[Federal Register: July 3, 2007 (Volume 72, Number 127)]
[Rules and Regulations]
[Page 36348-36359]
[DOCID:fr03jy07-6]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240 and 242

[Release No. 34-55970; File No. S7-21-06]
RIN 3235-AJ76

Regulation SHO and Rule 10a-1

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is
amending the short sale price test under the Securities Exchange Act of
1934 (``Exchange Act''). The amendments are intended to provide a more
consistent regulatory environment for short selling by removing
restrictions on the execution prices of short sales (``price tests'' or
``price test restrictions''), as well as prohibiting any self-
regulatory organization (``SRO'') from having a price test. In
addition, the Commission is amending Regulation SHO to remove the
requirement that a broker-dealer mark a sell order of an equity
security as ``short exempt,'' if the seller is relying on an exception
from a price test.

DATES: Effective Date: July 3, 2007.
    Compliance Date: July 6, 2007.

FOR FURTHER INFORMATION CONTACT: James A. Brigagliano, Associate
Director, Josephine J. Tao, Assistant Director, Lillian Hagen, Special
Counsel, Victoria L. Crane, Special Counsel, Office of Trading
Practices and Processing, Division of Market Regulation, at (202) 551-
5720, at the Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-6628.

SUPPLEMENTARY INFORMATION: The Commission is removing Rule 10a-1 [17
CFR 240.10a-1], amending Rule 200 of Regulation SHO [17 CFR 242.200],
and adding Rule 201 of Regulation SHO [17 CFR 242.201] under the
Exchange Act.

I. Introduction

A. Executive Summary

    In December 2006, the Commission proposed amendments to remove the
price test of Rule 10a-1 and add Rule 201 of Regulation SHO to provide
that no price test, including any price test of any SRO, shall apply to
short sales in any security.\1\ In addition, we proposed to prohibit
any SRO from having a price test.\2\ We also proposed to amend Rule
200(g) of Regulation SHO to remove the requirement that a broker-dealer
mark a sell order of an equity security as ``short exempt'' if the
seller is relying on an exception from a price test.\3\
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    \1\ See Exchange Act Release No. 54891 (Dec. 7, 2006), 71 FR
75068 (Dec. 13, 2006) (``Proposing Release'').
    \2\ See id.
    \3\ See id.
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    The proposed amendments were designed to modernize and simplify
short sale regulation and, at the same time, provide greater regulatory
consistency by removing restrictions where they no longer appear
effective or necessary.
    We received twenty-seven comment letters in response to the
proposed amendments. Commenters included individual investors,
attorneys, an academic, individual traders, brokerage firms, the New
York Stock Exchange LLC (``NYSE''), the International Association of
Small Broker-Dealers and Advisors (``IASBDA''), the Securities Traders
Association (``STA''), the Managed Funds Association (``MFA''), the
Securities Industry and Financial Markets Association (``SIFMA'') and
the American Stock Exchange LLC (``Amex''). While most commenters
supported the Commission's proposals, some expressed concerns regarding
particular provisions.\4\ We discuss specific comments below in
connection with the discussion of the amendments.
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    \4\ A number of comment letters received in response to the
proposed amendments discussed issues unrelated to the Proposing
Release. We have included a summary of these comment letters in
Section IV. Other Comments, below.
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    After carefully considering the comments, we are adopting the
amendments as proposed. In particular, we are removing Rule 10a-1 and
adding Rule 201 of Regulation SHO to provide that no price test,
including any price test by any SRO, shall apply to short selling in
any security. In addition, Rule 201, as adopted, will prohibit any SRO
from having a price test.
    Because we are adopting our proposal to remove all current price
test restrictions, as well as prohibit any SRO from having its own
price test, we are also amending Rule 200(g) of Regulation SHO \5\ to
remove the requirement that a broker-dealer mark a sell order of an
equity security as ``short exempt'' if the seller is relying on an
exception from the price test of Rule 10a-1, or any price test of any
exchange or national securities association.\6\
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    \5\ 17 CFR 242.200(g).
    \6\ These amendments affect price tests and related marking
requirements only. They do not relate to other provisions of
Regulation SHO. We note, however, that on June 13, 2007, at an Open
Commission Meeting, we approved amendments to eliminate the
``grandfather'' provision of Regulation SHO, and proposed amendments
to eliminate the options market maker exception of Regulation SHO.
These amendments do not alter the amendments to eliminate the
grandfather provision, or the proposal to eliminate the options
market maker exception.
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B. Background

    The Commission originally adopted Rule 10a-1 in 1938 to restrict
short selling in a declining market.\7\ Paragraph (a) of Rule 10a-1
covers short sales in securities registered on, or admitted to unlisted
trading privileges (``UTP'') on, a national securities exchange
(``listed securities''), if trades of the security are reported
pursuant to an ``effective transaction reporting plan'' and information
regarding such trades is made available in accordance with such plan on
a real-time basis to vendors of market transaction information.\8\
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    \7\ See Exchange Act Release No. 1548 (Jan. 24, 1938), 3 FR 213
(Jan. 26, 1938).
    \8\ Rule 10a-1 uses the term ``effective transaction reporting
plan'' as defined in Rule 600 of Regulation NMS (17 CFR 242.600)
under the Exchange Act. See 17 CFR 240.10a-1(a)(1)(i).
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    Rule 10a-1(a)(1) provides that, subject to certain exceptions, a
listed security may be sold short (A) at a price above the price at
which the immediately preceding sale was effected (plus tick), or (B)
at the last sale price if it is higher than the last different price
(zero-plus tick).\9\ Short sales are not permitted on minus ticks or
zero-minus ticks, subject to narrow exceptions. The operation of these
provisions is commonly described as the ``tick test.''
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    \9\ The last sale price is the price reported pursuant to an
effective transaction reporting plan, i.e., the consolidated tape,
or to the last sale price reported in a particular marketplace.
Under Rule 10a-1, the Commission gives market centers the choice of
measuring the tick of the last trade based on executions solely on
their own exchange rather than those reported to the consolidated
tape. See 17 CFR 240.10a-1(a)(2).
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    The core provisions of Rule 10a-1 have remained virtually unchanged
since its adoption almost 70 years ago. Over the years, however, in
response to changes in the securities markets, including changes in
trading strategies and systems used in the marketplace, the Commission
has added exceptions to Rule 10a-1 and granted numerous written
requests for relief from the rule's restrictions.\10\ These requests
for exemptive relief have increased dramatically in recent years in
response to significant developments in the securities markets, such as
the increased use of matching systems that execute trades at
independently derived prices during random times within specific time
intervals and the spread of fully automated markets. Also, decimal
pricing increments have substantially reduced the difficulty of short
selling on an uptick. In addition, under current price test regulation,
different price tests apply to different securities trading in

different markets and apply generally only to large or more actively-
traded securities.\11\
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    \10\ See Proposing Release, 71 FR at 75071-75072 (discussing
exceptions to Rule 10a-1 added by the Commission and relief granted
by the Commission from the rule's restrictions in recent years).
    \11\ Rule 10a-1's tick test is based on the last reported sale
and applies to securities listed on a national securities exchange.
The NASD's and Nasdaq's bid tests are based on the last bid rather
than the last reported sale and apply only to short sales in Nasdaq
Global Market securities. See NASD Rule 5100, available at http://nasd.complinet.com/nasd/display/display.html?rbid=1189&record_id=1159007939&element_id=1159006014&highlight=5100#r1159007939
;

ht=5100#r1159007939
;

display/display.html?rbid=1705&element--id=16. Thus, under the
current market structure, Nasdaq Global Market securities traded on
Nasdaq or the over-the-counter (``OTC'') market and reported to an
NASD facility are subject to Nasdaq's or the NASD's bid tests; other
listed securities traded on an exchange, or otherwise, are subject
to Rule 10a-1's tick test. Nasdaq-listed securities traded on
exchanges other than Nasdaq are not subject to any short sale price
test restrictions. In addition, smaller and more thinly-traded
securities, such as Nasdaq Capital Market securities and securities
quoted on the OTC bulletin board (``OTCBB'') and pink sheets, are
not subject to any price test restrictions wherever traded.
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    In 2004, we adopted Rule 202T of Regulation SHO,\12\ which
established procedures for the Commission to temporarily suspend price
tests so that the Commission could study the effectiveness of these
tests.\13\ Pursuant to the process established in Rule 202T of
Regulation SHO, we issued an order (``First Pilot Order'') creating a
one year pilot (``Pilot'') temporarily suspending the provisions of
Rule 10a-1(a) and any price test of any exchange or national securities
association for short sales of certain securities.\14\
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    \12\ 17 CFR 242.202T.
    \13\ See id.; see also Exchange Act Release No. 50103 (July 28,
2004), 69 FR 48008, 48012-48013 (Aug. 6, 2004) (``Regulation SHO
Adopting Release'').
    \14\ Exchange Act Release No. 50104 (July 28, 2004), 69 FR 48032
(Aug. 6, 2004). Specifically, the First Pilot Order suspended price
tests for: (1) Short sales in the securities identified in Appendix
A to the First Pilot Order; (2) short sales in the securities
included in the Russell 1000 index effected between 4:15 p.m. EST
and the open of the consolidated tape on the following day; and (3)
short sales in any security not included in paragraphs (1) and (2)
effected in the period between the close of the consolidated tape
and the open of the consolidated tape on the following day. In
addition, the First Pilot Order provided that the Pilot would
commence on January 3, 2005 and terminate on December 31, 2005, and
that the Commission might issue further orders affecting the
operation of the First Pilot Order. Id. at 48033. On November 29,
2004, we issued an order resetting the Pilot to commence on May 2,
2005 and end on April 28, 2006 to give market participants
additional time to make systems changes necessary to comply with the
Pilot. Exchange Act Release No. 50747 (Nov. 29, 2004), 69 FR 70480
(Dec. 6, 2004). On April 20, 2006, we issued an order (``Third Pilot
Order'') extending the termination date of the Pilot to August 6,
2007, the date on which temporary Rule 202T of Regulation SHO
expires. Exchange Act Release No. 53684 (April 20, 2006), 71 FR
24765 (April 26, 2006). The purpose of the Third Pilot Order was to
maintain the status quo with regard to price tests for Pilot
securities while the staff completed its analysis of the Pilot data
and the Commission conducted any additional short sale rulemaking.
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    The Pilot was designed to assist the Commission in assessing
whether changes to current short sale regulation are necessary in light
of current market practices and the purposes underlying short sale
regulation.\15\ The Commission stated in the Regulation SHO Adopting
Release that conducting a pilot pursuant to Rule 202T would ``allow us
to obtain data on the impact of short selling in the absence of a price
test to assist in determining, among other things, the extent to which
a price test is necessary to further the objectives of short sale
regulation, to study the effects of relatively unrestricted short
selling on market volatility, price efficiency, and liquidity, and to
obtain empirical data to help assess whether a price test should be
removed, in part or in whole, for some or all securities, or if
retained, should be applied to additional securities.'' \16\ As noted
in the Regulation SHO Adopting Release, the empirical data from the
Pilot was to be obtained and analyzed ``as part of [the Commission's]
assessment as to whether the price test should be removed or modified,
in part or whole, for actively-traded securities or other securities.''
\17\
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    \15\ 69 FR at 48032.
    \16\ Regulation SHO Adopting Release, 69 FR at 48009.
    \17\ Id. at 69 FR at 48013. In the Regulation SHO Adopting
Release we noted that ``the purpose of the [P]ilot is to assist the
Commission in considering alternatives, such as: (1) Eliminating a
Commission-mandated price test for an appropriate group of
securities, which may be all securities; (2) adopting a uniform bid
test, and any exceptions, with the possibility of extending a
uniform bid test to securities for which there is currently no price
test; or (3) leaving in place the current price tests.'' Id. at 69
FR at 48010.
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    Thus, the Commission's Office of Economic Analysis (``OEA'')
gathered the data made public during the Pilot, analyzed this data and
provided the Commission with a summary report on the Pilot.\18\ The OEA
Staff's Summary Pilot Report examined several aspects of market quality
including the overall effect of price tests on short selling,
liquidity, volatility and price efficiency. The Pilot data was also
designed to allow the Commission and members of the public to examine
whether the effects of price tests are similar across stocks.\19\
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    \18\ See Office of Economic Analysis U.S. Securities and
Exchange Commission, Economic Analysis of the Short Sale Price
Restrictions Under the Regulation SHO Pilot (Feb. 6, 2007) (the
``OEA Staff's Summary Pilot Report''), available at  https://www.sec.gov/news/studies/2007/regshopilot020607.pdf.
 See also Office

