E4-3899. Self-Regulatory Organizations; Notice of Filing and Immediate Effectiveness of Proposed Rule and Amendment No. 1 Thereto by the New York Stock Exchange, Inc. To Amend Exchange Rules 440B (“Short Sales) and 440C (“Deliveries Against Short ...

December 23, 2004.

Pursuant to Section 19(b)(1) ^[1] of the Securities Exchange Act of 1934 (“SEA” or the “Exchange Act”),^[2] and Rule 19b-4 thereunder,^[3] notice is hereby given that on December 1, 2004, the New York Stock Exchange, Inc. (“NYSE” or the “Exchange”) filed with the Securities and Exchange Commission (the “Commission” or “SEC”) the proposed rule change as described in Items I, II, and III below, which Items have been prepared by the Exchange. On December 23, 2004, NYSE filed Amendment No. 1 to the proposed rule change.^[4] The proposed rule change, as amended, was filed by NYSE as a non-controversial filing, under Rule 19b-4(f)(6) of the Act.^[5] The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons.

I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change

The New York Stock Exchange, Inc. (“NYSE” or the “Exchange”) is filing with the Securities and Exchange Commission (“SEC” or “Commission”) proposed amendments to Rule 440B (“Short Sales”) and 440C (“Delivery Against Short Sales”), including Supplementary Material to conform Exchange rules to the requirements of recent Commission rule amendments regarding short sales, and adoption of Regulation SHO—Regulation of Short Sales (“Regulation SHO”).^[6] The text of the proposed amendments is available from the NYSE and the Commission.^[7] New language is italicized; deletions are in brackets.

A. Self-Regulatory Organization's Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Changes

In its filing with the Commission, the Exchange included statements concerning the purpose of, and basis for, the proposed rule change and discussed any comments it received on the proposed rule change. The text of these statements may be examined at the places specified in Item IV below. The Exchange has prepared summaries, set forth in Sections A, B, and C below, of the most significant aspects of such statements.

(1) Purpose

Background. On June 23, 2004, the SEC adopted new Regulation SHO, under the Exchange Act.^[8] Regulation SHO, which together with other concurrent Commission actions, provide for significant changes to SEC short sale ^[9] rules that are referenced in, and apply to members and member organizations through, Exchange Rules 440B (“Short Sales”) and 440C (“Deliveries Against Short Sales”).^[10] These SEC amendments rescind Rules 3b-3 (“Definition of Short Sale”) ^[11] and 10a-2 (“Requirements for Covering Purchases”),^[12] under the Exchange Act, and replace them with new Rules 200 (“Definition of Short Sale and Marking Requirements”) ^[13] and 203 (“Borrowing and Delivery Requirements”),^[14] to Regulation SHO. In addition, the Commission has amended Rule 10a-1 ^[15] (“Short Sales”) to conform to Regulation SHO.

New SEA Rule 202T. Regulation SHO includes new Rule 202T,^[16] which provides procedures for the SEC to temporarily suspend the application of the tick test and any short sale price test of any exchange or national securities association for designated securities.^[17] Concurrently with the adoption of Regulation SHO, the SEC issued a Pilot Order ^[18] suspending the provisions of the tick test and any self-regulatory organization (“SRO”) price test for short sales in: (1) Certain “designated securities” (identified in Appendix A of the Pilot Order); (2) any security included in the Russell 1000 index effected between 4:15 p.m. EST and the open of the consolidated tape on the following day; and (3) any other security effected between the close of the consolidated tape (i.e., 8 p.m. EST) and the open of the tape on the following day. During the Pilot, all other provisions of Rule 10a-1 and Regulation SHO—including the marking, locate and delivery requirements—remain in effect.

The Exchange proposes to amend Rule 440B by adding new paragraph (c), which suspends the requirements of the price test for the period that the Pilot remains in effect.

New SEA Rule 200. Rule 200 ^[19] to Regulation SHO replaces Rule 3b-3,^[20] which had defined ownership of securities for purposes of short sales. Rule 200 incorporates the substance of Rule 3b-3, with some modifications, and provides guidance to broker-dealers to calculate net positions within defined aggregation units rather than on a firm-wide basis. Rule 200 also requires broker-dealers to mark sales in all equity securities “long,” “short,” or “short exempt.” In this regard, an order can be marked “long” only when the seller owns the security being sold and the security is in the physical possession or control of the broker-dealer, or it is reasonably expected that the security will be in the physical possession or control of the broker-dealer prior to settlement. An order can be marked “short exempt” if the seller is entitled to rely on any exception from the tick test, under Rule 10a-1, or any SRO rule (e.g., Rule 440B). As a general matter, orders marked “short exempt” still need to comply with the locate requirement. Short sales of securities in the Pilot should be marked “short exempt.”

