persons, securities, or transactions, from any provision or provisions
of this chapter or of any rule or regulation thereunder, to the extent
that such exemption is necessary or appropriate in the public interest,
and is consistent with the protection of investors.'' \155\
---------------------------------------------------------------------------

    \155\ See 15 U.S.C. 78mm(a).
---------------------------------------------------------------------------

    This delegation of authority to the Director is intended to
conserve Commission resources and provide market participants needed
flexibility by allowing the staff, pursuant to Section 36(a) of the
Exchange Act, to review and act by order on applications for exemptions
from Regulation SHO. Pursuant to the amendment, the Director may
consider and act upon appropriate requests for relief from the
provisions of Regulation SHO, and will consider the particular facts
and circumstances relevant to each such request, the potential
ramifications of granting any exemptive relief, and any appropriate
conditions to be imposed as part of such an exemption.
    The Commission anticipates that the delegation of authority will
facilitate efficient review. Nevertheless, the staff may submit matters
to the Commission for consideration as it deems appropriate, and the
Commission ``may, in its sole discretion, decline to entertain any
application for an order of exemption under this section.'' \156\
---------------------------------------------------------------------------

    \156\ See 15 U.S.C. 78mm(a)(2).
---------------------------------------------------------------------------

    The Commission finds, in accordance with the Administrative
Procedure Act, 5 U.S.C. 553(b)(3)(A), that this amendment to Rule 30-3
relates solely to agency organization, procedure and practice and thus,
notice and the opportunity for public comment before its effective date
are unnecessary. In addition, because the amendment to Rule 30-3
relates solely to the internal processes of the Commission with regard
to the grant of exemptions from the provisions of Regulation SHO, the
Commission finds, pursuant to Section 553(d)(3) of the Administrative
Procedure Act, 5 U.S.C. 553(d)(3), that there is good cause for making
the amendment effective upon publication in the Federal Register. For
similar reasons, the amendment does not require an analysis under the
Regulatory Flexibility Act or analysis of major status under the Small
Business Regulatory Enforcement Fairness Act.\157\
---------------------------------------------------------------------------

    \157\ See 5 U.S.C. 601(2) (for purposes of Regulatory
Flexibility Act analysis, the term ``rule'' means any rule for which
the agency publishes a general notice of proposed rulemaking) and 5
U.S.C. 804(3)(C) (for purposes of congressional review of agency
rulemaking, the term ``rule'' does not include any rule of agency
organization, procedure, or practice that does not substantially
affect the rights or obligations of non-agency parties).
---------------------------------------------------------------------------

VI. Paperwork Reduction Act

    Like temporary Rule 204T, several provisions under Rule 204 will
impose a ``collection of information'' within the meaning of the
Paperwork Reduction Act of 1995 (``Paperwork Reduction Act'').\158\
These collections of information are mandatory. With the single
exception of the elimination in Rule 204 of the exception in temporary
Rule 204T(b)(2) for market makers from the borrowing requirement in
Rule 204(b),\159\ all collections of information from temporary Rule
204T have been incorporated into Rule 204 without modification. The
collection of information requirements of temporary Rule 204T have not
been substantively or materially modified in Rule 204; therefore, the
time and cost estimates for compliance with these provisions are the
same for Rule 204 as our prior time and cost estimates for temporary
Rule 204T, which we incorporate by reference.\160\
---------------------------------------------------------------------------

    \158\ 44 U.S.C. 3501 et seq.
    \159\ In contrast to temporary Rule 204T(b), Rule 204(b) does
not include an exception from the borrowing requirement of the Rule
specific to market makers. We eliminated this exception because, as
with other broker-dealers, a market maker is excepted from the
borrowing requirements of Rule 204(b) if it timely certifies to the
participant that it has not incurred a fail to deliver position on
settlement date for a long or short sale in an equity security for
which the participant has a fail to deliver position at the
registered clearing agency or that it is in compliance with the
requirements of Rule 204(e). Market makers, like all other broker-
dealers, will continue to be subject to the certification
requirements under Rule 204(b). See supra Section III.B. (discussing
Rule 204(b)).
    \160\ See Rule 204T Adopting Release, 73 FR 61717-61722.
---------------------------------------------------------------------------

    We published a notice of our estimated time requirements for
participants to comply with these collection of information provisions
and requested comment on the collection of information requirements in
connection with temporary Rule 204T. We submitted the collection of
information to OMB for review and approval in accordance with 44 U.S.C.
3507(j) and 5 CFR 1320.13.
    One commenter indicated that compliance with temporary Rule 204T
resulted in an increase in man-hours to monitor multiple levels of data
across various system platforms and business

units within a firm,\161\ and other commenters expressed general
concerns with the administrative and operational burdens on clearing
firms, customers, and their regulators.\162\ The Commission, however,
did not receive any comments as to the burdens associated with the
collection of information requirements in temporary Rule 204T.
---------------------------------------------------------------------------

    \161\ See letter from SIFMA. The commenter noted that one firm
indicated its operations personnel initially spent an extra 60 man-
hours per day to comply with the rule, but acknowledged that time
amount had tapered down through automation. The comment is addressed
more directly in the cost-benefit analysis in Section VII below.
    \162\ See e.g., letters from CBOE; State Street.
---------------------------------------------------------------------------

    The information collected under Rule 204 will continue to be
retained and/or provided to other entities pursuant to the specific
rule provisions and will be available to the Commission and SRO
examiners upon request. The information collected will continue to aid
the Commission and SROs in monitoring compliance with these
requirements. In addition, the information collected will aid those
subject to Rule 204 in complying with its requirements.
    An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a
currently valid OMB control number. The title for the collection of
information is changed from ``Temporary Rule 204T'' to ``Rule 204'' to
indicate that the collection is no longer with regard to a temporary
rule and the OMB control number for the collection of information is
3235-0647.

VII. Cost-Benefit Analysis

A. Summary

    The Commission is sensitive to the costs and benefits of its rules
and we have considered such with respect to the adoption of Rule 204 of
Regulation SHO. We are incorporating by reference the cost-benefit
discussion in the Rule 204T Adopting Release, except to the extent that
we have made modifications or because we are addressing comments.
    In order to assist our evaluation, we solicited comment via
questions as to the costs and benefits of temporary Rule 204T, which is
substantially similar to Rule 204. We address these comments as applied
to permanent Rule 204 in detail below. In addition, we discuss in more
detail below that we believe the benefits of adopting Rule 204 justify
its costs. We also believe that the benefits of adopting Rule 204
justify forgoing benefits that might accrue if the Commission were to
allow temporary Rule 204T to expire without a substantially similar
replacement.\163\
---------------------------------------------------------------------------

    \163\ Temporary Rule 204T will expire on July 31, 2009.
---------------------------------------------------------------------------

    As discussed above, preliminary results from OEA indicate that our
actions to further reduce fails to deliver and, thereby, help address
potentially abusive ``naked'' short selling are having their intended
effect. For example, these preliminary results indicate a significant
downward trend in the number of fails to deliver in all equity
securities since, in addition to other measures, the adoption of
temporary Rule 204T.\164\
---------------------------------------------------------------------------

    \164\ See Memorandum from OEA Re: Impact of Recent SHO Rule
Changes on Fails to Deliver, November 26, 2008 at http://
www.sec.gov/comments/s7-30-08/s73008-37.pdf; see also Memorandum
from OEA Re: Impact of Recent SHO Rule Changes on Fails to Deliver,
March 20, 2009 at http://www.sec.gov/comments/s7-30-08/s73008-
107.pdf; Memorandum from OEA Re: Impact of Recent SHO Rule Changes
on Fails to Deliver, April 16, 2009 at http://www.sec.gov/comments/
s7-30-08/s73008-121.pdf.
---------------------------------------------------------------------------

    Due to the positive impact that temporary Rule 204T, among other
actions, is having on reducing fails to deliver and after considering
the comments received, we believe adopting the provisions of that rule
in a permanent rule, Rule 204 of Regulation SHO, with limited
modifications to promote the rule's workability and address commenters'
concerns, will further the goals outlined above and below. We believe
these modifications will aid compliance with Rule 204.
    We believe that Rule 204 will help maintain the recent reduction in
fails to deliver and address potentially abusive ``naked'' short
selling in all equity securities by requiring that, subject to certain
limited exceptions, if a participant of a registered clearing agency
has a fail to deliver position at a registered clearing agency it must
immediately purchase or borrow securities to close out the fail to
deliver position by no later than the beginning of regular trading
hours on the settlement day following the day the participant incurs
the fail to deliver position. We recognize that, like temporary Rule
204T, Rule 204 may impose increased purchasing and borrowing costs
beyond those that would occur if the rule was not in place and that
these costs may increase the costs of legitimate short selling. We
believe, however, that continuing the requirements of temporary Rule
204T by adopting them in Rule 204 is necessary to maintain the
reduction in fails to deliver and to continue to address potentially
abusive ``naked'' short selling. We believe that continuing these
benefits achieved under temporary Rule 204T justifies the potential
costs associated with making the requirements of that rule permanent.
    Further, we believe that the benefits of making the requirements of
temporary Rule 204T permanent in Rule 204 will justify forgoing any
potential benefits that might accrue if the Commission were to allow
temporary Rule 204T to expire. If the Commission were to allow
temporary Rule 204T to expire without replacement, there might be
potential benefits. For example, some commenters noted that they
believe that there has been price disruption and market volatility
resulting from temporary Rule 204T's requirement that participants
close out fails to deliver by no later than the beginning of regular
trading hours on the applicable close-out date.\165\ Some commenters
stated that temporary Rule 204T's close-out requirements cause over-
buying and over-borrowing at the market open by parties seeking to meet
the close-out requirements and has unnecessarily interfered in
transactions that would settle in the normal course.\166\
---------------------------------------------------------------------------

    \165\ See e.g., letters from BATS; LEK; MFA; SIFMA; State
Street.
    \166\ See, e.g., letter from SIFMA.
---------------------------------------------------------------------------

    If we were to allow temporary Rule 204T to expire without adopting
a substantially similar rule, the marketplace would revert back to the
close-out requirements of Rule 203(b)(3) of Regulation SHO that apply
only to those securities with a large and persistent level of fails to
deliver, i.e., threshold securities, and only to those fail to deliver
positions that have persisted for thirteen consecutive settlement
days.\167\ Thus, it is plausible that a return to this pre-temporary
Rule 204T close-out requirement might alleviate concerns expressed by
commenters regarding potential over-buying, over-borrowing, volatility,
and price disruption at the market open, be easier to comply with and,
therefore, potentially reduce transaction costs to market participants.
Further, according to some commenters, temporary Rule 204T may provide
disincentives to lenders of securities and, thus, may cause lower
liquidity levels in the market place.\168\
---------------------------------------------------------------------------

    \167\ See 17 CFR 242.203(b)(3).
    \168\ See letters from BATS; ICI; SIFMA.
---------------------------------------------------------------------------

    In addition, if we were to allow temporary Rule 204T to expire
without taking substantially similar action, participants might
experience fewer costs in terms of monitoring systems platforms and
notification obligations associated with complying with temporary Rule
204T \169\ and with Rule

