broker-dealer has a reasonable basis to believe that the 
seller owned the security being sold and that the seller intended to 
deliver the security as soon as all the restrictions on delivery have 
been removed. Similarly, proposed Rule 201(c)(1) of the proposed uptick 
rule would provide an exception for sales of owned securities. As a 
result, these provisions would allow for sales of securities that 
although owned, were subject to the provisions of Regulation SHO 
governing short sales due solely to the seller being unable to deliver 
the security to its broker-dealer prior to settlement due to 
circumstances outside the seller's control.
    Proposed Rule 201(d)(2) of the proposed modified uptick rule would 
allow a broker-dealer to mark a short sale order ``short exempt'' if 
the broker-dealer has a reasonable basis to believe that the short sale 
order is by a market maker to off-set a customer odd-lot order or to 
liquidate an odd-lot position by a single round lot sell order that 
changed such broker-dealer's position by no more than a unit of trading 
and, thereby, may be permitted to be executed or displayed at a down-
bid price. Similarly, in proposed Rule 201(c)(3) of the proposed uptick 
rule we would provide an exception for sales related to odd-lot orders. 
These provisions would allow market makers to facilitate customer 
orders that are not of a size that could facilitate a downward price 
movement in the market.
    Proposed Rule 201(d)(3) of the proposed modified uptick would 
permit qualifying short sale orders associated with certain bona fide 
domestic arbitrage transactions to be marked ``short exempt,'' and 
thereby permit them to be executed or displayed at a down-bid price. 
This provision would allow broker-dealers to engage in transactions 
that tend to reduce pricing disparities between securities.

[[Page 18097]]

Moreover, to facilitate arbitrage transactions in which a short 
position was taken in a security on the U.S. market, and which was to 
be immediately covered on a foreign market, Rule 201(d)(4) of the 
proposed modified uptick rule would permit short sale orders associated 
with certain international arbitrage transactions to be marked ``short 
exempt,'' and thereby permit such orders to be executed or displayed at 
a down-bid price. Similarly, proposed Rules 201(c)(4) and 201(c)(5) of 
the proposed uptick rule would provide exceptions related to domestic 
and international arbitrage transactions.
    In addition, proposed Rule 201(d)(5) of the proposed modified 
uptick rule is intended to facilitate distributions of securities by 
providing an exception for any sales of covered securities by 
underwriters or members of a syndicate or group participating in the 
distribution of a security in connection with an over-allotment of 
securities, and any lay-off sales by such persons in connection with a 
distribution of securities through a rights or standby underwriting 
commitment. By permitting short sales in connection with an over-
allotment or lay-off sales at or below the national best bid to be 
marked ``short exempt,'' and thereby permit them to be executed or 
displayed at a down-bid price, this provision would enable an 
underwriter to reduce its risk by pricing an offering at or below the 
current national best bid or last sale price, as applicable. Similarly, 
proposed Rule 201(c)(6) of the proposed uptick rule would provide an 
exception for sales in connection with over-allotments and lay-off 
sales.
    As discussed above, proposed Rule 201(d)(6) of the proposed 
modified uptick rule would allow a broker-dealer to mark short sale 
orders of a covered security ``short exempt,'' and thereby allow for 
their execution or display at a down-bid price where a broker-dealer is 
facilitating customer buy orders or sell orders where the customer is 
net long and the broker-dealer is net short but is effecting the sale 
as riskless principal, provided certain conditions are met. Similarly, 
proposed Rule 201(c)(9) of the proposed uptick rule would provide an 
exception for certain transactions on a riskless principal basis. These 
provisions would provide broker-dealers with additional flexibility to 
facilitate customer orders.
    Proposed Rule 201(d)(7) of the proposed modified uptick rule would 
permit certain short sale orders executed on a VWAP basis to be marked 
``short exempt,'' and, as a result, to be executed or displayed at a 
down-bid price.\403\ Similarly, proposed Rule 201(c)(7) of the proposed 
uptick rule would provide an exception for certain transactions on a 
VWAP basis. These provisions might help provide an additional source of 
liquidity for investors' VWAP orders and might help enable investors to 
achieve their objective of obtaining an execution at the VWAP.
---------------------------------------------------------------------------

    \403\ See supra note 181 (citing to VWAP relief letters under 
former Rule 10a-1).
---------------------------------------------------------------------------

    In addition, the proposed uptick rule would include cost-mitigating 
provisions that would be unique to the proposed uptick rule, designed 
to allow its proper functioning in today's markets, while at the same 
time being designed to further the purposes of our proposing short sale 
price test restrictions at this time. For example, proposed Rule 
201(c)(2) of the proposed uptick rule would provide an exception for 
errors in marking a short sale order, such as when a broker-dealer 
effected a sale marked ``long'' by another broker-dealer, but the sale 
was mis-marked such that it should have been marked as a ``short'' 
sale.\404\ This exception might help promote liquidity by avoiding 
implicating the broker-dealer effecting the sale where the broker-
dealer's participation in the violation was neither knowing nor 
reckless.\405\
---------------------------------------------------------------------------

    \404\ See proposed Rule 201(d)(2).
    \405\ Id.
---------------------------------------------------------------------------

    Proposed Rule 201(c)(8) of the proposed uptick rule would provide 
an exception from the proposed uptick rule for any sale of a covered 
security in an electronic trading system that matches buying and 
selling interest at various times throughout the day as long as such 
sales meet certain criteria. This exception might help promote market 
efficiency and liquidity by accommodating the increased use of 
automated trading systems and alternative strategies used in today's 
marketplace. It might also help provide an additional source of 
liquidity for investors' passively priced orders and better enable 
investors to engage in alternative trading strategies to achieve their 
investment objectives.
    Proposed Rule 201(c)(10) and (c)(11) of the proposed uptick rule 
might also help promote market efficiency and liquidity by providing 
exceptions to the requirements of the proposed uptick rule to help 
address conflicts between the proposed uptick rule and the Quote Rule 
under Rule 602 of Regulation NMS.\406\
---------------------------------------------------------------------------

    \406\ See 17 CFR 242.602.
---------------------------------------------------------------------------

    Proposed Rule 201(c)(12) of the proposed uptick rule would provide 
an exception from the proposed uptick rule for any sale of a security 
at the offer by a registered market maker or specialist publishing two-
sided quotes to sell short to facilitate customer market and marketable 
limit orders to buy regardless of the last sale price. This exception 
is intended to help provide relief in a decimals environment to 
registered market makers and specialists so that they could provide 
liquidity in response to customer buy orders.
2. Proposed Circuit Breaker Halt Rule
    We recognize that the proposed circuit breaker halt rule, if 
adopted, would impose costs on market participants to implement and 
assure compliance with the proposed circuit breaker halt rule's 
requirements. These costs could, in sum, increase the costs of 
legitimate short selling. For example, the proposed circuit breaker 
halt rule, when triggered, would impose a short selling halt that might 
restrict otherwise legitimate short selling activity during periods of 
extreme volatility. As such, we recognize that the proposed circuit 
breaker halt rule might result in a reduction of the benefits of 
legitimate short selling and, thereby, could result in a subsequent 
reduction in short selling generally. Such a reduction might 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.\407\ Thus, we believe there might be potential costs 
associated with the proposed circuit breaker halt rule in terms of 
potential impact of such a halt on quote depths, spread widths, and 
market liquidity.
---------------------------------------------------------------------------

    \407\ See Section IX.B. (discussing costs of the proposed 
modified uptick rule and proposed uptick rule).
---------------------------------------------------------------------------

    In addition, we recognize that imposing a circuit breaker halt rule 
when, currently, there is an absence of a short selling halt may result 
in costs in terms of modifications to systems and surveillance 
mechanisms, as well as changes to processes and procedures. We 
anticipate that these changes would likely result in immediate 
implementation costs for market participants associated with 
reprogramming trading and surveillance systems to now account for the 
requirements of the proposed circuit breaker halt, if adopted. We also 
believe the proposed circuit breaker halt rule may impose costs to 
market participants related to systems changes to computer hardware and 
software, reprogramming costs, and surveillance and compliance costs, 
as well as staff time and technology resources, associated with

[[Page 18098]]

monitoring compliance with the proposed circuit breaker halt rule.\408\
---------------------------------------------------------------------------

    \408\ See id.
---------------------------------------------------------------------------

    Moreover, imposing a circuit breaker halt rule when there are 
currently no short sale halts in place also could mean that staff 
(compliance personnel, associated persons, etc.) might need to be 
trained or re-trained regarding rules related to the circuit breaker 
requirements. Also, market participants could be required to hire 
additional staff (and train or re-train them) to comply with the 
proposed circuit breaker halt rule. As such, we believe the proposed 
circuit breaker halt rule, if adopted, might impose training and 
compliance costs for market participants.
    While we recognize that market participants would incur initial up-
front costs associated with having to update their systems, including 
systems changes to computer hardware and software, as well as staff 
time and technology resources to update their systems and surveillance 
mechanisms in order to ensure compliance with the requirements of the 
proposed circuit breaker halt rule,\409\ we believe that many of the 
systems changes that would be required to be implemented are similar to 
what was already required for implementation under Regulation NMS.\410\ 
Thus, we believe market participants may already have developed or 
programmed their trading and surveillance systems in accordance with 
the requirements of Regulation NMS which may help to reduce any 
implementation costs associated with the proposed circuit breaker halt 
rule and, therefore, may make the proposed circuit breaker halt rule 
less burdensome to implement.
---------------------------------------------------------------------------

    \409\ See, e.g., 2007 Price Test Adopting Release, 72 FR at 
36350 n. 113 (citing comment letter from SIFMA stating that cost 
estimates for firms to program for the changes that were necessary 
to meet the requirements of Regulation NMS varied, from as low as 
approximately $200,000 for some firms to as high as $2 million for 
others. See also letter from Credit Suisse.
    \410\ See Regulation NMS Adopting Release, 70 FR 37496. See also 
17 CFR 242.611.
---------------------------------------------------------------------------

    Thus, while we believe there would be costs associated with systems 
modifications and training staff that would be affected by these 
systems modifications, because most market participants would already 
have in place systems in order to comply with Regulation NMS, market 
participants may already have in place most of the infrastructure and 
processes necessary to comply with the proposed circuit breaker halt 
rule. Moreover, because the proposed circuit breaker halt rule might 
require less substantial modifications to existing systems, the 
implementation and compliance costs may not be significant.\411\ As 
discussed above, currently, all stock exchanges and FINRA have rules or 
policies to implement coordinated circuit breaker halts.\412\ Moreover, 
SROs have rules or policies in place to coordinate individual security 
trading halts corresponding to significant news events.\413\ 
Information on the securities subject to SRO regulatory trading halts 
is disseminated to market participants through the CMS and other 
electronic media.\414\ We, however, seek comment as to whether the time 
and implementation costs associated with the proposed circuit breaker 
halt rule may be lower than other alternatives proposed.
---------------------------------------------------------------------------

    \411\ See letter from Credit Suisse (stating that 
``[i]mplementation could be fast and costs would be modest'' and 
that ``listing exchanges already disseminate real-time status 
conditions as part of existing price feeds. By generalizing the 
existing ``Regulatory Halt'' flag to include a ``Do Not Short'' 
condition, both away trading venues and broker-dealers could react 
to the circuit breaker condition in real-time with very little 
coding and testing'').
    \412\ See Securities Exchange Act Release No. 39846 (Apr. 9, 
1998), 63 FR 18477 (Apr. 15, 1998) (order approving proposals by 
Amex, BSE, CHX, NASD, NYSE, and Phlx) (``1998 Release''). See also 
NYSE Rule 80B. The circuit breaker procedures call for cross-market 
trading halts when the DJIA declines by 10 percent, 20 percent, and 
30 percent from the previous day's closing value. See e.g., BATS 
Exchange Rule 11.18.
    \413\ See, e.g., FINRA Rule 6120.
    \414\ For example, in addition to disseminating news of trading 
halts through the CMS, Nasdaq publishes a daily list of securities 
subject to trading halts indicating the name of the issuer, the time 
the halt was initiated, and where applicable, the times at which 
quoting and trading may resume.
---------------------------------------------------------------------------

    We, however, recognize that there may be concerns about a potential 
``magnet effect'' that could arise as an unintended consequence of the 
proposed circuit breaker halt rule that could halt short selling and 
result in short sellers driving down the price of an equity security in 
a rush to execute short sales before the circuit breaker would be 
triggered. As discussed above, one commenter noted that a short sale 
circuit breaker could exacerbate downward pressure on stocks as their 
value reached the threshold level.\415\ Another commenter, however, in 
discussing the issue of a ``magnet effect'' cited empirical studies 
that question whether a circuit breaker would result in artificial 
pressure on the price of individual securities.\416\
---------------------------------------------------------------------------

    \415\ See letter to Mary Schapiro, Chairman, from Direct Edge, 
dated March 30, 2009.
    \416\ See letter from Credit Suisse (discussing potential costs 
associated with short sale price test restrictions and circuit 
breaker rules).
---------------------------------------------------------------------------

    In addition, we note that the proposed circuit breaker halt rule 
would include exceptions substantially identical to exceptions in the 
Short Sale Ban that would be designed to allow its proper functioning 
in today's markets and allow broker-dealer to provide liquidity to the 
market, while at the same time being designed to further the purposes 
of our proposing the alternative circuit breaker halt rule at this 
time.\417\
---------------------------------------------------------------------------

