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94-80 SEC Approves NASD Proposal Requiring Members To Annotate Their Affirmative Determinations As To Stock Availability Made In Connection With Short Sales

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Executive Summary

On September 12, 1994, the Securities and Exchange Commission (SEC) approved an NASD rule change that amends the Prompt Receipt and Delivery of Securities Interpretation (Interpretation) issued by the NASD Board of Governors under Article III, Section 1 of the NASD Rules of Fair Practice. Specifically, the Interpretation, as amended, requires members to annotate their affirmative determinations as to stock availability that are required to be made when effecting short sales for their own proprietary account or the account of a customer. The rule change will become effective November 30, 1994.

Background And Description

Under the Interpretation, members are required to make certain affirmative determinations as to stock availability when effecting sale transactions. Specifically, for long sales by customers, members must make an affirmative determination that the customer owns the security and will deliver it in good deliverable form within 5 business days of execution of the order. For customer short sales, the Interpretation requires members to make an affirmative determination that it will receive delivery of the security from the customer or that it can borrow the security on behalf of the customer for delivery by settlement date. Similarly, for short sales effected in a member's proprietary account, a member must make an affirmative determination that it can borrow the securities or otherwise provide for delivery of the securities by settlement date.

While members must make affirmative determinations as to stock availability when effecting long sales and short sales, the Interpretation presently only requires members to annotate their affirmative determinations made in connection with long sales.1 Accordingly, to enhance member firm compliance with the affirmative determination requirements already imposed by the Interpretation in connection with short sales and to enable the NASD to more effectively examine for compliance with the affirmative determination requirements, the NASD proposed, and the SEC approved, an amendment to the Interpretation that requires members to annotate their affirmative determinations as to stock availability that are required to be made when effecting short sales for their own proprietary account or the account of a customer. Thus, with this rule change, members will be required to annotate activities that they are already performing in connection with the execution of short sales.2

In particular, the Interpretation, as amended, will require members to annotate, on the trade ticket or on some other record maintained for that purpose by the member firm, the following information:

1. if a customer assures delivery, the member must annotate that conversation noting the present location of the securities; whether the securities are in good deliverable form; and whether they will be delivered to the firm within time for settlement; or
2. if the member locates the stock, the member must annotate the identity of the individual and firm contacted who offered assurance that the shares would be delivered or were available for borrowing by settlement date; and the number of shares needed to cover the short sale.

The manner by which a member or person associated with a member annotates compliance with the "affirmative determination" requirements for short sales (for example, marking the order ticket, recording inquiries in a log, etc.) is not specified by this Interpretation and, therefore, shall be decided by each member. However, an affirmative determination and annotation of that affirmative determination must be made for each and every transaction because a "blanket" or standing assurance that securities are available for borrowing is not acceptable to satisfy the affirmative determination requirement.

Accordingly, with this rule change, the NASD has made clear its longstanding policy that firms cannot rely on daily fax sheets of "borrowable stocks" to satisfy their affirmative determination requirements under the Interpretation. The annotation requirement will preclude this practice as members will have to annotate the name of the person contacted and number of shares for each short sale. Requiring annotation of affirmative determinations in connection with short sales also will enhance the NASD's ability to examine for compliance with various other NASD short-sale rules including those in Article III, Section 21 of the Rules of Fair Practice (recordkeeping) and in the Uniform Practice Code, Section 71 (mandatory delivery requirements for certain restricted securities). Further, the annotation requirement will assist in examining for compliance with the NASD's recently adopted short-sale rule.

Questions regarding this Notice should be directed to NASD Market Surveillance, at (301) 590-6080, or Thomas R. Gira, Assistant General Counsel, at (202) 728-8957.


1 Specifically, Section (b)(4) of the Interpretation requires that a member or person associated with a member "must make a notation on the order ticket at the time he takes the order which reflects his conversation with the customer as to the present location of the securities in question, whether they are in good deliverable form and his ability to deliver them to the member within five (5) business days."