204. For instance, the demonstration and notification requirements of
temporary Rule 204T and Rule 204 and related compliance costs in terms
of personnel, recordkeeping, systems, and surveillance mechanisms would
not apply. However, as noted in the temporary Rule 204T Adopting
Release, we believe any potential additional costs incurred in
implementing the collection of information requirements under temporary
Rule 204T would be minimal. We believe the same with respect to the
costs associated with Rule 204. In addition, we note that most of the
infrastructure necessary to comply with Rule 204 should already be in
place in order to meet the close-out requirements of Rule 203(b)(3) of
Regulation SHO and, more recently, of temporary Rule 204T.
---------------------------------------------------------------------------

    \169\ See letters from CBOE; SIFMA; State Street (noting some of
the potential costs associated with complying with temporary Rule
204T's close-out requirements).
---------------------------------------------------------------------------

    For the reasons articulated above and below, in more detail, we
believe that a reversion to the pre-temporary Rule 204T close-out
regime would result in a number of costs to the securities markets in
the forms of an increase in the level of fails to deliver and a lack of
incentive for sellers to promptly deliver securities by settlement
date. Such results would undermine our goals of reducing fails to
deliver and addressing potentially abusive ``naked'' short selling.
    As previously noted, and stated in the temporary Rule 204T Adopting
Release, we are concerned that the close-out requirements of Regulation
SHO do not adequately address our goals of reducing fails to deliver
and addressing potentially abusive ``naked'' short selling.\170\ In
part due to such concerns, we have taken measures to help further
reduce fails to deliver in all equity securities. As discussed above,
OEA's findings regarding the impact of temporary Rule 204T, and other
Commission actions, indicate a significant reduction in the number of
fails to deliver.\171\ Thus, we believe it is necessary to adopt
temporary Rule 204T's close-out requirements in a permanent rule, Rule
204, such that fails in all equity securities must be closed out within
specific timeframes and, thereby, help maintain the recent reduction in
fails to deliver and the benefits already achieved.
---------------------------------------------------------------------------

    \170\ See, e.g., Rule 204T Adopting Release, 73 FR 61711-61712.
    \171\ See supra note 164.
---------------------------------------------------------------------------

B. Benefits

    By continuing to require that participants of a registered clearing
agency immediately close-out a fail to deliver position on the
applicable close-out date, Rule 204 will further our goals of reducing
fails to deliver by maintaining the reductions in fails to deliver
achieved by the adoption of temporary Rule 204T, as well as other
actions taken by the Commission, and addressing potentially abusive
``naked'' short selling. This, in turn, will help to ensure that
investors remain confident that trading can be conducted without the
influence of illegal manipulation.\172\ The rule also furthers the
goals of helping to maintain fair and orderly markets against the
threat of sudden and excessive fluctuations of securities prices and
substantial disruption in the functioning of the securities markets.
The rule also promotes the prompt and accurate clearance and settlement
of transactions in equity securities.
---------------------------------------------------------------------------

    \172\ See 2006 Regulation SHO Proposed Amendments, 71 FR 41712;
2007 Regulation SHO Final Amendments, 72 FR 45545; 2007 Regulation
SHO Proposed Amendments, 72 FR 45558-45559; Anti-Fraud Rule
Proposing Release, 73 FR 15378; Rule 204T Adopting Release, 73 FR
61709-61710 (providing discussion of the impact of fails to deliver
on the market); see also 2003 Regulation SHO Proposing Release, 68
FR 62975 (Nov. 6, 2003) (discussing the impact of ``naked'' short
selling on the market).
---------------------------------------------------------------------------

    In addition, by helping to further our goal of reducing fails to
deliver by maintaining the reductions in fails to deliver achieved by
the adoption of temporary Rule 204T, as well as other actions taken by
the Commission, Rule 204, like temporary Rule 204T, will help continue
to address concerns that fails may create a misleading impression of
the market for securities. Large and persistent fails to deliver may
have a negative effect on shareholders, potentially depriving them of
the benefits of ownership, such as voting and lending.\173\ Thus, by
facilitating the prompt receipt of shares, Rule 204 will help enable
investors to receive the benefits associated with share ownership.
---------------------------------------------------------------------------

    \173\ See supra Section II. (discussing the potential negative
impact of large and persistent fail to delivers).
---------------------------------------------------------------------------

    Persistent fails to deliver in a security may also be perceived by
potential investors negatively and may affect their investment
decisions.\174\ Thus, providing greater assurance that securities will
be delivered might help alleviate investor apprehension about investing
in certain securities and increase investor confidence in the
settlement process.\175\
---------------------------------------------------------------------------

    \174\ See id.
    \175\ See id.
---------------------------------------------------------------------------

 1. Close-Out Requirements
    By maintaining the close-out requirements of temporary Rule 204T we
believe Rule 204 will continue to help restore, maintain, and enhance
investor confidence in the securities markets. It will also help
continue to limit the use of manipulative schemes involving ``naked''
short selling in all equity securities.\176\ Without the requirements
of Rule 204, sellers that fail to deliver securities on settlement date
may attempt to engage in trading activities that deliberately depress
the price of a security. Rule 204's close-out requirements will
continue the limitations on a potential means of manipulation, thereby
decreasing the possibility of artificial market influences and
contributing to price efficiency. Rule 204's close-out requirements are
also expected to prevent large, widespread build-ups of fails over
time.
---------------------------------------------------------------------------

    \176\ See 204T Adopting Release, 73 FR 61709-61710.
---------------------------------------------------------------------------

    As in temporary Rule 204T(a), Rule 204(a) provides that a
participant of a registered clearing agency must deliver securities to
a registered clearing agency for clearance and settlement on a long or
short sale in any equity security by settlement date or, if a
participant of a registered clearing agency has a fail to deliver
position at a registered clearing agency in any equity security for a
long or short sale transaction in that equity security, the participant
shall, by no later than the beginning of regular trading hours on the
settlement day following the settlement date, immediately close out the
fail to deliver position by borrowing or purchasing securities of like
kind and quantity.\177\ Similarly, consistent with temporary Rule
204T(a)(1) and (a)(3), the close-out requirements of Rule 204(a)(1) and
(a)(3) for fails to deliver resulting from long sales and certain bona
fide market making activity must be closed out by the beginning of
regular trading hours on the close-out date for such fails to deliver
(i.e., T+6).\178\
---------------------------------------------------------------------------

    \177\ See Rule 204(a).
    \178\ See Rules 204(a)(1) and 204(a)(3).
---------------------------------------------------------------------------

    As discussed in Section III above, some commenters requested that
we extend the close-out period for fails to deliver resulting from
short sales, long sales, and bona fide market making activity from the
beginning to the end of regular trading hours on the applicable close-
out date. Commenters expressed concern that temporary Rule 204T's
requirement to close out fails to deliver by no later than the
beginning of regular trading hours can create buying pressure at the
open, that may temporarily distort the price of the security.\179\
---------------------------------------------------------------------------

    \179\ See, e.g., letters from MFA; CBOE; SIFMA; BATS; RMA; State
Street.
---------------------------------------------------------------------------

    Other commenters requested additional days within which to close

out fails to deliver in connection with short sales. For example, some
commenters requested that the Commission extend the close-out period
for fails to deliver resulting from short sales to three settlement
days after the fail occurs, consistent with the close-out period for
fails to deliver resulting from long sales and market making
activity.\180\ Other commenters requested that the Commission extend
the close-out requirement for fails to deliver resulting from all sales
to five settlement days after the fail to deliver position occurs.\181\
These commenters stated that the additional time to close out fails to
deliver would allow the majority of trades to clear and settle on their
own within a few days following the regular settlement date (i.e.,
T+3).\182\
---------------------------------------------------------------------------

    \180\ See, e.g., letters from EWT; Coalition of Private
Investment Companies; SIFMA; MFA; State Street.
    \181\ See, e.g., letters from CBOE; Options Exchanges.
    \182\ See, e.g., letters from SIFMA; MFA; State Street; CBOE;
Options Exchanges; Coalition of Private Investment Companies.
---------------------------------------------------------------------------

    Some commenters expressed concerns about the effect of the close-
out requirements of temporary Rule 204T on securities lending.\183\ One
commenter also noted that in practice fails to deliver resulting from
sales of securities on loan, which are considered ``long'' sales, are
often closed out in accordance with the time-frames for fails to
deliver resulting from short sales rather than long sales because
temporary Rule 204T does not provide sufficient time to determine
whether or not a fail to deliver position resulted from a long or short
sale.\184\ According to this commenter, because some broker-dealers are
purchasing securities by no later than the beginning of regular trading
hours on the settlement date after the fail to deliver occurs, in
accordance with the close-out requirements for short sales, such
purchasing activity acts as a disincentive to lending and causes
institutions to question their participation in lending programs.\185\
---------------------------------------------------------------------------

    \183\ See, e.g., letter from SIFMA.
    \184\ See letter from SIFMA; see also letters from RMA; ICI.
    \185\ See letter from SIFMA; see also letter from RMA
(recommending the extension of the close-out period for fails to
deliver for all sales to settlement date plus three days (i.e., T+6)
``to ensure that beneficial owners selling on-loan positions are not
compromised by close-outs of long sales on T+4'').
---------------------------------------------------------------------------

    Other commenters stated that where the holder of a long position
sells securities that have been financed through a securities loan, the
close-out requirements of temporary Rule 204T may not provide
sufficient time for the securities to be recalled and delivered in time
for settlement of the sale transaction.\186\ These commenters stated,
among other things, that temporary Rule 204T's requirement that
securities be delivered by no later than the beginning of regular
trading hours does not allow for the completion of the securities
lending cycle, which may not occur until the close of the DTC
settlement window on the third settlement day after settlement date
(i.e., T+6).\187\
---------------------------------------------------------------------------

    \186\ See letters from EWT; BATS; RMA; ICI; Wedbush.
    \187\ See letters from EWT; BATS; RMA; ICI; RMA.
---------------------------------------------------------------------------

    Although we recognize commenters' concerns regarding the potential
market impact of the close-out requirements of temporary Rule 204T,
particularly at the market open, we believe that these potential
concerns are justified by the benefits of retaining in Rule 204 the
strict close-out requirements of temporary Rule 204T. As discussed
above, since the adoption of temporary Rule 204T, and other actions
taken by the Commission aimed at reducing fails to deliver, there has
been a significant reduction in fails to deliver. To maintain this
reduction, we believe it is appropriate at this time to continue to
require that participants close out fails to deliver by no later than
the beginning of regular trading hours on the applicable close-out
date. Thus, we are adopting as a permanent rule the requirement that
fails to deliver resulting from short sales, long sales, and certain
bona fide market making activity must be closed out by no later than
the beginning of regular trading hours on the applicable close-out
date.
    In addition, we believe that continuing to require that fails to
deliver be closed out on the day immediately following the day on which
the fail to deliver occurs is consistent with our goals of reducing
fails to deliver by maintaining the reductions in fails to deliver
achieved by the adoption of temporary Rule 204T, as well as other
actions taken by the Commission, and addressing ``naked'' short selling
and, in particular, potentially abusive ``naked'' short selling.
Although extending the time-frames within which fails to deliver must
be closed out may allow for ordinary course settlement, as several
commenters contend, we believe that the close-out requirements of Rule
204 are necessary to help encourage delivery by settlement date and
achieve our goal of not allowing fails to deliver to persist.\188\
---------------------------------------------------------------------------