    \417\ See Section III, above (discussing exceptions to proposed 
circuit breaker halt rule). See also Securities Exchange Act Release 
No. 58592 (Sept. 18, 2008), 73 FR 55169-02 (Sept. 24, 2008) 
(regarding exceptions to the Short Sale Ban).
---------------------------------------------------------------------------

    We believe the proposed circuit breaker halt rule should include 
exceptions that mirror certain of the exceptions in the Short Sale Ban 
because the proposed rule shares the same goal of prohibiting short 
selling that might exacerbate a price decline during a period of sudden 
and excessive price declines. For example, the proposed circuit breaker 
halt would include a bona fide market maker exception, which would 
allow market makers to effect a short sale as part of bona fide market 
making and hedging activity related directly to bona fide market making 
in derivatives on the publicly traded securities of a covered security. 
This proposed exception would permit market makers to continue to 
provide liquidity to the markets, facilitate orders, and otherwise 
comply with their obligations as market makers. This proposed exception 
would also apply to options market makers that sell short equity 
securities to hedge options positions.
    The proposed exception for short sales that occur as a result of 
automatic exercise or assignment of an equity option held before a 
circuit breaker on a particular security is triggered and a short 
selling halt is imposed in that security due to expiration of the 
option would allow short sales that occur as a result of the expiration 
of options contracts held before a circuit breaker is triggered in a 
particular security. This would allow persons that purchased or sold 
options prior to the effectiveness of a circuit breaker halt entered 
into such transactions with the expectation that they would be able to 
fulfill their contractual obligations and receive the benefits of their 
bargain in return. Providing this proposed exception to the circuit 
breaker halt rule would not raise the concerns that a circuit breaker 
rule is intended to address.
    To allow for creation of long call options, the proposed exception 
would permit short sales that occur as a result of assignment to call 
writers upon exercise. When options are exercised, call writers may be 
required to sell short in order to satisfy their obligations. Because 
call writers do not have discretion, and because the short sales are 
effected in order to fill buying

[[Page 18099]]

demand, we believe that including this exception in the proposed 
circuit breaker halt rule would benefit the markets while not opening 
the door to the abuses that the proposed rule is intended to address.
    The proposed exception for securities that a seller is deemed to 
own under Rule 200(b) (because Rule 144 securities are owned securities 
and do not raise the concerns that a short sale circuit breaker halt 
would be designed to address) would, during a halt triggered by a 
circuit breaker, allow sellers to sell securities that although owned, 
are subject to the provisions of Regulation SHO governing short sales 
due solely to the seller being unable to deliver the security to its 
broker-dealer prior to settlement based on circumstances outside the 
seller's control.
    We seek comment regarding any benefits or costs associated with the 
above described exceptions to the proposed circuit breaker halt rule.
3. Proposed Circuit Breaker Price Test Rules
    We also recognize that the proposed circuit breaker price test 
restrictions would result in costs on market participants responsible 
for implementing and assuring compliance with such requirements. We 
anticipate that there might be significant operational costs associated 
with reprogramming systems to comply with the proposed circuit breaker 
price test rules. We also anticipate that these costs might be greater 
than those required to comply with the proposed circuit breaker halt 
rule described above, which would, when triggered, impose a halt on 
short selling in individual NMS stocks rather than impose specific 
price test restrictions.\418\ In addition, we believe there might also 
be costs incurred for additional staff and costs associated with 
personnel hiring and training related to maintaining and ensuring 
compliance with the proposed circuit breaker price test rules.\419\
---------------------------------------------------------------------------

    \418\ See also Sections IX.B.1. (discussing costs of the 
proposed modified uptick rule and proposed uptick rule).
    \419\ See, e.g., letter from Credit Suisse (discussing potential 
costs associated with short sale price restrictions and circuit 
breaker rules). See also Section IX.B. (discussing costs associated 
with proposed modified uptick rule and proposed uptick rule).
---------------------------------------------------------------------------

    Further, we recognize that short sale price test restrictions that 
would be imposed as a result of the proposed circuit breaker price test 
rules being triggered might result in many of the same costs discussed 
in detail in Section IX.B.1 pertaining to the implementation of market-
wide short sale price test restrictions.\420\ Those costs might include 
a reduction of the benefit of legitimate short selling and a subsequent 
reduction in the quantity of short selling, which we recognize might 
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.\421\
---------------------------------------------------------------------------

    \420\ See Section IX.B.1. (discussing costs and benefits of the 
proposed modified uptick rule and the proposed uptick rule). See 
also Section IX.B.1.a. (discussing burden hour estimates, for 
purposes of the PRA, in connection with the proposed policies and 
procedure requirements under the modified uptick rule, the riskless 
principal exception to the proposed uptick rule, and the proposed 
marking requirements).
    \421\ See Section IX.B.1. (discussing costs of the proposed 
modified uptick rule and proposed uptick rule).
---------------------------------------------------------------------------

    Although under the proposed circuit breaker price test rules, a 
price test would not be in place full-time or for all securities, if 
the proposed circuit breaker modified uptick rule is adopted, trading 
centers would need to establish reasonable policies and procedures in 
advance to ensure compliance whenever a circuit breaker, and thus the 
proposed circuit breaker modified uptick rule, is triggered. We note 
that it would not be reasonable for a trading center to wait until the 
circuit breaker is triggered to begin establishing reasonable policies 
and procedures to prevent the execution or display of the particular 
NMS stock on a down-bid. Thus, we recognize that both of the proposed 
circuit breaker price tests would result in immediate upfront costs to 
trading centers.\422\
---------------------------------------------------------------------------

    \422\ See id.
---------------------------------------------------------------------------

    However, while we recognize that either proposed circuit breaker 
price test would create costs for trading centers that execute or 
display short sale orders in covered securities, as well as other 
market participants that engage in short selling, we note that the 
proposed circuit breaker price tests would include the same cost-
mitigating provisions discussed in Section IX(B)(1)(c) pertaining to 
the market-wide short sale price test restrictions that might help to 
reduce costs associated with the proposed circuit breaker price tests, 
while at the same time being designed to further the purposes of our 
proposing the alternative circuit breaker price test restrictions at 
this time.\423\ For example, we believe that the fact that either 
proposed circuit breaker price test, if adopted, would apply a uniform 
price test \424\ might help to reduce compliance costs for market 
participants associated with systems and surveillance mechanisms that 
would have to be programmed to consider only a single circuit breaker 
price test instead of different tests for different markets.
---------------------------------------------------------------------------

    \423\ See id.
    \424\ As discussed above, unlike the former Rule 10a-1, the 
proposed short sale price test restrictions, if adopted, would apply 
a uniform rule to trades in the same securities that occur in 
multiple, dispersed, and diverse markets. Under the proposed short 
sale price test restrictions, all covered securities, wherever 
traded, would be subject to the same short sale price test.
---------------------------------------------------------------------------

    Second, the proposed three month implementation period would be 
designed to provide trading centers and market participants with a 
sufficient amount of time in which to modify their systems and 
procedures in order to comply with the requirements of either proposed 
circuit breaker price test, if adopted, and, thus, might help reduce 
some of the costs and help to alleviate some of the potential 
disruptions that might be associated with implementing either proposed 
circuit breaker price test. We recognize, however, that a longer 
implementation period may be more manageable or preferable, 
particularly to smaller broker-dealers that might be disproportionately 
burdened by any implementation and compliance costs associated with the 
proposed circuit breaker price test restrictions, as well as 
competitively disadvantaged in terms of reduced order flow as a 
result.\425\ Thus, we seek comment as to what length of implementation 
period would be necessary or appropriate, and why, such that trading 
centers would be able to meet the proposed circuit breaker price test 
restrictions, if adopted.
---------------------------------------------------------------------------

    \425\ See letter from Credit Suisse supra note 122 (discussing 
need for a much longer implementation period, particularly for 
smaller broker-dealers). According to this commenter, compliance 
costs associated with a bid or tick test would disproportionately 
burden smaller broker-dealers, who would likely be forced to route 
their flow through a handful of larger broker-dealers, impeding 
competition and adding to systemic risk as flow is consolidated 
among fewer players).
---------------------------------------------------------------------------

    Third, as described below, we believe the ``broker-dealer'' 
provision in proposed Rule 201(c)(1) of the proposed circuit breaker 
modified uptick rule and the provisions contained in paragraph (d) of 
the proposed circuit breaker modified uptick rule, as well as the 
exceptions contained in paragraph (c) of the proposed circuit breaker 
uptick rule might also help to minimize any potential price distortions 
or costs associated with the proposed circuit breaker price 
restrictions. These provisions also would be designed to help promote 
the workability of the proposed circuit breaker price tests, while at 
the same time furthering the

[[Page 18100]]

Commission's stated goals of short sale price test regulation.\426\
---------------------------------------------------------------------------

    \426\ See Section IX.B.1.c. (discussing cost-mitigating features 
of proposed modified uptick rule and proposed uptick rule in 
detail).
---------------------------------------------------------------------------

4. Proposed Marking Requirements
    We do not anticipate that the ``short exempt'' marking requirements 
would impose significant costs on broker-dealers. For example, such 
broker-dealers might incur a one-time cost associated with 
implementation and reprogramming. In connection with the order marking 
requirements of Rule 200(g) of Regulation SHO, which had originally 
included the category of ``short exempt,'' industry sources at that 
time estimated initial implementation costs for the former ``short 
exempt'' marking requirement to be approximately $100,000 to 
$125,000.\427\
---------------------------------------------------------------------------

    \427\ See 2004 Regulation SHO Adopting Release, 69 FR at 48023.
---------------------------------------------------------------------------

    In addition, we do not believe the proposed order marking 
requirements would impose significant ongoing monitoring and 
surveillance costs for broker-dealers. Broker-dealers already have 
established systems, processes, and procedures in place to comply with 
the current marking requirements of Rule 200(g) of Regulation SHO with 
respect to marking a sell order either ``long'' or ``short'' and, thus, 
would likely continue to use such systems, processes and procedures to 
comply with the proposed ``short exempt'' marking requirements in 
proposed Rules 200(g) and 200(g)(2).
    We recognize that there would be an ongoing paperwork burden cost 
associated with adding the ``short exempt'' marking requirements. For 
example, as discussed in detail in Section VIII, above, for purposes of 
the PRA, we estimate that it would take each broker-dealer no more than 
approximately .000139 hours (.5 seconds) to mark a sell order ``short 
exempt.'' In addition, we estimate that the total annual hour burden 
per year for each broker-dealer subject to the proposed ``short 
exempt'' marking requirements would be 322 hours.
    If we were to adopt the proposed ``short exempt'' marking 
requirements of proposed Rules 200(g) of the proposed modified uptick 
rule (or the proposed circuit breaker modified uptick rule) or the 
proposed uptick rule (or the proposed circuit breaker uptick rule), or 
the proposed circuit breaker halt rule, we are proposing an 
implementation period under which market participants would have to 
comply with these requirements three months following the effective 
date of the proposed marking requirements. We believe that this 
proposed implementation period would provide market participants with 
sufficient time in which to modify their systems and procedures in 
order to comply with the proposed ``short exempt'' marking 
requirements. We realize, however, that a shorter or longer 
implementation period may be manageable or preferable. Thus, we seek 
specific comment as to what length of implementation period would be 
necessary or appropriate, and why, such that market participants would 
be able to meet the proposed marking requirements, if adopted.

