# Securities and Exchange Commission

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URL: https://www.frixlaw.com/law-library/documents/agency%3Asec%3A8ae85c9dc3f97242

## Record

- **Collection:** Agency decision
- **Document type:** Agency decision

## Text

March 12, 2025
Securities and Exchange Commission
100 F Street, NE
Washington, DC 20549
PETITION FOR RULEMAKING UNDER THE SECURITIES EXCHANGE ACT OF 1934
Petition to Amend Regulation SHO to Require Pre-Borrows for All Short Sales, Impose Fees for
Fails-to-Deliver, and Eliminate Market Maker Exceptions
To the Securities and Exchange Commission:
Pursuant to Section 10 of the Administrative Procedure Act (5 U.S.C. § 553(e)) and Rule 192(a)
of the Commission’s Rules of Practice (17 CFR § 201.192(a)), we hereby petition the Securities
and Exchange Commission (SEC) to amend Regulation SHO (17 CFR Part 242, Rules
200–204) to address persistent failures in short sale regulation and trade settlement. After
twenty years, Regulation SHO has failed to eliminate naked short selling and large, persistent
fails-to-deliver (FTDs), undermining investor confidence and market integrity. Attached to this
petition is a draft paper (Welborn, 2025) that provides a comprehensive analysis of Reg SHO
Threshold Lists and FTD data from 2005 to 2024. The persistence of FTDs—peaking at $19.8
billion in September 2024—reflects structural flaws in the current regulatory framework,
including inadequate penalties, loopholes for market makers, and reliance on unenforceable
"reasonable grounds" standards for short sales. This undermines confidence in markets and
represents a systemic risk. Based on this analysis, we propose three specific amendments to
Reg SHO: (1) mandate a pre-borrow requirement for all short sales, (2) impose monetary fees
or fines for FTDs, and (3) eliminate all market maker exceptions to locate and close-out rules.
Background and Rationale
Regulation SHO, enacted in 2005, aimed to standardize short selling rules and curb naked short
selling—sales executed without locating or borrowing shares—and resultant FTDs. The
attached research, detailed in "Reg SHO at Twenty" (Welborn, 2025), analyzes daily Threshold
Lists and FTD data from the National Securities Clearing Corporation (NSCC) over Reg SHO’s
history. Despite amendments in 2007, 2008, and 2009, including the elimination of the options
market maker exception, naked short selling persists. As of 2024, dozens of companies remain
on the Threshold List, with average daily FTDs at $2.9 billion—unchanged from 2005—and
peaks exceeding $19 billion in September 2024. Some companies have been on this list for
hundreds of days in a row throughout 2023 - 2024. High-profile events like GameStop in

January of 2021 (and several subsequent large price movements) and Robinhood’s 2025 $45
million fine for Reg SHO violations underscore these inadequacies.
As such, we are petitioning for the following changes to be made to Reg SHO:
1.​ Mandatory Pre-Borrow for All Short Sales​
The current "locate" requirement (Rule 203(b)) allows short sales if a broker-dealer
has "reasonable grounds" to believe shares can be borrowed, a standard easily
circumvented. Data from the SEC’s 2008 Emergency Order, requiring pre-borrows for
19 financial stocks, showed significant reductions in FTDs without harming market
quality (OEA, 2009). A universal pre-borrow mandate would eliminate ambiguity,
ensuring shares are secured before sale, reducing naked shorting, and aligning with
the SEC’s 2008 findings.
2.​ Fees or Fines for Fails-to-Deliver​
Reg SHO lacks punitive measures for FTDs, a flaw evident since the SEC dropped
monetary penalties from its 2003 proposal despite public support (SEC, 2004).
Consequently, daily FTDs have remained entrenched, with threshold securities like the
SPDR S&P Retail ETF (XRT) accumulating 1,691 threshold days and short interest
exceeding 699% of shares outstanding (Welborn, 2025). The U.S. Treasury market’s
"fails charge" since 2009 demonstrates that fees incentivize timely settlement,
reducing fails even in low-rate environments without impairing market liquidity (NY
Fed, 2020). Applying fees or fines to FTDs in equity markets would deter intentional
delays and fund enforcement, addressing the $2.9 billion daily FTD average
documented in the attached research (Welborn, 2025).
3.​ No Exceptions for Market Making​
Rule 204’s close-out exceptions for "bona fide" market making (e.g., T+6 versus T+4
for others) enable persistent FTDs, particularly in ETFs, which now dominate
Threshold Lists (OEA, 2011). Enforcement actions against firms like Arenstein (AMEX,
2007) and Wolfson (SEC, 2012) reveal abuse of such exceptions. Eliminating them
would ensure uniform accountability, as the supposed liquidity benefits do not justify
the systemic risks of unchecked FTDs, evidenced by ETF FTDs reaching 90% of daily
fails on some days (Bradley et al., 2011). OEA’s 2009 study found no adverse liquidity
effects after the elimination of the OMM exception. Bid-ask spreads for affected stocks
narrowed by 12%, while trading volumes remained stable (OEA, 2009). These results
align with Paul Atkins’ 2012 critique of regulatory carveouts: "Exceptions for ‘bona fide’
activities often become loopholes for abuse" (WSJ, 2012).
Request for Action
We urge the SEC to initiate rulemaking to amend Regulation SHO as follows:
●​ Rule 203: Require all short sales, without exception, to be backed by a confirmed
borrow of securities prior to execution.
●​ Rule 204: Impose escalating monetary fees or fines for FTDs, applicable to all market
participants, with proceeds supporting enforcement.

●​ Rule 204: Eliminate all market maker exceptions to locate and close-out requirements,
ensuring uniform settlement timelines.
These changes address Reg SHO’s mixed legacy, supported by two decades of data showing
persistent FTDs and enforcement gaps. They align with the SEC’s mandate under the Securities
Exchange Act of 1934 to maintain fair and orderly markets (15 U.S.C. § 78b). I respectfully
request the Commission publish this petition for public comment and act promptly to restore
trust in U.S. equity markets.
Respectfully submitted,

Dave Lauer
Co-Founder
Urvin Finance and We The Investors

John W. Welborn
Senior Lecturer
Dartmouth College

Attachment A: “Reg SHO at Twenty” by John Welborn (March 12, 2025)

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Reg SHO at Twenty°

John W. Welborn⃰
Department of Economics, Dartmouth College, Hanover, NH 03755

This Draft: March 2025
__________________________________________________________________
Abstract
Regulation SHO (“Reg SHO”) was enacted by the Securities and Exchange Commission in 2004
to address concerns regarding so-called naked short selling and large and persistent trade
settlement failures. Reg SHO was also designed to bring consistency, transparency, and fairness
to short sale rules that varied across the major stock exchanges. This paper is the first
comprehensive analysis of the impact and efficacy of Reg SHO at reducing naked short selling
and fails-to-deliver (FTDs) over its twenty-year history. I use daily Regulation SHO Threshold
Lists and FTD data for the period from the start of Reg SHO in 2005 through the end of 2024,
together with academic and proprietary databases, to document the composition and magnitude
of high FTD securities. I conclude that the Reg SHO legacy is mixed and further reforms are
necessary to ensure investor confidence in markets.

JEL Classification: G11; G12; G14; G21; G28; K22
Keywords: fail-to-deliver; Regulation SHO; short selling; Securities and Exchange Commission;
short interest
__________________________________________________________________

°I am grateful to Jackson Easley for invaluable research assistance and data cleaning.
*Corresponding author. Tel.: +1 (603) 646-1110.
Email address: john.w.welborn@dartmouth.edu (J. Welborn).

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1. Introduction
The year 2025 marks the 20-year anniversary of SEC Regulation SHO (“Reg SHO”), which
governs short selling and trade settlement in US stock markets. Reg SHO was proposed by the
SEC in January of 2004, approved in October 2004, and enacted in January 2005. Formally, Reg
SHO comprises SEC Rules 200 through 204 in the Federal Register (17 CFR Part 242).
Reg SHO standardized short selling rules and addresses concerns about “naked” short selling
and unsettled trades known as fails-to-deliver (FTDs). Prior to Reg SHO, the NYSE and Nasdaq
listing exchanges had their own rules concerning short selling and trade settlement. Reg SHO
was designed to regulate the different standards. Reg SHO was also written to address concerns
about naked short selling that emerged during the Dot Com boom and bust of the early 2000s.
Reg SHO’s legacy is mixed. The final rule, enacted in 2005, contained a series of regulatory
loopholes that were abused by dishonest market participants to naked short sell and fail to
deliver. Moreover, the final rule draft eliminated an initial proposal for monetary penalties for
failing to deliver. Reg SHO also did not require any disclosure about which firms were failing to
deliver and to what extent. As a result, thousands of companies experienced large and persistent
fail-to-deliver positions worth billions of dollars during the period from 2005 through 2008.
The SEC amended Reg SHO in 2007, 2008 and 2009 to address key loopholes and reduce
naked short selling and FTDs. Due to these changes, after 2009, the number of companies
experiencing persistent naked short selling declined, as did the aggregate dollar value of fails-todeliver. The SEC and FINRA also brought a series of high-profile enforcement cases which
revealed the extent to which Reg SHO was manipulated, particularly the so-called options
market maker (OMM) exception.

