SEC Rule 204: Amendments to Regulation SHO

By William James, Senior Securities Editor

Measures adopted in 2005 under Regulation SHO regarding the potential for abusive "naked" short selling are now permanent. SEC Rule 204T is now SEC Rule 204.

This permanent rule prohibits broker/dealers from effecting short sales of equity securities without first borrowing the securities.

Public customers may attempt to effect a "naked" short sale, i.e. not having borrowed the security in order to avoid the sometimes high cost associated with selling short or possibly to manipulate the price of a security. By contrast, their executing broker/dealer must borrow the security (or have reasonable grounds to believe that the security can be borrowed) on the customer's behalf in order to deliver the security within the standard three-day settlement period. This cuts down significantly on the number of "fails to deliver".  All buyers have the right to expect prompt delivery of their securities. 

Furthermore the executing BD must document the "good borrow" usually by obtaining a locate ID number from the clearing firm and entering it on the order ticket. This has to be done prior to effecting the short sale. Under Regulation SHO this is known as the locate requirement.

The above requirements are NOT applicable to market makers and on security futures transactions.