C. Request for Comment

    We are sensitive to the costs and benefits of the proposed 
amendments, and encourage 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 proposed 
amendments.
Questions Regarding Proposed Short Sale Price Test Restrictions
    1. The Commission believes that the erosion of investor confidence 
and questions concerning the volatility in the securities markets 
necessitate review of various alternatives with respect to short 
selling restrictions. Would the proposed market-wide short sale price 
test restrictions be more appropriate than the proposed circuit breaker 
rules in current market conditions? If so, why? If not, why not? Would 
the proposed market-wide short sale price test restrictions provide 
more potential benefit to the market than the proposed circuit breaker 
rules? Please explain. For example, would the proposed market-wide 
short sale price test restrictions be a more appropriate means for the 
Commission to achieve the objective helping to prevent short selling 
from being used as a tool to drive down the market? Please explain. 
Would the proposed market-wide short sale price test restrictions help 
to address the Commission's concerns regarding investor confidence? If 
so, why and how? If not, why not?
    2. What would be the costs and benefits of the proposed modified 
uptick rule versus the proposed uptick rule? Is a policies and 
procedures approach preferable to a prohibition on executing a short 
sale on a down-bid price? Why or why not? What would be the costs and 
benefits of a policies and procedures approach as compared to such a 
prohibition? Should we consider other forms of short sale price tests? 
What would be the costs and benefits of any alternative forms of short 
sale price tests?
    3. What would be the costs and benefits of short sales being 
subject to the proposed modified uptick rule? What would be the costs 
and benefits of short sales being subject to the proposed uptick rule? 
What would be the costs and benefits of having a uniform short sale 
price test in the covered securities across all markets? Please 
explain.
    4. What, if any, additional benefits, beyond those discussed 
herein, would result from the proposed modified uptick rule? What, if 
any, additional benefits, beyond those discussed herein, would result 
from the proposed uptick rule? Should either proposed price test be 
modified in any way to increase the benefits of a short sale price 
test? If so, how?
    5. What, if any, additional costs, beyond those discussed herein, 
would result from the proposed modified uptick rule? What, if any, 
additional costs, beyond those discussed herein, would result from the 
proposed uptick rule? What would be the types of costs, and what would 
be the amounts? Should the proposed short sale price tests be modified 
in any way to mitigate costs? If so, how?
    6. How would trading systems and strategies used in today's 
marketplace be impacted by the proposed modified uptick rule? How might 
market participants alter their trading systems and strategies in 
response to the proposed modified uptick rule, if adopted?
    7. Would the proposed modified uptick rule create any additional 
implementation or operational costs associated with systems (including 
computer hardware and software), surveillance, procedural, 
recordkeeping, or personnel modifications, beyond those discussed 
herein? Would the proposed uptick rule create any additional 
implementation or operational costs associated with systems (including 
computer hardware and software), surveillance, procedural, 
recordkeeping, or personnel modifications, beyond those discussed 
herein?
    8. Would smaller trading centers and other market participants be 
disproportionately impacted by any additional implementation or 
operational costs associated with systems (including computer hardware 
and software), surveillance, procedural, recordkeeping, or personnel 
modification as a result of the proposed short sale price test 
restrictions? If so, in what way. Please explain.
    9. To comply with the proposed modified uptick rule, broker-dealers

[[Page 18101]]

might be required to purchase new systems or implement changes to 
existing systems. Would changes to existing systems be significant? 
What would be the costs and benefits associated with acquiring new 
systems or making changes to existing systems? What, if any, changes 
would need to be made to existing recordkeeping systems? What would be 
the costs and benefits associated with any changes? How might smaller 
broker-dealers be impacted by having to purchase new systems or 
implement changes to existing systems in order to comply with the 
proposed modified uptick rule, if adopted?
    10. To comply with the proposed uptick rule, broker-dealers might 
be required to purchase new systems or implement changes to existing 
systems. Would changes to existing systems be significant? What would 
be the costs and benefits associated with acquiring new systems or 
making changes to existing systems? What, if any, changes would need to 
be made to existing records? What would be the costs and benefits 
associated with any changes?
    11. What would be the costs and benefits of requiring trading 
centers to establish, maintain, and enforce written policies and 
procedures reasonably designed to prevent the execution or display by 
the trading center of impermissibly priced short sale orders? What 
would be the costs and benefits of requiring trading centers to have 
policies and procedures reasonably designed to permit the execution or 
display of a short sale order of a covered security marked ``short 
exempt'' without regard to whether the order is at a down-bid price?
    12. What would be the costs and benefits of requiring that trading 
centers regularly surveil to ascertain the effectiveness of the 
policies and procedures required by proposed Rule 201(b)(1) and 
promptly take action to remedy deficiencies in such policies and 
procedures? What systems and surveillance changes by trading centers 
would be necessary to meet the requirements of the proposed modified 
uptick rule?
    13. Would the proposed modified uptick rule's compliance and 
surveillance requirements disproportionately burden smaller broker-
dealers? If so, in what way? Please explain.
    14. How much, if any, would the proposed price test restrictions 
affect compliance costs (e.g., personnel or system changes) for each 
category of broker-dealers: small, medium, and large?
    15. Would the proposed modified uptick rule affect different 
trading centers differently? If so, how? If not, why?
    16. Would there be any increases in staffing and associated 
overhead costs for trading centers and broker-dealers? Would other 
resources need to be re-dedicated to comply with the proposed modified 
uptick rule or proposed uptick rule?
    17. What, if any, impact on competition would the proposed price 
test restrictions have on smaller broker-dealers, e.g., due to systems 
modifications and implementation costs. Please explain.
    18. We solicit comment on whether any costs associated with the 
proposed modified uptick rule and proposed uptick rule would be 
incurred on a one-time or ongoing basis, as well as cost estimates. In 
addition, we seek comment as to whether the exceptions to the proposed 
modified uptick rule or proposed uptick rule would decrease or increase 
any costs for any market participants. We seek comment about any other 
costs and cost reductions associated with the proposed amendments.
    19. Would the proposed short sale price tests 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, would the proposed short sale price 
tests impact legitimate short selling and market efficiency?
    20. We seek comment regarding types of entities that would be 
affected, and the manner in which they would be affected, by the 
proposed amendments.
    21. We seek specific comments on the costs associated with systems 
changes for trading centers and broker-dealers, including the type of 
systems changes necessary and quantification of costs associated with 
changing the systems, including both start-up costs and maintenance. We 
request comments on the types of jobs and staff that would be affected 
by systems modifications and training with respect to the proposed 
modified uptick rule or proposed uptick rule, the number of labor hours 
that would be required to accomplish these matters, and the 
compensation rates of these staff members.
    22. Would reinstating a short sale price test restriction such as 
the proposed modified uptick rule or proposed uptick rule help restore 
investor confidence? If so, why? If not, why not? We note that short 
selling provides the market with important benefits, including market 
liquidity and pricing efficiency.\428\ What effect, if any, would the 
proposed modified uptick rule have on market liquidity? What effect, if 
any, would the proposed modified uptick rule have on pricing 
efficiency? Please provide empirical data in support of any arguments 
and/or analyses.
---------------------------------------------------------------------------

    \428\ See Section II.A.
---------------------------------------------------------------------------

    23. Should short sales be subject to a short sale price test 
restriction, or should we continue to rely on current short sale 
regulations, as well as anti-fraud and anti-manipulation provisions of 
the securities laws to address issues raised by potentially abusive 
short selling? What would be the costs and benefits of subjecting short 
sales to a short sale price test restriction versus the current short 
sale regulations, as well as anti-fraud and anti-manipulation 
provisions of the securities laws?
    24. We request comments on whether the pricing of securities 
affected by any short sale price test would be more or less efficient.
    25. We request comments on whether the pricing of securities 
affected by the proposed modified uptick rule would be more or less 
efficient.
    26. We request comments on whether the pricing of securities 
affected by the proposed uptick rule would be more or less efficient.
    27. If a short sale price test restriction were introduced, the 
rule would require some commitment of resources associated with 
compliance oversight, market surveillance, and enforcement. What would 
be the associated opportunity costs? What level of additional resources 
would be needed for that oversight, surveillance, and enforcement?
Questions Regarding Proposed Circuit Breaker Halt Rule
    1. The Commission believes that the erosion of investor confidence 
and questions concerning the volatility in the securities markets 
necessitate review of various alternatives with respect to short 
selling restrictions. Would the proposed circuit breaker halt rule be 
more appropriate than a market-wide short sale price test restriction 
in current market conditions? If so, why? If not, why not? Would the 
proposed circuit breaker halt rule provide more potential benefit to 
the market than a market-wide short sale price test restriction? Please 
explain. For example, would the proposed circuit breaker halt rule be a 
more appropriate means for the Commission to achieve the objective, 
helping to prevent short selling from being used as a tool to drive 
down the market? Please explain. Would the

[[Page 18102]]

proposed circuit breaker halt rule help to address the Commission's 
concerns regarding investor confidence? If so, why and how? If not, why 
not?
    2. Would implementation of the proposed circuit breaker halt rule 
be less or more costly than the implementation of a market-wide short 
sale price test restriction? Would the proposed circuit breaker halt 
rule that, when triggered, would impose a temporary halt on short 
selling be more or less costly than one that resulted in a short sale 
price test restriction? Please explain. Would the proposed circuit 
breaker halt rule be generally easier to implement in a post-Regulation 
NMS environment than a market-wide short sale price test restriction 
such as the proposed modified uptick rule, or the proposed uptick rule? 
Are there any additional costs associated with multiple day circuit 
breakers when compared to same day circuit breakers?
    3. Should the proposed circuit breaker halt rule be adopted in 
addition to a permanent, market-wide short sale price test restriction 
rule? Thus, while a short sale price test restriction rule would be in 
place as a permanent, market-wide rule, a circuit breaker would also 
trigger a short selling halt in any security that suffers a severe 
price decline. Please describe the advantages and disadvantages of such 
an approach.
    4. What would be the relative advantages and disadvantages of a 
short sale price test combined with a circuit breaker halt rule versus 
those of a short selling circuit breaker with short sale price test 
restrictions? Please explain.
    5. The Commission is seeking comment on the potential impact of the 
proposed circuit breaker halt rule on market function and efficiency. 
What would be the impact of the proposed circuit breaker halt rule, 
when triggered, on the liquidity of individual securities? What would 
be the impact of the proposed circuit breaker halt rule on capital 
formation? What would be the impact of the proposed circuit breaker 
halt rule on price discovery? Would different circuit breaker 
alternatives have different impacts on liquidity, capital formation and 
price discovery? Would a multiple circuit breaker impose any unique 
costs? Please explain.
    6. Should the percentage decline be linked to the stock's price 
level such that stocks with lower prices must experience a greater 
percentage decline before the circuit breaker is triggered? If so, what 
thresholds are appropriate? Please explain. If the percentage decline 
is linked to price level, what additional operational burdens would be 
experienced if stock values were required to be continuously monitored 
due to frequent fluctuation? Please explain. What costs and benefits 
may accrue from having the decline based on a dollar amount rather than 
a value derived from a percentage of the share value? What potential 
problems or benefits may arise from pegging a short selling circuit 
breaker threshold to a decline in a stock's dollar amount? Please 
explain.
    7. What other benefits, beyond those discussed herein, would be 
associated with the proposed circuit breaker halt rule? Would the 
proposed circuit breaker halt rule help stabilize the market for the 
individual security? If so, why? If not, why not? Would the proposed 
circuit breaker halt rule benefit investors by allowing the market to 
``cool off'' with respect to that individual security? Please explain. 
Would the proposed circuit breaker halt rule result in an increase in 
investor confidence? Please explain.
    8. What costs, beyond those discussed herein, would be incurred in 
terms of implementing the proposed circuit breaker halt rule? Please 
explain. What would it cost to update systems in a manner necessary to 
ensure compliance with the proposed circuit breaker halt rule? Would 
the expenditure necessary to ensure compliance be primarily an ``up-
front'' cost? Would the expenditure necessary to ensure compliance 
require long-term investment? Please explain. What technological 
challenges would be encountered in updating systems to ensure 
compliance with the proposed circuit breaker halt rule? Please explain. 
How long would it take to update systems in a manner that ensured 
compliance with the proposed circuit breaker halt rule? Please explain.
    9. What would be the costs and benefits associated with the 
proposed bona fide market making exception to the proposed circuit 
breaker halt rule? Please explain. What would be the costs and benefits 
associated with the proposed exception that would allow short sales 
that occur as a result of automatic exercise or assignment of an equity 
option held prior to the effectiveness of the short selling halt due to 
expiration of the option? Please explain. What would be the costs and 
benefits associated with the proposed exception for options market 
makers selling short as part of bona fide market making and hedging 
activities related directly to bona fide market making in derivatives 
on the individual security subject to the halt? Please explain.
Questions Regarding Proposed Circuit Breaker Price Test Rules
    1. What benefits, beyond those discussed herein, would be 
associated with the proposed circuit breaker price test rules? Would 
the proposed circuit breaker price test rules help stabilize the market 
for the individual security? If so, why? If not, why not? Would the 
proposed circuit breaker price test rules benefit investors by allowing 
the market to ``cool off'' with respect to that individual security? 
Please explain. Would the proposed circuit breaker price test rules 
result in an increase in investor confidence? Please explain.
    2. What would be the benefits of the proposed circuit breaker price 
test rules versus a permanent, market-wide short sale price test such 
as the modified uptick rule or the proposed uptick rule? Please explain 
and support explanations with data and analysis where appropriate.
    3. What costs would be associated with implementing the proposed 
circuit breaker modified uptick rule? Please explain. What costs would 
be associated with implementing the proposed circuit breaker uptick 
rule? What would be the degree of financial expenditure involved in 
updating systems in a manner necessary to ensure compliance with each 
proposed circuit breaker price test rule? Would the expenditure 
necessary to ensure compliance be primarily an ``up-front'' cost? Would 
the expenditure necessary to ensure compliance require long-term 
investment? Please explain. How would the costs of each of the proposed 
circuit breaker price test rules compare with the costs of permanent 
short sale price tests such as the proposed modified uptick rule or the 
proposed uptick rule? Please explain.
    4. What technological challenges would be encountered in updating 
systems to ensure compliance with each of the proposed circuit breaker 
price test rules on individual securities? Please explain. How long 
would it take to update systems in a manner that ensured compliance? 
Please explain. Would either of the proposed circuit breaker price test 
rules impede the efficient functioning of the equity markets? If so, 
why? If not, why not? Please explain. Are there any other operational 
challenges that may arise from implementing either of the proposed 
circuit breaker price test rules? Please explain. Would the operational 
challenges presented impede the effectiveness of the proposed circuit 
breaker modified uptick rule? Please explain. Would the operational 
challenges presented impede the effectiveness of the proposed circuit 
breaker uptick rule? Please explain.
    5. Are there other short sale price test restrictions, beyond those 
discussed herein, that should be considered in