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Nevertheless, these Reg SHO reforms and enforcement actions reduced but did not
eliminate naked short selling and FTDs. Dozens of public companies are currently on the Reg
SHO Threshold List, which is a list of firms with large and persistent FTD positions. The average
daily dollar value of FTDs is just under $3b and is relatively unchanged from 2005. A related
mystery is why so many Threshold List tickers are exchange traded funds (ETFs).
Reg SHO’s inadequacies are further revealed by the fact that certain companies remain
on the Threshold List for hundreds of trading days, including the S&P 500 Retail ETF (XRT) and
GameStop (GME). A related and unresolved regulatory challenge emerges when the same stock
is re-lent multiples times through short sales, a process known as “chained lending” or
“rehypothecation.” To wit, the XRT short interest is often over 100% of shares outstanding.
At the 20-year anniversary of Reg SHO, I explore concerns about naked short selling and
large and persistent FTDs. I also evaluate the merits of the following proposals: (1) A mandatory
pre-borrow requirement for all short sales; (2) Monetary penalties for failing to deliver; and (3)
Elimination of all market making exceptions to timely settlement rules.
A critical research challenge is the quality and accessibility of data related to Reg SHO. Daily
Regulation SHO Threshold Lists are provided directly by the exchanges, and these data files are
both incomplete and missing unique CUSIP identifiers. In contrast, FTD data from the National
Securities Clearing Corporation (NSCC), available through the SEC Freedom of Information Act
(FOIA) office, are complete historically and contain sufficient identifying information.
In the analysis below, I begin with a history of short selling and trade settlement regulations.
I then explore the data on naked short selling, the Reg SHO Threshold Lists, and fails-to-deliver
that I can reconstruct from academic and proprietary data sources. I close with a discussion of
the three policy proposals that may help to address ongoing settlement failure challenges

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2. Short Selling

Short selling is a trading strategy that profits when asset prices decline. In a typical short
sale, an asset is borrowed and sold with the expectation that it can be repurchased later, at a
lower price, for return to the lender. Short selling is legal and (generally) helps to ensure market
liquidity and efficient price discovery by moderating asset prices. There are many reasons why a
trader may choose to sell short, including hedging and speculating. There is no meaningful way
to differentiate between hedging and speculating from publicly available short sale data.
In securities markets, a naked short sale occurs when a short seller does not locate or
borrow shares prior to effecting a short sale. If the naked short seller does not borrow stock by
settlement date, then a trade settlement failure may occur. Naked short selling is generally
illegal, but there are exceptions, and the regulation of short selling is complex.
The fundamental challenge of analyzing short selling in modern securities markets is
there are layers of financial intermediaries that separate stock lenders and stock borrowers. Stock
is held in various account types at myriad institutions throughout the financial landscape. Often,
stock lent to short sellers is done without the knowledge of the beneficial owner. As a result,
there is no self-regulating mechanism to address trade settlement failures when they occur.
Previously, short selling was rare and a small fraction of total trading volume. This
changed in the 1990s with the advent of prime brokerage, which was a novel institutional service
offered by new class of investment funds to high-net-worth investors (SEC 1994). As the name
implies, “hedge” funds seek to maximize returns while limiting risk, which necessarily involves
hedging and shorting via stocks and options. Since that time, the quantity of short selling has
only increased, and is arguably just as common as long trading today in most markets.

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The act of borrowing securities from one party, and selling them to another, is a complex
multiparty transaction. Short selling is also complicated by the fact that trade settlement is not
instantaneous. Stock transfers are delayed by layers of trade netting within the brokers and at the
clearinghouse. Net settlement increases efficiency but reduces accountability insofar as failed
trades are not traceable to their origin. Settlement failures are documented as anonymous debits
at the clearinghouse, and counterparties have neither the information nor the incentive to force
settlement. Oversight of prompt and accurate trade settlement falls to securities regulators and
self-regulatory organizations (SROs) such as the major stock exchanges.

2.2 Short Selling and the Securities Exchange Act of 1934
The Securities Exchange Act of 1934 was motivated by a desire “to ensure the
maintenance of fair and honest markets” (73rd Congress, 1934, p. 881). There is evidence that
manipulation of the stock issuance process contributed to the market volatility that preceded the
1929 stock market crash (Flynn, 1934). The 1933 Pecora Investigation, which led to creation of
the SEC, concluded that stock “pool” operators had used “unsavory and unethical methods
employed in the flotation and sale of securities” to manipulate stock prices (Fletcher, 1934).
There is anecdotal support for the Pecora Commission’s claims. At the turn of the
century, the stock speculator Daniel Drew battled with Cornelius Vanderbilt over control of the
Harlem and Erie Railroads by issuing unregistered securities and selling short stock that he had
not borrowed. Drew famously quipped, “He who sells what isn’t his’n, must buy it back or go to
pris’n” (White, 1910, p. 3). Similarly, Alan Ryan, Chairman of Stutz Motor Car, battled with socalled “bear raiders” who sold millions of Stutz shares that they had not borrowed or did not own
(Brooks, 1969).

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Drew and other stock speculators of the era understood that trade settlement is not
instantaneous. In markets for fungible goods like stock, trade is often facilitated by a clearing
house that anonymizes the buyer–seller relationship. This intermediation encourages efficiency
and liquidity because the clearinghouse reduces transaction times and assumes counterparty risk.
Such intermediation, however, may reduce transparency and accountability. Trade settlement
failures can occur as a result. Short selling may exacerbate settlement problems because short
sellers do not own the stock they sell. The 1934 Act did not, however, specifically address
problems associated with naked short selling or trade settlement.

2.3 The Wall Street Back Office Crisis
The “Back Office Crisis” of the late 1960s compelled Wall Street firms and the SROs to
address trade settlement problems. Starting in the summer of 1967, the volume of trading on the
New York Stock Exchange (NYSE) and the American Stock Exchange (AMEX) far exceeded
the capacity of brokerage firms’ clerical staff to process related paperwork. This paperwork
backlog was serious enough that at least one brokerage firm was forced to close. By January
1968, aggregate trade “fails” had increased by 93 percent (Columbia Law Review, 1969).
Securities regulators voiced their concerns publicly. SEC Commissioner Hugh F. Owens
remarked that the “fails situation” could cripple market liquidity and “seriously threaten our
whole economy” (Owens, 1968). A February 1969 memo to Ken Cole, President Nixon’s aide,
from Paul W. McCracken, Chairman of President Nixon’s Council of Economic Advisors, shows
that concerns reached the Executive level. McCracken writes, “It is our judgment that there is a
substantive problem here…I recommend that we have a discussion of the matter at a meeting of
the Cabinet Committee on Economic Policy” (McCracken, 1969).

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To address the crisis, the exchanges closed every Wednesday, and settlement was
extended to trade date plus five days (“T+5”). Securities dealers at the time considered a range of
solutions to the back-office problem that would penalize firms who fail. In a “mandatory buyin,” a broker with a fail-to-receive (FTR) must, rather than waiting for delivery, buy stock at the
current market price and bill the owing firm for the shares not delivered. Another solution would
impose net capital penalties on broker–dealers with outstanding fails. A third proposal would
have severely limited the trading abilities of firms with high fails (Columbia Law Review, 1969).
These proposed punitive solutions did not address the main cause of the backlog, which
was direct settlement in paper certificates. To address inefficiencies associated with paper
settlement, NYSE members founded the Central Certificate Service (CCS) in June of 1968. The
CCS had two clear advantages over paper settlement. First, the CCS held all stock certificates in
a central location and noted ownership transfers using book entries. Second, the CCS automated
the trade clearing process electronically with punch cards. Nevertheless, participation in the CCP
was voluntary and success was initially limited (Benn, 2002). Eventually, wider CCS
participation led to creation of the Depository Trust Company (DTC) in 1973 (DTCC, 2012).
In the Securities Act Amendments of 1975, Congress required universal adoption of
“immobilization” in the clearing system. By ending the practice of physical certificate transfer,
the Amendments were designed “to foster the development of a national securities market
system and a national clearance and settlement system” (94th Congress, 1975). The National
Securities Clearing Corporation (NSCC) was founded in 1976 to provide clearing, settlement,
and central counterparty risk services. While physical stock was held “immobilized” in the DTC,
the NSCC aggregated order flow and generated instructions for net changes in DTC accounts at
the end of each trading day through a process known as “multilateral netting” (Donald, 2007).

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2.3 United States v. Naftalin (1979)
Though efficient, multilateral netting did not prevent fraud and market manipulation, as
was evident in the 1979 SCOTUS case United States v. Naftalin. In 1971, the SEC ordered
public hearings against Naftalin and Company, Inc., a registered broker–dealer, and its president,
Neil T. Naftalin. The SEC alleged that Naftalin executed sell orders for stock that he did not own
and could not deliver to a counterparty, Merrill Lynch, Pierce, Fenner and Smith.
In 1973, an administrative law judge found that Naftalin committed fraud by executing
long sales of stock that were short sales and delayed settlement indefinitely under false pretenses.
Naftalin’s conduct was revealed when the prices of the securities involved began to rise, at which
time he notified the counterparties that he could not make delivery. For the broker–dealers
waiting for delivery from Naftalin, the cost of buying-in securities on the open market to settle
the trades was over $1.2 million. Naftalin’s registration as a broker–dealer was revoked, and he
was barred from the securities industry for life (SEC, 1973).
Naftalin was convicted in United States District Court for the District of Minnesota on
eight counts of employing a scheme to defraud in the offer or sale of stock in violation of section
17(a)(1) of the Securities Act of 1933 and sentenced to five years imprisonment. Naftalin
appealed the District Court’s decision on the grounds that the fraud had occurred between
brokers and not investors whom the 1933 Act was designed to protect. The United States Court
of Appeals, Eighth Circuit, agreed and vacated the District Court Decision (8th Circuit, 1972).
In 1979, the U.S. Supreme Court agreed to hear United States v. Neil T. Naftalin. The
Supreme Court found that section 17(a)(1) of the 1933 Act applied to brokers and investors alike
and reversed the Appeals Court decision. The criminal conviction against Naftalin for
fraudulently selling short and intentionally failing to deliver stood.

