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86-59 Request for Comments on a Proposed Amendment to the Uniform Practice Code, Section 59, Close-Out Procedure; Buying-in

TO: All NASD Members and Other Interested Persons

ATTN: Operations Principal, Cashier, Buy-in Personnel

EXECUTIVE SUMMARY

Last Date for Comments: October 1, 1986.

The NASD Board of Governors is circulating for comment a proposed amendment to the Uniform Practice Code, Section 59, Close-Out Procedure; Buying-in. It would require that buy-ins returned by a clearing corporation to a broker be executed for "cash" or "guaranteed delivery" of certificates. The proposed amendment was recommended by the Uniform Practice Committee and coincides with one of the recommendations in the study on Short-Sale Regulation of NASDAQ Securities, prepared by former SEC Commissioner Irving M. Pollack.

The Board concluded that this amendment would effectively assure the timely delivery of fully paid-for securities. The text of the proposed amendment is attached.

BACKGROUND AND EXPLANATION OF THE PROPOSED AMENDMENT

One of the areas examined by the short-sale study prepared by Irving M. Pollack was the relationship between short selling and clearing corporation short interest (fails to deliver), i.e., the inability to deliver or election by a clearing participant to withhold delivery of securities to the clearing corporation. The short condition can exist indefinitely in a continuous net settlement system because the rules and procedures of the clearing corporations permit outstanding long or short positions to be carried forward on a virtually perpetual basis. The procedure provides that open positions be marked to the market daily, with market price fluctuations being reflected in a participant's daily cash settlement. This effectively insulates both the clearing corporation and broker-dealer participants from financial losses. The procedure also allows a clearing participant to postpone delivery indefinitely, or until a purchasing broker-dealer initiates buy-in procedures.

A problem revealed by the Pollack short-sale study concerned instances in which a long clearing broker did not receive securities from a clearing corporation, especially in situations where there were high levels of short selling in conjunction with large clearing-short interest. In some circumstances, when a long clearing broker initiated a buy-in, it was retransmitted to a short clearing broker who was also a short seller and thereby unable to satisfy the request for certificates.

In a continuous net settlement system, the identity of the clearing broker to whom a buy-in is retransmitted is unknown. The buy-in could be executed with a broker who was a short seller and also short to the clearing corporation, which would leave the long clearing broker unable to obtain physical delivery of the required certificates.

To expedite the delivery of fully paid-for securities and to limit the adverse effects of short selling, the proposed amendment to Section 59 of the Uniform Practice Code will require that buy-ins returned by a clearing organization to a broker be executed for cash or guaranteed delivery of certificates.

In reaching this recommendation, the Uniform Practice Committee took into consideration the fact that over 90 percent of clearing corporation buy-ins are never executed, but satisfied through either their priority in the daily settlement cycle or through retransmission of the buy-in to short clearing participants.

All members and other interested persons are invited to submit comments on the proposed amendment. Comments should be received no later than October 1, 1986, and should be directed to:

Mr. Lynn Nellius, Secretary
National Association of Securities Dealers, Inc.
1735 K Street, N.W.
Washington, D.C. 20006

Comments received will be considered by the Uniform Practice Committee and the NASD Board of Governors. If approved by the Board, the proposed amendment must be filed with and approved by the Securities and Exchange Commission before becoming effective.

Questions concerning this notice may be directed to Donald Catapano, Director, NASD Uniform Practice-TARS, at (212) 839-6255.

Sincerely,

John T. Wall
Executive Vice President
Member and Market Services

Attachment

PROPOSED AMENDMENT TO SECTION 59 OF THE NASD UNIFORM PRACTICE CODE*

Sec. 59. Close-Out Procedure; Buying-in

(a) and (b) are unchanged.

Seller's failure to deliver after receipt of notice

(c)
(i)
(a). On failure of the seller to effect delivery in accordance with the "buy-in" notice, or to obtain a stay as hereinafter provided, the buyer may close the contract by purchasing all or any part of the securities necessary to complete the contract. Such execution will also operate to close-out all contracts covered under re-transmitted notices of buy-in issued pursuant to the original notice of buy-in. A "buy-in" may be executed by a member from its long position and/or from customers' accounts maintained with such member. [In all cases, members must be prepared to defend the price at which the "buy-in" is executed relative to the current market at the time of the "buy-in.'1
(c)
(i)
(b) In the event of the failure of a clearing corporation to effect delivery in accordance with a buy-in notice, the buyer must close the contract by purchasing for "cash" in the best available market, or at the option of the buyer for guaranteed delivery, for the account and liability of the party in default all or any part of the securities necessary to complete the contract.
As provided in subsections (i)(a) and (i)(b) hereof, members must be prepared to defend the price at which the "buy-in" is executed relative to the current market at the time of the "buy-in."
(c)
(ii) is unchanged.
(d) through (n) are unchanged.

* New language is underlined; deleted language is bracketed.



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