of Economic Analysis U.S. Securities and Exchange Commission,
Economic Analysis of the Short Sale Price Restrictions Under the
Regulation SHO Pilot (Sept. 14, 2006) (the ``OEA Staff's Draft
Summary Pilot Report''), available at http://www.sec.gov/about/economic/shopilot091506/draft_reg_sho_pilot_report.pdf.
 Prior to

the publication of the Proposing Release, OEA made available on the
Commission's Internet Web site, the OEA Staff's Draft Summary Pilot
Report. The conclusions reached in the OEA Staff's Summary Pilot
Report do not differ from those in the OEA Staff's Draft Summary
Pilot Report.
    \19\ In the Regulation SHO Adopting Release, the Commission
stated its expectation that data on trading during the Pilot would
be made available to the public to encourage independent researchers
to study the Pilot. See Regulation SHO Adopting Release, 69 FR at
48009, n.9. Accordingly, nine SROs began publicly releasing
transactional short selling data on January 3, 2005. The nine SROs
were the AMEX, ARCA, BSE, CHX, NASD, Nasdaq, National Stock
Exchange, NYSE and Phlx. The SROs agreed to collect and make
publicly available trading data on each executed short sale
involving equity securities reported by the SRO to a securities
information processor. The SROs publish the information on a monthly
basis on their Internet Web sites.
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    In addition, the Commission encouraged outside researchers to
examine the Pilot. In response to this request, the Commission received
four completed studies (the ``Academic Studies'') from outside
researchers that specifically examine the Pilot data.\20\ The
Commission also held a public roundtable (the ``Regulation SHO
Roundtable'') that focused on the empirical evidence learned from the
Pilot data (the OEA Staff's Draft Summary Pilot Report, Academic
Studies, and Regulation SHO Roundtable are referred to collectively
herein as, the ``Pilot Results'').\21\ The Pilot Results contained a
variety of observations, which we considered in determining whether or
not to propose removal of current price test restrictions and whether
to adopt the amendments today. Generally, the Pilot Results supported
removal of current price test restrictions.\22\
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    \20\ See Karl Diether, Kuan Hui Lee and Ingrid M. Werner, It's
SHO Time! Short-Sale Price-Tests and Market Quality, June 20, 2006;
Gordon J. Alexander and Mark A. Peterson, The Effect of Price Tests
on Trader Behavior and Market Quality: An Analysis of Reg. SHO
(forthcoming in Journal of Financial Markets); J. Julie Wu, Uptick
Rule, short selling and price efficiency, August 14, 2006; Lynn Bai,
The Uptick Rule of Short Sale Regulation--Can it Alleviate Downward
Price Pressure from Negative Earnings Shocks? 2006 (``Bai'').
    \21\ A transcript from the roundtable (``Roundtable
Transcript'') is available at http://www.sec.gov/about/economic/shopilottrans091506.pdf
.

    \22\ See Proposing Release, 71 FR at 75072-75075 (discussing the
Pilot Results).
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    Based on our review of the Pilot Results and of the status of
current price test restrictions, we proposed to remove Rule 10a-1 and
add Rule 201 of Regulation SHO to provide that no price test, including
any price test of any SRO, shall apply to short sales in any security.
Rule 201 would also prohibit any SRO from having a price test. In
addition, because we proposed to remove all current price test
restrictions,

and prohibit any price test by any SRO, we proposed to amend Rule
200(g) of Regulation SHO to remove the requirement that a broker-dealer
mark a sell order of an equity security as ``short exempt'' if the
seller is relying on an exception from the price test of Rule 10a-1, or
any price test of any exchange or national securities association.

II. Removal of Price Test Restrictions

    We proposed to remove Rule 10a-1 and add Rule 201 of Regulation SHO
to provide that no price test, including any price test of any SRO,
shall apply to short sales in any security. In addition, we proposed to
prohibit any SRO from having a price test. We are adopting the
amendments, as proposed.

A. Comments Summary

    The comments on the proposed amendments varied. Most commenters
(including individual traders, academics, broker-dealers, MFA, STA,
NYSE, and SIFMA) advocated removing all price test restrictions.\23\
These commenters believe that price test restrictions are no longer
necessary in today's markets, which are more transparent and where
there is real-time regulatory surveillance that can easily monitor for
and detect any short sale manipulation.\24\ In addition, these
commenters noted that market developments, such as technological
innovations and decimalization, have transformed the trading landscape
since Rule 10a-1 was first adopted and has changed the impact of price
test restrictions.\25\
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    \23\ See, e.g., letter from Howard Teitelman, CSO, Trillium
Trading (Feb. 6, 2007) (``Teitelman Letter''); letter from S. Kevin
An, Deputy General Counsel, E*TRADE (Feb. 9, 2007) (``E*TRADE
Letter''); letter from Carl Giannone (Feb. 11, 2007) (``Giannone
Letter''); letter from David Schwarz (Feb. 12, 2007) (``Schwarz
Letter''); letter from John G. Gaine, President, MFA (Feb. 12, 2007)
(``MFA Letter''); letter from Lisa M. Utasi, Chairman of the Board
and John C. Giesea, President and CEO, STA (Feb. 12, 2007) (``STA
Letter''); letter from Gerard S. Citera, Executive Director, U.S.
Equities, UBS (Feb. 14, 2007) (``UBS Letter''); letter from Mary
Yeager, Assistant Secretary, NYSE (Feb. 14, 2007) (``NYSE Letter'');
letter from James J. Angel, PhD, CFA, Associate Professor of
Finance, McDonough School of Business, Georgetown University (Feb.
14, 2007) (``Angel Letter''); letter from Ira D. Hammerman, SIFMA
Managing Director and General Counsel (Feb. 16, 2007) (``SIFMA
Letter'').
    \24\ See, e.g., Giannone Letter, supra note 23; E*TRADE Letter,
supra note 23; STA Letter, supra note 23; UBS Letter, supra note 23.
    \25\ See, e.g., MFA Letter, supra note 23.
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    In supporting the proposal, one commenter expressed its view that
``short selling enhances market liquidity and contributes to stock
pricing efficiency, and thus is an important part of our securities
markets, and that the existing restrictions on the execution prices of
short sales * * * inhibit the free-market price discovery mechanism of
an efficient market.'' \26\ In addition, this commenter noted the
significant financial, technology and human resources it expends on
ensuring compliance with price test restrictions.\27\ This commenter
believes that the compliance costs and loss of market benefits created
by short sales (such as, added liquidity and price efficiency) outweigh
any potential or theoretical regulatory benefits of price tests.\28\
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    \26\ E*TRADE Letter, supra note 23. See also, MFA Letter, supra
note 23 (stating that the MFA regards short selling as an essential
method by which investors, including fiduciaries managing others'
assets, can manage risk, hedge their portfolios, and reflect their
view that the current market price of a security is higher than it
should be).
    \27\ See E*TRADE Letter, supra note 23.
    \28\ See id. See also, UBS Letter, supra note 23 (noting that
there are substantial programming, implementation, and ongoing
compliance costs associated with maintaining price test
restrictions).
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    In expressing its support for prohibiting SROs from having their
own price tests, SIFMA noted that without this prohibition SROs ``could
feel pressured to maintain a price test as a marketing tool for
attracting issuer listings. This would lead to an environment, as
exists today, where there would be disparate price tests, or even no
price test, depending on the market on which a security trades. Such a
result imposes unnecessary compliance costs upon broker-dealers
(without also providing real benefits to investors) and leads to
regulatory arbitrage.'' \29\
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    \29\ SIFMA Letter, supra note 23. See also, E*TRADE Letter,
supra note 23 (commenting that allowing SROs to have their own price
tests would increase compliance and systems change costs to market
participants, including broker-dealers executing customer short
sales). In addition, in its letter, SIFMA commented that allowing
SROs to have their own price tests could raise best execution
concerns for broker-dealers determining how best to route short sale
orders, i.e., in that a broker-dealer would need to consider whether
to route short sale orders received to a market that has a price
test, as opposed to a market which does not and which could thus
perhaps provide a faster execution. See SIFMA Letter, supra note 23.
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    Similarly, the STA commented that eliminating price test
restrictions and prohibiting SROs from implementing the same would
eliminate regulatory arbitrage in short sale regulation and would allow
marketplaces to compete with each other on the basis of execution
quality, rather than on regulatory disparities, which it believes,
would increase public investor confidence in the markets.\30\ The NYSE
stated its belief that all equity markets should be regulated equally,
noting that ``[i]t is inappropriate that the federal securities laws,
through the application of Rule 10a-1, requires trading of NYSE-listed
securities to be held to a different standard than those listed on
other markets.'' \31\ The NYSE further noted that it believes the
``practical effect of the proposed amendments will be to level the
playing field in the area of short sales and establish a more
consistent and uniform regulatory regime across all markets.'' \32\
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    \30\ See STA Letter, supra note 23.
    \31\ NYSE Letter, supra note 23.
    \32\ Id.
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    Two commenters (both individual investors) opposed the proposed
amendments noting the need for price tests to prevent ``bear raids.''
\33\ Other commenters (including individual traders and E*Trade),
however, noted that sharp market declines, such as those induced by
``bear raids,'' are highly unlikely to occur in today's markets which
are characterized by much smaller spreads, higher liquidity, and
greater transparency than when the rule was adopted almost 70 years
ago.\34\
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    \33\ See, e.g., letter from Jim Ferguson (Dec. 19, 2006);
letters from David Patch (Jan. 1, 2007; Jan. 12, 2007) (``Patch
Letters''). A ``bear raid'' involves the active selling of a
security short to drive down the security's price in the hopes of
convincing less informed investors of a negative material perception
of the security, triggering sell orders. Falling prices could
trigger margin calls and possibly forced liquidations of the
security, depressing the price further. This unrestricted short
selling could exacerbate a declining market in a security by
eliminating bids, and causing a further reduction in the price of a
security by creating an appearance that the security's price is
falling for fundamental reasons. At the time, many people blamed
``bear raids'' for the 1929 stock market crash and the market's
prolonged inability to recover from the crash. See 8 Louis Loss &
Joel Seligman, Securities Regulations, section 8-B-3 (3d ed. 2006).
    \34\ See, e.g., E*Trade Letter, supra note 23; Giannone Letter,
supra note 23; Schwarz Letter, supra note 23. In addition, we note
that panelists at the Regulation SHO Roundtable stated the belief
that price test restrictions do not provide protection from bear
raids. See Roundtable Transcript.
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    One commenter, although generally in support of removing all price
test restrictions, believes that at some level unrestricted short
selling should be collared.\35\ This commenter supported having a 10%
circuit breaker to prevent panic in the event there is a major market
collapse.\36\ The NYSE also noted its concern about unrestricted short
selling during periods of unusually rapid and large market declines.
This commenter stated that the effects of an unusually rapid and large
market decline could not be measured or analyzed during the Pilot
because such decline did not occur during the period studied.
Accordingly, the NYSE commented that it believes SROs should be
permitted to propose rules to be

