RRBDLAW.COM -- 917-520-2836 -- NASDR ISSUES SHORT SALE WARNINGS

NASDR ISSUES SHORT SALE WARNINGS

Members Must Comply With All Short Sale Rules (Special Focus on The Affirmative Determination Rule)When Receiving Orders Through Electronic Order Systems Or The Internet.

Inadvertent Short Sales

Trading errors are an unfortunate byproduct of the growth in online trading, whether caused by inexperienced public customers or created by flawed computer systems. So-called inadvertent short sales have plagued both member firms and their customers. Typically, this problem (also known as mistaken sale not long or as double or over selling) occurs as follows:

The Delayed-Confirmation Short
Customer places an online order to sell 100 shares XYZ at a time when account is long 100 shares XYZ. Customer does not receive what he/she deems a timely confirmation and assumes that sell order was not received. Customer enters a second sell order (believing it to be a re-entry rather than a new entry). Consequently, customer has entered two orders to sell 100 shares XYZ for a cumulative sell order of 200 shares, at a time when account is long only 100 shares
The Result: Customer has inadvertently created a 100 share short position.

The Failed-Cancel Short
Customer is long 100 shares XYZ and enters a limit order to sell 100 shares XYZ. Because the market begins to quickly move lower, customer attempts to cancel limit. Believing that the cancellation was successful (although generally not having received a confirmation of cancellation), customer now enters a market order to sell 100 shares XYZ. Subsequently, customer learns that the initial attempt to cancel the limit order was unsuccessful, that the limit order was executed, and the market order was also executed.
The Result: Customer has inadvertently created a 100 share short position.

The Operator-Error Short
Customer intends to purchase 100 shares XYZ. Using online interface, customer unwittingly enters order to sell 100 shares XYZ.
The Result: Customer has inadvertently created a 100 share short position.

NASD Rule 3350: Bid Test Rule provides that, absent an exemption, no member shall effect a short sale for the account of a customer or for its own account in a NASDAQ National Market security at or below the current best (inside) bid when the current best (inside) bid as displayed by NASDAQ is below the preceding best (inside) bid in the security. Moreover, firms must effect short sales in compliance with the Bid Test Rule regardless of whether the short sale is an "inadvertent" short sale from the customer’s perspective. Similarly, firms must effect short sales in exchange-listed securities in compliance with the Securities Exchange Act Rule 10a-1. Additionally, pursuant to NASD Rule 6130(d)(6), a transaction report entered into the Automated Confirmation Transaction Service ("ACT") that reports the execution of such an order must include a symbol that identifies the transaction as a short sale. As stated above, firms must comply with this rule regardless of the manner in which customer short sales are received (telephone, electronic, or Internet).

NASD Conduct Rule 3370: Affirmative Determination Rule regulates both customer and proprietary short sales. As to customer short sales, NASD Conduct Rule 3370(b)(2)(A) states, in relevant part, that "[n]o 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 will receive delivery of the security from the customer or that the member can borrow the security on behalf of the customer for delivery by settlement date." Members may not satisfy the Affirmative Determination Rule by merely giving warnings to customers that they are required to make good delivery of the securities or that they will be financially responsible for any losses incurred from covering short sales. An affirmative determination is mandatory prerequisite for accepting a customer’s short sale order.

NASDR WARNINGS:The "inadvertent" nature of a short sale in no way eliminates or reduces the obligations of member firms to comply with the short sale rules. NASDR urges members to carefully design order-entry systems to provide customers with notice when they may have placed an "inadvertent" short sale. It is also recommended that such systems automatically obtain and record Affirmative Determination information.

WAIT-AND-SEE ?

NASDR has apparently learned of a practice whereby members which are "flat" in a given security at the end of a trading day were not conducting affirmative determinations before executing proprietary short sales. The basis for such a practice appeared to have been a belief that so-called intraday shorts did not require the mandatory investigation. Accordingly, it was assumed that only overnight short positions required an affirmative determination.

WARNING: Members may not wait until the end of a trading day to determine whether an affirmative determination is required. The Affirmative Determination Rule requires that firms receive assurances that securities are available to cover potential short position before effecting the short sale order.

Questions concerning:

NASDR Rule 3350 (Bid Test Rule):
Office of General Counsel, The Nasdaq Stock Market, Inc. at (202) 728-8294
Legal Section, Market Regulation, NASDR at (301) 590-6410.

NASDR Rule3370 (Affirmative Determination Rule):
Office of General Counsel, NASDR at (202) 728-8071
Legal Section, Market Regulation, NASDR at (301) 590-6410

THIS WEBSITE MAY BE DEEMED AN ATTORNEY ADVERTISEMENT OR SOLICITATION IN SOME JURISDICTIONS. AS SUCH, PLEASE NOTE THAT THE HIRING OF AN ATTORNEY IS AN IMPORTANT DECISION THAT SHOULD NOT BE BASED SOLELY UPON ADVERTISEMENTS. MOREOVER, PRIOR RESULTS DO NOT GUARANTEE A SIMILAR OUTCOME. NEITHER THE TRANSMISSION NOR YOUR RECEIPT OF ANY CONTENT ON THIS WEBSITE WILL CREATE AN ATTORNEY-CLIENT RELATIONSHIP BETWEEN THE SENDER AND RECEIVER. WEBSITE SUBSCRIBERS AND ONLINE READERS SHOULD NOT TAKE, OR REFRAIN FROM TAKING, ANY ACTION BASED UPON CONTENT ON THIS WEBSITE. THE CONTENT PUBLISHED ON THIS WEBSITE REPRESENTS THE PERSONAL VIEWS OF THE AUTHOR AND NOT NECESSARILY THE VIEWS OF ANY LAW FIRM OR ORGANIZATION WITH WHICH HE MAY BE AFFILIATED. ALL CONTENT IS PROVIDED AS GENERAL INFORMATION ONLY AND MUST NOT BE RELIED UPON AS LEGAL ADVICE. CONTENT ON THIS WEBSITE MAY BE INCORRECT FOR YOUR JURISDICTION AND THE UNDERLYING RULES, REGULATIONS AND/OR DECISIONS MAY NO LONGER BE CONTROLLING OR PERSUASIVE AS A MATTER OF LAW OR INTERPRETATION.