The Exchange is proposing to amend the Supplementary Material to Exchange Rule 440B to incorporate the marking requirements and ownership aspects of Regulation SHO, Rule 200, to paragraphs 440B.13 (“Marking of Orders”), 440B.14 (“Ownership of Securities”) and 440B.20 (“Short Exempt Sell Orders”).

New SEA Rule 203. Rule 203 ^[21] provides various safeguards against “naked” short selling by consolidating and expanding stock “locate requirements,” and imposing new delivery requirements for securities in which a substantial number of fails have occurred (“threshold securities” ^[22] ). In this regard, Rule 203 requires broker-dealers, prior to effecting short sales in all equity securities, to locate securities available for borrowing. Specifically, Rule 203(b) ^[23] prohibits a broker-dealer from accepting a short sale in any equity security from another person, or effecting a short sale for the broker-dealer's own account, unless the broker-dealer has: (1) Borrowed the security, or entered into an arrangement to borrow the security; or (2) has “reasonable grounds” to the believe that the security can be borrowed so that it can be delivered on the delivery date; and (3) has documented compliance with the rule.

The Commission has set forth two ways to show a broker-dealer has “reasonable grounds” to believe the security can be borrowed: (1) Reliance on an “easy to borrow” list, provided the information used to generate the list is less than 24 hours old, and securities on the list are so readily available that fails to deliver are unlikely (reliance on the fact that a security is not on a “hard to borrow” list is not sufficient); ^[24] and (2) reliance on a customer's assurance that a “locate” was received from another source (e.g., a prime broker), provided the broker-dealer documents the customer's source, and prior assurances from such customer resulted in timely deliveries in settlement of the customer's transactions.

The SEC also identified a number of exceptions to this locate requirement, including exceptions for transactions in security futures, and for broker-dealers that have accepted a short sale order from another registered broker-dealer required to comply with Rule 203(b), unless the broker-dealer contractually undertook responsibility for compliance. Rule 203(a) ^[25] replaces current Rule 10a-2 ^[26] and incorporates its substantive requirements and extends them to all equity securities, as opposed to only exchange-listed securities. With certain exceptions, Rule 203(a) prohibits a broker-dealer from failing to deliver, or lending securities to prevent a fail to deliver, on a sale that it knows, or has reasonable grounds to believe, is marked “long.”

To conform with Regulation SHO, the Exchange is proposing to change the title of Rule 440C to “Short Sale Borrowing and Delivery Requirements,” delete paragraph .10 (“Failure to Deliver”), and incorporate by reference Rule 10a-1 and Regulation SHO, as if they were fully set forth therein. The Exchange expects additional interpretations to be added to the rule at a later date, after experience with the operation of Regulation SHO.

New SEA Rule 203(b). Rule 203(b) of Regulation SHO requires clearing brokers to close-out any fail to deliver position in a threshold security that has remained open for 13 consecutive settlement days, by purchasing securities of like kind and quantity. A list of threshold securities will be disseminated daily by the Exchange prior to the opening bell.^[27] In addition, certain restrictions are triggered if the clearing broker does not take action to close-out the open fail to deliver position.

The Exchange is proposing to amend paragraph .17 (“Covering Transactions”) to Rule 440B to delete aspects of the rule that do not conform with Regulation SHO, and to reference Rule 203(b)(3) to determine how to handle covering transactions.

Proposed Amendments to Exchange Rules. Currently, Exchange Rule 440B includes the complete text of Rule 10a-1, under the Exchange Act, and Rules 440B and 440C set forth many sections of repealed Rules 3b-3 and 10a-2, under the Exchange Act, respectively. The proposed amendments to Rules 440B and 440C, including Supplementary Material, conform to the changes in Rule 10a-1 and recently adopted Regulation SHO, under the Exchange Act. The changes remove the text of SEA Rule 10a-1 from Exchange Rule 440B, and instead incorporate both SEA Rule 10a-1 and Regulation SHO by reference, as though they were fully set forth therein.