applied in such situations should they deem it appropriate.\37\
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    \35\ See Giannone Letter, supra note 23.
    \36\ See id.
    \37\ See NYSE Letter, supra note 23. The NYSE also noted that it
believes that SROs should be permitted to maintain existing rules
consistent with this concept, such as NYSE Rule 80(A)(a) (requiring
the entry of any index arbitrage order to sell any component stock
of the S&P 500 Stock Price IndexSM with the instruction
``sell plus'' on any trading day when the NYSE Composite
Index[supreg] declines below its closing value on the prior trading
day by at least the ``two-percent'' value, as calculated according
to the methodology found in NYSE Rule 80A.10). See id.
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    As an alternative to removing all price test restrictions, one
commenter suggested extending the Pilot to include more securities to
better evaluate the benefits of completely eliminating current price
test restrictions.\38\ Another commenter, the IASBDA, noted that while
it believes that the staff makes a compelling case for the removal of
price test restrictions for the Russell 3000 securities, it fails to
address whether the issuers of other securities should have some choice
in whether they want their stock subject to a price test.\39\ IASBDA
commented that ``[b]y insisting that it must be all or none the staff
may unnecessarily force small issuers to accept an environment which is
most unkind to their securities.'' \40\ Furthermore, IASBDA criticized
the Pilot for not including OTCBB stocks and other small stocks.\41\
This commenter noted that ``[t]he Russell 3000 is a broad based index
in terms of capitalization but there are roughly 9000 stocks in the
publicly reporting universe. The Russell 3000 Index offers investors
access to the broad U.S. equity universe representing approximately 98%
of the U.S. market, but roughly 33% of individual stocks. The SEC's
Advisory Committee Report on Small Public Companies Final report
concluded there were 9,428 companies listed including the OTCBB. Report
at p.5.'' \42\ Thus, IASBDA stated that there may be an argument for
phasing in the elimination by starting with the larger stocks and
concluding with the OTCBB and smaller segments of the market. IASBDA
suggested that this methodology might allow the Commission to learn
something from its observance of the large stocks without a tick
test.\43\
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    \38\ See Teitelman Letter, supra note 23.
    \39\ See letter from Peter Chepucavage, General Counsel, Plexus
Consulting, on behalf of International Association of Small Broker-
Dealers and Advisors (Dec. 19, 2006) (``IASBDA Letter'').
    \40\ Id.
    \41\ Id.
    \42\ Id.
    \43\ See id.
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    Similarly, Amex believes that it is premature to remove price tests
from smaller securities pending further analysis.\44\ In its comment
letter, Amex stated that it has ``noted numerous statements in the
Proposing Release, the OEA Staff's Draft Summary Pilot Report, and the
Roundtable Transcript that suggest that the impact of eliminating short
sale price tests may differ between large capitalization and small
capitalization securities. Such a differential impact would obviously
be of great concern to the Amex, which has a large concentration of
small capitalization issuers.'' \45\ Thus, Amex commented that while it
is not suggesting that price test restrictions be extended to
additional securities, nor is it adamantly opposing the ultimate
removal of price test restrictions from small capitalization securities
to which price tests currently apply, it is advocating additional study
before such action is taken in connection with small capitalization
securities.\46\
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    \44\ See letter from Claire P. McGrath, Senior Vice President
and General Counsel, Amex (Feb. 16, 2007) (``Amex Letter'').
    \45\ Id.
    \46\ See id.
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    We noted in the Proposing Release that in connection with the
Pilot, nine reporting markets have been making public information about
short selling transactions,\47\ and we requested comment regarding
whether it would be in the public interest to request that markets
continue to release this information.\48\ In response, the NYSE
expressed its objection to the Commission continuing to require the
markets to collect and make this information publicly available, noting
that collecting and producing such information has proven to be costly
and time-consuming.\49\ The MFA commented that it believes such
information should only be made available to law enforcement
authorities.\50\ Another commenter, however, urged the Commission to
work with the SROs to ensure that data similar to that made publicly
available during the Pilot, continues to be available to researchers
after the Pilot.\51\
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    \47\ See Proposing Release, 71 FR at 75069; see also, supra note
19.
    \48\ See Proposing Release, 71 FR at 75077. Specifically, we
sought comment regarding whether requesting the markets to continue
to release such information would improve transparency of short
selling. In addition, we asked whether it would help the Commission
monitor the markets for potential abuses if the Commission were to
approve the removal of price tests. We also asked for comment
regarding how costly it would be for the markets to continue to
produce the data and whether there are any less costly alternatives
to the current information being released by the markets.
    \49\ See NYSE Letter, supra note 23.
    \50\ See MFA Letter, supra note 23. The MFA commented that it is
``concerned that public transactional short selling data may fuel
frivolous issuer lawsuits against market participants with a
legitimate but different view of the value of an issuer's
securities.'' Id.
    \51\ See Angel Letter, supra note 23.
---------------------------------------------------------------------------

    In its letter, the NYSE stated that it believes that ``the stated
purpose for publicly releasing such data during the pilot--i.e.,
encouraging independent researchers to study the pilot's effects--has
already been successfully accomplished, as evidenced by the academic
studies published and public roundtable held concerning the results of
the pilot data.'' \52\ The NYSE also did not believe that we should
request that the SROs submit periodic reports regarding the effects of
the removal of price test restrictions at regular intervals, such as on
a semi-annual or annual basis, stating that such a requirement, in
addition to collecting and making publicly available data on short sale
transactions, would ``greatly exacerbate costs.'' \53\
---------------------------------------------------------------------------

    \52\ NYSE Letter, supra note 23.
    \53\ See id.
---------------------------------------------------------------------------

B. Response to Comments

    We have carefully considered all the comments we received regarding
the proposed amendments. In particular, we note the comments regarding
the need for price test restrictions to prevent the use of short
selling to drive down the market in ``bear raids.'' One of the
Commission's stated objectives when it adopted Rule 10a-1 in 1938 was
to prevent short sellers from accelerating a declining market by
exhausting all remaining bids at one price level, causing successively
lower prices to be established by long sellers.\54\ In addition, in the
Proposing Release, we noted that although short selling serves useful
market purposes, such as increasing market liquidity and price
efficiency, it also may be used to illegally manipulate stock
prices.\55\ Because of the Commission's stated objective when it
adopted Rule 10a-1 and our concerns about the potential use of short
sales to manipulate stock prices, OEA examined the Pilot data for any
indication that there is an association between extreme price movements
and price test restrictions. OEA, however, did not find any such
association.\56\ We also note that although we are removing current
price test restrictions, today's markets are characterized by high
levels of transparency and regulatory surveillance. These
characteristics greatly reduce the risk of undetected manipulation and
permit regulators to

monitor for the types of activities that current price test
restrictions are designed to prevent. In addition, we note that the
general anti-fraud and anti-manipulation provisions of the federal
securities laws continue to prohibit activity designed to improperly
influence the price of a security.\57\
---------------------------------------------------------------------------

    \54\ See Exchange Act Release No. 13091 (Dec. 21, 1976), 41 FR
56530 (Dec. 28, 1976).
    \55\ See Proposing Release, 71 FR at 75070.
    \56\ See OEA Staff's Summary Pilot Report at 56, supra note 18.
    \57\ See, e.g., Securities Act of 1933 Section 17(a), Exchange
Act Section 9(a), 10(b), and 15(c), and Rule 10b-5 thereunder.
---------------------------------------------------------------------------

    In addition, with respect to comments regarding the Commission
allowing SROs to adopt price test restrictions in the event of
unusually rapid and large market declines, we have determined not to
take such action at this time.\58\ We believe that allowing SROs to
adopt price test restrictions under such circumstances could undermine
a primary objective of the proposed amendments of achieving regulatory
uniformity and simplicity.\59\ For the same reasons, we do not believe
that we should implement a circuit breaker for short sales at this
time.
---------------------------------------------------------------------------

