[Federal Register Volume 85, Number 169 (Monday, August 31, 2020)]
[Notices]
[Pages 53888-53890]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-19061]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-89659; File No. TP 20-02]
Order Granting Exemptions From Certain Rules Related to the Sale
and Delivery of Physical Securities Under Regulation SHO Related to
COVID-19
August 25, 2020.
I. Introduction
The Depository Trust & Clearing Corporation (``DTCC'') has
intermittently suspended physical securities processing services
provided by the Depository Trust Company (``DTC''), its subsidiary, due
to ongoing concerns related to the effects of COVID-19.\1\ While DTCC
has resumed limited services for new physical securities
transactions,\2\ there are likely to be delays in settlement for the
sales of equity securities that the seller is ``deemed to own''
pursuant to Rule 200(b) of Regulation SHO,\3\ and for which settlement
is dependent on the delivery of physical certificates (``owned physical
securities''), which may result in extended failures to deliver \4\ and
have resulting implications for compliance with Regulation SHO under
the Securities Exchange Act of 1934 (the ``Exchange Act'').\5\ The
Securities Industry and Financial Markets Association (``SIFMA'') has
requested on behalf of its member firms exemptive relief from certain
provisions of Regulation SHO \6\ in connection with the intermittent
suspension of physical securities processing at DTC due to ongoing
concerns related to COVID-19.\7\
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\1\ E.g., ``Temporary Suspension of DTC Physical Securities
Processing as of Close of
Business on April 8, 2020,'' Important Notice B# 13276-20 (Apr.
8, 2020) available at https://www.dtcc.com/-/media/Files/pdf/2020/4/8/13276-20.pdf; ``Update on Temporary Suspension of DTC Physical
Securities Processing,'' Important Notice B#13352-20 (Apr. 30, 2020)
available at https://www.dtcc.com/-/media/Files/pdf/2020/4/30/13353-20.pdf.
\2\ ``Coronavirus Client FAQ,'' DTCC (Aug. 4, 2020) available at
https://www.dtcc.com/~/media/Files/PDFs/Email-Files/Client-FAQ-
Coronavirus.pdf?mkt_tok=eyJpIjoiTURFellqVXhPR0V5TVRSaiIsInQiOiJPSzFvV
E1qM0ZWTWdXR1ZzZlB3c1pNYWJmOWZUUjh1Qyt0b29sYmV4cnIwWWRXYXdWTjQrSXNaOH
pyYWQ1RlNIWVFQeGhoYTN3cDJaRFwvb1JPRGdzR2c9PSJ9. DTC has requested
that participants only submit urgent time-sensitive transactions.
``Partial Resumption of DTC Physical Securities Processing,''
Important Notice B# 13402-20 (May 14, 2020) available at https://www.dtcc.com/-/media/Files/pdf/2020/5/14/13402-20.pdf.
\3\ 17 CFR 242.200(b).
\4\ Specifically, failures to deliver securities may occur at
the Continuous Net Settlement system, or ``CNS,'' which is operated
by the National Securities Clearing Corporation (``NSCC''), a
subsidiary of DTCC. Rule 204 of Regulation SHO applies specifically
to failures to deliver in equity securities occurring at CNS. 17 CFR
242.204.
\5\ 17 CFR 242.200 et seq.
\6\ Letter from Robert Toomey, Managing Director & Associate
General Counsel, SIFMA, dated May 21, 2020. SIFMA stated in its
request that the Commission granted similar exemptive relief in 2012
in the aftermath of Hurricane Sandy. See Order Granting Exemptions
From Certain Rules of Regulation SHO Related to Hurricane Sandy,
Release No. 34-68419 (Dec. 12, 2012) (the ``2012 Hurricane Sandy
Order''), available at https://www.sec.gov/rules/exorders/2012/34-68419.pdf. The 2012 Hurricane Sandy Order granted exemptions from
certain provisions of Regulation SHO related to the inaccessibility
of physical certificates that resulted from water damage incurred at
DTCC's vault used as part of its Custody Service for safekeeping of
physical certificates.
\7\ DTCC suspended but recently resumed processing of physical
securities. ``Partial Resumption of DTC Physical Securities
Processing,'' Important Notice B# 13402-20 (May 14, 2020) available
at https://www.dtcc.com/-/media/Files/pdf/2020/5/14/13402-20.pdf.