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2.4 Continuous Net Settlement and the Pollack Report
The 1970s settlement institutions were designed to eliminate the costs and risks from
lengthy delivery failures like those uncovered in the Naftalin case. Every day, NSCC aggregates
trade data and provides electronic settlement instructions to the Depository Trust Clearing
Corporation (DTCC). The NSCC organizes this process through the Continuous Net Settlement
(CNS) system. Through CNS, the NSCC effectively “steps in between two parties to a trade and
nets each party’s obligation to trade over multiple trades, so that each obligation to receive or
deliver, and an obligation to deliver or receive, can be combined together into one” (Sirri, 2007).
CNS helps to provide liquidity when there are occasional or temporary problems with
trade settlement. If a broker fails to deliver stock by T+3, the NSCC allocates that FTD to a
different broker–dealer using a random distribution algorithm. The DTC account that did not
receive securities because of this allocation will have a net fail-to-receive (FTR) position. The
broker who has failed to receive will nonetheless credit the securities positions to his customer
accounts. Additional liquidity comes from the Stock Borrow Program (SBP), which allows
NSCC firms to loan shares automatically from DTC accounts in the event of a CNS fail. CNS
and the SBP preclude identifying or tracking which specific brokers fail to deliver or receive.
The anonymity of CNS may open the settlement system to abuse by preventing
counterparties from self-regulating settlement failures. Regulators have voiced concerns
regarding CNS for decades. In 1985, the National Association of Securities Dealers (NASD)
commissioned Irving M. Pollack, a securities law expert and former SEC Commissioner, to
conduct a comprehensive review of short selling in NASDAQ securities. Pollack (1986)
concluded that better institutions were needed to guarantee prompt close-out of short sales.

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Pollack (1986) observed that, while CNS had substantially increased efficiency, the
system effectively insulated the clearing corporation and brokers from the costs associated with
FTDs and FTRs. Thus, CNS did not prevent FTDs and FTRs from increasing without limit and
permitted some brokers to postpone delivery indefinitely (Pollack, 1986, p. 50). Pollack (1986)
warned that FTDs and FTRs could therefore cause serious difficulties in a lengthy bear market.
“The fact that there is no automatic mechanism preventing the substantial buildup of short
positions at the clearing corporation and of fails to receive in brokerage firms carries the
potential for serious problems, particularly in the event of crisis market conditions (Pollack,
1986, p. 69). The phrase, “short positions at the clearing corporation” refers to fails-to-deliver.

2.5 SEC Regulation SHO
CNS’s inability to moderate FTDs became clear during the dotcom bust of the early
2000s. In 2003, the SEC requested comment on proposed regulations “to address the problem of
‘naked’ short selling” (SEC, 2003a). The SEC received comments from a wide range of market
participants, including industry professionals and retail investors (SEC, 2003b). The final short
sale rule, Regulation SHO, was passed in August 2004 and became effective in January 2005.
SEC Regulation SHO was designed to regulate short selling formally and reduce FTDs.
Regulation SHO requires the five major U.S. stock exchanges to publish a daily list, referred to
as the Regulation SHO Threshold List, of stocks with high FTDs. At the time, these exchanges
were the NASDAQ, NYSE, NYSE Arca, NYSE Amex, and the Chicago Stock Exchange
(CHX). To qualify for the Threshold List, a stock must have, for five consecutive settlement days
at a clearing agency, an aggregate FTD position totaling 10,000 shares or more and equal to at
least 0.5% of the issuer's total shares outstanding (SEC, 2004).

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Regulation SHO imposes locate and close-out requirements for short sales. The locate
requirement is satisfied if a broker–dealer has reasonable grounds to believe that a security can
be located (for borrow) prior to delivery date. A broker–dealer must document a locate prior to
executing a short sale. Specifically, the rule prohibits execution of a short sale unless a broker–
dealer has either borrowed the security or “has reasonable grounds to believe that the security
can be borrowed so that it can be delivered on the date delivery is due” (SEC, 2004). The closeout requirement obliges broker–dealers to settle FTD positions for threshold securities that have
persisted for 13 consecutive settlement days. Closing out requires the broker–dealer to purchase
securities of like kind and quantity and to settle the trade on behalf of the customer.
Regulation SHO was influenced by short sale rulemaking by the SROs. The “locate” and
“reasonable grounds” language above is borrowed from NASD Rule 3370 and NYSE Rule
440C, which predate Regulation SHO. The NYSE permitted use of an “Easy to Borrow” list to
satisfy the “reasonable grounds” standard that a security sold short was available for borrowing.
Note, however, that “repeated failures to deliver in securities included on an ‘Easy to Borrow’
list would indicate that the broker–dealer’s reliance on such a list did not satisfy the ‘reasonable
grounds’ standard” (NYSE 1997, p. 4662).
Similarly, the NASD required a member firm to make an “affirmative determination” that
stock sold short would be available to borrow by settlement date. The NASD approved use of a
so-called “Hard to Borrow” Lists to satisfy the affirmative determination requirement insofar as
“a specific security absent from the list is easy to borrow” (NASD 2000, p. 171). Furthermore,
Rule 3370 “was designed to prevent abusive short selling and ensure that short sellers satisfy
their settlement obligations” (NASD 2000, p. 171).

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NASD 3370 incorporated recommendations on the reporting and settlement of short sales
contained in a 1986 NASD study by former SEC Commissioner Irving M. Pollack. Pollack
(1986) concluded that, given the structure of the CNS system, it was possible for large FTD
positions to accumulate at the clearinghouse “in perpetuity.” “While these procedures generally
protect the clearing corporation, they permit short selling brokers to assume much larger
positions than they might otherwise be able to undertake if they were prevented from continually
rolling over short positions without borrowing securities for delivery” (Pollack 1986, p. 61).

2.6 Exceptions to Regulation SHO
Regulation SHO contained two loopholes that hampered the rules’ ability to reduce
settlement fails. First, the Grandfather Clause exempted all pre-existing FTD positions.
According to SEC Director of Market Regulation Erik Sirri, “Regulation SHO's grandfather
provision was adopted because the Commission was concerned about creating buy-side volatility
through short squeezes if large pre-existing fail to deliver positions had to be closed out too
quickly after a security became a threshold security” (Sirri 2007). The Commission proposed
eliminating the grandfather provision in 2006 and finalized its elimination in 2007.
Second, Regulation SHO contained an exception to the locate and close-out requirements
for short sales for market makers. Specifically, SEC (2004) allowed, “…[an] exception from the
uniform ‘‘locate’’ requirement, as Rule 203(b)(2)(iii), for short sales executed by market
makers...including specialists and options market makers, but only in connection with bona-fide
market making activities.” SEC (2003a) describes how the Exception was intended to mean that
all market makers were permitted to sell stock short without locating that stock

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Market makers act as temporary counterparties to buyers or sellers to foster liquidity.
Thus, market makers sometimes sell stock they do not have to hedge long positions. In general,
OMMs strive to offset long positions with short positions of similar magnitude and duration.
This is known as maintaining a “delta neutral” portfolio, where delta captures the sensitivity of
changes in options prices to changes in the underlying stock price. While most market maker
positions are closed out at the end of each trading day, OMMs take short positions that last until
an option contract expires, which may be weeks or months. Often, OMMs manage portfolios of
trades which require offsetting a book of long positions with short positions of similar magnitude
and duration. This is known as maintaining a “delta neutral” portfolio, where delta informs how
much of the underlying security must be bought or sold to hedge the options position.
NASD 3370 and NYSE 440C also contained limited short sale locate and close-out
exceptions for market makers engaged in bona fide market making, but the proposal to establish
Regulation SHO notes that “the SRO requirements [had] not fully addressed the problems of
naked short selling and extended fails to deliver” (SEC, 2003a). Thus, Regulation SHO did not
create a new exception per se. Rather, the rule was written to strengthen and narrow pre-existing
exceptions without disrupting legitimate market making activity. Regulation SHO was also
designed to “establish a uniform standard specifying the procedures for all short sellers to locate
securities for borrowing” (SEC, 2003a).
The Exception did not apply to stocks already on the Regulation SHO Threshold List; an
options market maker could only maintain FTDs “if the options positions were created prior to
the time that the underlying security became a threshold security” (SEC, 2004). Thus, all FTDs
in Threshold stocks are subject to the mandatory close-out requirement if they are older than 13
days and were not executed to hedge a pre-existing options position.

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According to the SEC (2007b), “The options market maker exception was created to
address concerns regarding liquidity and the pricing of options.” When OMMs sell put options or
buy call options they are in a long position. They can hedge their long options position by selling
short the underlying equity. The Exception allowed OMMs to hedge the risk of long options
positions for the duration of an options contract if unable to borrow, which allowed them to
delay short sale close-out until options expiration if necessary.
An example of this situation is when a market maker writes a put option with a future
expiration date (a long position for the market maker). The Exception allowed the market maker
to hedge that long position by shorting an equivalent quantity of the underlying stock and delay
delivery if unable to borrow. At option expiration, the put buyer either (a) sells stock back to the
market maker (which the OMM can use to settle his short hedge), or (b) the put expires out of the
money, and the market maker buys stock to settle the short hedge.
With hard to borrow securities, shorting is most costly because a short seller has to pay to
borrow the underlying equity in addition to posting collateral. Due to the Exception, OMMs did
not have to pay interest on short sales of stocks with negative rebates for the options contract
duration if unable to borrow. For contracts with expiration dates far in the future, this Exception
could result in large cost savings.
The SEC limited the Exception to bona-fide market making, which “does not include
activity that is related to speculative selling strategies or investment purposes of the broker–
dealer” (SEC, 2004). Further, “bona-fide market making does not include transactions whereby a
market maker enters into an arrangement with another broker–dealer or customer in an attempt to
use the market maker's exception for the purpose of avoiding compliance with [Regulation
SHO]” (SEC, 2004).

