In the recently released Notice to Members 99-28, the NASD warns against situations where customers with multiple accounts and a single investment strategy may be attempting to evade its Conduct Rule 3350 (the Short-Sale Rule) by failing to net security positions. The NASD reminds its members to net positions for accounts that are related or under common control in order to determine whether a sale is long or short. Members are further admonished to ensure that supervisory procedures are in place and being maintained to detect and deter improper short selling activity. The NASD characterizes itself as "committed to ensuring strict adherence" with its Short-Sale Rule and warns that violations "will be vigorously pursued."

In 1994 the NASD adopted the Short-Sale Rule to stop what was perceived as market destabilization (bear raiding or piling on) arising from speculative short selling on NASDAQ. With certain exceptions, the Short-Sale Rule prohibits member firms from effecting

Notably, short selling prohibitions do not apply to sales by qualified NASDAQ market makers in connection with bona fide market making activities.

A customer maintains an account to buy and sell various securities several times in a single day (The Long Account). The Long Account typically begins and ends each day with a long position of 1,000 shares in each security held.

Same customer (or a family member or a related person) maintains another account, which holds offsetting short positions of 1,000 shares (The Short Account) in the same securities that are held in the Long Account; however, the Short Account generally does not change positions in the securities. The customer cross guarantees for margin purposes the Short Account.

Cross-guaranteed accounts refer to an agreement where one account is guaranteed by another account to enable their consolidation for the purpose of allowing the margin that must be maintained in those accounts to be determined on the net positions of both accounts. Such a guarantee must be in writing and permit the member carrying the account to use the money and securities in the guaranteeing account to carry the guaranteed account or to pay any deficit therein.

Let's examine what the NASD thinks is going on. At the beginning of a typical trading day, the Long Account is long 1,000 shares of XYZ and the Short Account is short 1,000 shares of XYZ. Consequently , the combined securities positions in both accounts are flat. XYZ opens the trading day at $46 bid. XYZ then moves to $45 bid. The customer sells 1,000 shares of XYZ at $45 in the Long Account.

If you take the position that there are 1,000 shares owned long in the Long Account by the customer, this sale, which occurred on a down bid of $45, is a long sale.

If you take the NASD's apparent position, which is that the 1,000 shares short in the Short Account must first be combined with the 1,000 shares long in the Long Account, then the combined positions are flat and, technically, the customer does not own XYZ. Consequently, the first 1,000-share sale of XYZ at $45 per share in the Long Account is a short sale and could not occur on a down bid. The NASD characterizes this Long Account activity as creating the false appearance of alternating long and flat positions in the securities.

NASDR offers the following guidance as to how it will analyze transactions to determine violations of the Short-Sale Rule among multiple accounts:

1. Whether a single person exercises discretionover both accounts.

2. Whether the accounts are cross-guaranteed for margin purposes.

3. Whether the accounts belong to a family member or related person or were opened contemporaneously (same day).

4. Whether a similar pattern is occurring in other customer accounts at the firm.

WARNING!!!:NTM 98-65 led a number of members to erroneously believe that margin accounts may be cross guaranteed to satisfy Regulation T requirements. This is wrong. Reg T provides under Section 220.3(d) that no guarantee of a customer's account shall be given any effect for its purposes.