    \188\ See supra note 16 (discussing the standard three-day
settlement cycle).
---------------------------------------------------------------------------

    As we discussed in the Rule 204T Adopting Release, we believe that
delivery on sales should be made by settlement date.\189\ In the Rule
204T Adopting Release, we noted that the vast majority of fails to
deliver are closed out within five days after T+3.\190\ In addition, in
that release we referenced a recent analysis by OEA that found that
more than half of all fails to deliver and more than 70% of all fail to
deliver positions are closed out within two settlement days after
T+3.\191\ We also noted in that release, however, that although this
information shows that delivery is being made, it demonstrates that
often delivery is not being made until several days following the
standard three-day settlement cycle.
---------------------------------------------------------------------------

    \189\ See Rule 204T Adopting Release, 73 FR 61712-61713.
    \190\ See id.
    \191\ See id. at n. 68. We note that OEA's analysis examined the
period from January to July 2008 and used the age of the fail to
deliver position as reported by the NSCC. The NSCC data included
only securities with at least 10,000 shares in fails to deliver.
These numbers also included securities that were not subject to the
close-out requirement in Rule 203(b)(3) of Regulation SHO, which
applies only to ``threshold securities'' as defined in Rule
203(c)(6) of Regulation SHO.
---------------------------------------------------------------------------

    In addition, as discussed above, fails to deliver may be associated
with a scheme to manipulate the price of a security. We are also
concerned about the negative effect that fails to deliver and
potentially abusive ``naked'' short selling may have on individual
securities and the broader market, including on investor
confidence.\192\ The close-out requirements of Rule 204 help address
these concerns by encouraging timely settlement and not allowing fails
to deliver to persist.
---------------------------------------------------------------------------

    \192\ See, e.g., Anti-Fraud Rule Adopting Release, 73 FR 61666.
---------------------------------------------------------------------------

    We understand, however, that fails to deliver may occur from long
sales within the first two settlement days after settlement date for
legitimate reasons. For example, human or mechanical errors or
processing delays can result from transferring securities in custodial
or other form rather than book-entry form, thereby causing a fail to
deliver on a long sale.
    Thus, in Rule 204(a)(1), we are adopting, with certain limited
modifications, the provisions of temporary Rule 204T(a)(1) relating to
closing out fails to deliver resulting from long sales. Specifically,
Rule 204(a)(1) provides that if a participant of a registered clearing
agency has a fail to deliver position at a registered clearing agency
in any equity security and the participant can demonstrate on its books
and records that such fail to deliver position resulted from a long
sale, the participant shall by no later than the beginning of regular
trading hours on the third consecutive settlement day

following the settlement date immediately close out the fail to deliver
position by purchasing or borrowing securities of like kind and
quantity.\193\
---------------------------------------------------------------------------

    \193\ See Rule 204(a)(1).
---------------------------------------------------------------------------

    In addition, consistent with temporary Rule 204T(a)(3), Rule
204(a)(3) extends the close-out requirement for fails to deliver
attributable to certain bona fide market making activities by requiring
a participant to close out the fail to deliver position attributable to
such activities by no later than the beginning of regular trading hours
on the third settlement day after the settlement date. We believe this
exception to Rule 204(a)'s close-out requirement benefits clearing
agency participants because the two additional days to close-out these
fail to deliver positions may reduce close-out costs for such
participants.
    Although we have determined at this time not to provide additional
time within which fails to deliver must be closed out on the applicable
close-out date, we are providing additional flexibility to the close-
out requirements for fails to deliver resulting from long sales and
certain bona fide market making activity by, in contrast to temporary
Rule 204T(a)(1) and (a)(3), providing in Rule 204(a)(1) and (a)(3) the
ability to borrow as well as purchase securities to close out a fail to
deliver position. As some commenters noted, we believe that the ability
to borrow a security to close-out a fail to deliver position may have
less market impact than a purchase, while serving the objective of
closing-out a fail position.\194\ In addition, we believe that the
additional flexibility afforded by the ability to close out a fail to
deliver position either through a purchase or a borrow, will allow
participants to access additional liquidity sources, thereby
potentially reducing close-out costs and helping to ensure that fails
to deliver are closed out on the applicable close-out date.\195\
---------------------------------------------------------------------------

    \194\ See e.g., letters from SIFMA; EWT; MFA; State Street;
BATS; Wedbush.
    \195\ Although Rule 204(a)(1) permits borrowing to close out a
fail to deliver position resulting from a long sale, broker-dealers
must also comply with Rule 203(a) of Regulation SHO. Rule 203(a)(1)
provides that, unless an exception applies, ``[i]f a broker or
dealer knows or has reasonable grounds to believe that the sale of
an equity security was or will be effected pursuant to an order
marked `long,' such broker or dealer shall not lend or arrange for
the loan of any security for delivery to the purchaser's broker
after the sale, or fail to deliver a security on the date delivery
is due.'' 17 CFR 242.203(a).
---------------------------------------------------------------------------

    Temporary Rule 204T(d) provides that a participant may reasonably
allocate its responsibility to close out a fail to deliver position to
another broker-dealer from which the participant receives trades for
clearance and settlement.\196\ Consistent with temporary Rule 204T(d),
Rule 204(d) provides for allocation of a fail to deliver position by a
participant to a broker-dealer. Specifically, Rule 204(d) provides that
if a participant of a registered clearing agency reasonably allocates a
portion of a fail to deliver position to another registered broker-
dealer for which it clears trades or from which it receives trades for
settlement, based on such broker-dealer's short position, the
provisions of Rule 204(a) and (b) relating to such fail to deliver
position shall apply to such registered broker-dealer that was
allocated the fail to deliver position, and not to the
participant.\197\ This allocation provision benefits participants
because if a participant can identify the accounts of broker-dealers
for which they clear or from which they receive trades for settlement,
the participant can allocate the responsibility to close out the fail
to deliver position to the particular broker-dealer account(s) whose
trading activities caused the fail to deliver position, provided the
allocation is reasonable. In this way, the allocated broker-dealer
rather than the participant will incur any costs associated with Rule
204's close-out requirement.
---------------------------------------------------------------------------

    \196\ See temporary Rule 204T(d); see also 17 CFR
242.203(b)(3)(vi). Rule 203(b)(3)(vi) of Regulation SHO provides
that ``[i]f a participant of a registered clearing agency reasonably
allocates a portion of a fail to deliver position to another
registered broker or dealer for which it clears trades or for which
it is responsible for settlement, based on such broker or dealer's
short position, then the provisions of this paragraph (b)(3)
relating to such fail to deliver position shall apply to the portion
of such registered broker or dealer that was allocated the fail to
deliver position, and not to the participant.''
    \197\ See Rule 204(d).
---------------------------------------------------------------------------

    In addition, consistent with temporary Rule 204T(d), Rule 204(d)
imposes a notification requirement on a broker-dealer that has been
allocated responsibility for complying with the rule's requirements.
Thus, under the rule's allocation provision, if the broker-dealer does
not comply with the provisions of Rule 204(a), it must immediately
notify the participant that it has become subject to the borrowing
requirements of Rule 204(b). This notification requirement is intended
to let participants know when a broker-dealer from which the
participant receives trades for clearance and settlement has become
subject to the rule's borrowing requirements. The notification
requirement furthers the Commission's goals of limiting fails to
deliver and addressing abusive ``naked'' short selling by promoting the
prompt and accurate clearance and settlement of transactions involving
equity securities. The notification requirement will also help ensure
that participants that receive trades for clearance and settlement from
broker-dealers will be on notice that the broker-dealer is subject to
the borrow requirements of Rule 204(b) until the fail to deliver
position has been closed out.
    Under Rule 204(e), even if a participant of a registered clearing
agency has not closed out a fail to deliver position at a registered
clearing agency in accordance with Rule 204(a), or has not allocated a
fail to deliver position to a broker-dealer in accordance with Rule
204(d), a broker-dealer shall not be subject to the requirements of
Rule 204(a) or (b) if it purchases or borrows securities, and complies
with the conditions set forth in Rule 204(e)(1) through (4), as
described in detail in Section III.C. above. We note that, unlike
temporary Rule 204T(e), Rule 204(e) permits a broker-dealer to use a
borrow, as well as a purchase, to close out a position prior to the
applicable close-out date. Rule 204(e), similar to temporary Rule
204T(e), encourages early close-outs of fail to deliver positions, by
providing that a broker-dealer can satisfy the rule's close-out
requirements by purchasing securities prior to the applicable close-out
date provided the broker-dealer complies with certain conditions. In
addition, as noted above, Rule 204(e) provides more flexibility than
temporary Rule 204T(e) by allowing a broker-dealer to close out a fail
to deliver position prior to the applicable close-out date by
borrowing, as well as purchasing securities. We believe this ability to
borrow, as well as purchase, securities further encourages early close-
outs of fail to deliver positions which serves the benefit of promoting
our goal of maintaining the reductions in fails to deliver achieved by
the adoption of temporary Rule 204T, as well as other actions taken by
the Commission, by facilitating the ability to close-out fails faster.
    Further, Rule 204(e) is modified from temporary Rule 204T(e)(3)'s
provision that the purchase must be of a quantity of securities
sufficient to cover the entire amount of the broker-dealer's open short
position. The purpose of Rule 204(e) is to encourage broker-dealers to
close out fail to deliver positions prior to the applicable close-out
date (i.e., T+4 or T+6) by reducing the costs of the early close-out.
Requiring a broker-dealer to close out its open fail to deliver
position prior to the applicable close-out date is more closely
tailored towards achieving that goal than requiring a broker-dealer to
close out its open short position prior to the

applicable close-out date. Thus, in response to commenters' concerns,
in Rule 204(e)(3) we have modified the requirement of temporary Rule
204T(e)(3) to provide that a broker-dealer must purchase or borrow a
quantity of securities sufficient to cover the entire amount of that
broker-dealer's fail to deliver position at a registered clearing
agency in that security on the day of the purchase. Consequently, we
believe our incorporation of the conditions of temporary Rule 204T(e),
with the noted modifications, facilitates early close-outs of fail to
deliver positions.\198\
---------------------------------------------------------------------------

    \198\ See supra Section III.C. (explaining the conditions of
Rule 204(e), as well as commenters' concerns that by requiring
broker-dealers to close-out their entire open short position
temporary Rule 204T(e) does not encourage early close-outs).
---------------------------------------------------------------------------

2. Borrowing Requirements
    Under temporary Rule 204T(b), if a participant does not purchase or
borrow shares, as applicable, to close out a fail to deliver position
in accordance with temporary Rule 204T, the participant violates the
close-out requirements of that rule. We are adopting in Rule 204(b) the
borrowing requirements of temporary Rule 204T(b), without modification.
Accordingly, Rule 204(b) imposes on the participant and on all broker-
dealers from which that participant receives trades for clearance and
settlement (including introducing and executing brokers) a requirement
to borrow or arrange to borrow securities prior to accepting or
effecting further short sales in that security. We believe that this
borrow requirement is beneficial in that it furthers our goals of
reducing fails to deliver by helping to maintain the reductions in
fails to deliver achieved by the adoption of temporary Rule 204T, as
well as other actions taken by the Commission, and addressing
potentially abusive ``naked'' short selling, by promoting the prompt
and accurate clearance and settlement of securities transactions.
    Specifically, Rule 204(b) provides that the participant and any
broker-dealer from which it receives trades for clearance and
settlement, including any market maker that is otherwise entitled to
rely on the exception provided in Rule 203(b)(2)(iii) of Regulation
SHO,\199\ may not accept a short sale order in an equity security from
another person, or effect a short sale order in such equity security
for its own account, to the extent that the broker-dealer submits its
short sales to that participant for clearance and settlement, without
first borrowing the security, or entering into a bona-fide arrangement
to borrow the security, until the participant closes out the fail to
deliver position by purchasing securities of like kind and quantity and
that purchase has cleared and settled at a registered clearing
agency.\200\
---------------------------------------------------------------------------