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While the Exception was written to promote legitimate hedging by market makers, some
traders were not engaged in bona-fide market making and were consequently fined and barred
from trading. In 2007, FINRA, acting on behalf of AMEX’s regulatory division, found that Scott
and Brian Arenstein, “who were not bona-fide options market makers, improperly utilized the
Reg SHO market maker location exemption to avoid locating shares prior to effecting short sale
transactions in Reg SHO threshold securities…[and] engaged in transactions that circumvented
delivery obligations” (AMEX 2007a, p. 2).
The Arenstein cases also alerted the SEC to a fraudulent trading strategy to “reset” the
settlement date for a failed trade. “Options market makers’ practice of “rolling” positions from
one expiration month to the next potentially allows these options market makers to not close out
positions as required by the close-out requirements of Regulation SHO” (SEC, 2007b, p. 22).
The Arenstein case caused the SROs to restate the existing requirement that all
exceptions were limited to bona-fide market making. For example, the Chicago Board Options
Exchange states that, “only options market–makers that are engaged in bona-fide options marketmaking may utilize the exception to Regulation SHO’s “locate” requirement when effecting a
short sale in the underlying security as a hedge” (CBOE 2007).
In August of 2007, the SEC proposed eliminating the Options Market Maker Exception
to Regulation SHO. “The ability of options market makers to sell short and never have to close
out a resulting fail to deliver position... may have a negative impact on the market for those
securities” (SEC, 2007b, p. 21). The SEC eliminated the Exception in September 2008. In the
final rule, the SEC wrote that, “[f]ails to deliver in threshold securities that result from hedging
activities by options market makers will no longer be excepted from Regulation SHO’s close-out
requirement” (SEC, 2008b, p. 1).

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The SEC (2009b, 2011, and 2012) and FINRA found evidence that the OMM abuse
continued. The Wolfson case, for example, documents how one options market maker,
…improperly utilized the Market Maker Exception to avoid locating shares before
effecting short sales as part of “reverse conversion” and “assist” transactions…
As a result, [Wolfson was] … able to attract the business of prime brokerage
firms seeking to create inventory for stock loans on hard to borrow securities.
(SEC, 2012, pp. 3–4)

This is important because hedge funds and large institutional investors often rely on
prime brokers to locate and borrow stock for short sales. Options market makers like Arenstein
and Wolfson executed complex options trades known as “reverse conversions” to generate stock
loan inventory for prime brokers. For this purpose, a reverse conversion does not qualify as
bona-fide market making. Rather, according to the SEC,
Reverse conversions are executed to meet a one-sided demand for hard-to-borrow
threshold securities. The buyers of the threshold securities, in this case large
prime brokerage firms, engaged in the conversion transaction that allowed them to
acquire a long stock position that is hedged by the synthetic short options
position. The brokerage firm could then loan out the shares of the threshold
securities and received fees from the borrowers. Those loan fees can be quite
significant when the stock is a threshold security, because threshold securities are
generally hard to borrow and therefore command large fees in the stock loan
market (2012, pp. 3–4).

Numerous subsequent SEC and FINRA enforcement cases have outlined abuses of Reg
SHO and market making exceptions, including SEC (2009), The SEC and FINRA have since
brought numerous disciplinary actions against options market makers (OMMs) for naked short
selling and failing to deliver in connection with market making that is not bona fide, including
SEC (2009b), ISE (2011), NASDAQ (2011), and NYSE AMEX (2011), and (SEC, 2012, pp. 3–
4). Table 3 contains a partial list of SEC and FINRA enforcement actions related to Reg SHO.

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2.7 The 2008 Emergency Order

Reg SHO’s inadequacies became apparent to the SEC at the onset of the 2008 Global
Financial Crisis. In June 2008, the SEC used its emergency authority to impose a temporary preborrow requirement for short sales. The SEC claimed to be motivated out of concern that naked
short selling would exacerbate a burgeoning financial crisis. SEC Chairman Christopher Cox
said, “Today's Commission action aims to stop unlawful manipulation through 'naked' short
selling that threatens the stability of financial institutions.” (SEC 2008X).
Notably, the SEC order applied only to 19 financial stocks. These stocks were the 17
primary dealers, which are firms that make markets in U.S. Treasury Securities, and Fannie Mae
and Freddie Mac. The order was effective from July 21, 2008, to August 12, 2008. The SEC
wrote in its emergency order:
“In these unusual and extraordinary circumstances, we have concluded that
requiring all persons to borrow or arrange to borrow the securities identified in
Appendix A prior to effecting an order for a short sale of those securities is in the
public interest and for the protection of investors to maintain fair and orderly
securities markets, and to prevent substantial disruption in the securities markets.
This emergency requirement will eliminate any possibility that naked short selling
may contribute to the disruption of markets in these securities.” (SEC 2008a)
Later in 2008, the SEC also temporarily banned short selling in all financial stocks and finally
amended Regulation SHO to eliminate loopholes and impose close-out rules.
In 2009, the SEC Office of Economic Analysis produced an “Analysis of the July
Emergency Order Requiring a Pre-Borrow on Short Sales.” The OEA Report found “Large and
significant decreases in fails to deliver,” “little change in short interest,” and “no significant
changes in bid-ask spread or market depth.” On the other hand, the OEA report found evidence
that stock lending rates were higher than before the order. “Our results suggest that imposing a
pre-borrow requirement may have had the intended effect of reducing fails” (OEA, 2009).

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2.8 The 2008 Amendments to Regulation SHO
The daily dollar value of FTDs grew until the SEC took decisive action to address
settlement failures in the third quarter of 2008. First, the SEC eliminated the options market
maker exception to Regulation SHO, discussed above. Next, the SEC passed Interim Final
Temporary Rule 204T to address “abusive ‘naked’ short selling in all equity securities” (SEC,
2008a). Final Rule 204 was enacted on July 31, 2009 (SEC, 2009a). Concurrent with 204 and
other regulatory actions, Threshold Lists and the number of FTDs shrank significantly
(Stratmann and Welborn, 2013). SEC Rule 204T addressed concerns regarding large and
persistent settlement failures in all stocks including common stocks and ETFs. 1
[Short] sellers sometimes intentionally fail to deliver securities as part of a
scheme to manipulate the price of a security, or possibly to avoid borrowing costs
associated with short sales, especially when the costs of borrowing stock are
high…large and persistent fails to deliver may deprive shareholders of the
benefits of ownership, such as voting and lending…Moreover, sellers that fail to
deliver securities on settlement date may attempt to use this additional freedom to
engage in trading activities to improperly depress the price of a security (SEC,
2009a, pp. 5–7).

Rule 204 modified Regulation SHO in several ways. First, the Regulation SHO close-out
requirements were expanded to include all equity securities, whereas prior close-out rules
applied only to stocks with “large and persistent level of fails to deliver, i.e., threshold securities”
(SEC, 2009a, p. 24). Second, 204 modified the statutory close-out period for both long and short
sales to the start of trading hours on the day after settlement date (T+4). The rule requires market
participants with FTDs at the clearing corporation to “close out the fail to deliver position by
borrowing or purchasing securities of like kind and quantity” (SEC, 2009a, p. 13).

1

Angel (2008), in an open letter to the SEC, urges the Commission to address the “enormous settlement failures in
the ETF market.”

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Market participants who continue to fail after T+4 are subject to a pre-borrow
requirement for short sales and possible disciplinary action. For all market participants, the rule
imposed “a requirement to borrow or arrange to borrow securities prior to accepting or effecting
further short sales in that security” (SEC, 2009a, p. 30).
A statutory pre-borrow requirement for failing to deliver existed prior to Rule 204. Rule
203(b)(3)(iv) of Regulation SHO imposes a similar penalty on market participants with
outstanding FTDs in Threshold securities older than thirteen consecutive settlement days. Rule
204, however, expands the penalty to include all equity securities, including ETFs, and shortens
the close-out period to T+4 days. Rule 204 also permits the SROs or the SEC to impose
monetary penalties for failing to close out aged fail-to-deliver positions (FINRA, 2012).
Nevertheless, Final Rule 204 contains a key close-out exception for market makers.
Specifically, the Final Rule states that FTDs that result from “certain” bona fide market making
must be closed out by the “third settlement day after settlement date” (SEC, 2009a, p. 14). The
purpose of this exception is to ensure market liquidity by allowing market makers “to facilitate
customer orders in a fast-moving market” (SEC, 2009a, p. 37).
The temporary market making close-out exception to Rule 204 may explain the rise in
ETF FTDs. In addition, Rule 204(a)(3) “permits a borrow as well as a purchase to close out a fail
to deliver position” (SEC, 2009a, p. 39). This provision is important because a significant and
growing segment of ETF trading concerns so-called “borrow-to-create” and “create-to-lend”
transactions. The former characterizes transactions where market makers or APs borrow and
bundle shares of ETF component stocks to obtain one creation unit (Welter, 2010). The latter
concerns transactions where ETF market makers create ETF shares for securities lending
purposes (Shastry, 2011). I discuss concerns about ETF FTDs in the next section.

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2.8 ETF Settlement Failures

While common stock FTDs fell sharply after 2008, ETF FTDs rose. According to the
SEC OEA, ETFs are now a “significant portion” of the SEC Regulation SHO Threshold List,
(OEA, 2011). According to data from 2011, “ETF fails account for approximately 60 percent of
the nearly $2 billion of daily equity trading fails reported to the SEC, and on some days they
account for 90 percent of all exchange traded fails” (Bradley et al., 2011, p. 6).
ETF settlement failures were a concern when Regulation SHO was drafted in 2004. At
the time, regulators “observed high levels of fails in some ETFs” (SEC, 2004). SRO
representatives from the NASDAQ and AMEX argued, however, that ETF FTDs were not
problematic “[b]ecause ETF shares can be continuously created and redeemed in-kind, open
clearing positions can be closed-out through the creation of ETFs and the delivery of securities to
the clearing corporation” (NASDAQ, 2004). Similarly, the AMEX commented that ETF market
makers should be exempt from locate and close-out requirement to guarantee sufficient market
liquidity (AMEX, 2004).
The SEC rejected both arguments and declined to exempt ETFs from the Regulation
SHO locate requirements (SEC, 2004). Nevertheless, neither Regulation SHO nor Rule 204T has
reduced ETF FTDs. In 2012, it was reported that the SEC was conducting an ongoing
investigation into “failed trades and ETFs.” The regulatory focus on naked short selling and
FTDs in ETFs has prompted responses from industry experts. Nadig (2011) argues that ETFs
dominate the Regulation SHO Threshold List because of a “timing mismatch.” That is, market
makers have an extra three days past settlement date to close-out FTDs, and they take advantage
of this “extra time” (Nadig, 2011, p. 9). This suggests that ETF FTDs are potentially an
opportunistic yet benign response to close-out exceptions.