[[Page 18103]]

combination with proposed circuit breaker price test rules? Please 
explain.
    6. What would be the benefits and costs associated with the 
proposed exceptions to the proposed circuit breaker modified uptick 
rule? Please explain. What would be the benefits and costs associated 
with the proposed exceptions to the proposed circuit breaker uptick 
rule? Please explain.
    7. What would be the benefits and costs associated with a circuit 
breaker rule that, when triggered, would prohibit short selling in a 
particular NMS security on a down-bid unless the short sale is effected 
at a price that is more than 10% greater than the prior day's closing 
price? Please explain.
Questions Regarding Proposed Marking Requirements
    1. What, if any, additional benefits or costs, beyond those 
discussed herein, would result from complying with the ``short exempt'' 
marking requirements under the proposed amendments to Rules 200(g) and 
200(g)(2)? What would be the types of additional benefits, and what 
would be the amounts? What would be the types of additional costs, and 
what would be the amounts? Who would bear these costs? Should the 
proposed ``short exempt'' marking requirements be modified in any way 
to mitigate costs? If so, how?
    2. Would there be any operational or compliance concerns associated 
with the proposed ``short exempt'' marking requirements?
    3. What types of costs, if any, would be associated with requiring 
sell orders be marked ``short exempt'' only if the provisions of 
paragraph (c) or (d) of the proposed modified uptick rule (or paragraph 
(c) or (d) of the proposed circuit breaker modified uptick rule) are 
met? What type of costs, if any, would be associated with requiring 
sell orders to be marked ``short exempt'' when relying on an exception 
to the proposed uptick rule (or the proposed circuit breaker uptick 
rule)? What type of costs, if any, would be associated with requiring 
sell orders to be marked ``short exempt'' when relying on an exception 
to the proposed circuit breaker halt rule?
    4. What would be a sufficient implementation period for making any 
systems changes necessary to allow sell orders to be marked ``short 
exempt''?
    5. Please describe any anticipated difficulties in complying with 
``short exempt'' marking requirements.
    6. The short sales that qualify for the ``broker-dealer'' provision 
in proposed Rule 201(c) are still subject to the provisions of the 
proposed modified uptick rule and would be required to be marked as 
``short exempt.'' Should these short sales be marked as ``short 
exempt'' or is another mark more appropriate? What effect, if any, 
would marking these short sales as ``short exempt'' have on compliance 
or surveillance relative to another mark? What would be the costs 
associated with implementing a mark especially for these short sales?

X. 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 is required to consider or determine 
whether an action is necessary or appropriate in the public interest, 
to consider whether the action would promote efficiency, competition, 
and capital formation.\429\ In addition, Section 23(a)(2) of the 
Exchange Act requires the Commission, when making rules under the 
Exchange Act, to consider the impact such rules would have on 
competition.\430\ 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.
---------------------------------------------------------------------------

    \429\ 15 U.S.C. 78c(f).
    \430\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    We believe the proposed amendments might have minimal impact on the 
promotion of price efficiency and capital formation. The two 
alternative short sale price tests proposed are designed to allow 
relatively unrestricted short selling in an advancing market. In 
addition, the short sale price tests would restrict short selling at 
successively lower prices and, thereby, might help prevent short 
selling, including potentially abusive or manipulative short selling, 
from being used as a tool for driving the market down or from being 
used to accelerate a declining market by exhausting all remaining bids 
at one price level, causing successively lower prices to be established 
by long sellers. Further, by seeking to advance these goals, the two 
alternative short sale price tests might help restore investor 
confidence in the securities markets.\431\
---------------------------------------------------------------------------

    \431\ See supra Section II.C., above (discussing restoring 
investor confidence).
---------------------------------------------------------------------------

    If the proposed short sale price test restrictions help address the 
erosion of investor confidence in our markets, the proposed amendments 
might help to facilitate and maintain stability in the markets and help 
ensure that they function efficiently. Bolstering investor confidence 
in the markets could help to encourage investors to be more willing to 
invest in the market, thus adding depth and liquidity to the markets 
and promoting the ability of listed companies to raise capital.
    In particular, by proposing to require trading centers to 
establish, maintain, and enforce written policies and procedures 
reasonably designed to help prevent the execution or display of a short 
sale order at a down-bid price, in the case of the proposed modified 
uptick rule, or prohibiting persons from effecting short sales below 
the last sale price, in the case of the proposed uptick rule, the 
proposed short sale price test restrictions might help prevent short 
selling, including potentially abusive or manipulative short selling, 
from being used as a tool for driving the market down or from being 
used to accelerate a declining market by exhausting all remaining bids 
at one price level, causing successively lower prices to be established 
by long sellers. By doing so, the proposed amendments might help to 
facilitate and maintain stability to the markets and help ensure that 
they function efficiently.
    In addition, the proposed short sale price tests might help 
preserve instant execution and liquidity, by allowing relatively 
unrestricted short selling in an advancing market. As discussed above, 
one of the benefits of legitimate short selling is that it provides 
market liquidity by, for example, adding to the selling interest of 
stock available to purchasers, and, when sellers are covering their 
short sales, adding to the buying interest of stock available to 
sellers. Thus, the proposed short sale price tests are designed to help 
reduce the potential harm toward the useful market purposes served by 
short selling by allowing relatively unrestricted short selling in an 
advancing market.
    Moreover, unlike the former short sale price tests (including 
former Rule 10a-1), the proposed short sale price test restrictions 
would apply a uniform rule to trades in the same securities that occur 
in multiple, dispersed, and diverse markets. Under the proposed short 
sale price test restrictions, all covered securities, wherever traded, 
would be subject to the same short sale price test. As such, the 
proposed short sale price test restrictions would not result in the 
type of disparate short sale regulation that existed under former Rule 
10a-1 (in which different price tests were applied in different 
markets, potentially resulting in confusion, compliance difficulties, 
regulatory arbitrage, and an un-level playing field

[[Page 18104]]

among market participants).\432\ This might help to avoid undermining 
competition and efficiency in the market.
---------------------------------------------------------------------------

    \432\ See supra note 27 (discussing disparate short sale 
regulation under former Rule 10a-1).
---------------------------------------------------------------------------

    In addition, the proposed short sale price tests include a number 
of provisions that are designed to help promote market efficiency and 
liquidity, while at the same time helping to promote the goals of our 
proposing at this time short sale price test restrictions and 
alternative circuit breaker rules. Moreover, the proposed modified 
uptick rule (and proposed circuit breaker modified uptick rule) is 
designed to provide trading centers and their customers with 
flexibility in determining how to handle orders that are not 
immediately executable or displayable by the trading center because the 
order is impermissibly priced. For example, if an order is 
impermissibly priced, a trading center could re-price the order at the 
lowest permissible price, execute the order immediately if the order is 
marketable at its new price, or hold it for later execution at its new 
price or better.\433\ As quoted prices change, the proposed rule would 
allow a trading center to repeatedly re-price and display an order at 
the lowest permissible price down to the order's original limit order 
price (or, if a market order, until the order is filled). Permitting a 
trading center to re-price an impermissibly priced short sale order 
might help to allow for the more efficient functioning of the markets 
because trading centers would not have to reject or cancel 
impermissibly priced orders unless instructed to do so by the trading 
center's customer submitting the short sale order.
---------------------------------------------------------------------------

    \433\ For example, if a trading center received a short sale 
order priced at $47.00 when the current national best bid in the 
security was $47.00, but the immediately preceding national best bid 
was $47.01 (i.e., the current bid was below the previous bid), the 
trading center could re-price the order at the permissible offer 
price of $47.01, and display the order for execution at this new 
limit price.
---------------------------------------------------------------------------

    In addition, the proposed circuit breaker rules would be designed 
to target only those securities that experience severe intraday 
declines and, therefore, might also help prevent short selling, 
including potentially abusive or manipulative short selling, from being 
used as a tool for driving the market down or from being used to 
accelerate a declining market where needed most. By doing so, the 
proposed circuit breaker rules might help restore confidence in the 
securities markets \434\ and, in turn, might help stabilize the market 
for individual securities during times of substantial uncertainty and 
help ensure that the markets function efficiently. Bolstering investor 
confidence in the markets might help to encourage investors to be more 
willing to invest in the market during times of substantial 
uncertainty, thus adding depth and liquidity to the markets and 
promoting capital formation.
---------------------------------------------------------------------------

    \434\ See supra Section II.C. above (discussing restoring 
investor confidence).
---------------------------------------------------------------------------

    For example, by halting short selling for the remainder of the 
trading day following a significant decline in a security's price, we 
believe the proposed circuit breaker halt rule, in particular, would be 
designed to provide sufficient time to re-establish equilibrium between 
buying and selling interests in the individual security in an orderly 
fashion. It would also be designed to help ensure that market 
participants have a reasonable opportunity to become aware of, and 
respond to, a significant decline in a security's price. By providing a 
pause in short selling resulting from a significant decline in the 
price of an individual equity security, we believe the proposed circuit 
breaker halt rule might provide a measure of stability to the markets. 
However, by allowing short selling to continue with price test 
restrictions once a circuit breaker was triggered, the proposed circuit 
breaker price test rules might have less impact on legitimate short 
selling and normal market activity including price discovery and the 
provision of liquidity than a circuit breaker with halt on short 
selling.
    By targeting only those securities that experience severe intraday 
declines, all three proposed circuit breaker rules would be narrowly 
tailored so that most stocks would not fall under any new short sale 
restrictions. As such, the proposed circuit breaker rules might help 
preserve instant execution and liquidity. As discussed above, one of 
the benefits of legitimate short selling is that it provides market 
liquidity by, for example, adding to the selling interest of stock 
available to purchasers, and, when sellers are covering their short 
sales, adding to the buying interest of stock available to sellers. 
Thus, the proposed circuit breaker rules are designed to help reduce 
the potential harm toward the useful market purposes served by short 
selling by targeting only those securities that experience severe 
intraday declines.
    In addition, the proposed amendment to Rule 200(g)(2) of Regulation 
SHO to require broker-dealers to mark a sale order as ``short exempt'' 
if the provisions of paragraph (c) or (d) of the proposed modified 
uptick rule (or paragraph (c) or (d) of the proposed circuit breaker 
modified uptick rule) are met, or if the seller is relying on an 
exception in paragraph (c) of the proposed uptick rule (or paragraph 
(c) of the proposed circuit breaker uptick rule), or if the seller is 
relying on an exception in paragraph (c) of the proposed circuit 
breaker halt rule, could help to promote price efficiency by helping to 
preserve instant execution and liquidity of such orders.
    In addition, we believe that the proposed amendments would not 
impose any burden on competition not necessary or appropriate in 
furtherance of the purposes of the Exchange Act. We believe the 
proposed short sale price test restrictions and the proposed circuit 
breaker rules might help to avoid undermining competition by imposing a 
uniform price test on all similarly situated entities or individuals 
subject to the proposed amendments. We recognize, however, that the 
proposed three-month implementation period for the proposed short sale 
price test restrictions may not be sufficient for certain smaller 
broker-dealers and that any potential compliance costs associated with 
the short sale price test restrictions could likely disproportionately 
burden these smaller broker-dealers in terms of reduced order flow, 
thereby impeding competition.\435\ However, we believe the proposed 
circuit breaker halt rule, in particular, might help to avoid 
undermining competition in that it may require less time and 
significantly less costs for implementation and compliance with its 
requirements.\436\ In addition, the proposed ``short exempt'' marking 
requirements would apply to all NMS stocks wherever traded, thereby 
providing a uniform practice designed to ensure consistency within the 
equity markets. Moreover, the proposed amendments could help to address 
any possibility that abusive or manipulative short selling might be 
contributing to the disruption in the markets and, therefore, could 
help to address the erosion of investor confidence in the markets.
---------------------------------------------------------------------------

    \435\ See letter from Credit Suisse (discussing need for a much 
longer implementation period, particularly for smaller broker-
dealers, and how compliance costs of a bid or tick test would likely 
disproportionately burden smaller broker-dealers and impede 
competition by forcing these smaller broker-dealers to route their 
flow through a handful of larger broker-dealers).
    \436\ See id.
---------------------------------------------------------------------------

    We request comment on whether the proposed amendments would likely 
promote efficiency, capital formation, and competition.

[[Page 18105]]

XI. Consideration of Impact on the Economy

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996, or ``SBREFA,'' \437\ we must advise the Office of 
Management and Budget as to whether the proposed regulation constitutes 
a ``major'' rule. Under SBREFA, a rule is considered ``major'' where, 
if adopted, it results or is likely to result in:
---------------------------------------------------------------------------

    \437\ Public Law 104-121, Title II, 110 Stat. 857 (1996) 
(codified in various sections of 5 U.S.C. and as a note to 5 U.S.C. 
601).
---------------------------------------------------------------------------

     An annual effect on the economy of $100 million or more 
(either in the form of an increase or a decrease);
     A major increase in costs or prices for consumers or 
individual industries; or
     Significant adverse effect on competition, investment or 
innovation.

If a rule is ``major,'' its effectiveness will generally be delayed for 
60 days pending Congressional review. We request comment on the 
potential impact of the proposed amendments on the economy on an annual 
basis. Commenters are requested to provide empirical data and other 
factual support for their view to the extent possible.