    \199\ See 17 CFR 242.203(b)(2)(iii) (providing an exception from
Regulation SHO's ``locate'' requirement for short sales effected by
a market maker in connection with bona fide market making activities
in the securities for which the exception is claimed).
    \200\ See Rule 204(b). The borrow requirements of Rule 204(b)
are also consistent with the requirements of Rule 203(b)(3)(iv) of
Regulation SHO for a participant that has not closed out a fail to
deliver position in a threshold security that has persisted for
thirteen consecutive settlement days. See 17 CFR 242.203(b)(3)(iv).
Rule 203(b)(3)(iv) of Regulation SHO provides that ``[i]f a
participant of a registered clearing agency has a fail to deliver
position at a registered clearing agency in a threshold security for
thirteen consecutive settlement days, the participant and any broker
or dealer for which it clears transactions, including any market
maker that would otherwise be entitled to rely on the exception
provided in paragraph (b)(2)(iii) of this section, many not accept a
short sale order in the threshold security from another person, or
effect a short sale in the threshold security for its own account,
without borrowing the security or entering into a bona fide
arrangement to borrow the security, until the participant closes out
the fail to deliver position by purchasing securities of like kind
and quantity.''
---------------------------------------------------------------------------

    Rule 204, like temporary Rule 204T, is aimed at reducing fails to
deliver and addressing potentially abusive ``naked'' short selling. To
that end, we believe it is appropriate to include in the rule borrowing
requirements for broker-dealers, including participants, that sell
short a security for which a fail to deliver position has not been
closed out in accordance with the requirements of the rule. We believe
that the borrowing requirements of Rule 204(b) will help further our
goals of reducing fails to deliver by helping to maintain the
reductions in fails to deliver achieved by the adoption of temporary
Rule 204T, as well as other actions taken by the Commission, and
addressing potentially abusive ``naked'' short selling by promoting the
prompt and accurate clearance and settlement of securities
transactions. In addition, we believe the rule's requirement that
participants and broker-dealers from which they receive trades for
clearance and settlement borrow or arrange to borrow securities prior
to accepting or effecting short sales in the security that has a fail
to deliver position that has not been closed out will help continue to
ensure that shares will be available for delivery on any additional
short sales by settlement date and, thereby, help to avoid additional
fails to deliver occurring in the security.
    We note that one commenter asked for clarification regarding
whether a participant ceases to be subject to the borrow requirements
of temporary Rule 204T(b) if a participant no longer has a fail to
deliver position at a registered clearing agency due to the participant
borrowing the securities or the participant receiving securities from
the seller (e.g., in connection with long sales).\201\ Temporary Rule
204T(b) imposes short sale borrowing requirements until the participant
closes out the fail to deliver position by purchasing securities of
like kind and quantity and that purchase has cleared and settled at a
registered clearing agency. Thus, under temporary Rule 204T, regardless
of whether a participant borrows or receives delivery of securities,
the requirements of temporary Rule 204T(b) continue to apply until the
participant purchases securities to close out the fail to deliver
position and that purchase has cleared and settled at a registered
clearing agency.
---------------------------------------------------------------------------

    \201\ See letter from SIFMA.
---------------------------------------------------------------------------

    We have incorporated these same requirements into Rule 204(b)
without modification. The provisions of Rule 204(b) are intended to act
as an additional incentive to broker-dealers to deliver securities by
settlement date, and to close out fail to deliver positions in
accordance with the requirements of Rule 204. We believe that the
purchase requirement of Rule 204(b) is beneficial in that it will
continue to further these goals.
    In connection with the borrowing requirements of Rule 204(b), we
are incorporating into Rule 204(c) the notification requirement
contained in temporary Rule 204T(c), without modification. In
accordance with Rule 204(c), participants must notify all broker-
dealers from which they receive trades for clearance and settlement
that a fail to deliver position has not been closed out in accordance
with Rule 204. Specifically, Rule 204(c) provides that the participant
must notify any broker-dealer from which it receives trades for
clearance and settlement, including any market maker that is otherwise
entitled to rely on the exception provided in Rule 203(b)(2)(iii) of
Regulation SHO,\202\ (a) that the participant has a fail to deliver
position in an equity security at a registered clearing agency that has
not been closed out in accordance with the requirements of Rule 204,
and (b) when the purchase that the participant has made to close out
the fail to deliver position has cleared and settled at a registered
clearing agency.\203\
---------------------------------------------------------------------------

    \202\ See supra note 199.
    \203\ See Rule 204(c).
---------------------------------------------------------------------------

    We are including this notification requirement in Rule 204(c) so
that all broker-dealers that submit trades for clearance and settlement
to a participant

that has a fail to deliver position in a security that has not been
closed out in accordance with Rule 204 will be on notice that short
sales in that security to be cleared or settled through that
participant will be subject to the borrow requirements of Rule 204(b)
until the fail to deliver position has been closed out. We believe this
notification requirement will help serve the goal of addressing
potentially abusive ``naked'' short selling in equity securities.
    As noted above, Rule 204(d) provides that a participant may
reasonably allocate (e.g., the allocation must be timely) its
responsibility to close out a fail to deliver position to another
broker-dealer for which the participant clears or from which the
participant receives trades for settlement. Thus, to the extent that
the participant can identify the broker-dealer(s) that have contributed
to the fail to deliver position, and the participant has reasonably
allocated the close-out obligation to the broker-dealer(s), the
requirement to borrow or arrange to borrow prior to effecting further
short sales in that security will continue to apply to only those
particular broker-dealer(s).\204\
---------------------------------------------------------------------------

    \204\ See Rule 204(d).
---------------------------------------------------------------------------

    Rule 204(b) includes an exception from the borrowing requirements
for any broker-dealer that can demonstrate that it was not responsible
for any part of the fail to deliver position of the participant. We
have incorporated into Rule 204(b) the language of temporary Rule
204T(b)(1), without modification. Thus, Rule 204(b) provides that a
broker-dealer shall not be subject to the requirements of paragraph (b)
of Rule 204 if the broker-dealer timely certifies to the participant
that it has not incurred a fail to deliver position on settlement date
for a long or short sale in an equity security for which the
participant has a fail to deliver position at a registered clearing
agency or that the broker-dealer is in compliance with the requirements
of Rule 204(e).\205\ We have included this exception because we
continue to believe that a broker-dealer should not be subject to the
borrowing requirements of the rule if the broker-dealer can demonstrate
that it did not incur a fail to deliver position in the security on
settlement date, or if it has taken steps, in accordance with Rule
204(e), to close out the fail to deliver position.
---------------------------------------------------------------------------

    \205\ See Rule 204(b).
---------------------------------------------------------------------------

    Temporary Rule 204T(b)(2) included an exception from the borrowing
requirements of temporary Rule 204T(b) for market makers that can
demonstrate that they do not have an open short position in the equity
security at the time of any additional short sales.\206\ We do not
believe that a similar exception is necessary under Rule 204(b)
because, as with other broker-dealers, a market maker is excepted from
the borrowing requirements of Rule 204(b) if it timely certifies to the
participant that it has not incurred a fail to deliver position on
settlement date for a long or short sale in an equity security for
which the participant has a fail to deliver position at a registered
clearing agency or that it is in compliance with the requirements of
Rule 204(e). Because Rule 204(b) includes an exception applicable to
all broker-dealers, including market makers, we do not think it is
necessary to maintain a separate exception applicable only to market
makers.
---------------------------------------------------------------------------

    \206\ See temporary Rule 204T(b)(2).
---------------------------------------------------------------------------

3. Sales of Certain Deemed To Own Securities
    After considering the comments and to provide consistency between
the delivery requirements of Rule 203(b)(2)(ii) of Regulation SHO and
the close-out requirements of Rule 204, we are adopting in Rule
204(a)(2) the requirements of temporary Rule 204T(a)(2) with some
limited modifications.\207\ Specifically, we are expanding the universe
of securities to which Rule 204(a)(2) will apply. Rule 204(a)(2) will
apply to fails to deliver resulting from the sale of an equity security
that a person is ``deemed to own'' pursuant to Rule 200 of Regulation
SHO and that such person intends to deliver as soon as all restrictions
on delivery have been removed.\208\ In addition, we are revising the
close-out period within which a participant must close out fails to
deliver resulting from sales of such securities to be consistent with
the delivery period contained in Rule 203(b)(2)(ii) of Regulation SHO.
---------------------------------------------------------------------------

    \207\ See e.g., letter from SIFMA.
    \208\ See Rule 204(a)(2).
---------------------------------------------------------------------------

    Thus, Rule 204(a)(2) provides that if a participant of a registered
clearing agency has a fail to deliver position at a registered clearing
agency in any equity security resulting from the sale of a security
that a person is deemed to own pursuant to Rule 200 of Regulation SHO
and that such person intends to deliver as soon as all restrictions on
delivery have been removed, the participant shall, by no later than the
beginning of regular trading hours on the thirty-fifth consecutive
calendar day following the trade date for the transaction, immediately
close out the fail to deliver position by purchasing securities of like
kind and quantity.\209\ We believe that amending the close-out
requirement to 35 consecutive calendar days from trade date for fails
to deliver resulting from sales of such owned securities will better
permit the orderly settlement of such sales without the risk of causing
market disruption due to unnecessary purchasing activity (particularly
if the purchases are for sizable quantities of stock). In addition, the
amendment to the close-out period relieves an inconsistency between
Rule 203(b)(2)(ii) of Regulation SHO and temporary Rule 204T(a)(2), as
noted by one commenter.\210\
---------------------------------------------------------------------------

    \209\ See id.
    \210\ See letter from SIFMA.
---------------------------------------------------------------------------

    Although this amendment will provide an extended period of time
within which fails to deliver resulting from sales of certain ``deemed
to own'' securities must be closed out, we believe that such additional
time is warranted and does not undermine our goal of reducing fails to
deliver because these are sales of owned securities that cannot be
delivered by settlement date due solely to processing delays outside
the seller's or broker-dealer's control. Moreover, delivery will be
made on such sales as soon as all restrictions on delivery have been
removed. In addition, if a fail to deliver position is not closed out
in accordance with Rule 204(a)(2), the borrowing requirements of Rule
204(b) will apply. Rule 204(b)'s borrowing requirements will help
ensure that additional fails to deliver cannot occur until securities
have been purchased to close out the fail to deliver position and such
purchase has cleared and settled.
    Thus, if a participant does not close out a fail to deliver
position at a registered clearing agency in accordance with Rule
204(a)(2), the rule prohibits the participant, and any broker-dealer
from which it receives trades for clearance and settlement, including
market makers, from accepting any short sale orders or effecting
further short sales in the particular security without borrowing, or
entering into a bona-fide arrangement to borrow, the security until the
participant closes out the entire fail to deliver position by
purchasing securities of like kind and quantity and that purchase has
cleared and settled at a registered clearing agency.\211\
---------------------------------------------------------------------------