2 The NASD notes, however, that the rule change does not modify any exemptions from the affirmative determination requirements that are presently in the Interpretation. Specifically, transactions in corporate debt securities, bona fide market making transactions by members in securities in which they are registered as Nasdaq® market makers, bona fide market-maker transactions in non-Nasdaq securities in which the market maker publishes two-sided quotations in an independent quotation medium, and proprietary transactions by members that result in fully hedged or arbitraged positions, are still exempt from the affirmative determination requirements for short sales.


Text Of Amendments To The Prompt Receipt And Delivery Of Securities Interpretation Issued By The NASD Board Of Governors Under Article III, Section 1 Of The NASD Rules Of Fair Practice

(Note: New text is underlined; deleted text is bracketed.)

• • • Interpretation Of The Board Of Governors

Prompt Receipt And Delivery Of Securities

.04 It shall be deemed a violation of Article in, Section 1 of the Rules of Fair Practice of the Association for a member or person associated with a member to violate the provisions of the following interpretation thereof:
(a) Purchases: No member or person associated with a member may accept a customer's purchase order for any security unless it has first ascertained that the customer placing the order or its agent agrees to receive securities against payment in an amount equal to any execution, even though such an execution may represent the purchase of only a part of a larger order.
(b) Sales:
(1) Long Sales

No member or person associated with a member shall accept a long sale order from any customer in any security unless:
(A) No change.
(B) No change
(C) The member or person associated with a member makes an affirmative determination that the customer owns the security and will deliver it in good deliverable form within five (5) business days of the execution of the order; or
(D) No change.
(2) "Short Sales"
(A) Customer short sales. No member or person associated with a member shall accept a "short" sale order for any customer in any security unless the member or person associated with a member makes an affirmative determination that the member [it] will receive delivery of the security from the customer or that the member [it] can borrow the security on behalf of the customer for delivery by settlement date. This requirement shall not apply, however, to transactions in corporate debt securities.
(B) Proprietary short sales. No member or person associated with a member shall effect a "short" sale for its own account in any security unless the member or person associated with a member makes an affirmative determination that the member [it] can borrow the securities or otherwise provide for delivery of the securities by settlement date. This requirement will not apply to transactions in corporate debt securities, to bona fide market making transactions by a member in securities in which it is registered as a NASDAQ market maker, to bona fide market maker transactions in non-NASDAQ securities in which the market maker publishes a two-sided quotation in an independent quotation medium, or to transactions which result in fully hedged or arbitraged positions.
(3) Public Offering

No change.
(4) "Affirmative Determination"
(A) To satisfy the requirements for an "affirmative determination" contained in subsection (b)(1)(C) above for long sales, the member or person associated with a member must make a notation on the order ticket at the time [he takes] the order is taken which reflects [his] the conversation with the customer as to the present location of the securities in question, whether they are in good deliverable form and [his] the customer's ability to deliver them to the member within five (5) business days.
(B) To satisfy the requirement for an "affirmative determination" contained in subsection (b)(2) above for customer and proprietary short sales, the member or person associated with a member must keep a written record which includes:
(i) if a customer assures delivery, the present location of the securities in question, whether they are in good deliverable form and the customer's ability to deliver them to the member within five (5) business days; or
(ii) if the member or person associated with a member locates the stock, the identity of the individual and firm contacted who offered assurance that the shares would be delivered or that were available for borrowing by settlement date and the number of shares needed to cover the short sale.
(C) The manner by which a member or person associated with a member annotates compliance with the "affirmative determination" requirement contained in subsection (b)(2) above (e.g., marking the order ticket. recording inquiries in a log, etc.) is not specified by this Interpretation and, therefore, shall be decided by each member. However, an affirmative determination and annotation of that affirmative determination must be made for each and every transaction since a "blanket" or standing assurance that securities are available for borrowing is not acceptable to satisfy the affirmative determination requirement.
(5) "Bona Fide Fully Hedged" and "Bona Fide Fully Arbitraged"

No change.

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