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Similarly, Morningstar, an ETF index licensor, suggests that “The ETF
creation/redemption mechanism, along with the very high velocity of many ETFs' share bases,
explains why settlement failures are more frequent in ETF shares than in common equities”
(Johnson, 2011). Morningstar also argues that the process of creating new ETF shares to satisfy a
settlement obligation may take as long as trade date plus 4 or 5 days. They suggest that ETF
FTDs are ultimately resolved, but not in time to accommodate the T+3 settlement cycle. This
explanation, however, does not address why ETF FTD levels may be high and persistent.
Amery (2011) contends that ETF market makers have incentives to delay settlement.
First, it may be cheaper to borrow or create ETF shares via an AP rather than buy them on the
open market to cover a short sale. Second, time differences between ETF rebate rates and
financing rates may create arbitrage opportunities for market makers who delay settlement. A
2011 report for the Kauffman Foundation argues that ETF FTDs create systemic risk by creating
“a cumulative and potentially compounding liquidity risk” (Bradley et al., 2011).
Every fail introduces a cumulative and potentially compounding liquidity risk into
the orderly process of settling the $7.5 trillion of security transactions completed
each day, which could be especially dangerous during times when financial
institutions are short of liquidity (Bradley et al., 2011, p. 2).

A report by Goldman Sachs speaks to the mechanism by which this liquidity contraction
could occur. Boroujerdi et al. (2012) explain that ETFs may trade more than shares outstanding
because short sellers borrow and re-lend shares through “chained lending.” While the Goldman
Report argues that chained lending does not create systemic risk because ETF shares can be
bought, borrowed, or created at any time to unwind short position, “the overall liquidity and
availability of an ETF in the lending process will be directly impacted by that of the underlying
securities” (Boroujerdi, 2012, p. 14).

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Similarly, the Goldman Report argues that ETF FTDs are predominantly a result of heavy
trading volumes coupled with AP share creation and redemption delays that last longer than the
settlement cycle. Nevertheless, the authors recognize “the potential for economic loss … if one
[is] not able to lend out shares given settlement postponements” (Boroujerdi, 2012, p. 15). This
suggests that ETF FTDs may create stock borrow constraints that exacerbate market movements.
Bogan et al. (2012) provide evidence that ETF short selling more than shares outstanding
creates systemic risk. “As short interest builds in the ETF shares themselves, the underlying
index equities held by the ETF operator become a fraction of the implied ownership of the ETF
in the market—the rest is promised back by borrowers (short sellers through their prime
brokers). [Thus] the market value of the total ownership of the ETF far outstrips the underlying
assets held in index stocks by the ETF operator” (Bogan et al., 2012, p. 79). The author argues
that ETF values relative to component assets could be driven to zero during a liquidity crisis such
as May 6, 2010 “Flash Crash.” Further, Bogan et al. (2012) hypothesize that unusually high ETF
short interest and settlement failures are signs of potential market instability.
There is also evidence that ETF trading played a key role in the May 2010 Flash Crash.
Seventy percent of the equity trades broken by the SROs for price drops more than 60% were in
ETFs (CFTC and SEC, 2010a, p. 5). The final report by regulators notes the “disproportionate
impact the market disruption of May 6 had on ETFs” (CFTC and SEC, 2010b, p. 6). Additional
research on ETFs and liquidity crises are in Borkovec et al. (2010), Madhavan (2012), and Cespa
and Foucault (2012). Ben-David et al. (2018) find that “find that stocks with higher ETF
ownership display significantly higher volatility.” Evans et. al. (2024) present evidence that ETF
FTDs reflect “operational shorting” by market makers driven by the need to provide liquidity.

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2.9 Recent Academic Literature on FTDs
The literature on naked short selling has grown since the advent of the Regulation SHO
Threshold List in 2005 as well as the public release of FTD data in 2007. Angel and McCabe
(2009, p. 246) argue that “so-called ‘naked’ short selling involves an abuse of the flexibility in
the system for the settlement of stock trades.” Putniņš (2010, p. 13) concludes that “US clearing
and settlement system does not provide any significant disincentives for naked short selling.”
Stokes (2009) explores legal and regulatory remedies for firms that claim to be victims of naked
short selling and settlement failures. Using pre-Regulation SHO data, Evans et al. (2009)
demonstrate that market makers choose to fail when stock borrow costs are high.
Edwards and Hanley (2010) study short selling and FTDs during initial public offerings
(IPOs). The authors find no evidence that naked short selling causes FTDs or that short sellers
earn abnormal returns during IPOs. Stratmann and Welborn (2013) provide evidence that market
makers took advantage of an options market making exception to the short sale locate and closeout provisions of SEC Regulation SHO. This led to higher FTDs in optionable stocks relative to
non-optionable stocks.
A related literature looks at the relationship between the stock lending market and prices.
Asquith et al. (2005) find that stocks that are short sale-constrained tend to exhibit abnormal
negative returns. Avellaneda and Lipkin (2009) develop a theoretical model to demonstrate how
stock borrow constraints, such as low equity float or high borrow costs, lead to overpricing and
volatility. Branson (2010) argues that high short sale demand, coupled with weak securities
lending regulation, has led to an opaque stock lending market that does not adequately restrict
manipulative naked short selling. Dive et al. (2011) explore the growing importance of securities
lending as a revenue source for major banks.

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Boulton and Braga-Alves (2012) argue that naked short selling does not cause abnormal
negative returns because stocks that appear on the Regulation SHO Threshold List tend to be
overpriced. Lecce et al. (2012), however, reach the opposite conclusion using data from the
Australian Stock Exchange (ASX). The latter authors take advantage of a unique feature the
ASX whereby certain stocks may be sold short without borrowing on certain dates. They find
that naked short selling leads to higher abnormal negative returns, higher volatility, and lower
liquidity in stocks with higher borrowing costs.
Stratmann and Welborn (2013) use a difference-in-differences analysis to examine the
effects of eliminating the options market maker exception to Regulation SHO. The authors find
that “eliminating the Exception led to fewer fails-to-deliver and higher stock borrow rates for
optionable stocks as compared to non-optionable stocks. Further, removing the Exception
reduced fails-to-deliver for optionable stocks when the price of borrowing stock was high.”
Fotak et. al. (2014) examine settlement failures in NYSE stocks for the period from 2005
to 2008. They find that “greater FTDs lead to higher liquidity and pricing efficiency.” Fotak et.
al. (2014) also “do not find any evidence that FTDs caused price distortions or the failure of
financial firms during the 2008 financial crisis.”
Stratmann and Welborn (2016) examine how high FTDs affect abnormal returns. The
authors demonstrate that “stocks with fails-to-deliver (FTDs) experience negative abnormal
returns that are proportional to their FTD levels.” Stratmann and Welborn (2016) also find that
“short sellers of low and high FTD stocks obtain positive estimated profits” and “FTDs reflect
nonbinding short sale constraints which do not restrict informed short selling.” The authors show
that FTDs are highly correlated with short selling, but are able to conclude whether high FTDs
cause abnormal returns

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3. Data
We have only two metrics by which to evaluate the efficacy of Reg SHO. These are (1)
daily Reg SHO Threshold Lists, and (2) daily data on fails-to-deliver (FTDs) from the SEC
Freedom of Information Act (FOIA) Office. In this section, I consider how these two panel data
series have evolved from when Reg SHO was enacted in 2005.
The goal of this investigation is to generate meaningful aggregate statistics on Reg SHO
Threshold firms. To conduct an analysis of securities over 20 years, I use two databases from
Wharton Research Data Services (WRDS). The first dataset, from the Center for Research on
Security Prices (CRSP), is best for historical tickers that may no longer be active. The second
dataset, Compustat, is best for current active tickers and recent data. While there is overlap
between the two datasets, this is also real divergence in their coverage of the 15k+ SHO tickers.
15,190 unique tickers have appeared on Reg SHO Threshold Lists since January 3, 2005. Of
those, 14,771 have unique CUSIPs, as some companies have multiple tickers on the Threshold
List. Are related challenge is that some tickers are recycled among different companies, and
many tickers are dead or dormant. The biggest methodological challenge is that Reg SHO did not
require the major listing exchanges to include CUSIP data in their daily threshold lists.
Of the 15,190 unique Threshold tickers, 4,658 are not covered in any WRDS database,
such as CRSP or Compustat. This incomplete coverage frustrates analysis and reflects a policy
error created by omitting CUSIPs in Reg SHO reporting. Moreover, only 5,301 Threshold SHO
tickers appear in both the CRSP and Compustat databases. Within the CRSP data, we have
coverage on 2,105 Threshold tickers that are not in Compustat. Within the Compustat data, we
have coverage on 3,773 tickers that are not in CRSP. A “match” is created when we match a
ticker and a date to a specific Reg SHO Threshold List for a given day.