    \211\ See Rule 204(b).
---------------------------------------------------------------------------

C. Costs

    We recognize that temporary Rule 204T may have resulted in
increased short selling costs for participants that may have impacted
legitimate short

selling activities.\212\ To the extent that the requirements of
temporary Rule 204T have resulted in increased short selling costs, we
do not believe that such costs will increase, and may in fact decrease,
under Rule 204 because, as discussed below, among other things, we have
provided additional flexibility to closing out fails to deliver under
Rule 204 as compared to Rule 204T.
---------------------------------------------------------------------------

    \212\ See, e.g., letter from CBOE (noting its belief that
legitimate short selling activity has been damaged by temporary Rule
204T).
---------------------------------------------------------------------------

    Some commenters stated that temporary Rule 204T has imposed burdens
on market participants in several areas, including on firm operations
personnel.\213\ Some industry participants have stated that lending
rates increased significantly following the adoption of temporary Rule
204T and other recent Commission actions.\214\ We note, however, that
the evidence that attempts to specify the cause of any such increase in
lending rates is confounded by the unusual circumstances of the
continued credit crisis. In addition, we note that a recent academic
study that examined borrowing costs after the September Emergency Order
\215\ found no significant increase in average lending rates.\216\
---------------------------------------------------------------------------

    \213\ See letters from CBOE (stating that temporary Rule 204T
has created undue burdens in trading and risk management, clearing,
lending and buy-in operations and front-end trading, back-office and
regulatory systems); SIFMA; State Street (noting the ``additional
transactional, operational and market costs which the industry had
to incur'').
    \214\ See supra notes 39-42 and accompanying text (discussing
recent Commission actions in addition to the adoption of temporary
Rule 204T).
    \215\ See September Emergency Order, 73 FR 54875.
    \216\ See Adam C. Kolasinski, Adam V. Reed, and Jacob R.
Thornock, Prohibitions versus Constraints: The 2008 Short Sales
Regulations, March 2009 working paper.
---------------------------------------------------------------------------

    As discussed in more detail below, some commenters also stated that
the inflexibility of temporary Rule 204T's requirement that
participants purchase securities to close-out a fail to deliver
position by no later than the beginning of regular trading hours on the
applicable close-out date has led to increased market pressures and
market volatility due to the need to execute potentially large
purchases at the market open.\217\
---------------------------------------------------------------------------

    \217\ See e.g., letters from SIFMA; MFA; Wedbush; Lek
Securities; State Street.
---------------------------------------------------------------------------

    To the extent that the requirements of Rule 204 result in increased
costs to short selling in equity securities, it may lessen some of the
benefits of legitimate short selling and, thereby, result in a
reduction in short selling generally. Such a reduction may lead to a
decrease in market efficiency and price discovery, less protection
against upward stock price manipulations, a less efficient allocation
of capital, an increase in trading costs, and a decrease in liquidity.
We also recognize that requiring that participants close out fails to
deliver in equity securities in accordance with the rule may
potentially impact the willingness of participants to provide
liquidity. As one commenter stated, certain aspects of the close-out
process ``may have an unintended impact on the securities lending
market and therefore the efficient functioning of the markets.'' \218\
As a result, securities lending could become more risky and costly and,
in turn, impact market liquidity and price discovery benefits of short
selling.\219\
---------------------------------------------------------------------------

    \218\ Letter from ICI; see also letter from CBOE.
    \219\ See letters from ICI; BATS.
---------------------------------------------------------------------------

    Although we recognize that Rule 204 may result in the continuation
of some costs, as well as new costs, to certain participants, as
discussed in detail below, we believe such costs will be limited and
are justified by the fact that the rule will continue our efforts to
achieve our goals of reducing fails to deliver by maintaining the
reductions in fails to deliver achieved by the adoption of temporary
Rule 204T, as well as other actions taken by the Commission, and
addressing potentially abusive ``naked'' short selling and, thereby
help restore, maintain, and enhance investor confidence in the markets.
1. Close-Out Requirements
    Consistent with temporary Rule 204T(a), Rule 204(a) provides that a
participant of a registered clearing agency must deliver securities to
a registered clearing agency for clearance and settlement on a long or
short sale in any equity security by settlement date, or if a
participant of a registered clearing agency has a fail to deliver
position at a registered clearing agency in any equity security for a
long or short sale transaction in that equity security, the participant
shall, by no later than the beginning of regular trading hours on the
settlement date, immediately close out the fail to deliver position by
borrowing or purchasing securities of like kind and quantity.\220\
Similarly, consistent with temporary Rule 204T(a)(1) and (a)(3), the
close-out requirements of Rule 204(a)(1) and (a)(3) for fails to
deliver resulting from long sales and certain bona fide market making
activity must be closed out by the beginning of regular trading hours
on the close-out date for such fails to deliver (i.e., T+6).\221\
---------------------------------------------------------------------------

    \220\ See Rule 204(a).
    \221\ See Rules 204(a)(1) and 204(a)(3).
---------------------------------------------------------------------------

    As discussed in detail above in Section VII.B. in connection with
the benefits of Rule 204, some commenters requested that we extend the
close-out period for fails to deliver resulting from short sales, long
sales, and bona fide market making activity from the beginning to the
end of regular trading hours on the applicable close-out date due to
concerns that temporary Rule 204T's requirement to close out fails to
deliver by no later than the beginning of regular trading hours can
create buying pressure at the open, that may temporarily distort the
price of the security.\222\ Other commenters requested additional days
within which to close out fails to deliver in connection with short
sales.\223\ Commenters stated that the additional time to close out
fails to deliver would allow the majority of trades to clear and settle
on their own within a few days following the regular settlement date
(i.e., T+3).\224\
---------------------------------------------------------------------------

    \222\ See, e.g., letters from MFA; CBOE; SIFMA; BATS; RMA; State
Street.
    \223\ See e.g., letters from EWT; Coalition of Private
Investment Companies; SIFMA; MFA; State Street; CBOE; Options
Exchanges.
    \224\ See, e.g., letters from SIFMA; MFA; State Street; CBOE;
Options Exchanges; Coalition of Private Investment Companies.
---------------------------------------------------------------------------

    Some commenters expressed concerns about the effect of the close-
out requirements of temporary Rule 204T on securities lending.\225\ One
commenter also noted that in practice fails to deliver resulting from
sales of securities on loan, which are considered ``long'' sales, are
often closed out in accordance with the time-frames for fails to
deliver resulting from short sales rather than long sales because
temporary Rule 204T does not provide sufficient time to determine
whether or not a fail to deliver position resulted from a long or short
sale, which acts as a disincentive to lending and causes institutions
to question their participation in lending programs.\226\ Other
commenters expressed concerns regarding the impact of temporary Rule
204T's close-out requirements on the lending recall process.\227\
---------------------------------------------------------------------------

    \225\ See, e.g., letter from SIFMA.
    \226\ See letter from SIFMA; see also letters from RMA; ICI.
    \227\ See letters from EWT; BATS; RMA; ICI; Wedbush; RMA.
---------------------------------------------------------------------------

    As discussed above, although we recognize commenters' concerns
regarding the potential market impact of the close-out requirements of
temporary Rule 204T, such close-out requirements are furthering our
goal of reducing fails to deliver, as evidenced in part by preliminary
results from OEA regarding its impact on the number of fails to

deliver.\228\ To maintain this reduction, we believe it is appropriate
at this time to adopt as a permanent rule the requirement that fails to
deliver resulting from short sales, long sales, and certain bona fide
market making activity must be closed out by no later than the
beginning of regular trading hours on the applicable close-out date.
---------------------------------------------------------------------------

    \228\ See supra note 164.
---------------------------------------------------------------------------

    In addition, as discussed above, we believe that continuing to
require that fails to deliver be closed out on the day immediately
following the day on which the fail to deliver occurs is consistent
with our goal of reducing fails to deliver and addressing ``naked''
short selling and, in particular, potentially abusive ``naked'' short
selling. Although extending the time-frames within which fails to
deliver must be closed out may allow for ordinary course settlement, as
several commenters contend, we believe that the close-out requirements
of Rule 204 are necessary to help encourage delivery by settlement date
and achieve our goal of not allowing fails to deliver to persist.
    We recognize that Rule 204T's close-out requirement resulted in
costs for participants of a registered clearing agency in terms of
systems and surveillance modifications and recordkeeping, as well as
changes to processes and procedures. Because we have made limited
modifications in Rule 204 to some of the requirements of temporary Rule
204T, compliance with Rule 204's requirements may result in new costs
for participants in terms of systems and surveillance modifications and
recordkeeping, as well as changes to processes and procedures.
    We believe, however, that most of the infrastructure and personnel
necessary to comply with Rule 204 is already in place to meet the
requirements of Rule 203(b)(3) of Regulation SHO \229\ and temporary
Rule 204T. As temporary Rule 204T has been in effect since September
2008, and Rule 204 incorporates the substance of temporary Rule 204T
with limited modifications, market participants should already have
established systems and processes that should mitigate many of the
costs to comply with Rule 204. Thus, we believe any additional costs
incurred with respect to complying with Rule 204's close-out
requirements, over those incurred with respect to complying with
temporary Rule 204T, will be minimal.
---------------------------------------------------------------------------

    \229\ See 17 CFR 242.203(b)(3).
---------------------------------------------------------------------------

    In addition, we note that the close-out requirements of Rule 204
are consistent with current settlement practices and procedures and
with the close-out requirements of temporary Rule 204T and Rule
203(b)(3) of Regulation SHO. For example, because most transactions
settle by T+3, participants should already have had in place policies
and procedures to help ensure that delivery is being made by settlement
date prior to the implementation of the requirements of temporary Rule
204T.\230\ Nevertheless, under Rule 204, as under temporary Rule 204T,
we recognize that participants will continue to incur costs for each
close-out and these costs could accumulate to significant amounts over
time and across participants. For example, one commenter noted that
``the close-out process is manual in nature and involves intensive
monitoring of multiple levels of data across various system platforms
and business units within the firm.'' \231\ We believe, however, that
the experience participants have gained to date in complying with
temporary Rule 204T is expected to reduce the costs to participants in
complying with Rule 204 from those incurred in connection with
complying with Rule 204T.
---------------------------------------------------------------------------

    \230\ See supra note 16.
    \231\ Letter from SIFMA.
---------------------------------------------------------------------------

    Moreover, similar to the existing close-out requirements of Rule
203(b)(3) of Regulation SHO and consistent with temporary Rule 204T,
the requirements of Rule 204 are based on a participant's fail to
deliver position at a registered clearing agency. As noted above, the
NSCC clears and settles the majority of equity securities trades
conducted on the exchanges and in the over-the-counter markets.\232\
The NSCC clears and settles trades through the CNS system, which nets
the securities delivery and payment obligations of all of its
members.\233\ The NSCC notifies its members of their securities
delivery and payment obligations daily.\234\ Because Rule 204 is based
on a participant's fail to deliver position at a registered clearing
agency, it is consistent with current settlement practices and
procedures and with the Regulation SHO framework regarding delivery of
securities.\235\ As such, we anticipate that most participants will
already have systems, processes and procedures in place in order to
comply with Rule 204's close-out requirements and, therefore, that any
additional implementation costs associated with the rule will be
minimal.
---------------------------------------------------------------------------

