00-7843. Self Regulatory Organizations; National Association of Securities Dealers, Inc.; Order Approving Proposed Rule Change Relating to Use of Hard To Borrow Lists

March 23, 2000.

I. Introduction

On August 4, 1999, the National Association of Securities Dealers, Inc. (“NASD” or “Association”), through its wholly owned subsidiary, NASD Regulation, Inc. (“NASD Regulation”), filed with the Securities and Exchange Commission (“Commission” or “SEC”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”) ^[1] and Rule 19b-4 thereunder,^[2] a proposed rule change to amend NASD Rule 3370. The proposal permits the use of a “Hard to Borrow” list to comply with affirmative determination requirements for short sales. The NASD submitted Amendment No. 1 to the proposed rule change on November 1, 1999.^[3] Notice of the proposed rule change, as amended, was published in the Federal Register on January 7, 2000.^[4] The Commission received no comments on the proposal.^[5] This order approves the proposed rule change.

II. Description of the Proposal

NASD Rule 3370 was designed to prevent abusive short selling and ensure that short sellers satisfy their settlement obligations. The rule currently requires a member or associated person to make an affirmative determination prior to executing certain short sales that it will receive delivery of the subject security, or be able to borrow or otherwise provide delivery of the security, by settlement date. The rule also provides that the member or associated person must record the identity of both the individual and the firm contacted who offered assurances that the subject security would be delivered by settlement date or be available for borrowing by settlement date. The rule does not specify the manner in which compliance with its requirements must be recorded.

NASD Rule 3370 currently permits members and associated persons to rely on “blanket” or standing assurances that securities will be available for borrowing on settlement date to satisfy their affirmative determination obligations, provided that the information used to generate the “blanket” or standing assurance is less than 24 hours old and the member delivers the security on settlement date.^[6] “Blanket” assurances are commonly referred to as “Easy to Borrow” lists. The rule further provides that if a member relying on a blanket or standing assurance fails to deliver the security on settlement date, the NASD will deem such conduct inconsistent with the terms of the rule, absent mitigating circumstances adequately documented by the member.

A “Hard to Borrow” list is a list that includes all securities of a given category that are difficult to borrow or unavailable for borrowing. A user of such list may believe it reasonable to infer, under appropriate circumstances, that a specific security absent from the list is easy to borrow. Currently, however, NASD Rule 3370 does not specifically allow a member to rely on a “Hard to Borrow” list in this way.

The proposed rule change will permit members and associated persons to rely on a “Hard to Borrow” list for any short sales executed in The Nasdaq Stock Market (“Nasdaq”) National Market (“NM”) or exchange-listed securities, provided that (a) the creator of the list attests in writing that any Nasdaq NM or exchange-listed securities not included on the list are easy to borrow or are available for borrowing, and (b) any securities restricted pursuant to Uniform Practice Code (“UPC”) 11830 are included on the list.

Securities restricted pursuant to UPC 11830 are Nasdaq securities that, as published by the NASD, show an aggregate clearing short position of 10,000 shares or more and that are equal to at least 0.5% of the total shares outstanding of the issue. The NASD represents that in practice, securities falling into this category are difficult to borrow. By explicit terms of the proposal, a “Hard to Borrow” list must include all such securities in order to qualify for use.

Under the proposed rule change, the member will be able to refer to the “Hard to Borrow” list before executing a short sale in a given security. If that security is not on the list, the member or associated person will be considered to have made the requisite affirmative determination and will be permitted to execute the short sale without taking any further steps to satisfy the affirmative determination rule. Conversely, if the security is on the list, then a member or associated person will not be permitted to execute the short sale without taking additional steps to ensure the security's availability.

As with the current rule's provisions with respect to “Easy to Borrow” lists, a member or associated person will be permitted to use a “Hard to Borrow” list under the proposal only if the information used to generate the list is less than 24 hours old and the member delivers the security on settlement date. The proposal provides that if the member does not deliver the security on settlement date, the NASD shall consider such conduct—absent documented mitigating circumstances—inconsistent with the terms of NASD Rule 3370.

The proposed rule change will permit the use of “Hard to Borrow” lists only for Nasdaq NM and exchange-listed securities. For Nasdaq SmallCap and other over-the-counter equity securities not in this category, members will continue to be required to take active steps to determine stock availability. According to NASD Regulation, Nasdaq NM and exchange-listed securities are liquid and highly capitalized, and are less likely to be subject to shore sale abuses than Nasdaq SmallCap and other over-the-counter equity securities, which generally are more thinly traded and illiquid and potentially more vulnerable to short sale abuses.

III. Discussion

After careful review, the Commission finds that the proposed rule change is consistent with the Act and the rules and regulations thereunder, and, in particular, with the requirements of Section 15A ^[7] of the Act applicable to a registered securities association.^[8] Specifically, the Commission finds that approval of the proposed rule change is consistent with Section 15A(b)(6) ^[9] of the Act, which requires, among other things, that the Association's rules be designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, and, in general, to protect investors and the public interest.