The amendments to Exchange Rule 440B conform to Regulation SHO and also include a revised Explanatory Note, which generally describes the recent changes to short sale regulation and implementation dates. The Exchange proposes to amend the Supplementary Material to Rule 440B to delete references to repealed rules and incorporate amendments to conform to and reference amended Rule 10a-1 and Regulation SHO. In addition, the Exchange proposes to amend .10 (“General Rule”), .12 (“Place of Transaction”) and .15 (“Price At Which Short Sales May Be Made”) to make clear, consistent with the Adopting Release of Regulation SHO, that the Exchange short sale regulations apply to all trades in listed securities: (a) whenever they occur, including the after-hours market, and (b) which have been agreed to in the US, regardless of where the transaction is executed or “booked.”

(2) Statutory Basis

The statutory basis for the proposed rule change is Sections 6(b)(5) and 17A of the Exchange Act ^[28] which require, among other things, that the rules of the Exchange are designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in regulating, clearing, settling, processing information with respect to, and facilitating transactions in securities, to remove impediments to perfect the mechanism of a free and open market and national market system, and in general to protect investors and the public interest; and the prompt and accurate clearance and settlement of securities transactions.

B. Self-Regulatory Organization's Statement on Burden on Competition

The Exchange does not believe that the proposed rule change will impose any burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed Rule Change Received From Members, Participants or Others

The Exchange has neither solicited nor received written comments on the proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action

The proposed rule change is filed pursuant to paragraph (A) of Section 19(b)(3) ^[29] and Rule 19b-4(f)(6).^[30] Because the foregoing proposed rule change does not: (i) Significantly affect the protection of investors or the public interest; (ii) impose any significant burden on competition; and (iii) become operative for 30 days from the date on which it was filed, or such shorter time as the Commission may designate, it has become effective pursuant to Section 19(b)(3)(A) of the Exchange Act and Rule 19b-4(f)(6) thereunder.

At any time within 60 days of the filing of the proposed rule change, the Commission may summarily abrogate such rule change if it appears to the Commission that such action is necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Exchange Act.^[31]

The Exchange requests the Commission waive the five-day notification period and the 30-day pre-operative delay specified in Rule 19b-4(f)(6)(iii).^[32] Waiver of these periods will allow the Exchange to have the proposed rule change in place at the same time as the Commission's compliance date for Regulation SHO. The Exchange expects to make the proposed rule change operative on January 3, 2005.

The Commission believes that waiving both the 5-day notification period and the 30-day pre-operative delay requirements is consistent with the protection of investors and the public interest. The Commission believes that waiving these requirements does not raise any new regulatory issues, significantly affect the protection of investors or the public interest, or impose any significant burden on competition. Additionally, The Commission notes that the operative date of this proposed rule change, January 3, 2004, is the same date as the compliance date of Regulation SHO.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change, as amended, is consistent with the Exchange Act.

Electronic Comments

• Use the Commission's Internet comment form (http://www.sec.gov/​rules/​sro.shtml); or
• Send e-mail to [e-mail]. Please include File Number SR-NYSE-2004-68 on the subject line.

Paper Comments

• Send paper comments in triplicate to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-0609.

All submissions should refer to File Number SR-NYSE-2004-68. This file number should be included on the subject line if e-mail is used. To help the Commission 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/​sro/​shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission's Public Reference Room. Copies of such filing also will be available for inspection and copying at the principal office of the NYSE. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR-NYSE-2004-68 and should be submitted on or before January 20, 2005.

For the Commission, by the Division of Market Regulation, pursuant to delegated authority.^[33]

Margaret H. McFarland,

Deputy Secretary.

Footnotes

1.  15 U.S.C. 78s(b)(1).

2.  15 U.S.C. 78a et seq.

3.  17 CFR 240.19b-4.

4.  See letter from Mary Yeager, Assistant Corporate Secretary, NYSE, to Nancy Sanow, Assistant Director, Division of Market Regulation, Commission, dated December 23, 2004 (“Amendment No. 1”).