    \232\ See supra note 35.
    \233\ See id.
    \234\ See id.
    \235\ See 17 CFR 242.203(b)(3).
---------------------------------------------------------------------------

    In addition, to comply with Regulation SHO's close-out requirement
when it became effective in January 2005, participants needed to modify
their recordkeeping systems and surveillance mechanisms.\236\
Participants also should have retained and trained the necessary
personnel to ensure compliance with the Regulation SHO's close-out
requirements. As we noted in the Rule 204T Adopting Release, the
infrastructure necessary to comply with the requirements of that rule
should already be in place.\237\ Because Rule 204 incorporates the
substance of temporary Rule 204T with limited modifications, we
similarly believe that most of the infrastructure necessary to comply
with Rule 204's close-out requirements will already be in place. Thus,
we believe minimal modifications will be necessary to comply with Rule
204. Accordingly, we believe that any changes to personnel, computer
hardware and software, recordkeeping or surveillance costs will be
minimal.\238\
---------------------------------------------------------------------------

    \236\ See, e.g., letter from SIFMA (indicating that their
existing system for tracking and eliminating fails to deliver is
based on the Regulation SHO framework).
    \237\ See Rule 204T Adopting Release, 73 FR 61725.
    \238\ See also supra Section VII.B.I. (discussing benefits of
the close-out requirements despite commenters' costs concerns).
---------------------------------------------------------------------------

    We recognize that the requirements of Rule 204(a)(1) with respect
to closing out fails to deliver resulting from long sales, may impose
additional costs on participants. However, we believe that these costs
are consistent with those currently borne by these entities in
complying with temporary Rule 204T(a)(1). Under Rule 204(a)(1), a
participant of a registered clearing agency that has a fail to deliver
position at a registered clearing agency in an equity security and can
demonstrate on its books and records that the fail to deliver position
resulted from a long sale will have until no later than the beginning
of regular trading hours on the third consecutive settlement day
following the settlement date to immediately close out the fail to
deliver position by purchasing or borrowing securities of like kind and
quantity.\239\ Thus, to qualify for this additional time to close out a
fail to deliver position, the rule requires the participant to
demonstrate on its books and records that the fail to deliver position
resulted from a long sale. This demonstration requirement may result in
participants continuing to incur costs related to personnel,
recordkeeping, systems, and surveillance mechanisms. However, because
most of these systems have been in place since September 2008 in order
for broker-dealers to comply with the requirements of temporary Rule

204T, we do not believe that the demonstration requirements of Rule
204(a)(1) will result in significant additional cost.
---------------------------------------------------------------------------

    \239\ See Rule 204(a)(1).
---------------------------------------------------------------------------

    In addition, we recognize that the allocation notification
requirement of Rule 204(d) may continue to impose costs on broker-
dealers that have been allocated responsibility for the close-out
requirement under the rule. As discussed above, consistent with
temporary Rule 204T(d), Rule 204(d) requires a broker-dealer that has
been allocated a portion of a fail to deliver position that has not
complied with the close-out requirements under the rule to notify the
participant that it has become subject to the borrowing requirements of
Rule 204(b). This notification requirement may result in broker-dealers
incurring costs related to personnel, recordkeeping, systems, and
surveillance mechanisms. Again, as most of these mechanisms have been
in place since the implementation of temporary Rule 204T, we believe
any further implementation costs will be minimal, and the costs
incurred with each notification will be similar to those incurred under
temporary Rule 204T.
    We also recognize that like temporary Rule 204T, the requirements
of Rule 204(e) may continue to impose costs on broker-dealers. Rule
204(e) allows a broker-dealer to obtain credit if it purchases
securities in accordance with the conditions specified in that
provision of the rule. Rule 204(e) requires, among other things, that a
broker-dealer demonstrate that it has a net long position or net flat
position on its books and records on the settlement day for which the
broker-dealer is claiming credit. This demonstration requirement may
continue to result in participants incurring costs related to
personnel, recordkeeping, systems, and surveillance mechanisms.
However, we believe the costs associated with Rule 204(e) will be
minimal because the mechanisms necessary to comply with this
requirement should already be in place.
2. Borrowing Requirements
    Consistent with temporary Rule 204T, we believe that Rule 204's
borrowing requirements for fail to deliver positions that are not
closed out in accordance with the rule will result in limited, if any,
implementation costs--in terms of personnel, recordkeeping, systems and
surveillance mechanisms--to participants of a registered clearing
agency, and broker-dealers from which they receive trades for clearance
and settlement. These entities have already had to comply with the
borrowing requirements of Rule 203(b)(3)(iv) of Regulation SHO,\240\
since January 2005, and temporary Rule 204T since September 2008, as
applicable, if a fail to deliver position has not been closed out in
accordance with those rules' mandatory close-out requirements.
Accordingly, participants and broker-dealers are already required to
have in place the personnel, recordkeeping, systems, and surveillance
mechanisms necessary to comply with Rule 204(b)'s borrowing
requirements. Nevertheless, we recognize that these borrowing
requirements will impose costs on participants, broker-dealers, and
investors, and these costs can accumulate to significant amounts if the
borrowing requirement is triggered often. One commenter stated a
concern that, ``[R]equiring a borrow or arrangement to borrow
securities prior to accepting or effectuating further short sales in a
security that failed to deliver and has not been closed out, are overly
restrictive.'' \241\ Because Rule 204 does not modify this requirement,
we expect these costs to be similar to those under temporary Rule 204T.
---------------------------------------------------------------------------

    \240\ 17 CFR 242.203(b)(3)(iv).
    \241\ Letter from MFA.
---------------------------------------------------------------------------

    Consistent with temporary Rule 204T, however, Rule 204 is aimed at
addressing potentially abusive ``naked'' short selling. To that end, we
believe it is appropriate to continue to include in the rule borrowing
requirements for participants and broker-dealers that sell short a
security for which a fail to deliver position has not been closed out
in accordance with the requirements of the rule. We believe that the
borrowing requirements of Rule 204(b), like those already required by
temporary Rule 204T(b), will help further our goals of reducing fails
to deliver by helping to maintain the reductions in fails to deliver
achieved by the adoption of temporary Rule 204T, as well as other
actions taken by the Commission, and addressing potentially abusive
``naked'' short selling by promoting the prompt and accurate clearance
and settlement of securities transactions. By continuing to require
that participants and broker-dealers from which they receive trades for
clearance and settlement borrow or arrange to borrow securities prior
to accepting or effecting additional short sales in the security that
has a fail to deliver position that has not been closed out, the rule
will continue to help ensure that shares will be available for delivery
on the short sale by settlement date and, thereby, will continue to
help avoid additional fails to deliver occurring in the security.
    Moreover, we believe any other costs incurred in connection with
the borrowing requirements of Rule 204(b) will be limited because,
consistent with temporary Rule 204T(b)(1), if a participant becomes
subject to the borrowing requirements of Rule 204(b), a broker-dealer
that clears through the participant will not also be subject to the
borrowing requirements of Rule 204(b) if that broker-dealer can
demonstrate that it was not responsible for any part of the fail to
deliver position of the participant or that it has complied with the
requirement of Rule 204(e).\242\
---------------------------------------------------------------------------

    \242\ See Rule 204(b).
---------------------------------------------------------------------------

    The certification requirement of Rule 204(b) may impose some costs
on a broker-dealer having to demonstrate that it was not responsible
for any part of the fail to deliver position of the participant. As
discussed above, Rule 204(b) requires a broker-dealer to timely certify
to the participant that it has not incurred a fail to deliver position
on settlement date in an equity security for which the participant has
a fail to deliver position at a registered clearing agency or the
broker-dealer is in compliance with the requirements set forth in Rule
204(e).\243\ However, as we noted in the PRA section for temporary Rule
204T, the certification requirement's impact on broker-dealers' costs
related to personnel, recordkeeping, systems, and surveillance
mechanisms is expected to be limited.\244\ We expect that Rule 204's
impact on broker-dealers' costs similarly will be limited because the
requirements of Rule 204(b) are consistent with the requirements of
temporary Rule 204T(b)(1).
---------------------------------------------------------------------------

    \243\ See id.
    \244\ See Rule 204T Adopting Release, 73 FR 61726-61727.
---------------------------------------------------------------------------

    Consistent with existing requirements under temporary Rule 204T(c),
the notification requirement of Rule 204(c) may continue to impose
costs on participants of a registered clearing agency. Rule 204(c)
requires a participant to notify any broker-dealer from which it
receives trades for clearance and settlement, including any market
maker that would otherwise be entitled to rely on the exception
provided in Rule 203(b)(2)(iii) of Regulation SHO,\245\ (1) that the
participant has a fail to deliver position in an equity security at a
registered clearing agency that has not been closed out in accordance
with the requirements of Rule 204(a), and (2) when the purchase that
the participant has made to close out the fail to deliver position has
cleared and settled at a registered

clearing agency.\246\ This notification requirement may result in
participants incurring costs related to personnel, recordkeeping,
systems, and surveillance mechanisms. We believe, however, that any
additional costs under Rule 204 will be minimal because participants
should already have in place mechanisms necessary to comply with this
requirement pursuant to temporary Rule 204T.
---------------------------------------------------------------------------

    \245\ See supra note 199.
    \246\ See Rule 204(c).
---------------------------------------------------------------------------

 3. Sales of Certain Deemed To Own Securities
    We do not believe that the modification in Rule 204(a)(2) to apply
the close-out requirement to fails to deliver resulting from the sale
of any equity security that a person is ``deemed to own'' pursuant to
Rule 200 of Regulation SHO, and that such person intends to deliver as
soon as all restrictions on delivery have been removed, rather than
just fails to deliver resulting from sales of Rule 144 Securities as in
temporary Rule 204T(a)(2), will impose any significant additional cost
on participants.\247\ In fact, this modification is responsive to
issues raised by commenters and should decrease costs from those of
temporary Rule 204T by providing additional time to close out fails to
deliver in additional ``deemed to own'' securities.\248\
---------------------------------------------------------------------------

    \247\ See Rule 204(a)(2).
    \248\ See, e.g., letter from SIFMA.
---------------------------------------------------------------------------

    Participants may incur some costs to implement changes to their
current systems to comply with the limited modifications in Rule
204(a)(2) as compared with temporary Rule 204T(a)(2). Specifically,
participants will have to ensure that their systems apply the close-out
requirements to all ``deemed to own'' securities, rather than just
equity securities sold pursuant to Rule 144 of the Securities Act, as
well as monitor for compliance with the 35 calendar day close-out
period. However, we believe the costs for such adjustments will be
minimal.