The Commission believes that the proposal is likely to reduce the time and effort required for a member or associated person to make the requisite determination that a security is available for borrowing. This is because a person using a “Hard to Borrow” list needs to check the security against what is usually a relatively short roster of unavailable issues rather than locate it in a long “Easy to Borrow” list that may include thousands of names.

Thus the Commission finds that the proposed rule change will promote the objectives of Section 15A(b)(6) by reducing the administrative burdens on members in complying with the affirmative determination rule, thereby expediting the execution of short sales on behalf of investors and possibly affording them better executions.

At the same time, the Commission believes that NASD Rule 3370 as amended under the proposal will continue to assure that short sales are effected only when the securities being sold are in fact readily available for borrowing, and will continue to protect against conduct inconsistent with the purposes of the rule.

When the creator of a “Hard to Borrow” list attests in writing, as the proposal requires, that any securities not included on the list are available for borrowing or are easy to borrow, reliance on such “Hard to Borrow” list is substantially similar to reliance on an “Easy to Borrow” list, which is already permitted under NASD Rule 3370.^[10] The proposed rule change further stipulates that in order to qualify for use, a “Hard to Borrow” list must include any Nasdaq security that has a clearing short position large enough to warrant the special requirements of UPC 11830.^[11]

As in the case of reliance on an “Easy to Borrow” list, a member or associated person will be permitted to rely upon a “Hard to Borrow” list only when the information on the list is no more than 24 hours old. Likewise, the member or associated person will be obligated to maintain a written record of the determination that the security was available for borrowing, including the identity of the individual and firm that offered the assurance that securities absent from the list were available for borrowing or easy to borrow.

Moreover, NASD Rule 3370, as amended, will put members on notice that even if they have relied on the information provided by a “Hard to Borrow” list, if they in fact fail to deliver the security by settlement date, they will be deemed to have acted in a manner inconsistent with the rule.

IV. Conclusion

For the above reasons, the Commission finds that the proposed rule change is consistent with the provisions of the Act, and in particular with Section 15A(b)(6).

It is Therefore Ordered, pursuant to Section 19(b)(2) ^[12] of the Act, that the proposed rule change (SR-NASD-99-37) is hereby approved.

For the Commission, by the Division of Market Regulation, pursuant to delegated authority. ^[13]

Margaret H. McFarland,

Deputy Secretary.

Footnotes

1.  15 U.S.C. 78s(b)(1).

2.  17 CFR 240.19b-4.

3.  See Letter from Alden Adkins, Senior Vice President and General Counsel, NASD Regulation, to Katherine England, Assistant Director, Division of Market Regulation, Commission, dated October 26, 1999.

4.  See Securities Exchange Act Release No. 42306 (January 3, 2000), 64 FR 49261 (“Notice”).

5.  Per the Commission's request, NASD submitted an additional, technical amendment to the proposed rule change deleting a sentence from the descriptive portion of the Notice. The sentence stated that member firms that rely on “Hard to Borrow” lists would be required under the proposed rule change to maintain such lists. This requirement is not stated in the actual text of the proposed rule change, which was published as part of the Notice. See Letter from Mary N. Revell, Associate General Counsel, NASD Regulation, to Katherine England, Assistant Director, Division of Market Regulation, Commission, dated March 14, 2000.

6.  See Securities Exchange Act Release No. 36859 (February 20, 1996), 61 FR 7127 (February 26, 1996) (File No. SR-NASD-95-62), approving reliance on “blanket” assurances.

7.  15 U.S.C. 78 o-3

8.  In approving this proposal, the Commission has considered the proposed rule's impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f)

9.  15 U.S.C. 78 o-3(b)(6).

10.  According to NASD Regulation, it will be the responsibility of the member or associated person using the list to determine that the creator of the list is reliable. As noted below, if the security is not delivered by settlement date, the member or associated person will be deemed to have acted in a manner inconsistent with the terms of the rule, absent mitigating circumstances. In addition, NASD Regulation may investigate whether the creator of the list, if a member, has acted in a manner inconsistent with NASD Rule 2110 regarding standards of commercial honor and principles of trade. Telephone conversation between Thomas R. Gira, Vice President, Market Regulation, Mary N. Revell, Associate General Counsel, NASD Regulation, et al., and Gordon Fuller, Special Counsel, and Ira Brandriss, Attorney, Division of Market Regulation, Commission (February 18, 2000).

11.  The Commission notes that because UPC 11830 applies only to Nasdaq securities, this extra measure of protection is provided only for Nasdaq securities.

12.  15 U.S.C. 78s(b)(2).

13.  17 CFR 200.30-3(a)(12).