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3.1 Regulation SHO Data
Figure 1 presents the historical daily Reg SHO totals, broken down by listing exchange.
The exchanges which currently publish daily Reg SHO Threshold List data are the New York
Stock Exchange (NYSE), the Nasdaq Stock Market, FINRA OTC, and BATS Exchange (CBOEBZX). Due to consolidation in exchange ownership, the Chicago Stock Exchange (CHX) data is
now part of the NYSE Reg SHO Threshold data.
For the period from January 2005, when Reg SHO was enacted, through Q4 2008, when
the options market maker exception to Reg SHO was eliminated, mean daily Threshold List
totals were 282 stocks, with a standard deviation of 83 stocks. The highest total number of Reg
SHO stocks was 514 on April 1, 2008. During this time, Nasdaq stocks averaged 80% of total
Threshold Securities.
For the period from 2009 through 2019, average daily total threshold stocks dropped to
95, with a standard deviation of 26. NYSE stocks were half of daily totals on average, and
Nasdaq stocks were 1/3. In October 2014, securities who failed to meet new Nasdaq listing
requirements shifted to the FINRA “Over the counter” (OTC) market. Thereafter, an average of
15% of daily threshold securities were from FINRA OTC listings.
For the period from 2020 through 2024, average daily threshold securities were 75, with a
max of 215 and standard deviation of 25. NYSE securities were 30% of the daily average and
Nasdaq were 33%. In Q2 2023, Nasdaq securities again began to dominate threshold totals. As of
the end of 2024, Nasdaq securities were roughly 60% of daily threshold totals. Securities listed
on BATS Global Markets, which is owned by the Chicago Board Options Exchange (CBOE),
averaged 10% of threshold stocks during this recent period. There was also a new local high of
96 total threshold securities on 26 December 2024.

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Figure 2 breaks down the daily threshold list totals by security type. For the period from
2005 through 2008, common stocks averaged 145, or 50% of daily threshold totals, with a high
of 7% and a standard deviation of 8%. Unknown category securities are averaged 102, or 37% of
daily totals from this period. As discussed above, these stock tickers are reported in daily files
with names but without CUSIPs. As a result, we are unable to recover classifying data for these
Threshold securities from either the CRSP or Compustat databases.
For the period from 2009 through 2019, ETFs were over half of daily threshold securities,
with a daily average of 50 ETFs. In contrast, known common stocks fell to 22% of average daily
totals, or 20 securities. ADRs and Unknown securities tied for the 3rd largest category with 12%
each of daily threshold totals.
For the period from 2020 to 2024, ETFs declined from 51% to 40% of average daily
totals. At the same time, common stocks rose to 31% of the daily average, ADRs rose to 15%,
and Unknown securities fell to 10%. Other security types, including mutual funds, preferred
shares, structured products, common stock plus warrant units, and warrants alone were at or
under 1%. Notably, ETFs and total threshold securities peaked at 135 and 215, respectively, on
March 27, 2020, at the height of market concerns regarding the Covid-19 Pandemic.
Tables 4 through 7 present lists of securities with the longest tenure on Reg SHO
Threshold Lists. Tables 4 present threshold summary data for the all-time top common stocks
such as Overstock.com (OSTK; 921 total days), Krispy Kreme Doughnuts (KKD; 645 total
days), Netflix.com (NFLX; 641 total days), and Chipotle Mexican Grill (CMG; 544 total days).
Table 5 lists common stocks with a 2024 threshold date, such as Sunpower Corp (SPWR; 547
days), Beyond Meat Inc (BYND; 382 days); Nikola Corp. (NKLA; 138 days), and Bakkt
Holdings (BKKT; 123 days).

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Tables 6 and 7 list ETFs with the largest Reg SHO Threshold Totals. The ETF with the
longest total days on the list is XRT, the S&P 100 Retail ETF, with 1,691 total threshold days.
XRT was on the threshold list as recently as 27 December 2024. FTDs in XRT have been as high
as $418 million dollars. XRT is notable for frequently having short interest greater than shares
outstanding, which is a mystery that we explore in greater depth below.
Many of the ETFs with long Reg SHO Threshold listings are leveraged, such as the
Direxion Daily Gold Miners Bear 2x Shares, (DUST; 1627 days), the Direxion Daily 30-Year
Treasury Bull 3X (TMF; 1583 days), Direxion Energy Bear 3X Shares (ERY; 1464 days), and
the ProShares Ultra VIX Short-Term Futures ETF (UVXY; 1297 days). Of those ETFs that were
on the threshold list in 2024, the regional banking ETF KRE saw FTDs peak at $274 million.
Figure 3 shows the breakdown of Reg SHO Threshold securities by type. Common stocks
are the largest group with 39.70% of the total. ETFs are in second place with 20%. Unknown
securities, which are mostly from the 2005-2008 period, are 8.5%. ADRs are 8.5%.
Figure 4 breaks down the total Threshold days for the period from 2005 to 2024 by
security type. Surprisingly, unknown securities account for almost 65%, or 2/3, of all Reg SHO
Threshold days. This may reflect the fact that many of these tickers are temporary and related to
corporate actions. Nevertheless, it is striking that almost 2/3 of the Threshold database contains
ticker symbols and names that are not stored in CRSP or Compustat. Common stocks are the
next largest category at under 20%. One reason this may be “low” is that a relatively small set of
tickers end up on the Threshold List. ETFs are in third place with 10.4% of total threshold days.
Figure 5 is a histogram that shows the distribution of total Reg SHO Threshold days.
Unsurprisingly, this is a long-tailed distribution with a median of 4 days, a mode of 1 day, and a
max of 1,546 days. This reflects the fact that most stocks drop off the list after 1 day.

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3.2 Fail-to-deliver Data
Figures 6 and 7 show the daily total dollar value of FTD for the period from 2007
through 2024. These data are from the SEC Freedom of Information Act (FOIA) office and are
reported on a bi-monthly basis, with a two-week lag. I generated these totals using the daily price
and fail quantity data provided by the SEC, per ticker (and/or cusip) per day. I did not use any
WRDS data, such as CRSP or Compustat to determine these totals, which is why the data set
begins in April 2007, which is when the SEC started to report price data with daily FTDs.
Figure 6 presents the daily dollar value of FTDs for the full period. The average for this
period is $2.9 billion USD. The figure shows clearly the “drop” in daily FTDs after the October
2008 amendments to Reg SHO. The highest FTD level was $20.3 billion on 23 September 2008.
Notably, the second highest FTD level was $19.8 billion on 23 September 2024. Median FTDs
were $2.26 billion for this period.
Figure 7 truncates the data from Figure 6 to just consider the last five years of data, from
2019 to 2024. Interestingly, the average daily FTDs for this period were $2.8billion, which is just
under the full sample average of $2.9 billion. Moreover, median FTDs were higher at $2.44
billion. One noteworthy “trend” in the data are spikes that tend to coincide with quarterly options
expiration dates. For example, in 2021, FTDs appear to peak on 23 March, 21 June, and 21
September, which are each 1-2 settlement days after options expiration dates. This suggests that
there may be a connection between settlement failures and options trading, at least temporarily.
Figures 8 and 9 show daily FTDs (USD) by security type for Threshold stocks only. For
the period from 2005 through 2008, common stocks averaged 80% of daily FTDs. From 2009 to
2019, however, ETFs were 75% of average of daily FTDs. For the final period, from 2009
through 2019, common stocks and ETFs were 41% and 44.5% of FTDs, respectively.

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Table 8 lists the securities according to their maximum value of FTDs, in descending
order. It is notable that 5 of the top 10 securities on this list are major Index ETFs. The largest
maximum FTDs were in IWM, the Russell 2000 Index ETF, with $10.99 billion on 27 June
2007. The next highest FTDs were in SPY, the S&P 500 ETF, with $7.5 billion on 16 March
2023. Next are Microsoft and Nvidia, which each had an FTD peak on 23 September 2024 of
over $3 billion dollars each. This is a remarkable coincidence and merits further investigation.
Table 9 is a sample list of securities that have experienced a short interest of 90% or more
at some point during the period from 2004 through 2024. The daily short interest data are highly
proprietary data from FIS Securities. I paired these data with the Compustat daily data, which
reflect daily changes in shares outstanding. As we have already established, the Compustat data
do not provide good coverage of inactive or dead tickers, or at least not as good as CRSP. But the
CRSP data do not update shares outstanding daily, so they are of limited use for daily insights.
Again, XRT is at the top of the list with 699 days over 90% shares short. Curiously, the
maximum loan percentage is 699%, which indicates that there are days where short interest is
almost 7x shares outstanding. Again, this is a shocking statistic, and merits further investigation.
Also on this list are Ameriprise Financial (AMP), Barclay’s S&P 500 ETF (VXX), Peleton
Interactive Inc (PTON), and Pre-Paid Legal Services (PPD).
We look more carefully at XRT in Figures 10 and 11. Figure 10 shows FTDs versus the
loan percentages for XRT for the period from 2007 to present. Figure swaps FTDs for price.
Figure 10 shows a strong correlation between FTDs and loan percentage, which is consistent
with the logic that short selling and settlement failures are related. Figure 10 indicates that some
spikes in XRT FTDs correspond to price drops, such as in September 2020 and in September
2022.

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4. Policy Proposals
The data in the previous section indicates that Reg SHO has been ineffective at reducing
the size and persistence of trade settlement failures. I therefore consider three proposals for
reforming Reg SHO to reduce large and persistent fail-to-deliver (FTD) positions. First, I discuss
monetary penalties for failing to deliver securities. Second, I consider the logistics and
implications of a mandatory pre-borrow requirement for all short sales. Finally, I explore options
for reasonable restrictions on market maker exceptions to timely settlement rules.

4.1 Monetary Penalties for failing to deliver
In the original 2003 draft of Regulation SHO, the SEC proposed imposing monetary
Penalties for failing to deliver. SEC (2003) contains the following language, (emphasis added):
“In addition, the rule would require the rules of the registered clearing agency that
processed the transaction to include the following provisions: (A) A broker or
dealer failing to deliver such securities shall be referred to the NASD and the
designated examining authority for such broker-dealer for appropriate
action;55 and (B) The registered clearing agency shall withhold a benefit of any
mark-to-market amounts or payments that otherwise would be made to the party
failing to deliver,56 and take other appropriate action, including assessing
appropriate charges against the party failing to deliver. Both of these
requirements should assist the Commission in preventing abuses and promote the
prompt and accurate clearance and settlement of securities transactions.