5.  17 CFR 240.19b-4(f)(6). For purposes of determining the effective date and calculating the sixty-day period within which the Commission may summarily abrogate the proposed rule change under Section 19(b)(3)(C) of the Act, the Commission considers that period to commence on December 22, 2004, the date NYSE filed Amendment No. 1. See 15 U.S.C. 78s(b)(3)(C).

6.  See Securities Exchange Act Release No. 50103 (July 28, 2004), 69 FR 48008 (August 6, 2004) (“Adopting Release”), available at http://www.sec.gov/​rules/​final/​34-50103.htm.

7.  Both Exhibits A and B are available at http://www.nyse.com/​regulation/​ and http://www.sec.gov/​rules/​sro.shtml.

8.  U.S.C. 78a et seq.

9.  A short sale is the sale of a security that the seller does not own or any sale that is consummated by the delivery of a security borrowed by, or for the account of, the seller. In order to deliver the security to the purchaser, the short seller will borrow the security, typically from a broker-dealer or an institutional investor. The short seller later closes out the position by purchasing equivalent securities on the open market, or by using an equivalent security it already owned, 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 a long position in the same, or related, security.

10.  The “tick test” of Rule 440B, which limits short sales only to an advancing market, and delivery requirements of Rule 440C, which requires short sellers to “locate” the stock to deliver prior to making a trade, are designed to prevent abusive short selling activities, including “short squeezes” and “naked” short selling. Regulation SHO also seeks to reduce the number of “fails to deliver” in the Continuous Net Settlement (“CNS”) system.

11.  17 CFR 240.3b-3.

12.  17 CFR 240.10a-2.

13.  17 CFR 242.200.

14.  17 CFR 242.203.

15.  17 CFR 240.10a-1.

16.  17 CFR 242.202T.

17.  The SEC deferred consideration of their proposal to replace the current “tick test” with a new uniform bid test restricting short sales to a price above the consolidated best bid, and also deferred consideration of the proposed exceptions to the uniform bid test. The SEC will reconsider any further action on these proposals after the completion of the Pilot.

18.  See Securities Exchange Act Release No. 50104 (July 28, 2004), 69 FR 48032 (August 6, 2004) (“Pilot Order”), available at http://www.sec.gov/​rules/​other/​34-50104.htm. See also Securities Exchange Act Release No. 50747 (November 29, 2004)(Order Delaying Pilot Period for Suspension of the Operation of the Operation of Short Sale Price Provisions) (“Second Pilot Order”), available at http://www.sec.gov/​rules/​other/​34-50747.htm.

19.  17 CFR 242.200.

20.  17 CFR 240.3b-3.

21.  17 CFR 242.203.

22.  Regulation SHO defines “threshold securities” as equity securities of reporting issuers, where: for five consecutive days the security has aggregate fails to deliver at a registered clearing agency of 10,000 shares or more; this figure is equal to at least 0.5% of the issue's total shares outstanding; and a list of such threshold securities is calculated and disseminated daily by the SRO on which the security is listed or for which the SRO bears primary surveillance responsibility. The SEC has estimated that approximately 4% of all equity securities would meet this threshold.

23.  17 CFR 242.203(b).

24.  In the Adopting Release, the SEC noted that “threshold securities” generally should not be included on “easy to borrow” lists. While the Commission has stated that easy to borrow lists could satisfy the “reasonable grounds” determination in Rule 203, it has also clearly stated that reliance on the fact that a security is not on a “hard to borrow” list cannot satisfy the “reasonable grounds test.

25.  25 17 CFR 242.203(a).

26.  17 CFR 240.10a-2.

27.  As the exact means of conveying the list of threshold securities has not yet been determined, members and member organizations will be informed by a later Information Memo of the exact time, location and form of dissemination of the list prior to the launch of the Pilot.

28.  15 U.S.C. 78f(b)(5) and 15 U.S.C. 78q-1, respectively.

29.  15 U.S.C. 78s(b)(3)(A).

30.  17 CFR 240.19b-4(f)(6).

31.  For purposes of determining the effective date and calculating the sixty-day period within which the Commission may summarily abrogate the proposed rule change under Section 19(b)(3)(C) of the Exchange Act, the Commission considers that period to commence on December 23, 2004, the date NYSE filed Amendment No. 1. See 15 U.S.C. 78s(b)(3)(C).

32.  17 CFR 240.19b-4(f)(6)(iii).

33.  17 CFR 200.30-3(a)(12).