VIII. 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 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.\249\ In addition, Section 23(a)(2) of the Exchange Act
requires the Commission, when adopting rules under the Exchange Act, to
consider the impact such rules would have on competition.\250\ 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.
---------------------------------------------------------------------------

    \249\ 15 U.S.C. 78c(f).
    \250\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    We believe Rule 204 will not materially affect the promotion of the
efficiency of the capital markets. Rule 204 makes some modifications
relative to temporary Rule 204T and we believe that Rule 204 will help
limit disruptions due to potentially abusive ``naked'' short selling,
but several commenters argue that temporary Rule 204T created
disruptions at the open and empirical evidence suggests that fails to
deliver, on average, are unrelated to stock prices.\251\
---------------------------------------------------------------------------

    \251\ See, e.g., Fotak, Raman, and Yadav, 2009, Naked Short
Selling: The Emperor's New Clothes?, working paper, University of
Oklahoma.
---------------------------------------------------------------------------

    As discussed in the Rule 204T Adopting Release, we believe that
Rule 204 will help further our goals of reducing fails to deliver by
maintaining the reductions in fails to deliver achieved by the adoption
of temporary Rule 204T, as well as other actions taken by the
Commission, and addressing potentially abusive ``naked'' short selling
without unduly burdening legitimate short selling activity. Rule 204 is
intended to maintain the significant reductions in the number of fails
to deliver in all equity securities since, among other actions, the
adoption of temporary Rule 204T \252\ by requiring that participants of
a registered clearing agency that have a fail to deliver position,
immediately close out the fail to deliver position by borrowing or
purchasing securities of like kind and quantity by no later than the
beginning of regular trading hours on the applicable close-out date. A
participant that does not comply with Rule 204's close-out
requirements, and any broker-dealer from which it receives trades for
clearance and settlement, will not be able to short sell the security
either for itself or for the account of another, unless it has borrowed
the security, or entered into a bona fide arrangement to borrow the
security, until the fail to deliver position is closed out.
---------------------------------------------------------------------------

    \252\ See supra note 164.
---------------------------------------------------------------------------

    The rule is designed to help ensure that buyers of equity
securities receive delivery of their shares, thereby helping to
discourage persistent fails to deliver, which may have a negative
effect on the securities markets and investors and also may be used to
facilitate manipulative trading strategies. By requiring that
participants of a registered clearing agency borrow or purchase
securities to close out a fail to deliver position by no later than the
beginning of regular trading hours on the applicable close-out date,
Rule 204 will promote the prompt clearance and settlement of securities
transactions. By doing so, the rule will help further our goals of
reducing fails to deliver by maintaining the reductions in fails to
deliver achieved by the adoption of temporary Rule 204T, as well as
other actions taken by the Commission, and addressing potentially
abusive ``naked'' short selling and, thereby, will help ensure that
investors remain confident that trading can be conducted without the
illegal influence of manipulation. A loss of confidence in the market
for these securities can lead to panic selling, which may be further
exacerbated by potentially abusive ``naked'' short selling.
    We sought comment regarding whether the rule may adversely impact
liquidity, disrupt markets, or unnecessarily increase risks or costs to
participants of a registered clearing agency. We are incorporating by
reference the discussion in the Rule 204T Adopting Release regarding
the burden on competition and promotion of efficiency, competition, and
capital formation,\253\ except to the extent that we have made
modifications or because we are addressing comments.
---------------------------------------------------------------------------

    \253\ See Rule 204T Adopting Release, 73 FR 61728-61729.
---------------------------------------------------------------------------

    Several commenters suggested that temporary Rule 204T has had a
negative impact, particularly at the market open.\254\ Although we
recognize commenters' concerns regarding the potential market impact of
the close-out requirements of temporary Rule 204T, we believe that
these potential concerns are justified by the benefits of retaining the
strict close-out requirements of temporary Rule 204T. In addition, we
note that the close-out provisions of Rule 204 provide additional
flexibility in 204(a)(1) and (a)(3) by allowing a participant to close
out a fail to deliver position resulting from a long sale or certain
bona fide market making activity by borrowing as well as purchasing
securities. In addition, as discussed above, in contrast to temporary
Rule 204T, participants may satisfy the close-out requirement to
purchase securities of like kind and quantity with a VWAP order.\255\
This increased flexibility in

Rule 204, as compared with temporary Rule 204T, is expected to reduce
the possibility of the increased volatility and market disruptions
potentially caused by temporary Rule 204T by potentially providing
additional sources of liquidity from which to obtain shares to close
out fail to deliver positions.
---------------------------------------------------------------------------

    \254\ See supra Section III (discussing commenters' concerns
regarding the market impact of temporary Rule 204T).
    \255\ See supra note 66.
---------------------------------------------------------------------------

    We believe that the rule will promote capital formation. Issuers
and investors have repeatedly expressed concerns about fails to deliver
in connection with potentially manipulative ``naked'' short
selling.\256\ The perception that potentially abusive ``naked'' short
selling is occurring in securities could undermine the confidence of
investors. These investors, in turn, may be reluctant to commit capital
to an issuer they believe to be subject to such manipulative
conduct.\257\ To the extent that ``naked'' short selling and fails to
deliver result in an unwarranted decline in investor confidence about a
security, the rule will improve investor confidence about the security.
As previously noted, preliminary results from OEA indicate that the
Commission's various recent actions with respect to further reducing
fails to deliver, including the adoption of temporary Rule 204T, have
contributed to a significant reduction in the number of fails to
deliver.\258\ In addition, the rule may lead to a greater certainty in
the settlement of these securities which is expected to strengthen
investor confidence in the settlement process. Therefore, we believe
maintaining the substance of temporary Rule 204T in permanent Rule 204
will help achieve the Commission's goals of preventing substantial
disruption in the securities markets, reducing fails to deliver by
maintaining the reductions in fails to deliver achieved by the adoption
of temporary Rule 204T, as well as other actions taken by the
Commission, and helping to prevent potentially abusive ``naked'' short-
selling.
---------------------------------------------------------------------------

    \256\ See, e.g., 2008 Regulation SHO Final Amendments, 73 FR
61690.
    \257\ See supra note 28 (discussing comments in response to the
Rule 204T Adopting Release expressing concern about the impact of
potential ``naked'' short selling on capital formation, claiming
that ``naked'' short selling causes a drop in an issuer's stock
price and may limit the issuer's ability to access the capital
markets). In connection with prior proposed amendments to Regulation
SHO aimed at reducing fails to deliver and addressing potentially
abusive ``naked'' short selling, such as the 2007 Regulation SHO
Proposed Amendments, we sought comment on whether such proposed
amendments would promote capital formation, including whether the
proposed increased short sale restrictions would affect investors'
decisions to invest in certain equity securities. In response,
commenters expressed concern about the potential impact of ``naked''
short selling on capital formation claiming that ``naked'' short
selling causes a drop in an issuer's stock price that may limit the
issuer's ability to access the capital markets. See, e.g., letters
from Medis; NCANS.
    \258\ See supra note 164.
---------------------------------------------------------------------------

    We also believe that the rule will not impose any burden on
competition not necessary or appropriate in furtherance of the purposes
of the Exchange Act. By requiring that participants of a registered
clearing agency borrow or purchase securities to close out a fail to
deliver position by no later than the beginning of regular trading
hours on the applicable close-out date, we believe the rule will
promote competition by requiring similarly situated participants of a
registered clearing agency, including broker-dealers from which they
receive trades for clearance and settlement, to close out fail to
deliver positions in any equity securities within similar time-frames.
Moreover, the requirements of the rule will help to further reduce any
possibility that potentially abusive ``naked'' short selling may
contribute to the disruption of markets in equity securities and,
therefore, will help ensure that all investors remain confident that
trading in these securities can be conducted without the influence of
illegal manipulation. We also believe that the rule will promote
competition by protecting and enhancing the operation, integrity, and
stability of the markets. At the same time, the rule will help to
maintain fair and orderly markets without unduly restricting legitimate
short selling.

IX. Final Regulatory Flexibility Analysis

    The Final Regulatory Flexibility Analysis (``FRFA'') has been
prepared in accordance with 5 U.S.C. 604. This FRFA relates to the
adoption of Rule 204 to Regulation SHO.\259\
---------------------------------------------------------------------------

    \259\ Although the requirements of the Regulatory Flexibility
Act are not applicable to rules adopted under the Administrative
Procedure Act's ``good cause'' exception, see 5 U.S.C. 601(2)
(defining ``rule'' and notice requirements under the Administrative
Procedures Act), we nevertheless prepared an FRFA.
---------------------------------------------------------------------------

A. Need for and Objectives of the Rule

    Sections I through VI of this release describe the reasons for and
objectives of Rule 204. As previously stated in the temporary Rule 204T
Adopting Release,\260\ we are concerned that the close-out requirements
of Regulation SHO have not gone far enough in reducing fails to deliver
and addressing potentially abusive ``naked'' short selling. Thus, we
are incorporating the requirements of temporary Rule 204T with limited
modification into Rule 204 to help maintain the recent reductions in
fails to deliver resulting from the implementation of temporary Rule
204T and other Commission actions. We believe the adoption of Rule 204
is appropriate to continue our goals of reducing fails to deliver by
maintaining the reductions in fails to deliver achieved by the adoption
of temporary Rule 204T, as well as other actions taken by the
Commission, addressing potentially abusive ``naked'' short selling, and
providing an incentive for sellers to promptly deliver securities by
settlement date.
---------------------------------------------------------------------------

    \260\ See Rule 204T Adopting Release, 73 FR 61712.
---------------------------------------------------------------------------

B. Small Entities Affected by the Rule

    The entities covered by the rule will include small entities that
are participants of a registered clearing agency and small broker-
dealers from which participants receive trades for clearance and
settlement. In addition, the entities covered by the rule will include
small entities that are market participants that effect sales subject
to the requirements of Regulation SHO. Although it is impossible to
quantify every type of small entity covered by the rule, Paragraph
(c)(1) of Rule 0-10 under the Exchange Act \261\ 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. We estimate that as of 2008 there were
approximately 915 broker-dealers that qualified as small entities as
defined above.\262\
---------------------------------------------------------------------------

    \261\ 17 CFR 240.0-10(c)(1).
    \262\ These numbers are based on OEA's review of 2008 FOCUS
Report filings reflecting registered broker-dealers. This number
does not include broker-dealers that are delinquent on FOCUS Report
filings.
---------------------------------------------------------------------------

    As noted above, the entities covered by the rule will include small
entities that are participants of a registered clearing agency. As of
May 30, 2009, approximately 89% of participants of the NSCC, the
primary registered clearing agency responsible for clearing U.S.
transactions, were registered as broker-dealers. Participants not
registered as broker-dealers include such entities as banks, U.S.-
registered exchanges, and clearing agencies. Although these entities
are participants of a registered clearing agency, generally these
entities do not engage in the types of activities that would implicate
the close-out requirements of Regulation SHO.