In total, the SEC received 462 comment letters on proposed Regulation SHO, including from 1
academic, 10 associations and organizations, 10 attorneys and law firms, 13 Broker-Dealers, 7
companies, 1 national securities clearing agency, 14 national securities exchange & markets, and
over 400 individuals. Due to the overwhelming response to proposed Regulation SHO, in July
2004, after the commend period had closed, the SEC released a summary of the comments
received.

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Most commenters opposed naked short selling and settlement failures of any kind.
Moreover, “About half of the commenters focusing on the delivery portion of Rule 203 requested
the Commission impose harsher penalties for failures to deliver” (SEC, 2004). Nevertheless,
industry leaders opposed monetary penalties for failing to deliver. A group letter from officials
Citigroup, Goldman Sachs, Merrill Lynch and Morgan Stanley recommended “that the
Commission proceed with imposing a mandatory buy-in for failures, while eliminating the 90day suspension and penalties associated with securities with a significant number of delivery
failure” (SEC, 2004a).
Ultimately, the SEC followed the advice of industry officials and ignored the support of
retail investors. The final rule of Reg SHO made no mention of “charges” or “penalties” for
failing to deliver. In so doing, the SEC may have followed the guidance of the Securities Industry
Assocation (SIA, now known as SIFMA), which argued that, “[b]ecause of NSCC’s continuous
net settlement system nets all buys and sells within a particular firm, the broker-dealer cannot
determine which customer’s transaction gave rise to the fail” (SEC, 2004a).
Nevertheless, subsequent major enforcement actions the American Stock Exchange,
FINRA, and the SEC have demonstrated that this claim was false. In numerous cases, including
Amex (2007), SEC (2009), SEC (2011), SEC (2012), and others, securities regulators had no
difficulty connecting specific trade settlement failures with specific unlawful actors,
notwithstanding the challenges presented by the net settlement system.
While the SEC was debating whether to impose penalties for failing to deliver equity
securities, the U.S. Treasury was engaging the same debate and analysis over U.S. Treasury fails.
In 2005, the NY Federal Reserve Bank published a report entitled “Explaining Settlement Fails.”
This report examined the size, causes, and consequences of UST fails for the 1990-2004 period.

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The authors of this study document a growing but volatile record of settlement failures in
UST. “The evidence suggests that most episodes of elevated settlement fails are related to market
participants’ incentive to avoid failing. Fails have tended to be high in the weeks before and
during the Treasury Department’s quarterly refundings and in the weeks that include the end of a
calendar quarter, when security borrowing costs tend to be high” (NY Fed, 2005).
The problem of UST settlement fails became acute in 2008, in connection with the failure
of Lehman Brothers and other market disruptions. One analysis noted that “the Treasury market
experienced an extraordinary volume of fails that threatened to erode the perception of the
market as being free of credit risk” (NY Fed, 2010). In response, the Treasury Market Practices
Group (TPMG) met to discuss solutions to the US fails problem. In 2009, TMPG introduced a
“dynamic fails charge” to incentivize timely settlement of Treasury securities and reduce fails.
“The fails charge thus preserves a significant economic incentive for timely settlement even
when interest rates are close to zero” (NY Fed, 2010).
The TMPG fails charge policy was later updated in 2016 and 2018 and reflects grave
concerns about fails-to-deliver in connection with orderly markets. A 2020 TMPG FAQ notes:
“Persistent elevated fail levels create market inefficiencies, increase credit risk for
market participants and heighten overall systemic risk. In higher rate
environments, the time value of money that is lost when delivery is not made as
contracted provides an incentive to sellers to deliver bonds as agreed. Given that
this incentive is smaller in low short-term rate environments, sellers are less
sensitive to the timeliness of delivery. The TMPG recommends a financial charge
to provide an incentive to sellers to deliver securities in a timely fashion or cure
fails that do occur thereby minimizing overall fail levels.” (NY Fed, 2020)
Nevertheless, UST fails are still not zero, and TMPG may need to update their fails considering
new from 2024 which indicate that US fails have risen to a new record high (FA Mag, 2024). The
UST experience underscores the need for monetary penalties for failing to deliver stocks.

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4.2 Universal pre borrow requirement
As discussed above, the July 15, 2008 SEC Emergency Order required traders to borrow
securities prior to effecting short sales in the stocks of the 17 primary dealers and the 2
Government-sponsored enterprises (GSE), Fannie Mae and Freddie Mac. The SEC said,
“False rumors can lead to a loss of confidence in our markets. Such loss of
confidence can lead to panic selling, which may be further exacerbated by
“naked” short selling. As a result, the prices of securities may artificially and
unnecessarily decline well below the price level that would have resulted from the
normal price discovery process. If significant financial institutions are involved,
this chain of events can threaten disruption of our markets” (SEC 2008a)

The SEC Order referred to market volatility related to the sale of The Bear Stearns Companies
Inc in March 2008 as inspiration for the order. Notably, in response to industry pressure, the SEC
later exempted market makers from the pre-borrow requirement.
The borrow and arrangement-to-borrow requirement of the Order does not apply
to certain bona fide market makers. (The settlement date delivery requirement of
the Order applies to these market makers.) The purpose of this accommodation is
to permit market makers to facilitate customer orders in a fast-moving market
without possible delays associated with complying with the borrow and
arrangement-to-borrow requirement of the Order. (SEC 2008a2)

Nevertheless, the OEA (2009) report documents a clear reduction in naked short selling
and FTDs in the affected securities. Below are the key findings of the OEA (2009) report:
•
•
•
•
•
•
•
•

Large and statistically significant decreases in short selling volume
Dramatic, but temporary, initial increases in stock lending rates followed by rates still
higher than before the Order
Large and significant decreases in fails to deliver
Little change in short interest
No significant changes in bid-ask spread or market depth
No significant migration of trading volume to London for cross-listed securities
No significant changes in option trading volume or open interest
No significant changes in volume

The implication is that a short sale pre-borrow requirement would not impact market quality.

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4.3 Elimination of all market making exceptions
While the options market maker exception was eliminated in 2008, Reg SHO still offers
certain locate and delivery flexibility for registered market makers. Specifically, market makers
engaged in short selling can rely on the "locate" requirement differently when they are executing
transactions as part of normal market-making activities, such as hedging or filling customer
orders. Market makers are also allowed to sell short without a locate when the short sale is made
to hedge their inventory positions and is part of bona fide market-making activity. This
justification for this is that market makers can manage risk and provide market liquidity.
For market makers, Rule 204 amended Reg SHO in the following ways. First,
Rule 204 instituted mandatory close-out requirements for situations where there are persistent
fails to deliver. If a security has a fail to deliver for a certain period (usually no more than 13
consecutive settlement days), then the market maker (or any entity failing to deliver) must close
out that position. This was a shift from Rule 203, where there were no such explicit closure
requirements for ongoing fails.
Second, Rule 204 established a time frame for when close-out actions need to
occur. This timeline required market makers and others to be more diligent in managing their
short positions and ensuring they can deliver securities in a timely fashion. Previously, there
were no definitive timelines set for resolving FTDs.
Third, while the locate requirement continued to exist in some form, Rule 204
clarified and expanded the expectations placed upon market makers regarding the need to have a
reasonable belief that securities can be borrowed when executing short sales. For market makers,
this required adopting more systematic procedures to ensure compliance and trades could not be
executed on an "as-available" basis without proper locates.

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Fourth, Rule 204 brought explicit attention to threshold securities. If a security is
designated as a threshold security, then additional obligations apply to market makers, including
close-out requirements after certain fails. Arguably, this provision was novel in creating a
heightened level of scrutiny on specific stocks.
Finally, while Rule 204 required compliance from all market participants, it nevertheless
recognized the unique role of market makers, allowing some exceptions for bona fide marketmaking activities. This recognition meant that while they had to comply with regulations, they
also retained some operational flexibility to perform their essential function in the marketplace
without facing undue restrictions.
Whatever the justification for continued market making exceptions to Reg SHO,
the data presented above show that the current rule regime is inadequate to prevent large and
persistent FTDs. Furthermore, after Rule 204 was added to Reg SHO in 2009, the overall trend
in FTDs has been upward and with higher highs. As previously observed, the second highest
total FTD day was on 23 September 2024 with $19.8 billion.
Perhaps not coincidentally, the largest Reg SHO fines and most noteworthy SEC
enforcement actions have involved securities firms engaged in executing and clearing short sales.
Indeed, market makers and industry professionals who commented on the original 2003 Reg
SHO proposal were among the most vocal proponents of the market making exceptions to locate
and close-out provisions. Many of those Reg SHO commenters were later sanctioned by the SEC
for engaging in fraudulent or violative activities, including Bernard and Peter Madoff (2003),
Scott Arenstein (2003), UBS Securities (2003), Goldman Sachs & Co. (2004), Morgan Stanley &
Co (2004), and Citigroup Global Markets (2004).