XII. Initial Regulatory Flexibility Analysis

    The Commission has prepared an Initial Regulatory Flexibility 
Analysis (``IRFA''), in accordance with the provisions of the 
Regulatory Flexibility Act,\438\ regarding the proposed amendments to 
Rules 200(g) and 201 of Regulation SHO under the Exchange Act.
---------------------------------------------------------------------------

    \438\ 5 U.S.C. 603.
---------------------------------------------------------------------------

A. Reasons for the Proposed Action

    We are proposing to amend Regulation SHO to impose a short sale 
price test that would restrict the prices at which certain securities 
may be sold short. We are also proposing as alternatives to a full-time 
price short sale price test two alternative circuit breaker rules. As 
discussed above, we believe it is appropriate at this time to examine 
and seek comment on whether to restore short sale price tests in light 
of the extreme market conditions that we are currently facing and the 
resulting deterioration in investor confidence.
    We are proposing two alternative short sale price tests. The first 
test would be the proposed modified uptick rule that would be based on 
the national best bid. The second test would be the proposed uptick 
rule that would be a modernized version of the tick test under former 
Rule 10a-1, and would be based on a last sale price. We are also 
proposing, as alternatives to a full-time short sale price test, 
circuit breaker rules that would establish limitations on short selling 
in a particular security during severe market declines in the price of 
that security. The proposed circuit breaker halt rule, when triggered 
by a severe price decline in a particular security, would temporarily 
prohibit any person from selling short that security during the 
effectiveness of the circuit breaker.\439\ The proposed circuit breaker 
price test rules, when triggered by a severe market decline in a 
particular security, would temporarily establish either the proposed 
modified uptick rule or the proposed uptick rule, as each are described 
in detail above, for that security.\440\
---------------------------------------------------------------------------

    \439\ The proposed circuit breaker halt rule could be imposed in 
place of, or in addition to, a permanent short sale price 
restriction rule.
    \440\ A circuit breaker that triggers a short sale price test 
rule would be adopted in place of a short sale price test rule.
---------------------------------------------------------------------------

    In addition, we are proposing amendments to Rule 200(g) of 
Regulation SHO to impose a ``short exempt'' marking requirement and to 
Rule 200(g)(2) of Regulation SHO to require broker-dealers to mark a 
sell order ``short exempt'' only if the provisions in paragraph (c) or 
(d) of the proposed modified uptick rule (or paragraph (c) or (d) of 
the proposed circuit breaker modified uptick rule) are met, or if a 
seller is relying on an exception in paragraph (c) of the proposed 
uptick rule (or paragraph (c) of the proposed circuit breaker uptick 
rule), or if a seller is relying on an exception in paragraph (c) of 
the proposed circuit breaker halt rule.

B. Objectives

    The two alternative short sale price tests proposed are designed to 
allow relatively unrestricted short selling in an advancing market. In 
addition, the short sale price tests are designed to restrict short 
selling at successively lower prices and, thereby, might help prevent 
short selling, including potentially abusive or manipulative short 
selling, from being used as a tool for driving the market down or from 
being used to accelerate a declining market by exhausting all remaining 
bids at one price level, causing successively lower prices to be 
established by long sellers. Further, by seeking to advance these 
goals, the two alternative short sale price tests would also be 
designed to help restore investor confidence in the securities markets.
    Moreover, the proposed alternative circuit breaker rules would be 
designed to target only those securities that experience severe 
intraday declines and, therefore, might also help prevent short 
selling, including potentially abusive or manipulative short selling, 
from being used as a tool for driving the market down or from being 
used to accelerate a declining market when needed most.

C. Legal Basis

    Pursuant to the Exchange Act and particularly, Sections 2, 3(b), 6, 
9(h), 10, 11A, 15, 15A, 17, 19, 23(a), and 36 thereof, 15 U.S.C. 78b, 
78c(b), 78(f), 78i(h), 78j, 78k-1, 78o, 78o-3, 78q, 78s, 78w(a), and 
78mm the Commission is proposing amendments to Sec. Sec.  242.200 and 
242.201 of Regulation SHO.

D. Small Entities Subject to the Proposed Amendments

    The proposed modified uptick rule and proposed circuit breaker 
modified uptick rule would require each trading center to establish, 
maintain, and enforce written policies and procedures reasonably 
designed to prevent the execution or display of a short sale order at a 
down-bid price.\441\ A ``trading center'' is defined as ``a national 
securities exchange or national securities association that operates an 
SRO trading facility, an alternative trading system, an exchange market 
maker, an OTC market maker, or any other broker-dealer that executes 
orders internally by trading as principal or crossing orders as 
agent.'' \442\
---------------------------------------------------------------------------

    \441\ See proposed Rule 201(b)(1).
    \442\ See 17 CFR 242.600(b)(78).
---------------------------------------------------------------------------

    Rule 0-10(e) under the Exchange Act provides that the term ``small 
business'' or ``small organization,'' when referring to an exchange, 
means any exchange that: (i) Has been exempted from the reporting 
requirements of Rule 601 under the Exchange Act; \443\ and (ii) 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.\444\ No 
national securities exchanges are small entities because none meet 
these criteria. There is one national securities association (FINRA) 
that would be subject to the proposed modified uptick rule. FINRA is 
not a small entity as defined by 13 CFR 121.201. Thus, the current 
national securities exchanges and one national securities association 
that would be subject to the proposed modified uptick rule are not 
considered ``small entities'' for purposes of the Regulatory 
Flexibility Act.
---------------------------------------------------------------------------

    \443\ 17 CFR 242.601.
    \444\ See 17 CFR 240.0-10(e) and 13 CFR 121.201.
---------------------------------------------------------------------------

    The remaining non-SRO trading centers that would be subject to the 
proposed modified uptick rule or the proposed circuit breaker modified

[[Page 18106]]

uptick rule are registered broker-dealers. The Commission has 
preliminarily determined that approximately 372 broker-dealers 
registered with the Commission that could meet the proposed definition 
of a trading center,\445\ which includes broker-dealers operating as 
equity ATSs, broker-dealers registered as market makers or specialists 
in NMS stocks, and any broker-dealer that is in the business of 
executing orders internally in NMS stocks. Pursuant to Rule 0-10(c) 
under the Exchange Act, 17 CFR 240.0-10(c), a broker-dealer is defined 
as a small entity for purposes of the Exchange Act and the Regulatory 
Flexibility Act if the broker-dealer had a 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, and it is not affiliated with any person (other than a 
natural person) that is not a small entity.\446\ Of these 372 non-SRO 
trading centers, only five \447\ are considered small for purposes of 
the Regulatory Flexibility Act pursuant to the standards of Rule 0-
10(c) under the Exchange Act.
---------------------------------------------------------------------------

    \445\ See supra note 10.
    \446\ 17 CFR 240.0-10(c)(1).
    \447\ This number was derived from OEA's review of 2007 FOCUS 
Report filings and discussion with SRO staff.
---------------------------------------------------------------------------

    The entities covered by the proposed uptick rule, the proposed 
circuit breaker uptick rule, the proposed circuit breaker halt rule, 
and the proposed ``short exempt'' marking requirements, would include 
small entities that are small broker-dealers, small businesses, and any 
investor who effected a short sale that qualifies as a small entity. 
Although we are not aware of data that is available to permit us to 
quantify every type of small entity covered by the proposed amendments, 
paragraph (c)(1) of Rule 0-10 under the Exchange Act, as mentioned 
above, states that the term ``small business'' or ``small 
organization,'' when referring to a broker-dealer, means a broker-
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.\448\
---------------------------------------------------------------------------

    \448\ These numbers are based on OEA's review of 2007 FOCUS 
Report filings reflecting registered broker-dealers, including 
introducing broker-dealers. This number does not include broker-
dealers that are delinquent on FOCUS Report filings.
---------------------------------------------------------------------------

    As mentioned above, paragraph (e) of Rule 0-10 under the Exchange 
Act \449\\\ states that the term ``small business'' or ``small 
organization,'' when referring to an exchange, means any exchange that: 
(i) Has been exempted from the reporting requirements of Rule 11Aa3-1 
under the Exchange Act; and (ii) 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. As mentioned above, no U.S. 
registered exchange is a small entity because none meets these 
criteria. Any business, however, regardless of industry, could be 
subject to the proposed uptick rule and the proposed provisions 
contained in paragraph (c) and (d) of the proposed modified uptick rule 
(or paragraph (c) or (d) of the proposed circuit breaker modified 
uptick rule), or the exceptions contained in paragraph (c) of the 
proposed uptick rule (or paragraph (c) of the proposed circuit breaker 
uptick rule), or the exceptions contained in paragraph (c) of the 
proposed circuit breaker halt rule if it effects a short sale. The 
Commission believes that, except for the broker-dealers discussed 
above, it is not possible to estimate the number of small entities that 
would fall under the proposed amendments because we are not aware of 
data, including the number of investors, who do or will engage in short 
selling.
---------------------------------------------------------------------------

    \449\ 17 CFR 240.0-10(e).
---------------------------------------------------------------------------

E. Projected Reporting, Recordkeeping and Other Compliance Requirements

    The proposed amendment may impose some new or additional reporting, 
recordkeeping, or compliance costs on trading centers and other broker-
dealers that are small entities. The proposed modified uptick rule 
would focus on a trading center's written policies and procedures as 
the mechanism through which to help prevent the execution or display of 
short sale orders on a down-bid price. In addition, the proposed 
modified uptick rule's ``broker-dealer'' provision (and the proposed 
circuit breaker modified uptick rule's ``broker-dealer'' provision) 
would include a policies and procedures requirement to help prevent 
incorrect identification of orders for purposes of the proposed 
``broker-dealer'' provision. In order to comply with Regulation NMS 
when it became effective in 2005, entities were required to modify 
their systems and surveillance mechanisms in order to comply with the 
order protection rule's policies and procedures requirement. Thus, the 
five non-SRO trading centers that would qualify as small entities may 
already have in place most of the infrastructure necessary to comply 
with the proposed modified uptick rule (or the proposed circuit breaker 
modified uptick rule), if adopted.
    In addition, in order to implement and comply with former Rule 10a-
1, entities were required to modify their systems and surveillance 
mechanisms. Thus, the small entities that would be subject to the 
proposed uptick rule (or proposed circuit breaker uptick rule or 
proposed circuit breaker halt rule) may already be familiar with, and 
may have retained systems, that would aid in their implementation and 
compliance with the proposed uptick rule (or proposed circuit breaker 
uptick rule or proposed circuit breaker halt rule). Small entities, 
however, may still need to make some modifications to their systems and 
surveillance mechanisms to implement and ensure compliance with the 
proposed uptick rule (or proposed circuit breaker uptick rule or 
proposed circuit breaker halt rule), if adopted.\450\
---------------------------------------------------------------------------

    \450\ See letter from Credit Suisse. See also supra note 122 and 
accompanying text.
---------------------------------------------------------------------------

    In addition, the proposed amendment to Rule 200(g)(2) that would 
require that a sale order be marked ``short exempt'' only if the 
provisions of proposed Rule 201(c) or (d) of the proposed modified 
uptick rule (or proposed Rule 201(c) or (d) of the proposed circuit 
breaker modified uptick rule) are met, or if the seller is relying on 
an exception from the proposed uptick rule (or the proposed circuit 
breaker uptick rule), could impose some new or additional reporting, 
recordkeeping, or compliance costs on broker-dealers that are small 
entities. We believe, however, that such costs would not be 
significant. Rule 200(g) currently requires that broker-dealers mark 
all sell orders of any equity security as either ``long'' or ``short.'' 
\451\ Broker-dealers that are small entities should already be familiar 
with the current marking requirements and should already have in place 
mechanisms that could be used to comply with the proposed ``short 
exempt'' marking requirement if adopted.
---------------------------------------------------------------------------

    \451\ See 17 CFR 242.200(g).
---------------------------------------------------------------------------

F. Duplicative, Overlapping, or Conflicting Federal Rules

    We believe that there are no rules that duplicate, overlap, or 
conflict with the proposed amendments to Rules 200(g) and 201 of 
Regulation SHO.

[[Page 18107]]

G. 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.\452\ In 
connection with the proposed amendments, we considered the following 
alternatives: (i) Establishing different compliance or reporting 
requirements or timetables that take into account the resources 
available to small entities; (ii) clarifying, consolidating, or 
simplifying compliance and reporting requirements under the rule for 
small entities; (iii) using performance rather than design standards; 
and (iv) exempting small entities from coverage of the rule, or any 
part of the rule.
---------------------------------------------------------------------------

    \452\ See 5 U.S.C. 603(c).
---------------------------------------------------------------------------

    A primary goal of the proposed amendments is to help restore 
investor confidence by restricting short selling at successively lower 
prices and, thereby, help prevent short selling, including potentially 
abusive or manipulative short selling, from being used as a tool for 
driving the market down or from being used to accelerate a declining 
market by exhausting all remaining bids at one price level, while at 
the same time allowing relatively unrestricted short selling in an 
advancing market. As such we believe that imposing different compliance 
requirements, and possibly a different timetable for implementing 
compliance requirements, for small entities would undermine the goal of 
restoring investor confidence. It also could create confusion in the 
market if some sellers were not required to comply. Further, it could 
undermine the goals of the proposed short sale price test restrictions 
or the proposed circuit breaker rules because it could provide an 
avenue for short sellers to evade the proposed amendments. In addition, 
we have concluded similarly that it is not consistent with the primary 
goal of the proposals to further clarify, consolidate or simplify the 
proposals for small entities. Finally, the proposals would impose 
performance standards rather than design standards.