    The Federal securities laws do not define what is a ``small
business'' or ``small organization'' when referring to a bank. The
Small Business Administration regulations define ``small entities'' to
include banks and savings associations with total assets of $175
million or less.\263\ As of May 30, 2009, no bank that was a
participant of the NSCC was a ``small entity'' because none met that
criteria.
---------------------------------------------------------------------------

    \263\ See 13 CFR 121.201.
---------------------------------------------------------------------------

    Paragraph (e) of Rule 0-10 under the Exchange Act \264\\\ 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 601 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 U.S. registered exchange is a small entity because
none meets these criteria.
---------------------------------------------------------------------------

    \264\ 17 CFR 240.0-10(e).
---------------------------------------------------------------------------

    Paragraph (d) of Rule 0-10 under the Exchange Act \265\ states that
the term ``small business'' or ``small organization,'' when referring
to a clearing agency, means a clearing agency that: (1) Compared,
cleared and settled less than $500 million in securities transactions
during the preceding fiscal year (or in the time that it has been in
business, if shorter); (2) had less than $200 million in funds and
securities in its custody or control at all times during the preceding
fiscal year (or in the time that it has been in business, if shorter);
and (3) 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 clearing agency that is subject to the requirements of
Regulation SHO is a small entity because none meets these criteria.
---------------------------------------------------------------------------

    \265\ 17 CFR 240.0-10(d).
---------------------------------------------------------------------------

C. Projected Reporting, Recordkeeping and Other Compliance Requirements

    The rule may impose some new or additional reporting,
recordkeeping, or compliance costs on small entities that are
participants of a clearing agency registered with the Commission and
small broker-dealers from which the participant receives trades for
clearance and settlement. We do not believe, at this time, that any
specialized professional skills will be necessary to comply with the
rule.

D. Agency Action To Minimize Effect on Small Entities

    As required by the Regulatory Flexibility Act, we have considered
alternatives that would accomplish our stated objectives, while
minimizing any significant adverse impact on small entities. Rule 204
is not expected to adversely affect small entities because it imposes
minimal reporting, record keeping, or compliance requirements, many of
which were previously required of small entities pursuant to the
implementation of Regulation SHO and, more recently, temporary Rule
204T. Moreover, it is not appropriate to develop separate requirements
for small entities because we believe that to accomplish the
Commission's stated goals, all broker-dealers, regardless of size,
should be subject to the same enhanced delivery requirements imposed by
the rule.

E. Duplicative, Overlapping, or Conflicting Federal Rules

    The Commission believes that there are no rules that duplicate,
overlap, or conflict with Rule 204. The Commission has designed the
rule so that it is consistent with the close-out requirements of Rule
203(b)(3) of Regulation SHO. In addition, with limited modifications to
address commenters' concerns, Rule 204 incorporates the substance and
maintains most of the components of temporary Rule 204T of Regulation
SHO and will become effective on July 31, 2009, the expiration date for
temporary Rule 204T.

F. Significant Alternatives

    The Regulatory Flexibility Act directs us to consider significant
alternatives that would accomplish our stated objective, while
minimizing any significant adverse impact on small entities.\266\ In
connection with the rule, we considered the following alternatives: (1)
Establishing different compliance or reporting standards or timetable
that take into account the resources available to small entities; (2)
clarifying, consolidating, or simplifying compliance requirements under
the rule for small entities; (3) using performance rather than design
standards; and (4) exempting small entities from coverage of the rule,
or any part of the rule.
---------------------------------------------------------------------------

    \266\ See 5 U.S.C. 603(c).
---------------------------------------------------------------------------

    The rule furthers the Commission's stated goal of helping to
eliminate the possibility that potentially abusive ``naked'' short
selling may contribute to disruption in the securities markets and,
therefore, to help ensure that investors remain confident that trading
in equity securities can be conducted without the illegal influence of
manipulation. The rule also furthers the goals of helping to maintain
fair and orderly markets against the threat of sudden and excessive
fluctuations of securities prices generally.
    The rule should not adversely affect small entities because the
rule will impose only minimal compliance requirements, many of which
were previously required of small entities pursuant to the
implementation of Regulation SHO and, more recently, temporary Rule
204T. Moreover, it is not appropriate to develop different compliance
requirements for small entities with respect to the rule because we
believe all entities, including small entities, should be subject to
the requirements of the rule. We believe that imposing different
compliance requirements, and possibly a different timetable for
implementing compliance requirements, for small entities would
undermine the Commission's goals of reducing fails to deliver by
maintaining the reductions in fails to deliver achieved by the adoption
of temporary Rule 204T, as well as other actions taken by the
Commission, and addressing potentially abusive ``naked'' short selling.
We have concluded similarly that it is not consistent with the goal of
the rule to further clarify, consolidate or simplify the rule for small
entities. The Commission also believes that it is inconsistent with the
purposes of the Exchange Act to exempt small entities from having to
comply with the rule.

X. Statutory Authority

    Pursuant to the Exchange Act and, particularly, Sections 2, 9(h),
10, 11A, 15, 17, 17A, and 23(a) thereof, 15 U.S.C. 78b, 78i(h), 78j,
78k-1, 78o, 78q, 78q-1, and 78w(a), the Commission is amending
Regulation SHO to adopt Rule 204.

XI. Text of Amendments

List of Subjects

17 CFR Part 200

    Administrative practice and procedure, Authority delegations
(Government agencies).

17 CFR Part 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 200--ORGANIZATION; CONDUCT AND ETHICS; AND INFORMATION AND
REQUESTS

0
1. The authority citation for Part 200, Subpart A, continues to read in
part as follows:

    Authority:  15 U.S.C. 77o, 77s, 77sss, 78d, 78d-1, 78d-2, 78w,
78ll(d), 78mm, 80a-37, 80b-11, and 7202, unless otherwise noted.
* * * * *

0
2. Section 200.30-3 is amended by adding paragraph (a)(11) to read as
follows:

Sec.  200.30-3  Delegation of authority to Director of Division of
Trading and Markets.

* * * * *
    (a) * * *
    (11) Upon written application or upon its own motion, either
unconditionally or on specified terms and conditions, to grant or deny
by order an exemption from the requirements of Regulation SHO (Sec.
242.200 of this chapter) under the Act pursuant to Section 36 of the
Act (15 U.S.C. 78mm).
* * * * *

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), 781, 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 242.204 is added to read as follows:

Sec.  242.204  Close-out requirement.

    (a) A participant of a registered clearing agency must deliver
securities to a registered clearing agency for clearance and settlement
on a long or short sale in any equity security by settlement date, or
if a participant of a registered clearing agency has a fail to deliver
position at a registered clearing agency in any equity security for a
long or short sale transaction in that equity security, the participant
shall, by no later than the beginning of regular trading hours on the
settlement day following the settlement date, immediately close out its
fail to deliver position by borrowing or purchasing securities of like
kind and quantity; Provided, however:
    (1) If a participant of a registered clearing agency has a fail to
deliver position at a registered clearing agency in any equity security
and the participant can demonstrate on its books and records that such
fail to deliver position resulted from a long sale, the participant
shall by no later than the beginning of regular trading hours on the
third consecutive settlement day following the settlement date,
immediately close out the fail to deliver position by purchasing or
borrowing securities of like kind and quantity;
    (2) If a participant of a registered clearing agency has a fail to
deliver position at a registered clearing agency in any equity security
resulting from a sale of a security that a person is deemed to own
pursuant to Sec.  242.200 and that such person intends to deliver as
soon as all restrictions on delivery have been removed, the participant
shall, by no later than the begining of regular trading hours on the
thirty-fifth consecutive calendar day following the trade date for the
transaction, immediately close out the fail to deliver position by
purchasing securities of like kind and quantity; or
    (3) If a participant of a registered clearing agency has a fail to
deliver position at a registered clearing agency in any equity security
that is attributable to bona fide market making activities by a
registered market maker, options market maker, or other market maker
obligated to quote in the over-the-counter market, the participant
shall by no later than the beginning of regular trading hours on the
third consecutive settlement day following the settlement date,
immediately close out the fail to deliver position by purchasing or
borrowing securities of like kind and quantity.
    (b) If a participant of a registered clearing agency has a fail to
deliver position in any equity security at a registered clearing agency
and does not close out such fail to deliver position in accordance with
the requirements of paragraph (a) of this section, the participant and
any broker or dealer from which it receives trades for clearance and
settlement, including any market maker that would otherwise be entitled
to rely on the exception provided in Sec.  242.203(b)(2)(iii), may not
accept a short sale order in the equity security from another person,
or effect a short sale in the equity security for its own account, to
the extent that the broker or dealer submits its short sales to that
participant for clearance and settlement, without first borrowing the
security, or entering into a bona fide arrangement to borrow the
security, until the participant closes out the fail to deliver position
by purchasing securities of like kind and quantity and that purchase
has cleared and settled at a registered clearing agency; Provided,
however: A broker or dealer shall not be subject to the requirements of
this paragraph if the broker or dealer timely certifies to the
participant of a registered clearing agency that it has not incurred a
fail to deliver position on settlement date for a long or short sale in
an equity security for which the participant has a fail to deliver
position at a registered clearing agency or that the broker or dealer
is in compliance with paragraph (e) of this section.
    (c) The participant must notify any broker or dealer from which it
receives trades for clearance and settlement, including any market
maker that would otherwise be entitled to rely on the exception
provided in Sec.  242.203(b)(2)(iii):
    (1) That the participant has a fail to deliver position in an
equity security at a registered clearing agency that has not been
closed out in accordance with the requirements of paragraph (a) of this
section; and
    (2) When the purchase that the participant has made to close out
the fail to deliver position has cleared and settled at a registered
clearing agency.
    (d) If a participant of a registered clearing agency reasonably
allocates a portion of a fail to deliver position to another registered
broker or dealer for which it clears trades or from which it receives
trades for settlement, based on such broker's or dealer's short
position, the provisions of paragraphs (a) and (b) of this section
relating to such fail to deliver position shall apply to such
registered broker or dealer that was allocated the fail to deliver
position, and not to the participant. A broker or dealer that has been
allocated a portion of a fail to deliver position that does not comply
with the provisions of paragraph (a) of this section must immediately
notify the participant that it has become subject to the requirements
of paragraph (b) of this section.
    (e) Even if a participant of a registered clearing agency has not
closed out a fail to deliver position at a registered clearing agency
in accordance with paragraph (a) of this section, or has not allocated
a fail to deliver position to a broker or dealer in accordance with
paragraph (d) of this section, a broker or dealer shall not be subject
to the requirements of paragraph (a) or (b) of this section if the
broker or dealer purchases or borrows the securities, and if:
    (1) The purchase or borrow is bona fide;
    (2) The purchase or borrow is executed after trade date but by no
later than the end of regular trading hours on settlement date for the
transaction;
    (3) The purchase or borrow is of a quantity of securities
sufficient to cover the entire amount of that broker's or

dealer's fail to deliver position at a registered clearing agency in
that security; and
    (4) The broker or dealer can demonstrate that it has a net flat or
net long position on its books and records on the day of the purchase
or borrow.
    (f) A participant of a registered clearing agency shall not be
deemed to have fulfilled the requirements of this section where the
participant enters into an arrangement with another person to purchase
or borrow securities as required by this section, and the participant
knows or has reason to know that the other person will not deliver
securities in settlement of the purchase or borrow.
    (g) Definitions. (1) For purposes of this section, the term
settlement date shall mean the business day on which delivery of a
security and payment of money is to be made through the facilities of a
registered clearing agency in connection with the sale of a security.
    (2) For purposes of this section, the term regular trading hours
has the same meaning as in Rule 600(b)(64) of Regulation NMS (17 CFR
242.600(b)(64)).

    Dated: July 27, 2009.

    By the Commission.
Elizabeth M. Murphy,
 Secretary.
[FR Doc. E9-18185 Filed 7-30-09; 8:45 am]

BILLING CODE 8010-01-P