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5. Conclusion
This analysis shows how Reg SHO, despite years of consideration and amendments, has
provided an ineffective framework for governing short selling and trade settlement. Data from
the NSCC CNS system show that daily FTDs average are consistently $3b dollars. Moreover, as
established in the academic literature, FTDs are highly correlated with shorts selling and are not
the result of random clerical errors. Regulation SHO Threshold List data from the self-regulatory
organizations (SROs) show that the number of stocks with large and persistent FTDs has not
decreased. FTDs are concentrated in ETFs like XRT, for reasons poorly understood.
I propose a series of remedies to reduce FTDs and improve market integrity. The first
proposal involves universal penalties and/or charges for firms that fail to deliver securities for
any reason. I base this recommendation on best practices in the market for U.S. Treasury
securities, where fails charges have been in place since 2008. The SEC knew that penalties for
failing to deliver securities were the appropriate remedy when Reg SHO was proposed in 2003,
and the SEC has an opportunity now to implement the original proposal.
Second, I propose a universal pre borrow requirement for all shorts by all market
participants. This recommendation is based on the SEC’s own 2008 emergency order in the
securities of the primary dealers, which the SEC Office of Economic Analysis found reduced
naked short selling and FTDs without reducing market quality or trading volumes. The related
finding, that a pre-borrow requirement raised borrow costs, is a logical finding when compared
to a rules regime where short sellers benefitted from “fuzzy” borrowing requirements.
Third, I propose to eliminate all market making exceptions to short sale rules. While
perhaps well intended, market making exceptions appear to be the reason why dozens of stocks
remain on the threshold list for weeks and months. At age twenty, the SEC has an important
opportunity to fix Reg SHO and eliminate large and persistent FTDs once and for all.

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List of Tables and Figures
#
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25

Item
Table 1
Table 2a
Table 2b
Table 2c
Table 2d
Table 3
Figure 1
Figure 2
Table 4
Table 5
Table 6
Table 7
Fugure 3
Figure 4
Figure 5
Figure 6
Figure 7
Figure 8
Figure 9
Table 8
Table 9
Figure 10
Figure 11
Figure 12
Figure 13

Description
Timeline of Key Short Selling and Regulation SHO Events
Regulation SHO, Rule 200
Regulation SHO, Rule 201
Regulation SHO, Rule 203
Regulation SHO, Rule 204
List of Key Reg SHO Enforcement Actions
Reg SHO Threshold List - Daily Totals by Listing Exchange
Reg SHO Threshold List - Daily Totals by Security Type, 2005-2024
Reg SHO Threshold List - Top Common Stocks, 2005-2024
Reg SHO Threshold List - Top Common Stocks (with 2024 date)
Reg SHO Threshold List - Top ETFs, 2005-2024
Reg SHO Threshold List - Top ETFs (with 2024 Date)
Reg SHO Threshold List - Total SHO Days by Security Type, 2005-2024
Reg SHO Threshold List - Total SHO Securities by Type, 2005-2024
Histogram - Number of Days on SHO Threshold List
Daily Total FTDs ($ USD), 2007-2024
Daily Total FTDs ($ USD), 2019-2024
Daily Total FTDs ($ USD) by Security Type, SHO Stocks only, 2007-2024
Daily Total FTDs ($ USD) by Security Type, SHO Stocks only, 2019-2024
Stocks with Highest FTDs, 2007-2024
Sample of Securities with > 90% Short Interest
XRT, FTDs vs SI/Shares Out, 2007-2024
XRT, Price vs SI/Shares Out, 2007-2024
GME, FTDs vs SI/Shares Out, 2007-2024
GME, Price vs SI/Shares Out, 2007-2024

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Table 1
Timeline of Key Short Selling and Regulation SHO Events

#
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28

Month
February
June

Year Event
Code / Title
Link
1963 NYSE shuts down trading on Feb 6 to tackle backlog of trades
1967 NYSE founds Central Certificate Service (CCC)
1973 Creation of Depository Trust Company (DTC)
1975 Securities Act Amendments of 1975
1976 Creation of National Securities Clearing Corporation (NSCC)
1986 NASD "Pollack Report" on short selling
June
1992 "Short Sales"
NYSE Rule 10 / FINRA 3310
1996 "Customer Account Statements: Recommendations and Obligations..." NYSE Rule 440C
February 1997 "Short Sales and Borrowing"
NASD Rule 2650 / FINRA 4320 https://www.finra.org/rules-guidance/rulebooks/finra-rules/4320
1998 Collapse of Long Term Capital Management (LTCM)
March
1999 "Credited and Debited Securities."
NASD Rule 3370
October 2001 Enron Collapse
October 2003 Proposed Rule, Short Sales. (Replaces Rules 3b-3, 10a-1, and 10a-2)
SEC Rules 200, 202T, and 203 https://www.sec.gov/rules-regulations/2004/07/short-sales#34-48709proposed
July
2004 SEC Comments on Reg SHO
SEC Rule 242 (formally)
https://www.sec.gov/files/rules/extra/s72303comsum.pdf
September 2004 Final Rule, Short Sales
Rule 242 of SEC Act.
https://www.sec.gov/rules-regulations/2004/07/short-sales#34-48709proposed
July
2006 Proposed Rule, Amendments to Regulation SHO
Rule 203b3
March
2007 Proposed Rule, Amendments to Regulation SHO
Rule 203b3
https://www.sec.gov/rules-regulations/2007/08/amendments-regulation-sho#34-55520propose
August
2007 Elimination of the Grandfather Clause
Rule 203b3
https://www.sec.gov/rules-regulations/2007/08/amendments-regulation-sho#34-56212final
July
2008 Proposed Rule; Reopening comment on Amendments to Regulation SHORule 203
https://www.sec.gov/rules-regulations/2008/10/amendments-regulation-sho#34-58107propose
July
2008 SEC Enhances Investor Protections Against Naked Short Selling
12(k)2 of the 1934 Act
https://www.sec.gov/news/press/2008/2008-143.htm
March
2008 “Naked” Short Selling Anti-Fraud Rule
Rule 10b-21
https://www.sec.gov/rules-regulations/rulemaking-activity?search=S7-08-08
August
2008 Comments on "Naked" Short Selling Anti-Fraud Rule
Rule 10b-21
https://www.sec.gov/comments/s7-08-08/s70808.shtml
October 2008 Elimination of the Options Market Maker Exception
Rules 200 and 203
https://www.sec.gov/rules-regulations/rulemaking-activity?search=S7-19-07
October 2008 Final - "Naked" Short Selling Anti-Fraud Rule
Rule 10b-21
https://www.sec.gov/rules-regulations/rulemaking-activity?search=S7-08-08
October 2008 Interim final temporary rule; request for comments
Rule 204T
https://www.sec.gov/rules-regulations/2009/07/amendments-regulation-sho#34-58773final
July
2009 Rule 204 Finalized
Rule 204
https://www.sec.gov/rules-regulations/2009/07/amendments-regulation-sho#34-60388final
August
2009 Short Sale Price Test Restriction
Rule 10a-1
https://www.sec.gov/rules-regulations/rulemaking-activity?search=S7-08-09
November 2009 OEA, "Impact of Recent SHO Rule Changes on Fails to Deliver"
Rules 203, 204T
https://www.sec.gov/files/oeamemo110409.pdf

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Table 2a
Regulation SHO, Rule 200

Part 242

Name

200

Definition of
“short sale” and
marking
requirements

Description
Definition of Short Sale : A short sale is defined as any sale of a security that the seller does not own or a sale that is executed through a borrowed security.
Ownership Conditions : A person is considered to own a security if they have title to it, have made an unconditional purchase contract, hold convertible or
exchangeable securities, have exercised an option to acquire it, have rights or warrants that have been exercised, or hold a futures contract with a notification of
physical settlement.
Broker-Dealer Provisions : Brokers or dealers are deemed to own a security under certain conditions, even if not net long, particularly when acting in specific
capacities related to arbitrage or index position unwinding, provided the sale occurs outside of significant index declines.
Marking Requirements : All sell orders for equity securities must be marked as “long,” “short,” or “short exempt” based on the seller's ownership status and the
conditions under which the sale is made.
Exemptions : The Commission may grant exemptions from these provisions upon written application or on its own motion, which may apply to specific transactions,
securities, or groups of persons.

Source: Code of Federal Regulations. 2023. Definition of ‘Short Sale’ and Marking Requirements, vol. 17, sec. 242.200. U.S. Government Publishing Office, https://www.ecfr.gov/current/title-17/chapte
242

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Table 2b
Regulation SHO, Rule 201

Part 242
201

Name

Description

Circuit Breaker Circuit Breaker Mechanism : A trading center must establish policies to prevent the execution of short sale orders of a covered security at prices equal to or below the
current national best bid if the security has decreased by 10% or more from its previous closing price.
Enforcement and Monitoring : Trading centers are required to regularly monitor the effectiveness of their short sale policies and take immediate corrective action when
deficiencies are identified.
Short Exempt Orders : After a 10% price decline notification, brokers can mark short sale orders as "short exempt" if they are at a price above the current national best
bid. Brokers must implement procedures to prevent incorrect designation of these orders.
Conditions for Short Exempt Orders : Specific conditions allow brokers to mark short sale orders as "short exempt," including ownership of the covered security, market
maker activities, and compliance with good faith requirements for short selling, particularly in odd lots or in the context of underwriting.
VWAP Transactions and Limits : Short sales executed at the volume-weighted average price (VWAP) must adhere to specific criteria, including limits on the percentage
of a security's average daily trading volume that can be shorted, to prevent market manipulation.

Source: Code of Federal Regulations. 2023. Circuit breaker, vol. 17, sec. 242.201. U.S. Government Publishing Office, https://www.ecfr.gov/current/title-17/chapter-II/part-242.

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WORKING PAPER

Table 2c
Regulation SHO, Rule 203

Part 242
203

Name

Description

Borrowing and Long Sales Restrictions : Brokers or dealers may not lend or arrange the loan of any security for delivery if the sale is marked "long" and the broker has reasonable
delivery
grounds to believe the security will not be delivered on the settlement date. Exceptions exist under certain conditions, including loans to other brokers and specific
requirements circumstances involving seller notification.
Short Sale Requirements : Brokers and dealers cannot accept short sale orders unless they have either borrowed the security or have a reasonable belief that it can be
borrowed, along with documentation of this compliance. There are specific exceptions for registered brokers relying on another broker who is compliant.
Fail to Deliver Provisions : Participants at a registered clearing agency must close out fail to deliver positions for threshold securi

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Asec%3A8ae85c9dc3f97242. Public record. Not legal advice.