H. General Request for Comments

    We solicit written comments regarding our IRFA analysis. In 
particular, the Commission seeks comment on the number of small 
entities that would be affected by the proposed amendments. We request 
that commenters provide empirical data to quantify the number of small 
entities that could be affected by the proposed amendments. We request 
comment on whether the proposed amendments would have any effects that 
we have not discussed. We also request that commenters describe the 
nature of any impact on small entities and provide empirical data to 
support the extent of the impact.

XIII. Additional Request for Comment

    In addition to the specific requests for comment found throughout 
this proposing release, we seek comment generally from all members of 
the public on all aspects of the proposed amendments to Rules 200(g) 
and 201 of Regulation SHO. We request that commenters provide empirical 
data to support their views and arguments related to these proposals. 
In addition to the questions set forth above, commenters are welcome to 
offer their views on any other matter raised by the proposed amendments 
to Regulation SHO. Specifically, are there any other possible 
restrictions on short selling that the Commission should consider, 
particularly ones that might be helpful in a severe market decline?

XIV. Statutory Authority

    Pursuant to the Exchange Act and, particularly, Sections 2, 3(b), 
6, 9(h), 10, 11A, 15, 15A, 17, 19, 23(a), and 36 thereof, 15 U.S.C. 
78b, 78c(b), 78(f), 78i(h), 78j, 78k-1, 78o, 78o-3, 78q, 78s, 78w(a), 
and 78mm the Commission is proposing amendments to Sec. Sec.  242.200 
and 242.201 of Regulation SHO.

XV. Text of the Amendments to Regulation SHO

List of Subjects in 17 CFR Part 242

    Brokers, Fraud, Reporting and recordkeeping requirements, 
Securities.

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

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

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

    Authority:  Pursuant to the Exchange Act and, particularly, 
Sections 2, 3(b), 6, 9(h), 10, 11A, 15, 15A, 17, 19, 23(a), and 36 
thereof, 15 U.S.C. 78b, 78c(b), 78(f), 78i(h), 78j, 78k-1, 78o, 78o-
3, 78q, 78s, 78w(a), and 78mm the Commission is proposing amendments 
to Sec. Sec.  242.200 and 242.201 of Regulation SHO.

Alternative I--Price Tests

A. Modified Uptick Rule
    2. Section 242.200 is amended by revising paragraph (g) 
introductory text and adding paragraph (g)(2) to read as follows:


Sec.  242.200  Definition of ``short sale'' and marking requirements.

* * * * *
    (g) A broker or dealer must mark all sell orders of any equity 
security as ``long,'' ``short,'' or ``short exempt.''
    (1) * * *
    (2) A sale order shall be marked ``short exempt'' only if the 
provisions of Sec.  242.201(c) or (d) are met.
* * * * *
    3. Section 242.201 is revised to read as follows:


Sec.  242.201  Price test.

    (a) Definitions. For the purposes of this section:
    (1) The term covered security shall mean any NMS stock as defined 
in Sec.  242.600(b)(47).
    (2) The term down-bid price shall mean a price that is less than 
the current national best bid or, if the last differently priced 
national best bid was greater than the current national best bid, a 
price that is less than or equal to the current national best bid.
    (3) The term national best bid shall have the same meaning as in 
Sec.  242.600(b)(42).
    (4) The term national market system plan shall have the same 
meaning as in Sec.  242.600(b)(43).
    (5) The term odd lot shall have the same meaning as in Sec.  
242.600(b)(49).
    (6) The term riskless principal shall mean a transaction in which a 
broker or dealer, after having received an order to buy a security, 
purchases the security as principal at the same price to satisfy the 
order to buy or, after having received an order to sell, sells the 
security as principal at the same price to satisfy the order to sell.
    (7) The term trading center shall have the same meaning as in Sec.  
242.600(b)(78).
    (b)(1) A trading center shall establish, maintain, and enforce 
written policies and procedures reasonably designed to prevent the 
execution or display of a short sale order of a covered security at a 
down-bid price. Provided, however,
    (i) The policies and procedures must be reasonably designed to 
permit the execution of a displayed short sale order of a covered 
security by a trading center if, at the time of display of the short 
sale order, the order was not at a down-bid price.
    (ii) The policies and procedures must be reasonably designed to 
permit the execution or display of a short sale order of a covered 
security marked ``short exempt'' without regard to whether the order is 
at a down-bid price.

[[Page 18108]]

    (2) A trading center shall regularly surveil to ascertain the 
effectiveness of the policies and procedures required by paragraph 
(b)(1) of this section and shall take prompt action to remedy 
deficiencies in such policies and procedures.
    (c) A broker or dealer may mark a short sale order of a covered 
security ``short exempt'' if the broker or dealer that submits the 
order identifies that the order is not on a down-bid price at the time 
of submission of the order to the trading center. Provided, however,
    (1) The broker or dealer that identifies a short sale order of a 
covered security in accordance with this paragraph must establish, 
maintain, and enforce written policies and procedures reasonably 
designed to prevent incorrect identification of orders for purposes of 
this paragraph; and
    (2) The broker or dealer shall regularly surveil to ascertain the 
effectiveness of the policies and procedures required by paragraph (c) 
of this section and shall take prompt action to remedy deficiencies in 
such policies and procedures.
    (d) A broker or dealer may mark a short sale order of a covered 
security ``short exempt'' if the broker or dealer has a reasonable 
basis to believe:
    (1) The short sale order of a covered security is by a person that 
is deemed to own the covered security pursuant to Sec.  242.200, 
provided that the person intends to deliver the security as soon as all 
restrictions on delivery have been removed.
    (2) The short sale order of a covered security is by a market maker 
to off-set customer odd-lot orders or to liquidate an odd-lot position 
that changes such broker's or dealer's position by no more than a unit 
of trading.
    (3) The short sale order of a covered security is for a good faith 
account by a person who then owns another security by virtue of which 
he is, or presently will be, entitled to acquire an equivalent number 
of securities of the same class as the securities sold; provided such 
sale, or the purchase which such sale offsets, is effected for the bona 
fide purpose of profiting from a current difference between the price 
of the security sold and the security owned and that such right of 
acquisition was originally attached to or represented by another 
security or was issued to all the holders of any such securities of the 
issuer.
    (4) The short sale order of a covered security is for a good faith 
account submitted to profit from a current price difference between a 
security on a foreign securities market and a security on a securities 
market subject to the jurisdiction of the United States, provided that 
the short seller has an offer to buy on a foreign market that allows 
the seller to immediately cover the short sale at the time it was made. 
For the purposes of this section, a depository receipt of a security 
shall be deemed to be the same security as the security represented by 
such receipt.
    (5)(i) The short sale order of a covered security is by an 
underwriter or member of a syndicate or group participating in the 
distribution of a security in connection with an over-allotment of 
securities; or
    (ii) Any short sale order with respect to a lay-off sale by an 
underwriter or member of a syndicate or group in connection with a 
distribution of securities through a rights or standby underwriting 
commitment.
    (6) The short sale order of a covered security is by a broker or 
dealer effecting the execution of a customer purchase or the execution 
of a customer ``long'' sale on a riskless principal basis; provided, 
however, the purchase or sell order must be given the same per-share 
price at which the broker or dealer sold shares to satisfy the 
facilitated order, exclusive of any explicitly disclosed markup or 
markdown, commission equivalent or other fee. In addition, for purposes 
of this section, a broker or dealer must have written policies and 
procedures in place to assure that, at a minimum: The customer order 
was received prior to the offsetting transaction; the offsetting 
transaction is allocated to a riskless principal or customer account 
within 60 seconds of execution; and the broker or dealer has 
supervisory systems in place to produce records that enable the broker 
or dealer to accurately and readily reconstruct, in a time-sequenced 
manner, all orders on which a broker or dealer relies pursuant to this 
exception.
    (7) The short sale order is for the sale of a covered security at 
the volume weighted average price (VWAP) that meets the following 
criteria:
    (i) The VWAP for the covered security is calculated by:
    (A) Calculating the values for every regular way trade reported in 
the consolidated system for the security during the regular trading 
session, by multiplying each such price by the total number of shares 
traded at that price;
    (B) Compiling an aggregate sum of all values; and
    (C) Dividing the aggregate sum by the total number of reported 
shares for that day in the security.
    (ii) The transactions are reported using a special VWAP trade 
modifier.
    (iii) No short sales used to calculate the VWAP are marked ``short 
exempt.''
    (iv) The VWAP matched security:
    (A) Qualifies as an ``actively-traded security''; or
    (B) The proposed short sale transaction is being conducted as part 
of a basket transaction of twenty or more securities in which the 
subject security does not comprise more than five percent of the value 
of the basket traded.
    (v) The transaction is not effected for the purpose of creating 
actual, or apparent, active trading in or otherwise affecting the price 
of any security.
    (vi) A broker or dealer shall be permitted to act as principal on 
the contra-side to fill customer short sale orders only if the broker's 
or dealer's position in the covered security, as committed by the 
broker or dealer during the pre-opening period of a trading day and 
aggregated across all of its customers who propose to sell short the 
same security on a VWAP basis, does not exceed 10% of the covered 
security's relevant average daily trading volume.
    (e) No self-regulatory organization shall have any rule that is not 
in conformity with, or conflicts with this section.
    (f) The provisions of this section shall apply to short sale orders 
in a covered security at times when a national best bid for the covered 
security is calculated and disseminated on a current and continuing 
basis by a plan processor pursuant to an effective national market 
system plan.
    (g) Upon written application or upon its own motion, the Commission 
may grant an exemption from the provisions of this section, either 
unconditionally or on specified terms and conditions, to any person or 
class of persons, to any transaction or class of transactions, or to 
any security or class of securities to the extent that such exemption 
is necessary or appropriate, in the public interest, and is consistent 
with the protection of investors.
B. Uptick Rule
    2. Section 242.200 is amended by revising paragraph (g) 
introductory text and adding paragraph (g)(2) to read as follows:


Sec.  242.200  Definition of ``short sale'' and marking requirements.

* * * * *
    (g) A broker or dealer must mark all sell orders of any equity 
security as ``long,'' ``short,'' or ``short exempt.''
    (1) * * *
    (2) A sale order shall be marked ``short exempt'' if the seller is 
relying on an exception from the price test of Sec.  242.201.
* * * * *

[[Page 18109]]

    3. Section 242.201 is revised to read as follows:


Sec.  242.201   Price test.