However, based on conversations with SIFMA, we understand that
regular processing may be intermittent during the current crisis,
and that there may be delays in processing certain physical
securities after DTCC resumes processing after a suspension. See,
e.g., letter from Robert Toomey, supra note 6 (``While DTCC has
resumed limited services in connection with processing physical
securities . . . we believe the requested relief continues to be
appropriate and should also provide, given the ongoing uncertainties
in connection with the COVID-19 crisis, mechanisms that would allow
market participants to rely on the relief should there be further
intermittent suspensions of physical securities processing during
this crisis period.'').
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The Commission is providing certain exemptive relief from the
``locate'' and close-out requirements of Regulation SHO, as described
in more detail below, for sales of owned physical securities.
II. Regulation SHO
A. Rule 200 Marking Requirement and Rule 203 ``Locate'' Requirement
Rule 200(g) of Regulation SHO \8\ provides that broker-dealers must
mark all sell orders of any equity security as ``long,'' ``short,'' or
``short exempt.'' Under Rule 200(g)(1), a broker-dealer may mark an
order to sell ``long'' only if the seller is ``deemed to own'' the
security being sold pursuant to paragraphs (a) through (f) of Rule 200
and either: (1) the security to be delivered is in the physical
possession or control of the broker-dealer; or (2) it is reasonably
expected that the security will be in the physical possession or
control of the broker-dealer no later than the settlement of the
transaction.
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\8\ 17 CFR 242.200(g).
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Due to the intermittent inaccessibility of physical certificates at
DTC as a result of ongoing concerns related to the effects of COVID-19,
sell orders for owned physical securities may not qualify for ``long''
order marking under Rule 200(g)(1).\9\ Specifically, a broker-dealer
may not have a reasonable expectation that such securities will be in
the physical possession or control of the broker-dealer by the
settlement date.\10\ Therefore, the broker-dealer would be required to
mark such sale orders as ``short'' or, if eligible for Rule 201(c) or
(d), ``short exempt.'' \11\
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\9\ See Exchange Act Release No. 50103 (July 28, 2004), 69 FR
48008, 48012, 48015 (Aug. 6, 2004) (``Regulation SHO Adopting
Release''). As noted below, sales marked ``short'' and ``short
exempt'' are generally subject to the Rule 203(b) locate requirement
absent an exception.
\10\ 17 CFR 242.200(g)(1)(ii).
\11\ Certain sales of owned physical securities may also qualify
under Rule 201(d)(1) to be marked ``short exempt'' provided that the
broker-dealer executing the transaction makes the required
determination regarding the seller's ownership of the security, and
that the seller intends to deliver the security as soon as the
current restrictions on delivery have been removed. 17 CFR
242.201(d)(1).
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Pursuant to Rule 203(b) of Regulation SHO, a broker-dealer may not
accept a short sale order in an equity security from another person, or
effect a short sale in an equity security for its own account, unless
the broker-dealer has: (1) Borrowed the security, or entered into a
bona fide arrangement to borrow the security; or (2) reasonable grounds
to believe that the security can be borrowed so that it can be
delivered on the date delivery is due.\12\ This requirement is known as
the ``locate'' requirement, and must be met and
[[Page 53889]]
documented prior to effecting a short sale.\13\
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\12\ 17 CFR 242.203(b).
\13\ Certain exceptions to the ``locate'' requirement are
provided under Rule 203(b)(2). See 17 CFR 242.203(b)(2).
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The Commission provided a specific exception to the ``locate''
requirement, however, for sales of such securities that the person is
``deemed to own'' pursuant to Rule 200(b) of Regulation SHO. Pursuant
to Rule 203(b)(2)(ii), sales of such ``deemed to own'' securities are
excepted from the ``locate'' requirement provided that the seller
intends to deliver the securities as soon as all restrictions on
delivery have been removed, and further provided that if the seller has
not delivered such securities within 35 days after the trade date, the
broker-dealer that effected the sale must borrow securities or close
out the short position by purchasing securities of like kind and
quantity.\14\ In adopting this exception, the Commission emphasized
that these sales are treated as short sales solely because the seller
is unable to deliver the security that it owns to its broker-dealer
prior to settlement, based on circumstances outside the seller's
control and through no fault of the seller or the broker-dealer.\15\
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\14\ See 17 CFR 242.203(b)(2)(ii); see also Regulation SHO
Adopting Release, 69 FR at 48015.
