HARD-TO-BORROW LISTS MADE EASY

On June 9, 2000 National Association of Securities Dealers, Inc.'s (NASD) members will be permitted under certain circumstances to use a Hard-to-Borrow list to comply with their affirmative determination requirements for short sales.

THE LONG AND THE SHORT OF IT

NASD Conduct Rule (CR) 3370(b): Sales prohibits both members and their associated persons from accepting a long sale order from any customer in any security unless

1. The member has possession of the security;

2. The customer is long the security in his/her account with that member;

3. The member or associated person makes an affirmative determination that the customer owns the security and will deliver it in good deliverable form within three (3) business days of the execution or the order; or

4. The security is on deposit in good deliverable form with a member of the NASD, a national securities exchange, an SEC registered broker-dealer, or any organization subject to state/federal banking regulations, and that instructions have been forwarded to that depository to deliver the securities against payment (DVP accounts). 

The long sales rules do not apply during the commencement of a public offering of securities until seven (7) business days following settlement between the underwriter and the issuer; provided, that the member must still believe in good faith that the customer purchased the securities at issue.

CR 3370(b)also prohibits members and associated persons from accepting a short sale order from any customer in any security unless the member or associated person makes an affirmative determination that

1. the member will receive delivery of the security from the customer; or

2. the member can borrow the security on behalf of the customer for delivery by settlement date.

The requirements of CR 3370(b) are generally applicable to members effecting short sales for their proprietary accounts, with the notable exception that the prohibitions are not applicable to

• bona fide market making transactions in securities in which the member is registered as a NASDAQ market maker ---

• in non-NASDAQ securities the market maker must publish a two-sided quotation in an independent quotation medium ---

• transactions resulting in fully hedged or arbitraged positions. 

AFFIRMATIVE DETERMINATION

As should be obvious, whether the transaction undertaken is a long or short sale, the function of an affirmative determination is frequently critical in avoiding lawsuits and regulatory proceedings. CR 3370(b)(4): Affirmative Determination (the "Affirmative Determination Rule") sets out the criteria to be observed in staying compliant.   

In the case of long sales, the member or associated person must

Make a notation on the order ticket at the time the order is taken

1. which reflects the conversation with the customer as to the present location of the long securities, and

2. notes whether the securities are in good deliverable form, and

3. the customer's ability to deliver them to the member within three (3) business days.

In the case of customer and proprietary short sales, the member or associated person must

Keep a written record that includes

for situations when the customer assures delivery

1. the present location of the securities

2. whether the securities are in good deliverable form, and

3. the customer's ability to deliver them to the member within three (3) business days.

for situations when the member/associated person locates the securities

1. the identity of the individual/firm contacted who offered the assurance that

•  the shares would be delivered, or

•  the shares were available for borrowing by settlement date

2. the number of shares needed to cover the short sale

A casual reading of the above requirements may fail to pick up the distinction that long sales are required to reflect the affirmative determination by written notation on the order ticket; however, short sales only require a written record. CR 3370(b)(4)(C) specifically allows that members may best decide what constitutes compliance with the written record requirement.

EASY-TO-BORROW LISTS

The Affirmative Determination Rule also provided that members could rely on so-called "blanket" assurances in satisfaction of their affirmative determination obligations. These blanket or standing assurances are frequently transmitted by facsimile to members and are required to meet the following standards:

1. The information relied upon is less than 24-hours old and

2. the member delivers the security on settlement date.

Over the years the blanket assurance became known in industry jargon as the Easy-to-Borrow list. Relying upon Easy-to-Borrow lists may be held in violation of NASD rules if there occurs a subsequent failure to deliver the securities by settlement date, absent adequately documented mitigating circumstances.

HARD-TO-BORROW LISTS

Conversely, securities that were generally known to be difficult to borrow --- if not outright unavailable --- wound up on a Hard-to-Borrow list. Given that it is often easier and simpler to list all the securities that are hard to borrow, rather than all that are available for, many members generated Hard-to-Borrow lists. An industry practice developed whereby securities that were not on the Hard-to-Borrow list were generally assumed to be easy to borrow. The question continually arose as to whether a firm could rely upon the absence of a security on its Hard-to-Borrow list as satisfaction of its affirmative determination obligations. 

The amendments to the Affirmative Determination Rule permit members and associated persons to rely on a Hard-to-Borrow list for any short sales executed in NASDAQ National Market (NNM) or exchange-listed securities, provided that:

(1)   the creator of the list attests in writing that any NNM or exchange-listed securities not included on the list are easy to borrow or are available for borrowing; and

(2)   any securities restricted pursuant to Uniform Practice Code (UPC) 11830are included on the list. Securities restricted pursuant to UPC 11830 are NASDAQ securities that, as published by the NASD, show an aggregate clearing short position of 10,000 shares or more and that are equal to at least 0.5% of the total shares outstanding of the issue. In practice, securities falling into this category are difficult to borrow. 

Effective June 9, 2000, member firms will be able to refer to the "Hard to Borrow" list before executing short sales.

• If a given security is not on that list, the member or associated person will be considered to have made the requisite affirmative determination and will be permitted to execute the short sale without taking any further steps to satisfy the Affirmative Determination Rule.  
  

• If the security is on the list, then a member or associated person will not be permitted to execute the short sale without taking additional steps to ensure the security's availability. 
  

• Creators of a "Hard to Borrow" list must attest in writing as to the availability of securities not on the list and provide such written statement for each "Hard to Borrow" list created. 
  

• It is the responsibility of the member or associated person using the list to determine that the creator of the list is reliable.

The amended rule will permit the use of "Hard to Borrow" lists only for NNM and exchange-listed securities. For NASDAQ SmallCap (NSC) and over-the-counter (OTC) equity securities, members can continue to comply with the requirements of Rule 3370 through the use of "Easy to Borrow" lists. The NASD explains this distinction as based upon the fact that NNM and exchange-listed securities are less likely to be subject to short sale abuses than NSC and OTC equity securities, which generally are more thinly traded.

Questions concerning these amendments should be directed to NASD Regulation, Inc.:
Stephanie M. Dumont, Assistant General Counsel,  (202) 728-8176; or Legal Section, Market Regulation Department,  (301) 590-6410.