    (a) Definitions. For the purposes of this section:
    (1) The term actively traded security shall have the same meaning 
as in Sec.  242.101(c)(1).
    (2) The term average daily trading volume shall have the same 
meaning as in Sec.  242.100(b).
    (3) The term national market system plan shall have the same 
meaning as in Sec.  242.600(b)(43).
    (4) The term covered security shall mean any NMS stock as defined 
in Sec.  242.600(b)(47).
    (5) The term odd lot shall have the same meaning as in Sec.  
242.600(b)(49).
    (6) The term riskless principal shall mean a transaction in which a 
broker or dealer, after having received an order to buy a security, 
purchases the security as principal at the same price to satisfy the 
order to buy or, after having received an order to sell, sells the 
security as principal at the same price to satisfy the order to sell.
    (b) No person shall, for his own account or for the account of any 
other person, effect a short sale of any covered security, if trades in 
such security are reported pursuant to an effective national market 
system plan and information as to such trades is made available in 
accordance with such plan on a real-time basis to vendors of market 
transaction information:
    (1) Below the price at which the last sale thereof, regular way, 
was reported pursuant to an effective national market system plan; or
    (2) At such price unless such price is above the next preceding 
different price at which a sale of such security, regular way, was 
reported pursuant to an effective national market system plan.
    (c) The provisions of paragraph (b) of this section shall not apply 
to:
    (1) Any sale by any person of a covered security that the person is 
deemed to own pursuant to Sec.  242.200, provided that the person 
intends to deliver the security as soon as all restrictions on delivery 
have been removed.
    (2) Any sale by a broker or dealer of a covered security for an 
account in which it has no interest, pursuant to an order marked long.
    (3) Any sale of a covered security by a market maker to off-set 
customer odd-lot orders or to liquidate an odd-lot position which 
changes such broker's or dealer's position by no more than a unit of 
trading.
    (4) Any sale of a covered security for a good faith account by a 
person who then owns another security by virtue of which he is, or 
presently will be, entitled to acquire an equivalent number of 
securities of the same class as the securities sold; provided such 
sale, or the purchase which such sale offsets, is effected for the bona 
fide purpose of profiting from a current difference between the price 
of the security sold and the security owned and that such right of 
acquisition was originally attached to or represented by another 
security or was issued to all the holders of any such securities of the 
issuer.
    (5) Any sale of a covered security for a good faith account 
submitted to profit from a current price difference between a security 
on a foreign securities market and a security on a securities market 
subject to the jurisdiction of the United States, provided that the 
short seller has an offer to buy on a foreign market that allows the 
seller to immediately cover the short sale at the time it was made. For 
the purposes of this section, a depository receipt of a security shall 
be deemed to be the same security as the security represented by such 
receipt.
    (6)(i) Any sale of a covered security by an underwriter or member 
of a syndicate or group participating in the distribution of a security 
in connection with an over-allotment of securities; or
    (ii) Any lay-off sale by an underwriter or member of a syndicate or 
group in connection with a distribution of securities through a rights 
or standby underwriting commitment.
    (7) Any sale of a covered security at the volume weighted average 
price (VWAP) that meets the following criteria:
    (i) The VWAP for the covered security is calculated by:
    (A) Calculating the values for every regular way trade reported in 
the consolidated system for the security during the regular trading 
session, by multiplying each such price by the total number of shares 
traded at that price;
    (B) Compiling an aggregate sum of all values; and
    (C) Dividing the aggregate sum by the total number of reported 
shares for that day in the security.
    (ii) The transactions are reported using a special VWAP trade 
modifier.
    (iii) No short sales used to calculate the VWAP are marked ``short 
exempt'';
    (iv) The VWAP matched security:
    (A) Qualifies as an ``actively-traded security''; or
    (B) The proposed short sale transaction is being conducted as part 
of a basket transaction of twenty or more securities in which the 
subject security does not comprise more than five percent of the value 
of the basket traded.
    (v) The transaction is not effected for the purpose of creating 
actual, or apparent, active trading in or otherwise affecting the price 
of any security.
    (vi) A broker or dealer shall be permitted to act as principal on 
the contra-side to fill customer short sale orders only if the broker's 
or dealer's position in the covered security, as committed by the 
broker or dealer during the pre-opening period of a trading day and 
aggregated across all of its customers who propose to sell short the 
same security on a VWAP basis, does not exceed 10% of the covered 
security's relevant average daily trading volume.
    (8) Any sale of a covered security in an electronic trading system 
that matches buying and selling interest at various times throughout 
the day that meets the following criteria:
    (i) Matches occur at an externally derived price within the 
existing market and above the current national best bid;
    (ii) Sellers and purchasers are not assured of receiving a matching 
order;
    (iii) Sellers and purchasers do not know when a match will occur;
    (iv) Persons relying on the exception contained in paragraph (c)(8) 
of this section shall not be represented in the primary market offer or 
otherwise influence the primary market bid or offer at the time of the 
transaction;
    (v) Transactions shall not be made for the purpose of creating 
actual, or apparent, active trading in, or depressing or otherwise 
manipulating the price of, any security;
    (vi) The covered security:
    (A) Qualifies as an ``actively-traded security''; or
    (B) The proposed short sale transaction is being conducted as part 
of a basket transaction of twenty or more securities in which the 
subject security does not comprise more than five percent of the value 
of the basket traded; and
    (vii) During the period of time in which the electronic trading 
system may match buying and selling interest, there can be no 
solicitation of customer orders, or any communication with customers 
that the match has not yet occurred.
    (9) Any sale of a covered security by a broker or dealer effecting 
the execution of a customer purchase or the execution of a customer 
``long'' sale on a riskless principal basis; provided, however, the 
purchase or sell order must be given the same per-share price at which 
the broker or dealer sold shares to satisfy the facilitated order, 
exclusive of any explicitly disclosed markup or markdown, commission 
equivalent or other fee. In addition, for purposes of

[[Page 18110]]

this section, a broker or dealer must have written policies and 
procedures in place to assure that, at a minimum: The customer order 
was received prior to the offsetting transaction; the offsetting 
transaction is allocated to a riskless principal or customer account 
within 60 seconds of execution; and the broker or dealer has 
supervisory systems in place to produce records that enable the broker 
or dealer to accurately and readily reconstruct, in a time-sequenced 
manner, all orders on which a broker or dealer relies pursuant to this 
exception.
    (10) Any sale of a covered security (except a sale to a stabilizing 
bid complying with Sec.  242.104) by a registered specialist or 
registered exchange market maker for its own account on any exchange 
with which it is registered for such security, or by a third market 
maker for its own account over-the-counter:
    (i) Effected at a price equal to the most recent offer communicated 
for the security by such registered specialist, registered exchange 
market maker or third market maker to an exchange or a national 
securities association (``association'') pursuant to Sec.  242.602, if 
such offer, when communicated, was equal to or above the last sale, 
regular way, reported for such security pursuant to an effective 
national market system plan. Provided, however,
    (ii) That any self-regulatory organization, by rule, may prohibit 
its registered specialist and registered exchange market makers from 
availing themselves of the exemption afforded by this paragraph (c)(10) 
if that self-regulatory organization determines that such action is 
necessary or appropriate in its market in the public interest or for 
the protection of investors.
    (11) Any sale of a covered security (except a sale to a stabilizing 
bid complying with Sec.  242.104) by any broker or dealer, for his own 
account or for the account of any other person, effected at a price 
equal to the most recent offer communicated by such broker or dealer to 
an exchange or association pursuant to Sec.  242.602 in an amount less 
than or equal to the quotation size associated with such offer, if such 
offer, when communicated, was:
    (i) Above the price at which the last sale, regular way, for such 
security was reported pursuant to an effective national market system 
plan; or
    (ii) At such last sale price, if such last sale price is above the 
next preceding different price at which a sale of such security, 
regular way, was reported pursuant to an effective national market 
system plan.
    (12) Any sale of a security by a registered market maker or 
specialist publishing two-sided quotes to facilitate customer market or 
marketable limit buy orders.
    (d) No self-regulatory organization shall have any rule that is not 
in conformity with, or conflicts with this section.
    (e) The provisions of this section shall apply to short sale orders 
in a covered security at times when a last sale price for the covered 
security is calculated and disseminated on a current and continuing 
basis by a plan processor pursuant to an effective national market 
system plan.
    (f) Upon written application or upon its own motion, the Commission 
may grant an exemption from the provisions of this section, either 
unconditionally or on specified terms and conditions, to any person or 
class of persons, to any transaction or class of transactions, or to 
any security or class of securities to the extent that such exemption 
is necessary or appropriate, in the public interest, and is consistent 
with the protection of investors.

Alternative II--Circuit Breaker Rules

A. Circuit Breaker Halt Rule
    2. Section 242.200 is amended by revising paragraph (g) 
introductory text and adding paragraph (g)(2) to read as follows:


Sec.  242.200   Definition of ``short sale'' and marking requirements.

* * * * *
    (g) A broker or dealer must mark all sell orders of any equity 
security as ``long,'' ``short,'' or ``short exempt.''
    (1) * * *
    (2) A sale order shall be marked ``short exempt'' if the seller is 
relying on an exception from the prohibition against short selling of 
Sec.  242.201.
* * * * *
    3. Section 242.201 is revised to read as follows:


Sec.  242.201   Circuit breaker.

    (a) Definitions. For the purposes of this section:
    (1) The term covered security shall mean any NMS stock as defined 
in Sec.  242.600(b)(47).
    (2) The term regular trading hours shall have the same meaning as 
in Sec.  242.600(b)(64).
    (3) The term national market system plan shall have the same 
meaning as in Sec.  242.600(b)(43).
    (b) If the price of a covered security, as reported in the 
consolidated system, decreases by ten percent or more from that covered 
security's last price reported during regular trading hours the prior 
day, as reported in the consolidated system, no person shall, for his 
own account or for the account of any other person, effect a short sale 
of that covered security, wherever traded, at times when a last sale 
price for the covered security is calculated and disseminated on a 
current and continuing basis by a plan processor pursuant to an 
effective national market system plan, for the remainder of the day.
    (c) The provisions of paragraph (b) of this section shall not apply 
if the decrease in the price of a covered security occurs within thirty 
minutes from the end of regular trading hours.
    (d) The provisions of paragraph (b) of this section shall not apply 
to:
    (1) Any sale of a covered security by a registered market maker, 
block positioner, or other market maker obligated to quote in the over-
the-counter market, in each case that are selling short a covered 
security as part of bona fide market making in such covered security.
    (2) Any sale of a covered security by any person as a result of 
automatic exercise or assignment of an equity option, or in connection 
with a futures contract, that is held prior to the trigger event 
identified in paragraph (b) of this section due to expiration of the 
option or futures contract.
    (3) Any sale of a covered security by any person that is the writer 
of a call option if the sale is as a result of assignment following 
exercise by the holder of the call.
    (4) Any sale of a covered security by any person that is a market 
maker, including an over-the-counter market maker, if the sale is part 
of a bona fide market making and hedging activity related directly to 
bona fide market making in: (i) Derivative securities based on that 
covered security; or (ii) exchange traded funds and exchange traded 
notes of which that covered security is a component.
    (5) Any sale of a covered security by any person that is deemed to 
own the covered security pursuant to Sec.  242.200, provided that the 
person intends to deliver the security as soon as all restrictions on 
delivery have been removed.
    (e) No self-regulatory organization shall have any rule that is not 
in conformity with, or conflicts with, this section.
    (f) Upon written application or upon its own motion, the Commission 
may grant an exemption from the provisions of this section, either 
unconditionally or on specified terms and conditions, to any person or 
class of persons, to any transaction or class of transactions, or to

[[Page 18111]]

any security or class of securities to the extent that such exemption 
is necessary or appropriate, in the public interest, and is consistent 
with the protection of investors.
B. Circuit Breaker With Modified Uptick Rule
    2. Section 242.200 is amended by revising paragraph (g) 
introductory text and adding paragraph (g)(2) to read as follows:


Sec.  242.200   Definition of ``short sale'' and marking requirements.

* * * * *
    (g) A broker or dealer must mark all sell orders of any equity 
security as ``long,'' ``short,'' or ``short exempt.''
    (1) * * *
    (2) A sale order shall be marked ``short exempt'' only if the 
provisions of Sec.  242.201(d) or (e) are met.
* * * * *
    3. Section 242.201 is revised to read as follows:


Sec.  242.201   Circuit breaker.

    (a) Definitions. For the purposes of this section:
    (1) The term covered security shall mean any NMS stock as defined 
in Sec.  242.600(b)(47).
    (2) The term regular trading hours shall have the same meaning as 
in Sec.  242.600(b)(64).
    (3) The term down-bid price shall mean a price that is less than 
the current national best bid or, if the last differently priced 
national best bid was greater than the current national best bid, a 
price that is less than or equal to the current national best bid.
    (4) The term national best bid shall have the same meaning as in 
Sec.  242.600(b)(42).
    (5) The term national market system plan shall have the same 
meaning as in Sec.  242.600(b)(43).
    (6) The term odd lot shall have the same meaning as in Sec.  
242.600(b)(49).
    (7) The term riskless principal shall mean a transaction in which a 
broker or dealer, after having received an order to buy a security, 
purchases the security as principal at the same price to satisfy the 
order to buy or, after having received an order to sell, sells the 
security as principal at the same price to satisfy the order to sell.
    (8) The term trading center shall have the same meaning as in Sec.  
242.600(b)(78).
    (b) (1) A trading center shall establish, maintain, and enforce 
written policies and procedures reasonably designed to prevent, when 
the price of a covered security decreases by ten percent or more from 
that covered security's last price reported during regular trading 
hours the prior day, as reported in the consolidated system, the 
execution or display of a short sale order of that covered security at 
a down-bid price at times when a national best bid for the covered 
security is calculated and disseminated on a current and continuing 
basis by a plan processor pursuant to an effective national market 
system plan, for the remainder of the day. Provided, however,
    (i) The policies and procedures must be reasonably designed to 
permit the execution of a displayed short sale order of a covered 
security by a trading center if, at the time of display of the short 
sale order, the order was not at a down-bid price.
    (ii) The policies and procedures must be reasonably designed to 
permit the execution or display of a short sale order of a covered 
security marked ``short exempt'' without regard to whether the order is 
at a down-bid price.
    (2) A trading center shall regularly surveil to ascertain the 
effectiveness of the policies and procedures required by paragraph 
(b)(1) of this section and shall take prompt action to remedy 
deficiencies in such policies and procedures.
    (c) The provisions of paragraph (b) of this section shall not apply 
if the decrease in the price of a covered security occurs within thirty 
minutes from the end of regular trading hours.
    (d) A broker or dealer may mark a short sale order of a covered 
security ``short exempt'' if the broker or dealer that submits the 
order identifies that the order is not on a down-bid price at the time 
of submission of the order to the trading center. Provided, however,
    (1) The broker or dealer that identifies a short sale order of a 
covered security in accordance with this paragraph must establish, 
maintain, and enforce written policies and procedures reasonably 
designed to prevent incorrect identification of orders for purposes of 
this paragraph; and
    (2) The broker or dealer shall regularly surveil to ascertain the 
effectiveness of the policies and procedures required by paragraph (c) 
of this section and shall take prompt action to remedy deficiencies in 
such policies and procedures.
    (e) A broker or dealer may mark a short sale order of a covered 
security ``short exempt'' if the broker or dealer has a reasonable 
basis to believe:
    (1) The short sale order of a covered security is by a person that 
is deemed to own the covered security pursuant to Sec.  242.200, 
provided that the person intends to deliver the security as soon as all 
restrictions on delivery have been removed.
    (2) The short sale order of a covered security is by a market maker 
to off-set customer odd-lot orders or to liquidate an odd-lot position 
that changes such broker's or dealer's position by no more than a unit 
of trading.
    (3) The short sale order of a covered security is for a good faith 
account by a person who then owns another security by virtue of which 
he is, or presently will be, entitled to acquire an equivalent number 
of securities of the same class as the securities sold; provided such 
sale, or the purchase which such sale offsets, is effected for the bona 
fide purpose of profiting from a current difference between the price 
of the security sold and the security owned and that such right of 
acquisition was originally attached to or represented by another 
security or was issued to all the holders of any such securities of the 
issuer.
    (4) The short sale order of a covered security is for a good faith 
account submitted to profit from a current price difference between a 
security on a foreign securities market and a security on a securities 
market subject to the jurisdiction of the United States, provided that 
the short seller has an offer to buy on a foreign market that allows 
the seller to immediately cover the short sale at the time it was made. 
For the purposes of this section, a depository receipt of a security 
shall be deemed to be the same security as the security represented by 
such receipt.
    (5)(i) The short sale order of a covered security is by an 
underwriter or member of a syndicate or group participating in the 
distribution of a security in connection with an over-allotment of 
securities; or
    (ii) Any short sale order with respect to a lay-off sale by an 
underwriter or member of a syndicate or group in connection with a 
distribution of securities through a rights or standby underwriting 
commitment.
    (6) The short sale order of a covered security is by a broker or 
dealer effecting the execution of a customer purchase or the execution 
of a customer ``long'' sale on a riskless principal basis; provided, 
however, the purchase or sell order must be given the same per-share 
price at which the broker or dealer sold shares to satisfy the 
facilitated order, exclusive of any explicitly disclosed markup or 
markdown, commission equivalent or other fee. In addition, for purposes 
of this section, a broker or dealer must have written policies and 
procedures in place to assure that, at a minimum: The customer order 
was received prior to the offsetting transaction; the offsetting