\15\ See Regulation SHO Adopting Release, 69 FR at 48015; see
also Exchange Act Release No. 61595 (Feb. 26, 2010), 75 FR 11232,
11266 (Mar. 10, 2010).
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SIFMA has stated in conversations with Commission staff that fail
to deliver positions resulting directly from DTC's intermittent
suspension of physical securities processing may persist for longer
than the 35 day delivery requirement provided for under the Rule
203(b)(2)(ii) exception to the locate requirement for sales of
securities that the seller is ``deemed to own.'' Therefore, absent the
requested exemptive relief, SIFMA stated that broker-dealers effecting
short sales for such owned physical securities would be required to
either comply with the Rule 203(b) locate requirement, or
alternatively, comply with the delivery requirement under Rule
203(b)(2)(ii) (i.e., if the seller has not delivered such security
within 35 days after the trade date, the broker-dealer that effected
the sale must borrow securities or close out the short position by
purchasing securities of like kind and quantity). We believe that
requiring compliance with the Rule 203(b) ``locate'' requirement or the
delivery requirement under Rule 203(b)(2(ii) in spite of the
anticipated delivery delays as a result of DTC's intermittent
suspension of physical securities processing due to ongoing concerns
related to COVID-19 may cause undue burdens on various market
participants, particularly in the context of physical securities for
which lending markets are small or non-existent. As a result, we
believe that the temporary relief from the Rule 203(b) ``locate''
requirement of Regulation SHO for owned physical securities provided by
this Exemptive Order is appropriate in the public interest and
consistent with the protection of investors.
Accordingly, it is ordered, pursuant to Section 36 of the Exchange
Act,\16\ that a broker-dealer is exempt from the ``locate'' requirement
of Rule 203(b), including the delivery requirement of Rule
203(b)(2)(ii), with respect to a short sale order in an owned physical
security, subject to the following conditions:\17\
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\16\ Section 36 of the Exchange Act authorizes the Commission,
by rule, regulation or order, to exempt, either conditionally or
unconditionally, any person, security or transaction, or any class
or classes of persons, securities or transactions, from any
provision or provisions of the Exchange Act or any rule or
regulation thereunder, to the extent that such exemption is
necessary or appropriate in the public interest, and is consistent
with the protection of investors. 15 U.S.C. 78mm(a).
\17\ These conditions are designed to (1) ensure that executing
brokers do not rely on the relief from Rule 203(b) granted in this
Order beyond the extent to which the seller is ``deemed to own'' the
relevant security, and (2) aid in ensuring participants' compliance
with this Order (to the extent they choose to avail themselves of
the relief). The relief granted in this Order applies only in the
context of suspensions of physical securities processing resulting
directly from ongoing concerns related to COVID-19.
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(a) The broker-dealer determines, prior to accepting such short
sale order from another person, or effecting such short sale for its
own account, that the sale is a sale of an owned physical security that
the seller is ``deemed to own'' pursuant to Rule 200 of Regulation SHO;
\18\
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\18\ 17 CFR 242.200.
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(b) The broker-dealer maintains contemporaneous records reflecting
any reliance on this Order, and makes this information available to
Commission staff upon request; and
(c) The broker-dealer provides notice on its website promptly upon
its initial reliance on the Order and maintains the notice on its
website until it ceases reliance on the Order.
B. Close-Out Requirements Under Rule 204 of Regulation SHO
Rule 204(a) of Regulation SHO \19\ generally requires that
participants of a registered clearing agency (``Participants'') close
out fail to deliver positions at a registered clearing agency \20\ in
any equity security for a sale transaction in that equity security by
no later than the beginning of regular trading hours on the next
settlement day after a fail to deliver resulting from a short sale
(generally T+3), and no later than the beginning of regular trading
hours on the third settlement day after a fail to deliver resulting
from a long sale or a sale resulting from bona fide market making
activities at the time of the sale (generally T+5). A close-out of a
fail to deliver position is effected by purchasing or borrowing shares
of like kind and quantity.
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\19\ 17 CFR 242.204(a).
\20\ The term ``registered clearing agency'' means a clearing
agency, as defined in Section 3(a)(23)(A) of the Exchange Act, that
is registered as such pursuant to Section 17A of the Exchange Act.
