Derivatives practitioners and attorneys expressed some initial concerns last week over additional requirements placed by the Securities and Exchange Commission's long awaited Short Sale Regulation for short sales on threshold securities. David Katz, partner at Sidley Austin Brown & Wood in New York, noted that the new rules could create additional burdens for dealers that hedge their positions in threshold securities by entering into short sales. Edward Johnsen, partner at Katten Muchin Zavis Rosenman, also wrote this month in a client advisory piece that several market makers believed that the failure to include a market maker exemption in section 203(b), which deals with threshold securities, could "seriously impair liquidity in securities and options on securities that are difficult to borrow."
Threshold securities are defined as equity securities for which there is an aggregate fail-to-deliver position for five consecutive settlement days at a registered clearing agency of 10,000 shares or more, and that is equal to at least 0.5% of the issue's total shares outstanding. The SEC estimates around 4% of equities meet this criteria.
Under section 203(b) of the new Short Sale rule, dubbed SHO, short selling participants, including market makers, are required to close out any fail-to-deliver position in a threshold security that has remained for 13 consecutive settlement days. In this situation, the market maker is prohibited from effecting further short sales on the particular threshold security without borrowing, or arranging to borrow the security, until the position is closed out.
