The SEC issued an emergency order on July 15, 2008 (modified
July 18, 2008) designed to limit "naked" short selling in
the publicly traded securities of Fannie Mae, Freddie Mac and 17
other primary dealers that are part of commercial and investment
banks (see list below). The order requires a person to borrow or
arrange to borrow, or otherwise have the security available to
borrow from its inventory, prior to executing a short sale in the
relevant securities. This requirement is much more stringent than
Regulation SHO, which only requires a person to locate shares prior
to executing a short sale. Through discussion with industry groups,
the SEC is expected to agree to some limited exemptions to this
requirement which are discussed in more detail below.
The order does not apply to short sales effected pursuant to
Rule 144 of the Securities Act of 1933. It does not apply to short
sales by underwriters, members of a syndicate or group
participating in distributions of the relevant securities in
connection with an over-allotment of securities, or any lay-off
sale through a rights or a standby underwriting commitment.
The order takes effect at 12:01 a.m. Eastern Time on Monday,
July 21, 2008, and terminates at 11:59 p.m. Eastern Time on
Tuesday, July 29, 2008, unless it is extended further by the SEC.
The SEC can (and likely will) extend the order up to a total of 30
The order presents compliance implications for both sell-side
and buy-side firms. Industry groups and the SEC are still in
discussions with respect to certain aspects of the order, which may
result in modification of the order.
The following information is based on verbal discussions between
the SEC staff and the industry. Of course, the statements from the
SEC staff are not necessarily the views of the Commission.
Broker-dealers and their customers will be required to
pre-borrow or have arranged for a pre-borrow, rather than locate
the securities on the attached list. We understand that these
securities will not be on broker-dealers' "easy to
Market makers, option market makers, ETF market makers,
specialists and block positioners who are registered as such will
be exempt from the borrow requirement, but will be expected to
deliver securities by settlement date.
Brokers will expect buy-side customers to indicate,
electronically or otherwise, the source of the borrow. Brokers who
have no reason to doubt such a representation will be able to rely
on it. However, the SEC expects all deliveries in these securities
to occur by settlement date. Failure to deliver would likely make
any further reliance on such representations unreasonable.
Executing brokers will likely be able to rely on the order entry
or originating broker to comply with the borrow requirements.
Similarly, clearing brokers will be able to rely on executing
brokers to comply with the borrow requirements. We recommend that
these arrangements be documented in some fashion.
Arrangements to borrow securities include
"Pay-to-Hold" arrangements or similar arrangements. In
addition, a firm's inventory is deemed to include the pending
settlement of positions.
Following are the securities identified in the Commission's
BNPQF or BNPQY
Bank of America Corporation
Credit Suisse Group
Daiwa Securities Group Inc.
Deutsche Bank Group AG
Goldman, Sachs Group Inc.
Royal Bank ADS
HSBC Holdings PLC ADS
JPMorgan Chase & Co.
Lehman Brothers Holdings Inc.
Merrill Lynch & Co., Inc.
Mizuho Financial Group, Inc.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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