See 15 U.S.C. 78c(a)(23)(A); 15 U.S.C. 78q-1. The majority of equity
trades in the United States are cleared and settled through systems
administered by clearing agencies registered with the Commission.
NSCC clears and settles the majority of equity securities trades
conducted on the exchanges and in the over-the-counter market. NSCC
clears and settles trades through CNS, which nets the securities
delivery and payment obligations of all of its members. See Exchange
Act Release No. 60388 (July 27, 2009), 74 FR 38266, 38268 n.35 (July
31, 2009) (``Rule 204 Adopting Release'').
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Similar to the exception to the ``locate'' requirement discussed
above, Rule 204(a)(2) provides an extended close-out timeframe (T+35)
for fail to deliver positions resulting from a sale of a security that
a person is ``deemed to own'' and intends to deliver as soon as all
restrictions on delivery have been removed.\21\ Thus, fail to deliver
positions resulting from sales of owned physical securities would
ordinarily be eligible for the extended close-out timeframe provided by
Rule 204(a)(2).\22\ As noted above, however, SIFMA has stated in
discussions with the Commission staff that, due to the inaccessibility
of the physical certificates resulting from DTC's intermittent
suspension of physical securities processing, there may be instances in
which sales of owned
[[Page 53890]]
physical securities may result in a CNS fail to deliver position that
persists beyond the T+35 close-out timeframe.
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\21\ See 17 CFR 242.204(a)(2); see also Rule 204 Adopting
Release, 74 FR at 38277 n.141. Under Rule 204(a)(2), a Participant
that has a fail to deliver position resulting from a sale of a
security that a person is ``deemed to own'' pursuant to Rule 200 of
Regulation SHO and that such person intends to deliver as soon as
all restrictions on delivery have been removed must, by no later
than the beginning of regular trading hours on the thirty-fifth
consecutive calendar day following the trade date for the
transaction, immediately close out the fail to deliver position by
purchasing or borrowing securities of like kind and quantity.
\22\ See Rule 204 Adopting Release, 74 FR at 38277-38278. In
providing an extended close-out timeframe for sales of ``deemed to
own'' securities, the Commission stated that additional time is
warranted for these sales and such additional time would not
undermine the goal of reducing fail to deliver positions because
``these are sales of owned securities that cannot be delivered by
settlement date due solely to processing delays outside the seller's
or broker-dealer's control,'' and that ``[m]oreover, delivery will
be made on such sales as soon as all restrictions on delivery have
been removed.'' Id.
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Pursuant to Rule 204(b) of Regulation SHO,\23\ if a Participant has
not closed out a fail to deliver position in an equity security in
accordance with Rule 204(a), the Participant and any broker-dealer from
which the Participant receives trades for clearance and settlement, may
not accept a short sale order in that equity security from another
person or effect a short sale in that equity security for its own
account, without first borrowing, or arranging to borrow, the security
until the Participant closes out the fail to deliver position by
purchasing securities of like kind and quantity, and that purchase has
cleared and settled at a registered clearing agency. This requirement
is known as the ``Penalty Box'' provision. As stated by the Commission,
this provision is ``intended to act as an additional incentive to
broker-dealers to deliver securities by settlement date, and to close
out fail to deliver positions in accordance with the requirements of
Rule 204.'' \24\ Absent relief, Participants would be required to close
out any fail to deliver positions resulting from the sale of owned
physical securities pursuant to Rule 204(a)(2) and, if they did not,
would be subject to the Penalty Box provision.
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\23\ 17 CFR 242.204(b).
\24\ Rule 204 Adopting Release at 38275.
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We believe that, due to DTC's intermittent suspension of physical
securities processing, sales of owned physical securities raise policy
considerations that warrant granting limited exemptive relief.\25\
Moreover, requiring compliance with the Rule 204(a)(2) close-out
requirement may create undue burdens for Participants and other broker-
dealers for which they clear and settle trades, and we do not believe
that subjecting Participants or other broker-dealers to the Penalty Box
provision in this context would further the policy goal of
incentivizing broker-dealers to deliver securities by settlement and to
close out fail to deliver positions in accordance with Rule 204. Thus,
we believe that the temporary relief from the close-out requirement of
Regulation SHO provided by this Exemptive Order is appropriate in the
public interest and consistent with the protection of investors.