    \58\ See NYSE Letter, supra note 23.
    \59\ We note, however, that Section 12(k)(2) of the Exchange Act
provides that the Commission, ``in an emergency, may by order
summarily take such action to alter, supplement, suspend, or impose
requirements or restrictions with respect to any matter or action
subject to regulation by the Commission or a self-regulatory
organization under the securities laws, as the Commission determines
is necessary in the public interest and for the protection of
investors (i) to maintain or restore fair and orderly securities
markets (other than markets in exempted securities); (ii) to ensure
prompt, accurate, and safe clearance and settlement of transactions
in securities (other than exempted securities); or (iii) to reduce,
eliminate, or prevent the substantial disruption by the emergency of
(I) securities markets (other than markets in exempted securities),
investment companies, or any other significant portion or segment of
such markets, or (II) the transmission or processing of securities
transactions (other than transactions in exempted securities).'' In
addition, SROs may also continue to have rules consistent with the
concept of circuit breakers.
---------------------------------------------------------------------------

    We note, however, that pursuant to Section 36 of the Exchange Act,
in the future the Commission could determine that circumstances have
arisen that justify the issuance of an exemption from the provisions of
Rule 201.\60\ Should an SRO request the Commission issue such an
exemption in conjunction with the filing of an SRO proposed rule change
to establish a price test restriction, when considering any such
request, the Commission would consider, among other things, whether the
proposed rule change is consistent with the objectives of today's
amendments of providing regulatory simplicity and consistency. In
addition, to issue an exemption pursuant to Section 36, the Commission
would have to find that such an exemption is necessary or appropriate
in the public interest, and is consistent with the protection of
investors.\61\
---------------------------------------------------------------------------

    \60\ See 15 U.S.C. 78mm.
    \61\ See id.
---------------------------------------------------------------------------

    In response to IASBDA's comment regarding allowing issuers to have
a choice as to whether or not they want their stock to be subject to a
price test, we have determined not to take such action at this time. A
primary goal of the amendments is to bring uniformity to, and simplify,
short sale regulation. To allow issuers to have a choice as to whether
or not their stock is subject to a price test would undermine this
primary objective. In addition, we note that in the Proposing Release
we specifically requested comment from issuers regarding their views of
the impact of the proposed amendments on their securities.\62\ We did
not, however, receive any comments from issuers.\63\
---------------------------------------------------------------------------

    \62\ See Proposing Release, 71 FR at 75076.
    \63\ We note that the IASBDA is an advocacy group for small
broker-dealers and advisers (including lawyers and hedge funds).
---------------------------------------------------------------------------

    In addition, with respect to IASBDA's comment regarding the
universe of securities subject to the Pilot and, in particular, that
the Pilot did not include securities quoted on the OTCBB, we note that
the Pilot did not include this class of securities because securities
quoted on the OTCBB are not currently subject to any price test
restrictions.
    Both the IASBDA and Amex suggested removing price tests from larger
securities first to allow time to study the impact of the permanent
removal of price test restrictions before such action is taken for
smaller securities. We do not believe that such an approach would
provide new results relevant to smaller securities.\64\ As we noted in
the Proposing Release, while there is some evidence supporting the
application of price test restrictions to smaller securities, the
evidence is not strong enough to warrant the continuation of current
price test restrictions to any subset of securities.\65\ Such
continuation would also undermine a primary goal of these amendments of
providing greater uniformity and simplicity to short sale regulation.
---------------------------------------------------------------------------

    \64\ See IASBDA Letter, supra note 39; Amex Letter, supra note
44. We note that many smaller or thinly-traded securities, such as
Nasdaq Capital Market securities and securities quoted on the OTCBB
and pink sheets, are not currently subject to any price test
restrictions.
    \65\ See Proposing Release, 71 FR at 75076. In addition, we note
that academics have previously examined short selling in a matched
sample of Nasdaq National Market stocks, which were subject to price
test restrictions, and Nasdaq SmallCap stocks, which were not,
during a period of high volatility and rapidly declining stock
prices (September 2000 to August 2001). In this study's sample of
2,275 observations, the study found no significant differences in
the overall level of short selling, or the frequency of days with
abnormally negative returns and abnormally high short selling. See
Michael G. Ferri, Stephen E. Christophe, and James J. Angel, A short
look at bear raids: Testing the bid test, 2004.
---------------------------------------------------------------------------

    In connection with whether we should request that SROs continue to
make public information regarding short sale transactions similar to
that obtained during the Pilot, we note that the SROs have provided
such information during the Pilot at our request so that researchers
could provide the Commission with their own empirical analyses of the
Pilot.\66\ We have determined at this time not to propose to require
the SROs to make information similar to that obtained during the Pilot
publicly available on a regular basis.
---------------------------------------------------------------------------

    \66\ See Regulation SHO Adopting Release, 69 FR at 48009.
---------------------------------------------------------------------------

    With respect to whether the SROs should submit periodic reports
regarding the effects of the removal of price tests, and in response to
commenters concerns that traders may have been on ``good behavior''
during the Pilot,\67\ we note that while we believe that current price
test restrictions are no longer effective or necessary, we intend to
closely monitor for potentially abusive trading activities. We expect
that the markets will similarly continue to surveil for trading abuses.
To the extent we obtain evidence of possible violations of the federal
securities laws, we will pursue investigations and law enforcement
actions as warranted.
---------------------------------------------------------------------------

    \67\ For example, in its letter, Amex noted a comment by OEA in
the OEA Staff's Draft Summary Pilot Report that it is possible that
traders might behave differently if a rule were permanently and
completely removed than if it is only temporarily and incompletely
removed, and that traders with manipulative intentions might be on
good behavior if they believe that heightened scrutiny during the
Pilot increases their chances of getting caught. See Amex Letter,
supra note 44.
---------------------------------------------------------------------------

    We have carefully considered the comments and continue to believe
that the amendments are appropriate in light of market developments
that have occurred in the securities industry since the Commission
adopted Rule 10a-1 in 1938, such as decimalization, the increased use
of matching systems that execute trades at independently derived prices
during random times within specific time intervals, and, most recently,
the spread of fully automated markets. We believe the amendments will
bring increased uniformity to short sale regulation, level the playing
field for market participants, and remove an opportunity for regulatory
arbitrage.
    In addition, we note that only one commenter questioned the
economic evidence supporting the amendments, but we believe that the
critique is

inapplicable.\68\ The Pilot was designed to assist the Commission in
assessing whether changes to current short sale regulation are
necessary in light of current market practices and the purposes
underlying price test regulation.\69\ During the comment period, we
received one additional study examining the results of the Pilot.\70\
This study found results that are consistent with other Pilot studies
previously submitted to, and discussed by, the Commission, which
generally found that current price test restrictions do not enhance
market quality.\71\
---------------------------------------------------------------------------

    \68\ One commenter expressed concern about the methodologies
used in the Pilot studies. See Patch Letters, supra note 33 (stating
that ``the methods in which the OEA conducted their analysis
(specifically the duration of time) is flawed. Bear raids do not
last for months but over days or weeks and such analysis by the OEA,
looking over large windows of time without looking at micro trading,
is a flawed approach''). But see, OEA Staff's Summary Pilot Report
at 9, supra note 18 (stating that OEA focused its investigation on
price patterns that might indicate manipulative behavior at a daily
or intraday frequency). In addition, we note that panelists from the
Regulation SHO Roundtable were asked to critique the studies and all
panelists generally agreed with the results. See Roundtable
Transcript at 49-57, 72-80, supra note 21.
    \69\ 69 FR at 48032. See also, Proposing Release, 71 FR at
75068-75069, 75072-75073 (discussing the Pilot and the Pilot
Results).
    \70\ See Bai, supra note 20. See also, OEA Staff's Summary Pilot
Report at 85, supra note 18.
    \71\ Bai found that the Pilot had no effect on stock price
reactions to negative earnings shocks. See Bai, supra note 20. See
also, Proposing Release, 71 FR at 75072-75075 (discussing the Pilot
Results).
---------------------------------------------------------------------------

    Thus, after carefully considering the comments received, we are
adopting the amendments, as proposed.

III. Removal of ``Short Exempt'' Marking Requirement

    Because we proposed to remove Rule 10a-1 and prohibit any SRO from
having a price test, we also proposed to amend Rule 200(g) of
Regulation SHO \72\ to remove the requirement that a broker-dealer mark
a sell order of an equity security as ``short exempt'' if the seller is
relying on an exception from the tick test of Rule 10a-1, or any price
test of any exchange or national securities association.\73\ We are
adopting the amendment as proposed.
---------------------------------------------------------------------------

    \72\ 17 CFR 242.200(g).
    \73\ Broker-dealers would, however, continue to be required to
mark sell orders as either ``long'' or ``short'' in compliance with
Rule 200(g).
---------------------------------------------------------------------------

    Rule 200(g) of Regulation SHO provides that a broker-dealer must
mark all sell orders of any security as ``long,'' ``short,'' or ``short
exempt.'' \74\ Further, Rule 200(g)(2) of Regulation SHO provides that
a short sale order must be marked ``short exempt'' if the seller is
``relying on an exception from the tick test of 17 CFR 240.10a-1, or
any short sale price test of any exchange or national securities
association.'' \75\ The ``short exempt'' marking requirement provides a
record that short sellers are availing themselves of the various
exceptions to, or exemptions from, the application of the restrictions
of Rule 10a-1 or of any price test of any exchange or national
securities association.
---------------------------------------------------------------------------

    \74\ See 17 CFR 242.200(g).
    \75\ See id. at 242.200(g)(2).
---------------------------------------------------------------------------

A. Comments Summary

    We received five comment letters, from the MFA, STA, UBS, NYSE, and
SIFMA in response to the proposed amendment.\76\ Generally, the
commenters supported the Commission's proposal to remove the `short
exempt' marking requirement.\77\
---------------------------------------------------------------------------

    \76\ See MFA Letter, supra note 23; STA Letter, supra note 23;
UBS Letter, supra note 23; NYSE Letter, supra note 23; SIFMA Letter,
supra note 23.
    \77\ See MFA Letter, supra note 23; STA Letter, supra note 23;
UBS Letter, supra note 23. In its letter, the MFA noted that it
believes broker-dealers are in the best position to raise compliance
issues related to their systems and the ``short exempt'' marking
requirement. Thus, the MFA urged the Commission to carefully
consider any compliance concerns raised by broker-dealers in
considering this proposal. See MFA Letter, supra note 23.
---------------------------------------------------------------------------