[[Page 18112]]

transaction is allocated to a riskless principal or customer account 
within 60 seconds of execution; and the broker or dealer has 
supervisory systems in place to produce records that enable the broker 
or dealer to accurately and readily reconstruct, in a time-sequenced 
manner, all orders on which a broker or dealer relies pursuant to this 
exception.
    (7) The short sale order is for the sale of a covered security at 
the volume weighted average price (VWAP) that meets the following 
criteria:
    (i) The VWAP for the covered security is calculated by:
    (A) Calculating the values for every regular way trade reported in 
the consolidated system for the security during the regular trading 
session, by multiplying each such price by the total number of shares 
traded at that price;
    (B) Compiling an aggregate sum of all values; and
    (C) Dividing the aggregate sum by the total number of reported 
shares for that day in the security.
    (ii) The transactions are reported using a special VWAP trade 
modifier.
    (iii) No short sales used to calculate the VWAP are marked ``short 
exempt.''
    (iv) The VWAP matched security:
    (A) Qualifies as an ``actively-traded security''; or
    (B) The proposed short sale transaction is being conducted as part 
of a basket transaction of twenty or more securities in which the 
subject security does not comprise more than five percent of the value 
of the basket traded.
    (v) The transaction is not effected for the purpose of creating 
actual, or apparent, active trading in or otherwise affecting the price 
of any security.
    (vi) A broker or dealer shall be permitted to act as principal on 
the contra-side to fill customer short sale orders only if the broker's 
or dealer's position in the covered security, as committed by the 
broker or dealer during the pre-opening period of a trading day and 
aggregated across all of its customers who propose to sell short the 
same security on a VWAP basis, does not exceed 10% of the covered 
security's relevant average daily trading volume.
    (f) No self-regulatory organization shall have any rule that is not 
in conformity with, or conflicts with, this section.
    (g) Upon written application or upon its own motion, the Commission 
may grant an exemption from the provisions of this section, either 
unconditionally or on specified terms and conditions, to any person or 
class of persons, to any transaction or class of transactions, or to 
any security or class of securities to the extent that such exemption 
is necessary or appropriate, in the public interest, and is consistent 
with the protection of investors.
C. Circuit Breaker With Uptick Rule
    2. Section 242.200 is amended by revising paragraph (g) 
introductory text and adding paragraph (g)(2) to read as follows:


Sec.  242.200   Definition of ``short sale'' and marking requirements.

* * * * *
    (g) A broker or dealer must mark all sell orders of any equity 
security as ``long,'' ``short,'' or ``short exempt.''
    (1) * * *
    (2) A sale order shall be marked ``short exempt'' if the seller is 
relying on an exception from the price test of Sec.  242.201.
* * * * *
    3. Section 242.201 is revised to read as follows:


Sec.  242.201   Circuit breaker.

    (a) Definitions. For the purposes of this section:
    (1) The term covered security shall mean any NMS stock as defined 
in Sec.  242.600(b)(47).
    (2) The term regular trading hours shall have the same meaning as 
in Sec.  242.600(b)(64).
    (3) The term actively traded security shall have the same meaning 
as in Sec.  242.101(c)(1).
    (4) The term average daily trading volume shall have the same 
meaning as in Sec.  242.100(b).
    (5) The term national market system plan shall have the same 
meaning as in Sec.  242.600(b)(43).
    (6) The term odd lot shall have the same meaning as in Sec.  
242.600(b)(49).
    (7) The term riskless principal shall mean a transaction in which a 
broker or dealer, after having received an order to buy a security, 
purchases the security as principal at the same price to satisfy the 
order to buy or, after having received an order to sell, sells the 
security as principal at the same price to satisfy the order to sell.
    (b) If the price of a covered security, as reported in the 
consolidated system, decreases by ten percent or more from that covered 
security's last price reported during regular trading hours the prior 
day, as reported in the consolidated system, no person shall, for his 
own account or for the account of any other person, effect a short sale 
of that covered security, wherever traded, at times when a last sale 
price for the covered security is calculated and disseminated on a 
current and continuing basis by a plan processor pursuant to an 
effective national market system plan, for the remainder of the day, if 
trades in such security are reported pursuant to an effective national 
market system plan and information as to such trades is made available 
in accordance with such plan on a real-time basis to vendors of market 
transaction information:
    (1) Below the price at which the last sale thereof, regular way, 
was reported pursuant to an effective national market system plan; or
    (2) At such price unless such price is above the next preceding 
different price at which a sale of such security, regular way, was 
reported pursuant to an effective national market system plan.
    (c) The provisions of paragraph (b) of this section shall not apply 
if the decrease in the price of a covered security occurs within thirty 
minutes from the end of regular trading hours.
    (d) The provisions of paragraph (b) of this section shall not apply 
to:
    (1) Any sale by any person of a covered security that the person is 
deemed to own pursuant to Sec.  242.200, provided that the person 
intends to deliver the security as soon as all restrictions on delivery 
have been removed.
    (2) Any sale by a broker or dealer of a covered security for an 
account in which it has no interest, pursuant to an order marked long.
    (3) Any sale of a covered security by a market maker to off-set 
customer odd-lot orders or to liquidate an odd-lot position which 
changes such broker's or dealer's position by no more than a unit of 
trading.
    (4) Any sale of a covered security for a good faith account by a 
person who then owns another security by virtue of which he is, or 
presently will be, entitled to acquire an equivalent number of 
securities of the same class as the securities sold; provided such 
sale, or the purchase which such sale offsets, is effected for the bona 
fide purpose of profiting from a current difference between the price 
of the security sold and the security owned and that such right of 
acquisition was originally attached to or represented by another 
security or was issued to all the holders of any such securities of the 
issuer.
    (5) Any sale of a covered security for a good faith account 
submitted to profit from a current price difference between a security 
on a foreign securities market and a security on a securities market 
subject to the jurisdiction of the United States, provided that the 
short seller has an offer to buy on a foreign market that allows the 
seller to immediately cover the short sale at the time it was made. For 
the purposes of this section, a

[[Page 18113]]

depository receipt of a security shall be deemed to be the same 
security as the security represented by such receipt.
    (6)(i) Any sale of a covered security by an underwriter or member 
of a syndicate or group participating in the distribution of a security 
in connection with an over-allotment of securities; or
    (ii) Any lay-off sale by an underwriter or member of a syndicate or 
group in connection with a distribution of securities through a rights 
or standby underwriting commitment.
    (7) Any sale of a covered security at the volume weighted average 
price (VWAP) that meets the following criteria:
    (i) The VWAP for the covered security is calculated by:
    (A) Calculating the values for every regular way trade reported in 
the consolidated system for the security during the regular trading 
session, by multiplying each such price by the total number of shares 
traded at that price;
    (B) Compiling an aggregate sum of all values; and
    (C) Dividing the aggregate sum by the total number of reported 
shares for that day in the security.
    (ii) The transactions are reported using a special VWAP trade 
modifier.
    (iii) No short sales used to calculate the VWAP are marked ``short 
exempt.''
    (iv) The VWAP matched security:
    (A) Qualifies as an ``actively-traded security''; or
    (B) The proposed short sale transaction is being conducted as part 
of a basket transaction of twenty or more securities in which the 
subject security does not comprise more than five percent of the value 
of the basket traded.
    (v) The transaction is not effected for the purpose of creating 
actual, or apparent, active trading in or otherwise affecting the price 
of any security.
    (vi) A broker or dealer shall be permitted to act as principal on 
the contra-side to fill customer short sale orders only if the broker's 
or dealer's position in the covered security, as committed by the 
broker or dealer during the pre-opening period of a trading day and 
aggregated across all of its customers who propose to sell short the 
same security on a VWAP basis, does not exceed 10% of the covered 
security's relevant average daily trading volume.
    (8) Any sale of a covered security in an electronic trading system 
that matches buying and selling interest at various times throughout 
the day that meets the following criteria:
    (i) Matches occur at an externally derived price within the 
existing market and above the current national best bid;
    (ii) Sellers and purchasers are not assured of receiving a matching 
order;
    (iii) Sellers and purchasers do not know when a match will occur;
    (iv) Persons relying on the exception contained in paragraph (c)(8) 
of this section shall not be represented in the primary market offer or 
otherwise influence the primary market bid or offer at the time of the 
transaction;
    (v) Transactions shall not be made for the purpose of creating 
actual, or apparent, active trading in, or depressing or otherwise 
manipulating the price of, any security;
    (vi) The covered security:
    (A) Qualifies as an ``actively-traded security''; or
    (B) The proposed short sale transaction is being conducted as part 
of a basket transaction of twenty or more securities in which the 
subject security does not comprise more than five percent of the value 
of the basket traded; and
    (vii) During the period of time in which the electronic trading 
system may match buying and selling interest, there can be no 
solicitation of customer orders, or any communication with customers 
that the match has not yet occurred.
    (9) Any sale of a covered security by a broker or dealer effecting 
the execution of a customer purchase or the execution of a customer 
``long'' sale on a riskless principal basis; provided, however, the 
purchase or sell order must be given the same per-share price at which 
the broker or dealer sold shares to satisfy the facilitated order, 
exclusive of any explicitly disclosed markup or markdown, commission 
equivalent or other fee. In addition, for purposes of this section, a 
broker or dealer must have written policies and procedures in place to 
assure that, at a minimum: the customer order was received prior to the 
offsetting transaction; the offsetting transaction is allocated to a 
riskless principal or customer account within 60 seconds of execution; 
and the broker or dealer has supervisory systems in place to produce 
records that enable the broker or dealer to accurately and readily 
reconstruct, in a time-sequenced manner, all orders on which a broker 
or dealer relies pursuant to this exception.
    (10) Any sale of a covered security (except a sale to a stabilizing 
bid complying with Sec.  242.104) by a registered specialist or 
registered exchange market maker for its own account on any exchange 
with which it is registered for such security, or by a third market 
maker for its own account over-the-counter:
    (i) Effected at a price equal to the most recent offer communicated 
for the security by such registered specialist, registered exchange 
market maker or third market maker to an exchange or a national 
securities association (``association'') pursuant to Sec.  242.602, if 
such offer, when communicated, was equal to or above the last sale, 
regular way, reported for such security pursuant to an effective 
national market system plan. Provided, however,
    (ii) That any self-regulatory organization, by rule, may prohibit 
its registered specialist and registered exchange market makers from 
availing themselves of the exemption afforded by this paragraph (d)(10) 
if that self-regulatory organization determines that such action is 
necessary or appropriate in its market in the public interest or for 
the protection of investors.
    (11) Any sale of a covered security (except a sale to a stabilizing 
bid complying with Sec.  242.104) by any broker or dealer, for his own 
account or for the account of any other person, effected at a price 
equal to the most recent offer communicated by such broker or dealer to 
an exchange or association pursuant to Sec.  242.602 in an amount less 
than or equal to the quotation size associated with such offer, if such 
offer, when communicated, was:
    (i) Above the price at which the last sale, regular way, for such 
security was reported pursuant to an effective national market system 
plan; or
    (ii) At such last sale price, if such last sale price is above the 
next preceding different price at which a sale of such security, 
regular way, was reported pursuant to an effective national market 
system plan.
    (12) Any sale of a security by a registered market maker or 
specialist publishing two-sided quotes to facilitate customer market or 
marketable limit buy orders.
    (e) No self-regulatory organization shall have any rule that is not 
in conformity with, or conflicts with this section.
    (f) Upon written application or upon its own motion, the Commission 
may grant an exemption from the provisions of this section, either 
unconditionally or on specified terms and conditions, to any person or 
class of persons, to any transaction or class of transactions, or to 
any security or class of securities to the extent that such exemption 
is necessary or appropriate, in the public interest, and is consistent 
with the protection of investors.

    By the Commission.

    Dated: April 10, 2009.
Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-8730 Filed 4-17-09; 8:45 am]