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\25\ These policy considerations are similar to those considered
in the context of the 2012 Hurricane Sandy Order. See supra note 6.
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Accordingly, it is further ordered, pursuant to Section 36 of the
Exchange Act,\26\ that a Participant is exempt from the close-out
requirement of Rule 204(a) \27\ and the Penalty Box provision of Rule
204(b) \28\ of Regulation SHO with respect to a fail to deliver
position resulting from the sale of an owned physical security,\29\
subject to the following conditions: \30\
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\26\ See supra note 16.
\27\ 17 CFR 242.204(a).
\28\ 17 CFR 242.204(b).
\29\ Rule 203(b)(3) of Regulation SHO provides that if a
Participant has a fail to deliver position at a registered clearing
agency in a threshold security, as defined by Rule 203(c)(6), for
thirteen consecutive settlement days, the Participant shall
immediately thereafter close out the fail to deliver position by
purchasing securities of like kind and quantity. If the sale of an
owned physical security resulted in a fail to deliver position in a
threshold security and that fail to deliver position persisted for
thirteen consecutive settlement days because the close-out date
applicable under this Exemptive Order had not yet arrived, Rule
203(b)(3) would nonetheless require the Participant to close out the
fail to deliver position. Accordingly, Participants are exempt from
the close-out requirements of Rule 203(b)(3) with respect to fail to
deliver positions in threshold securities resulting from sales of
owned physical securities, provided that the Participants close out
the fail to deliver positions in compliance with this Exemptive
Order. See 17 CFR 242.203(b)(3).
\30\ These conditions are designed to (1) promote the prompt
delivery of securities by participants as soon as practical under
the circumstances surrounding COVID-19 without putting undue burdens
on participants or their customers, and (2) aid in ensuring
participants' compliance with this Order.
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(a) The Participant must determine and document that the fail to
deliver position resulted from a sale of an owned physical security
\31\ that a person is ``deemed to own'' pursuant to Rule 200 of
Regulation SHO; \32\
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\31\ Such determination could be based, for example, on records
indicating that the sale involves a physical certificate custodied
at DTCC.
\32\ 17 CFR 242.200.
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(b) The Participant must check DTCC systems on a daily basis to
determine when an owned physical security, the sale of which resulted
in a fail to deliver position, is available for settlement; \33\
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\33\ We understand based on conversations with SIFMA that
processing for certain securities may resume prior to that for
others. As such, this determination must be made on a security-by-
security basis. We further understand that DTC systems (including
the Participant Browser System and the Participant Terminal System)
enable Participants to verify their positions in physical securities
held at DTC and issue withdrawal instructions. We understand that
these systems permit Participants, in conjunction with the
Participant's own books and records, to track when physical
securities have been debited (withdrawn) and sent to the transfer
agent and when the physical securities are available for settlement
after they have been returned to DTC and are available for
Participant pickup, are mailed directly to the customer, or are set
up as a Direct Registration System account, and that Participants
check these systems for completed status of physical certificate
processing on a daily basis.
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(c) The Participant must deliver the owned physical security as
soon as possible, and in any event, must deliver the security or close
out the fail to deliver position resulting from the sale by purchasing
or borrowing securities of like kind and quantity by no later than the
beginning of regular trading hours on the fourth settlement day
following the date on which the Participant determines, in accordance
with condition (b) above, that the owned physical security, the sale of
which resulted in the fail to deliver position, is available for
settlement;
(d) The Participant's books and records must reflect that it made
delivery of the owned physical security or closed out the fail to
deliver position resulting from the sale within the applicable time
period, consistent with this Exemptive Order;
(e) The Participant must maintain contemporaneous records
reflecting any reliance on this Order, and make this information
available to Commission staff upon request; and
(f) The participant provides notice on its website promptly upon
its initial reliance on the Order and maintains the notice on its
website until it ceases reliance on the Order.
III. Modification, Revocation, and Expiration of Exemptions
The relief provided in this Order shall expire on December 31,
2020. The Commission intends to continue to monitor the current
situation. The time period for any or all of the relief may, if
necessary, be extended with any additional conditions that are deemed
appropriate, and the Commission may issue other relief as necessary or
appropriate.
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\34\ See 17 CFR 200.30-3(a)(11).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\34\
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2020-19061 Filed 8-28-20; 8:45 am]
BILLING CODE 8011-01-P