    Although the STA stated that it supports the proposal to remove the
``short exempt'' marking requirement in Regulation SHO, the STA
commented that it believes that securities currently marked ``short
exempt'' pursuant to Rule 203(b)(2)(ii) of Regulation SHO \78\ should
be marked ``long'' rather than ``short'' because marking such orders
``short'' ``does not accurately describe the customer's ownership of
the same and could cause confusion and anger from public investors when
they receive confirmation of the sale of a security they understood
they owned.'' \79\ Similarly, SIFMA commented that its member firms
would encourage the Commission to amend the definition of a ``long''
sale to include these types of sales ``to avoid unintended consequences
and mistaken perceptions by issuers and others as to the nature of the
sale.'' \80\
---------------------------------------------------------------------------

    \78\ 17 CFR 242.203(b)(2)(ii). Rule 203(b)(2)(ii) of Regulation
SHO excepts from the locate requirement of Regulation SHO any sale
of a security that a person is deemed to own pursuant to Rule 200 of
Regulation SHO, provided that the broker-dealer has been reasonably
informed that the person intends to deliver such security as soon as
all restrictions on delivery have been removed. If the person 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. Such circumstances could include the situation where a
convertible security, option, or warrant has been tendered for
conversion or exchange, but the underlying security is not
reasonably expected to be received by settlement date. Another
situation could be where a customer owns stock that was formerly
restricted, but pursuant to Rule 144 under the Securities Act of
1933, the security may be sold without restriction. In connection
with the sale of such security, the security may not be capable of
being delivered on settlement date due to processing to remove the
restricted legend.
    \79\ STA Letter, supra note 23.
    \80\ SIFMA Letter, supra note 23.
---------------------------------------------------------------------------

    In addition, SIFMA commented that rather than removing the ``short
exempt'' marking requirement, SIFMA firms generally would prefer that
the Commission preserve the ``short exempt'' marking requirement,
specifically amending Regulation SHO to indicate that a sale should be
marked ``short exempt'' if effected in reliance on an exception from
the ``locate'' requirement, pursuant to Rule 203(b)(2) of Regulation
SHO.\81\ According to SIFMA, firms ``generally are of the view that
preserving ``short exempt'' marking for such situations should assist
their compliance efforts by identifying short sales for which a locate
is not required to be obtained.'' \82\
---------------------------------------------------------------------------

    \81\ Id. Rule 203(b)(2) provides an exception from the locate
requirement of Rule 203(b)(1) for: ``(i) A broker or dealer that has
accepted a short sale order from another registered broker or dealer
that is required to comply with paragraph (b)(1) of this section,
unless the broker or dealer relying on this exception contractually
undertook responsibility for compliance with paragraph (b)(1) of
this section; (ii) Any sale of a security that a person is deemed to
own pursuant to Sec.  242.200, provided that the broker or dealer
has been reasonably informed that the person intends to deliver such
security as soon as all restrictions on delivery have been removed.
If the person 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; (iii) Short sales effected by a market
maker in connection with bona-fide market making activities in the
security for which this exception is claimed; and (iv) Transactions
in security futures.''
    \82\ SIFMA Letter, supra note 23. SIFMA noted in its letter
that, if the Commission decides not to amend the definition of a
``long'' sale in Rule 200(g) as suggested by SIFMA, it would
strongly urge the Commission to continue to allow firms to mark
sales ``short exempt,'' in reliance on the exception from the
Regulation SHO ``locate'' requirement in Rule 203(b)(2)(ii) of
Regulation SHO. Id. UBS also commented that we should retain the
``short exempt'' marking requirement to ``identify certain short
sale transactions as exempt from the affirmative determination
requirements for regulatory and compliance requirements.'' UBS
Letter, supra note 23.
---------------------------------------------------------------------------

    The MFA and NYSE responded to our request for comment in the
Proposing Release regarding whether, in the absence of price test
restrictions, the marking of sell orders would continue to need to be
transparent to market makers and specialists.\83\ Currently, to

facilitate the application of price test restrictions, market makers
and specialists receive information allowing them to distinguish short
sales from other sales.
---------------------------------------------------------------------------

    \83\ See Proposing Release, 71 FR at 75078. Specifically, in the
Proposing Release we stated that: ``To facilitate the application of
Rule 10a-1, NASD Rule 5100, and Nasdaq Rule 3350, market makers and
specialists receive information allowing them to distinguish short
sales from other sales. In other words, the information on whether
an order is marked ``long,'' ``short,'' or ``short exempt'' is made
transparent to market makers and specialists but not to other market
participants or the public. In the absence of price test
restrictions, would the marking of sell orders need to be
transparent to market makers and specialists? Would there be any
systems or market quality costs/benefits associated with not
revealing this information to specialists and market makers?''
---------------------------------------------------------------------------

    In its comment letter, the MFA stated that ``[i]n protecting the
confidentiality of customer orders and maintaining a level playing
field for all market participants, MFA supports the idea of availing
order marking information only to brokers preparing order tickets.''
\84\ The MFA believes that the ``best safeguard for maintaining the
integrity of order information is by limiting order marking information
to those necessary in carrying out compliance functions.'' \85\
---------------------------------------------------------------------------

    \84\ MFA Letter, supra note 23.
    \85\ Id.
---------------------------------------------------------------------------

    NYSE, on the other hand, expressed its belief that it is
``necessary that the overall short interest in a security, as well as
information on whether a particular sell order introduced to the
Exchange is long or short, continue to be transparent intra-day to
specialists in the securities in which they are registered.'' \86\ NYSE
noted that ``[f]or a specialist, making the correct determination
regarding the necessity of a dealer transaction at any given moment
includes an understanding of the general market conditions in a
particular security, including the actual or reasonably anticipated
needs of the market. The intra-day short interest position in a
security as well as whether particular orders are long or short are
critical pieces of information in the overall mix of factors that
combine to form the ``market'' in that security.'' \87\ The NYSE
believes that the absence of such information would result in poorer
overall market quality.\88\
---------------------------------------------------------------------------

    \86\ NYSE Letter, supra note 23.
    \87\ Id.
    \88\ See id.
---------------------------------------------------------------------------

B. Response to Comments

    We have carefully considered all the comments we received. In
response to the STA's and SIFMA's comments regarding revising the
definition of when an order should be marked ``long'' to include sales
of securities excepted from the locate requirement pursuant to Rule
203(b)(2)(ii) of Regulation SHO, we have determined not to take such
action at this time. Although these are sales of securities that a
person is ``deemed to own'' pursuant to Rule 200 of Regulation SHO,\89\
the securities will not be delivered in time for settlement of the
transaction and, therefore, we believe that such sales are more
appropriately marked as ``short'' rather than ``long'' sales.\90\
---------------------------------------------------------------------------

    \89\ 17 CFR 242.200(a)-(f).
    \90\ Regulation SHO provides that an order can only be marked
``long'' if the seller is deemed to own the security being sold
pursuant to paragraphs (a) through (f) of Rule 200 of Regulation SHO
and either: (i) The security to be delivered is in the physical
possession or control of the broker or dealer; or (ii) It is
reasonably expected that the security will be in the physical
possession or control of the broker or dealer no later than
settlement of the transaction. See 17 CFR 242.200(g). Thus,
Regulation SHO contemplates that only those sell orders that will be
available for delivery on settlement date can be marked ``long.''
---------------------------------------------------------------------------

    In addition, in response to STA's comment that the marking of these
orders as ``short'' does not accurately describe the customer's
ownership of the same and could cause confusion and anger from public
investors when they receive confirmation of the sale of a security they
understood they owned, we note that the order marking requirements are
to facilitate the surveillance and monitoring of compliance with other
provisions of Regulation SHO, such as the borrowing and delivery
requirements for long sales under Rule 203(a),\91\ and the locate
requirements for short sales under Rule 203(b).\92\ Regulation SHO does
not require that a broker-dealer reveal an order marking to its
customer. Nor do we believe at this time that it is necessary for a
customer to receive such information.
---------------------------------------------------------------------------

    \91\ 17 CFR 242.203(a).
    \92\ 17 CFR 242.203(b).
---------------------------------------------------------------------------

    In addition, we have determined not to retain the ``short exempt''
marking requirement or revise the definition of when an order should be
marked ``short exempt'' to include those circumstances in which a short
sale is excepted from the locate requirements of Rule 203(b)(2) of
Regulation SHO.\93\ The ``short exempt'' marking requirement has only
ever applied if the seller is relying on an exception from a price
test. It has never applied to sales that do not have to comply with the
locate requirement of Regulation SHO.\94\ Today's amendment to remove
the ``short exempt'' marking requirement is necessitated by the fact
that we are removing current price test restrictions and prohibiting
any SRO from having a price test. Thus, we do not believe that it is
appropriate at this time to re-define the order marking requirements of
Regulation SHO as suggested by commenters. We will, however, consider
separately whether further action in this area is necessary or
warranted.
---------------------------------------------------------------------------

    \93\ 17 CFR 242.203(b)(2).
    \94\ See id.
---------------------------------------------------------------------------

    With respect to the MFA's and NYSE's comments regarding the
transparency of order markings to market participants other than those
broker-dealers with responsibility for compliance with the marking
requirements of Regulation SHO, we have determined at this time to not
take any action to limit the transparency of order markings in this
way.\95\ We will continue, however, to review whether further action by
the Commission on this matter is necessary or warranted.
---------------------------------------------------------------------------

    \95\ Currently, which market participants are able to see the
marking for a sell order is established by SRO rule and varies among
the SROs.
---------------------------------------------------------------------------

    After carefully considering the comments received, we are adopting
the proposed amendment without modification.

IV. Other Comments

    We received eight comment letters from individual investors
discussing other provisions of Regulation SHO,\96\ most notably the
grandfather provision of that rule.\97\ In addition, these commenters
expressed concerns about naked short selling. This release discusses
amendments that will affect price tests and related marking
requirements only. They do not relate to other provisions of Regulation
SHO or naked short selling, which are the subject of other Commission
rulemaking.\98\
---------------------------------------------------------------------------

    \96\ See 17 CFR 242.200 et seq.
    \97\ See letter from Joan Oleary (Jan. 22, 2007); letter from
Candice Grant (Jan. 21, 2007); letter from Roland L. Pitts (Dec. 28,
2006); letter from Charles P. Bennett, M.D. (Jan. 18, 2007); letter
from Carlos Molina (Jan. 17, 2007); letter from Lars D. Roose (Feb.
11, 2007); letter from Hillary Thomas (Feb. 11, 2007); letter from
H. Glenn Bagwell, Jr. (Feb. 12, 2007). These comment letters relate
to File No. S7-12-06 regarding proposed amendments to Regulation SHO
and were considered in connection with that rulemaking.
    \98\ See Regulation SHO Amendments Proposing Release, 71 FR
41710; see also, supra n.[6].
---------------------------------------------------------------------------

V. Paperwork Reduction Act

    The adopted amendments to Regulation SHO impose a ``collection of
information'' within the meaning of the Paperwork Reduction Act of
1995;\99\ however, the collection of information is covered by the
approved collection for Exchange Act Rule 19b-4.\100\ Rule 201(a) of
Regulation SHO provides that no price test, including any price test of
any SRO, shall apply to short sales in any security. In addition, Rule
201(b) of Regulation SHO prohibits any SRO from having a price test.
Thus, to the extent that any SRO currently has a price test,

that SRO is required to amend its rules to comply with these amendments
to Regulation SHO. Any such amendments will need to be filed with the
Commission as proposed rule changes, pursuant to Section 19(b) of the
Exchange Act \101\ and Rule 19b-4 thereunder. This collection of
information, however, will be collected pursuant to Exchange Act Rule
19b-4 and, therefore, will not be a new collection of information for
purposes of the amendments.
---------------------------------------------------------------------------

    \99\ 44 U.S.C. 3501 et seq.
    \100\ 17 CFR 240.19b-4.
    \101\ 15 U.S.C. 78s(b).
---------------------------------------------------------------------------

VI. Consideration of Costs and Benefits of Proposed Amendments to Rule
10a-1 and Regulation SHO

    The Commission is sensitive to the costs and benefits that result
from our rules. Thus, in the Proposing Release, we solicited comments
related to the costs and benefits associated with the proposed
amendments.\102\ We explicitly requested that commenters provide
supporting empirical data for any positions advanced. In addition, we
specifically requested comment regarding the costs and benefits of
unrestricted short selling activity and any costs associated with
complying with the proposed amendments, if the Commission were to adopt
the proposed amendments. We also requested comment regarding any costs
relating to the removal of price test restrictions adopted by the SROs.
In addition, we requested comment on the potential costs for any
modification to both computer systems and surveillance mechanisms and
for information gathering, management, and recordkeeping systems or
procedures, as well as any potential benefits resulting from the
proposals for registrants, issuers, investors, brokers or dealers,
other securities industry professionals, regulators, and other market
participants.
    Four commenters, the STA, UBS, SIFMA, and Amex provided comments
related to the costs and benefits of the proposed rule amendments.\103\
We discuss these comment letters below.
---------------------------------------------------------------------------

    \102\ See Proposing Release, 71 FR at 75078-75079.
    \103\ See STA Letter, supra note 23; UBS Letter, supra note 23;
SIFMA Letter, supra note 23; Amex Letter, supra note 44.
---------------------------------------------------------------------------

A. Removal of Price Test Restrictions

1. Benefits
    In the Proposing Release, we solicited comment on any benefits that
could be realized if the Commission adopts the proposed amendments,
including both short-term and long-term benefits. In addition, we
solicited comment regarding benefits to market efficiency, pricing
efficiency, market stability, market integrity, and investor
protection. Only the STA submitted comments noting benefits of the
proposed amendments.\104\
    In its comment letter, the STA noted that it does not believe that
the proposed amendments would result in higher trading costs or wider
spreads.\105\ In addition, the STA stated that it believes the proposed
amendments would lead to a reduction in surveillance and compliance
costs.\106\
---------------------------------------------------------------------------

    \104\ See STA Letter, supra note 23.
    \105\ See id.
    \106\ See id.
---------------------------------------------------------------------------

    We believe that this is an appropriate time to remove existing
price test restrictions because current price test regulation is
inconsistent across markets, potentially creates an unlevel playing
field, allows for regulatory arbitrage and has not kept pace with the
types of trading systems and strategies currently used in the
marketplace. In addition, today's markets are characterized by high
levels of transparency and regulatory surveillance. These
characteristics greatly reduce the risk of undetected manipulation and
permit regulators to monitor for the types of activities that Rule 10a-
1 and other price tests are designed to prevent.
    We believe that the removal of current price test restrictions will
benefit market participants by providing market participants with the
ability to execute short sales in all securities in all market centers
without regard to price test restrictions. In addition, market centers
will be competing for executions on a level playing field because they
will not be affected by the existence or non-existence of price test
restrictions.
    We also believe that removing all current price test restrictions
is preferable to applying different tests in different markets, which
can require market participants to apply different rules to different
securities depending on which market the trade is executed. Thus, we
believe that the amendments will reduce confusion and compliance
difficulties for market participants.
    We also believe that the amendments will benefit exchanges and
other market centers because market participants will no longer be able
to select a market on which to execute a short sale based on the
applicability of price test restrictions. The amendments will remove a
competitive disadvantage purportedly experienced by some market centers
because market participants will no longer route orders to avoid
application of a market center's price test. Nor will market centers
that do not have a price test be able to use that factor to attract
order flow away from market centers that have a price test.
    In addition, the amendments will result in benefits associated with
systems and surveillance mechanisms because these systems and
mechanisms will no longer need to be programmed to account for price
test restrictions based on last sale and last bid information. We also
note that in the absence of price test restrictions, new staff
(compliance personnel, associated persons, etc.) will no longer need to
be trained regarding rules relating to price tests. Over the long run,
we believe this will likely lead to decreased training and compliance
costs for market participants.
    We also believe that the amendments will lead to a reduction in
costs because market participants and their lawyers, both in-house and
outside counsel, will no longer need to make either informal (phone
calls) or formal (letters) requests for exemptions from Rule 10a-1.
    In addition, we anticipate that the removal of price test
restrictions may result in increased price efficiency because prices
will be determined by buy and sell interest, without any artificial
restraints on short selling.
2. Costs
    We recognize that the amendments may result in some costs to market
participants. As an aid to evaluating the costs of the proposed
amendments, we solicited comment in the Proposing Release. In
particular, we sought comment regarding the costs of the proposed
amendments to market participants, including broker-dealers and SROs,
related to systems changes to computer hardware and software,
reprogramming costs, and surveillance and compliance costs, including
whether these costs would be incurred on a one-time or ongoing
basis.\107\ Four commenters, the STA, UBS, SIFMA and Amex submitted
comments regarding costs associated with the proposed amendments.\108\
---------------------------------------------------------------------------

    \107\ See Proposing Release, 71 FR at 75079-75080.
    \108\ See STA Letter, supra note 23; UBS Letter, supra note 23;
SIFMA Letter, supra note 23; Amex Letter, supra note 44.
---------------------------------------------------------------------------

    In their comment letters, the STA, UBS and SIFMA noted potential
reprogramming costs that market participants may incur if the
Commission does not act on the proposed amendments prior to market
participants reprogramming their systems in response to the new
regulatory framework created by

Regulation NMS \109\ and the desire of investors and other market
participants for more automated and efficient trading services.\110\ On
January 24, 2007, we extended the date for all automated trading
centers (both SRO trading facilities and Alternative Display Facility
participants) to have fully operational Regulation NMS-compliant
trading systems to July 9, 2007 (the ``Regulation NMS Compliance
Date'').\111\ In meeting the Regulation NMS Compliance Date, market
participants have been developing new systems or modifying existing
systems to be Regulation NMS-compliant.
---------------------------------------------------------------------------

    \109\ See Exchange Act Release No. 51808 (June 9, 2005), 70 FR
37496 (June 29, 2005).
    \110\ See STA Letter, supra note 23; UBS Letter, supra note 23;
SIFMA Letter, supra note 23.
    \111\ See Exchange Act Release No. 55160 (Jan. 24, 2007), 72 FR
4202 (Jan. 30, 2007).
---------------------------------------------------------------------------

    In their comment letters, STA, UBS, and SIFMA urged the Commission
to act on the proposed amendments prior to the Regulation NMS
Compliance Date.\112\ In its letter, STA noted that ``[i]f the SEC's
proposal is implemented subsequent to the operation of Regulation NMS
to certain securities, it will require industry-wide reprogramming of
Regulation NMS compliance systems during the infancy of the Rules
implementation, a most sensitive time period. As a result, the
immediate success of Regulation NMS could be compromised.'' \113\ As
discussed in Section IX below, these amendments will be effective
immediately upon publication in the Federal Register. Thus, market
participants will have notice and time prior to the Regulation NMS
Compliance Date to reprogram their systems without regard to current
price test restrictions.
---------------------------------------------------------------------------

    \112\ See STA Letter, supra note 23; UBS Letter, supra note 23;
SIFMA Letter, supra note 23.
    \113\ STA Letter, supra note 23. In addition, in its comment
letter, SIFMA urged the Commission to take steps to eliminate price
test restrictions prior to the Regulation NMS Compliance Date to
alleviate the necessity for firms to, in the course of instituting
programming changes to meet the new requirements of Regulation NMS,
program systems to comply with price test restrictions, only to be
required to reverse such programming costs shortly thereafter. SIFMA
stated that cost estimates for firms to program for such changes
varied, from as low as approximately $200,000 for some firms to as
high as $2 million for others. See SIFMA Letter, supra note 23.
---------------------------------------------------------------------------

    In its comment letter, Amex stated that ``[w]hile it is difficult
to predict future trading activities and the resultant need for new or
different regulatory programs, [its] best estimate is that there would
probably be no material impact on [its] regulatory costs.'' \114\ Amex
noted that although staff time and technology resources would no longer
be required to monitor compliance with price tests, surveillance by
Amex staff of order marking violations would still be required. In
addition, Amex commented that ``the absence of a tick test to
discourage potential ``bear raids'' and other manipulative activities
could result in the need to devote additional resources to such
regulatory programs than is currently the case.'' \115\
---------------------------------------------------------------------------

    \114\ Amex Letter, supra note 44.
    \115\ Id.
---------------------------------------------------------------------------

    We believe that costs associated with the amendments will be
minimal because the infrastructure necessary to comply with the
amendments are, for the most part, already be in place. Market
participants have needed to establish or modify their systems and
surveillance mechanisms to exempt those securities included in the
Pilot from all price test restrictions.\116\ In addition, any further
changes to systems and surveillance mechanisms or procedures will be
relatively minor because the amendments will remove all price test
restrictions rather than, for example, impose a modified price test. We
also believe that market participants will not need to incur costs to
purchase new systems, or increase staffing based solely on the
implementation of the amendments.
---------------------------------------------------------------------------

    \116\ The Pilot exempts a select group of securities from price
test restrictions during regular trading hours. Between the close of
the consolidated tape and the open of the consolidated tape on the
following day, however, all equity securities are exempted from
price test restrictions. See 69 FR at 48033.
---------------------------------------------------------------------------

    Although we recognize that market participants may incur costs to
modify, establish or implement existing or new supervisory and
compliance procedures due to the amendments, these costs will be
minimal because market participants already have in place supervisory
or compliance procedures to monitor for trading activity that current
price test restrictions are designed to deter.
    We recognize that SROs that have adopted price tests will incur
costs associated with removing such price tests. For example, the NASD
and Nasdaq have their own bid tests that, under the amendments, will no
longer be applicable.\117\ In addition, some exchanges have adopted
rules in conformity with the provisions of Rule 10a-1, which will no
longer be applicable. SROs may incur costs associated with the
processes to remove such rules, including filing rule changes with the
Commission, as well as reprogramming systems designed to enforce these
rules. Although we requested comment regarding these costs, including
costs relating to preparing and filing any necessary rule changes with
the Commission,\118\ we did not receive any comments.
---------------------------------------------------------------------------

    \117\See NASD Rule 5100, available at http://nasd.complinet.com/nasd/display/display.html?rbid=1189&record_id=1159007939&element_id=1159006014&highlight=5100#r1159007939
; Nasdaq Rule 3350,

39
; Nasdaq Rule 3350,

display.html?rbid=1705&element--id=16.
    \118\ See Proposing Release, 71 FR at 75079-75080.
---------------------------------------------------------------------------

    We also recognize that the amendments may increase transaction
costs, decrease quoted depth, and increase intraday price volatility,
particularly in small stocks. The Pilot results suggest, however, that
these changes are small in magnitude and would not significantly
increase costs or reduce liquidity.\119\
---------------------------------------------------------------------------

    \119\ See id. at 75072-75075 (discussing the results of the
Pilot).
---------------------------------------------------------------------------

B. Removal of ``Short Exempt'' Marking Requirement

1. Benefits
    We are amending Rule 200(g) of Regulation SHO to remove the ``short
exempt'' marking requirement.\120\ Rule 200(g)(2) of Regulation SHO
provides that a short sale order must be marked ``short exempt'' if the
seller is ``relying on an exception from the tick test of 17 CFR
240.10a-1, or any short sale price test of any exchange or national
securities association.'' \121\ Thus, because we are removing all
current price test restrictions, as well as prohibiting any SRO from
having a price test, the ``short exempt'' marking requirement will no
longer be applicable. In addition, we note that removing the ``short
exempt'' marking requirement will promote regulatory simplification
because the marking requirement will no longer be applicable.
---------------------------------------------------------------------------

    \120\ 17 CFR 242.200(g).
    \121\See id. at Sec.  242.200(g)(2).
---------------------------------------------------------------------------

2. Costs
    Although we sought public comment on costs, we did not receive any
such comments relating to this proposed amendment. We recognize,
however, that there may be some costs associated with removing the
``short exempt'' marking requirement. Some market participants,
including broker-dealers and SROs, may have to reprogram systems and
update supervisory procedures due to the removal of the ``short
exempt'' marking requirement. Sales of securities previously marked
``short exempt,'' however, will continue to be marked either ``long''
or ``short.'' Thus, we believe that such costs will be minor.

VII. Consideration of Burden on Competition and Promotion of
Efficiency, Competition, and Capital Formation

    Section 3(f) of the Exchange Act requires the Commission, whenever
it engages in rulemaking and whenever it is required to consider or
determine if an action is necessary or appropriate in the public
interest, to consider whether the action would promote efficiency,
competition, and capital formation.\122\ In addition, Section 23(a)(2)
of the Exchange Act requires the Commission, when making rules under
the Exchange Act, to consider the impact such rules would have on
competition.\123\ Exchange Act Section 23(a)(2) prohibits the
Commission from adopting any rule that would impose a burden on
competition not necessary or appropriate in furtherance of the purposes
of the Exchange Act.
---------------------------------------------------------------------------

    \122\ 15 U.S.C. 78c(f).
    \123\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    In the Proposing Release, we solicited comment on the proposed
amendments' effects on efficiency, competition, and capital formation.
In addition, we requested, but did not receive, comments regarding the
impact of the proposed amendments on the economy generally pursuant to
the Small Business Regulatory Enforcement Fairness Act of 1996.\124\
---------------------------------------------------------------------------

    \124\ Pub. L. 104-121, tit. II, 110 Stat. 857 (1996).
---------------------------------------------------------------------------

    We have considered the proposed amendments to Rule 10a-1 and
Regulation SHO in light of the standards of Section 23(a)(2) of the
Exchange Act and believe the adopted amendments will not impose any
burden on competition not necessary or appropriate in furtherance of
the Exchange Act.
    The amendments will remove the price test restrictions of Rule 10a-
1 \125\ and provide that no price test, including any price test of any
SRO, shall apply to short sales in any security. The amendments will
also prohibit any SRO from having a price test. In addition, the
amendments will remove the ``short exempt'' marking requirement of Rule
200(g) of Regulation SHO because this marking requirement applies only
if the seller is relying on an exception from the tick test of Rule
10a-1 or any short sale price test of any exchange or national
securities association.
---------------------------------------------------------------------------

    \125\ 17 CFR 242.10a-1.
---------------------------------------------------------------------------

    Current short sale regulation is inconsistent. For example, Rule
10a-1 applies only to short sale transactions in listed securities. The
NASD's and Nasdaq's bid tests apply only to Nasdaq Global Market
securities. No price tests apply to short sales in Nasdaq Capital
Market securities or securities quoted on the OTCBB or pink sheets. In
addition, no price test applies to short sales of Nasdaq Global Market
securities executed on exchanges trading Nasdaq securities on a UTP
basis, unless the market on which the securities are being traded has
adopted its own price test. Moreover, the current exceptions to, and
exemptions from, the price tests for a wide range of short selling
activities have limited the applicability of the restrictions contained
in these rules. The end result is inconsistent short sale regulation of
securities, depending on the market where the securities are trading,
and the type of short selling activity. Thus, the amendments are
intended to promote regulatory simplification and uniformity by no
longer permitting the current price test restrictions on short selling.
    We believe that the amendments will not harm efficiency because the
empirical evidence from the Pilot Results shows that the Pilot did not
adversely impact price efficiency. Further, market participants will no
longer have to apply different price tests to securities trading in
different markets.
    In addition, we believe that the amendments will not have an
adverse impact on capital formation because the empirical evidence from
the Pilot Results shows that the price tests have very little impact on
overall market quality and, particularly in large securities, may be
harmful to overall market quality.
    We believe that the amendments will promote competition among
exchanges and other market centers because market participants will no
longer be able to select a market on which to execute a short sale
based on the applicability of price test restrictions. The amendments
will remove a purported competitive disadvantage experienced by some
market centers because market participants will no longer route orders
to avoid application of a market center's price test. Nor will market
centers that do not have a price test be able to use that factor to
attract order flow away from market centers that have a price test.
Moreover, the amendments will level the playing field for all market
participants by requiring that no price test shall apply to any short
sale in any security in any market.\126\
---------------------------------------------------------------------------

    \126\ Although we recognize there could conceivably be a need in
the future for SROs to propose new price test restrictions, in
considering whether to approve any such proposals, the Commission
would, among other things, determine whether or not such proposals
are consistent with the objectives of today's amendments.
Additionally, in order for an SRO to adopt new price test
restrictions pursuant to Section 19(b) of the Exchange Act, an
exemption from the provisions of Rule 201 pursuant to Section 36 of
the Exchange Act would be necessary.
---------------------------------------------------------------------------

VIII. Final Regulatory Flexibility Analysis

    The Commission has prepared the Final Regulatory Flexibility
Analysis (``FRFA''), in accordance with the provisions of the
Regulatory Flexibility Act (``RFA''),\127\ regarding the proposed
amendments to Rule 10a-1 and Regulation SHO, Rules 200 and 201, under
the Exchange Act.
---------------------------------------------------------------------------

    \127\ 5 U.S.C. 604.
---------------------------------------------------------------------------

A. Need for the Amendments

    Based on the Pilot Results as well as our review of the status of
short sale regulation in the context of the current application of Rule
10a-1 and other price tests, including the exceptions to the current
rules and grants of relief from Rule 10a-1 by the Commission for a wide
range of short selling activities, we believe it is necessary to remove
Rule 10a-1 and to amend Regulation SHO to provide that no price test,
including any price test by any SRO, shall apply to short selling in
any security. In addition, the amendments will prohibit any SRO from
having a price test. These amendments are designed to modernize and
simplify short sale regulation in light of current short selling
systems and strategies used in the marketplace, while providing greater
regulatory consistency to short selling. We are also removing the
``short exempt'' marking requirement of Regulation SHO because this
requirement only applies if a seller is relying on an exception to a
price test.

B. Significant Issues Raised by Public Comment

    The Initial Regulatory Flexibility Analysis (``IRFA'') appeared in
the Proposing Release.\128\ We requested comment in the IRFA on the
impact the proposed amendments would have on small entities and how to
quantify the impact. We received two comment letters generally
discussing the impact of the proposed amendments to remove price test
restrictions on small issuers,\129\ which we discuss below.
---------------------------------------------------------------------------

    \128\ See Proposing Release, 71 FR at 75081-75082.
    \129\ See IASBDA Letter, supra note 39; Amex Letter, supra note
44. IASBDA expressed concern that the proposed amendments might
``unnecessarily force small issuers to accept an environment which
is most unkind to their securities.'' See IASBDA Letter, supra note
39. In its letter, Amex advocated for additional study of the
effects of price test restrictions on small capitalization
securities before the Commission removes such restrictions on these
securities. See Amex Letter, supra note 44.

---------------------------------------------------------------------------

C. Small Entities Subject to the Rule

    The entities covered by the amendment will include small broker-
dealers, small businesses, and any investor who effects a short sale
that qualifies as a small entity. Although it is impossible to quantify
every type of small entity that may be able to effect a short sale in a
security, Paragraph (c)(1) of Rule 0-10 under the Exchange Act \130\
states that the term ``small business'' or ``small organization,'' when
referring to a broker-dealer, means a broker or dealer that had total
capital (net worth plus subordinated liabilities) of less than $500,000
on the date in the prior fiscal year as of which its audited financial
statements were prepared pursuant to Sec.  240.17a-5(d); and is not
affiliated with any person (other than a natural person) that is not a
small business or small organization. In the IRFA in the Proposing
Release, we estimated that as of 2005, there were approximately 910
broker-dealers that qualified as small entities as defined above.\131\
Presently, we estimate that as of 2006 there are approximately 894
broker-dealers that qualify as small entities, as defined above.\132\
---------------------------------------------------------------------------

    \130\ 17 CFR 240.0-10(c)(1).
    \131\ These numbers are based on OEA's review of 2005 FOCUS
Report filings reflecting registered broker-dealers. This number
does not include broker-dealers that are delinquent on FOCUS Report
filings.
    \132\ These numbers are based on OEA's review of 2006 FOCUS
Report filings reflecting registered broker-dealers. This number
does not include broker-dealers that are delinquent in their FOCUS
Report filings.
---------------------------------------------------------------------------

    Paragraph (e) of Rule 0-10 under the Exchange Act \133\ states that
the term ``small business'' or ``small organization,'' when referring
to an exchange, means any exchange that: (1) Has been exempted from the
reporting requirements of Rule 11Aa3-1 under the Exchange Act; and (2)
is not affiliated with any person (other than a natural person) that is
not a small business or small organization, as defined by Rule 0-10. No
national securities exchanges are small entities because none meets
these criteria. There is one national securities association (NASD)
that is subject to these amendments. NASD is not a small entity as
defined by 13 CFR 121.201.
---------------------------------------------------------------------------

    \133\ 17 CFR 240.0-10(e).
---------------------------------------------------------------------------

    Any business, however, regardless of industry, will be subject to
the amendments if it effects a short sale. The Commission believes
that, except for the broker-dealers discussed above, an estimate of the
number of small entities that fall under the amendments is not
feasible.

D. Reporting, Recordkeeping, and Other Compliance Requirements

    We recognize that the amendments may impose some new or additional
reporting, recordkeeping, or compliance costs on any affected party,
including broker-dealers, that are small entities.
    As discussed above, three commenters noted potential reprogramming
costs that market participants may incur if the Commission does not act
on the proposed amendments prior to the Regulation NMS Compliance Date.
In meeting the Regulation NMS Compliance Date, market participants have
been developing new systems or modifying existing systems to be
Regulation NMS-compliant. In their comment letters, STA, UBS, and SIFMA
urged the Commission to act on the proposed amendments prior to the
Regulation NMS Compliance Date.\134\ In its letter, STA noted that
``[i]f the SEC's proposal is implemented subsequent to the operation of
Regulation NMS to certain securities, it will require industry-wide re-
programming of Regulation NMS compliance systems during the infancy of
the Rules implementation, a most sensitive time period. As a result,
the immediate success of Regulation NMS could be compromised.'' \135\
As discussed in Section IX below, these amendments will be effective
immediately upon publication in the Federal Register. Thus, market
participants will have notice and time prior to the Regulation NMS
Compliance Date to reprogram their systems without regard to current
price test restrictions.
---------------------------------------------------------------------------

    \134\ See STA Letter, supra note 23; UBS Letter, supra note 23;
SIFMA Letter, supra note 23.
    \135\ STA Letter, supra note 23.
---------------------------------------------------------------------------

    In order to comply with the Pilot when it became effective on May
2, 2005, small entities needed to modify their systems and surveillance
mechanisms to exempt those securities included in the Pilot from
current price test restrictions. Thus, the systems and surveillance
mechanisms required to comply with the amendments are already in place.
We believe that any necessary additional systems and surveillance
changes will be small because, due to the Pilot, systems are currently
programmed to exempt many securities from price test restrictions prior
to the close of the consolidated tape and exempt all securities from
price test restrictions between the close of the consolidated tape and
the open of the consolidated tape on the following day.
    We believe that any reprogramming costs or updating of surveillance
mechanisms associated with the removal of the ``short exempt'' marking
requirement will be minimal because sales of securities will continue
to be required to be marked either ``long'' or ``short.'' The
amendments will merely remove an alternative marking requirement.

E. Agency Action To Minimize the Effect on Small Entities

    The RFA directs the Commission to consider significant alternatives
that will accomplish the stated objective, while minimizing any
significant adverse impact on small entities. Pursuant to Section 3(a)
of the RFA,\136\ the Commission considered the following types of
alternatives in connection with the amendments: (a) The establishment
of differing compliance or reporting requirements or timetables that
take into account the resources available to small entities; (b) the
clarification, consolidation, or simplification of compliance and
reporting requirements under the rule for small entities; (c) the use
of performance rather than design standards; and (d) an exemption from
coverage of the rule, or any part thereof, for small entities.
---------------------------------------------------------------------------

    \136\ 5 U.S.C. 603(c).
---------------------------------------------------------------------------

    The amendments are intended to modernize and simplify price test
regulation by removing restrictions on the execution prices of short
sales contained in current price tests, such as Rule 10a-1. As such, we
believe that imposing different compliance requirements, and possibly a
different timetable for implementing compliance requirements, for small
entities would undermine the goal of the amendments. In particular, the
request by IASBDA and Amex for a gradual phase-in of the amendments to
permit price test restrictions to continue for small securities pending
further study, would cause considerable uncertainty, such as how to
treat securities that episodically move between the definition of small
and large capitalization. Moreover, we do not believe that such an
approach would provide new results relevant to smaller securities. As
we noted in the Proposing Release, while there is some evidence
supporting the application of price test restrictions to smaller
securities, the evidence is not strong enough to warrant its
continuation in any subset of securities.\137\ In addition, we note
that many smaller or thinly-traded securities, such as Nasdaq Capital
Market securities, and securities

quoted on the OTCBB and pink sheets, are not currently subject to any
price test restrictions.
---------------------------------------------------------------------------

    \137\ See Proposing Release, 71 FR at 75076. See also, supra,
note 65 (discussing a prior study by academics of price test
restrictions on smaller securities).
---------------------------------------------------------------------------

    Thus, we have concluded that it would be inconsistent with the goal
of the amendments to phase-in small capitalization securities or to
further clarify, consolidate, or simplify the amendments for small
entities. Finally, the amendments will impose performance standards
rather than design standards.

IX. Administrative Procedure Act

    Section 553(d) of the Administrative Procedure Act (``APA'')
generally provides that a substantive rule may not be made effective
less than 30 days after notice is published in the Federal
Register.\138\ Two exceptions to the 30-day requirement, among others,
are (i) for a substantive rule that relieves a restriction, and (ii) an
agency's finding of good cause for providing a shorter effective
date.\139\
---------------------------------------------------------------------------

    \138\ 5 U.S.C. 553(d).
    \139\ See id. at 553(d)(1), 553(d)(3).
---------------------------------------------------------------------------

    The amendments will remove all current restrictions on the price at
which a security can be sold short. Because the amendments relieve a
restriction on short selling, these amendments may be made effective
less than 30 days after notice is published in the Federal Register.
    In addition, we note that a number of commenters to the proposed
amendments discussed potential reprogramming costs that market
participants may incur if the proposed amendments are not effective
prior to the Regulation NMS Compliance Date.\140\ In meeting the
Regulation NMS Compliance Date, market participants have been
developing new systems or modifying existing systems to be Regulation
NMS-compliant. Immediate effectiveness of these amendments is necessary
to provide market participants with sufficient notice and time prior to
the Regulation NMS Compliance Date to reprogram their systems without
regard to current price test restrictions.
---------------------------------------------------------------------------

    \140\ See, e.g., STA Letter, supra note 23; UBS Letter, supra
note 23; SIFMA Letter, supra note 23.
---------------------------------------------------------------------------

    Specifically, immediate effectiveness of the amendments is expected
to alleviate any necessity for market participants to, in the course of
instituting programming changes to meet the requirements of Regulation
NMS, program systems to comply with price test restrictions, only to be
required to reverse such programming shortly thereafter. Absent
immediate effectiveness, market participants may expend unnecessary
time and resources programming systems to comply with price test
restrictions that are being removed. Thus, the Commission finds that
there is good cause for making the amendments effective immediately
upon publication in the Federal Register.

X. Statutory Authority and Text of the Amendments

    Pursuant to the Exchange Act and, particularly, Sections 2, 3(b),
6, 9(a), 10(a), 11A, 15, 15A, 17, 17A, 23(a) thereof, 15 U.S.C. 78b,
78c(b), 78f, 78i(a), 78j(a), 78k-1, 78o, 78o-3, 78q, 78q-1, 78w(a), the
Commission is removing Rule 10a-1, Sec.  240.10a-1, and amending
Regulation SHO, Sec. Sec.  242.200 and 201.

Text of the Amendments to Rule 10a-1 and Regulation SHO

List of Subjects in 17 CFR Parts 240 and 242

    Brokers, Fraud, Reporting and recordkeeping requirements,
Securities.

0
For the reasons set out in the preamble, Title 17, Chapter II, of the
Code of Federal Regulations is amended as follows.

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934

0
1. The authority citation for part 240 continues to read in part as
follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i,
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5,
78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37, 80b-3, 80b-4,
80b-11, and 7201 et. seq.; and 18 U.S.C. 1350, unless otherwise
noted.
* * * * *

Sec.  240.10a  [Removed]

0
2. Section 240.10a-1 is removed and reserved and the undesignated
heading preceding the section is removed.

PART 242--REGULATIONS M, SHO, ATS, AC AND NMS, AND CUSTOMER MARGIN
REQUIREMENTS FOR SECURITY FUTURES

0
3. The authority citation for part 242 continues to read as follows:

    Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2),
78i(a), 78j, 78k-1(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g),
78q(a), 78q(b), 78q(h), 78w(a), 78dd-1, 78mm, 80a-23, 80a-29, and
80a-37.

0
4. Section 242.200 is amended by revising the introductory text of
paragraph (g) and removing and reserving paragraph (g)(2) to read as
follows:

Sec.  242.200  Definition of ``short sale'' and marking requirements.

* * * * *
    (g) A broker or dealer must mark all sell orders of any equity
security as ``long'' or ``short.''
* * * * *

0
5. Section 242.201 is added to read as follows:

Sec.  242.201  Price test.

    (a) No short sale price test, including any short sale price test
of any self-regulatory organization, shall apply to short sales in any
security.
    (b) No self-regulatory organization shall have any rule that is not
in conformity with, or conflicts with, paragraph (a) of this section.

    Dated: June 28, 2007.

    By the Commission.
J. Lynn Taylor,
Assistant Secretary.
 [FR Doc. E7-12868 Filed 7-2-07; 8:45 am]

BILLING CODE 8010-01-P