Self-Regulatory Organizations; Notice of Proposed Rule Change by National Association of Securities Dealers, Inc. Amending the Prompt Receipt and Delivery of Securities Interpretation Relating to Short Sales

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-34487; File No. SR-NASD-94-32]

Self-Regulatory Organizations; Notice of Proposed Rule Change by

National Association of Securities Dealers, Inc. Amending the Prompt

Receipt and Delivery of Securities Interpretation Relating to Short

Sales

August 4, 1994.

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934

(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on July 28,

1994, the National Association of Securities Dealers, Inc. (``NASD'' or

``Association'') filed with the Securities and Exchange Commission

(``Commission'' or ``SEC'') the proposed rule change as described in

Items I, II, and III below, which Items have been prepared by the

NASD.1 The Commission is publishing this notice to solicit

comments on the proposed rule change from interested persons.

\1\The NASD amended the proposed rule change subsequent to the

original filing on May 26, 1994. Amendment No. 1 was filed in order

to clarify that the proposal applies to both NASD members and

persons associated with NASD members.

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I. Self-Regulatory Organization's Statement of the Terms of Substance

of the Proposed Rule Change

The NASD is proposing to amend the Prompt Receipt and Delivery of

Securities Interpretation (``Interpretation'') issued by the NASD Board

of Governors under Article III, Section 1 of the NASD Rules of Fair

Practice. Specifically, the NASD proposes to amend the Interpretation

to require members to annotate their affirmative determinations as to

stock availability that are required to be made when effecting short

sales. The following is the complete text of the proposed rule change.

(Additions are italicized and deletions are bracketed.)

Interpretation of the Board of Governors

Prompt Receipt and Delivery of Securities

It shall be deemed a violation of Article III, Section 1 of the

Rules of Fair Practice of the Association for a member or person

associated with a member to violate the provisions of the following

interpretation thereof:

(a) Purchases: No member or person associated with a member may

accept a customer's purchase order for any security unless it has

first ascertained that the customer placing the order of its agent

agrees to receive securities against payment in an amount equal to

any execution, even though such an execution may represent the

purchase of only a part of a larger order.

(b) Sales:

(1) Long Sales

No member or person associated with a member shall accept a long

sale order from any customer in any security unless:

(A) The member has possession of the security;

(B) The customer is long in his account with the member;

(C) The member or person associated with a member makes an

affirmative determination that the customer owns the security and

will deliver it in good deliverable form within five (5) business

days of the execution of the order; or

(D) The security is on deposit in good deliverable form with a

member of the Association, a member of a national securities

exchange, a broker-dealer registered with the Securities and

Exchange Commission, or any organization subject to state or federal

banking regulations and that instructions have been forwarded to

that depository to deliver the securities against payment.

(2) Short Sales

(A) Customer short sales. No member or person associated with a

member shall accept a ``short'' sale order for any customer in any

security unless the member or person associated with a member makes

an affirmative determination that the member [it] will receive

delivery of the security from the customer or that the member [it]

can borrow the security on behalf of the customer for delivery by

settlement date. This requirement shall not apply, however, to

transactions in corporate debt securities.

(B) Proprietary short sales. No member or person associated with

a member shall effect a ``short'' sale for its own account in any

security unless the member or person associated with a member makes

an affirmative determination that the member [it] can borrow the

securities or otherwise provide for delivery of the securities by

settlement date. This requirement will not apply to transactions in

corporate debt securities, to bona fide market making transactions

by a member in securities in which it is registered as a Nasdaq

market maker, to bona fide market maker transactions in non-Nasdaq

securities in which the market maker publishes a two-sided quotation

to an independent quotation medium, or to transactions which result

in fully hedged or arbitraged positions.

(3) Public Offering

In the case of a public offering of securities, paragraph 1

hereof shall not apply during the period from the commencement of

the public offering until seven (7) business days following the date

of settlement between the underwriter and the issuer of the

securities; provided, however, that the member or person associated

with a member believes in good faith that the customer has purchased

the securities.

(4) ``Affirmative Determination''

(A) To satisfy the requirements for an ``affirmative

determination'' contained in subsection (b)(1)(C) above for long

sales, the member or person associated with a member must make a

notation on the order ticket at the time [he takes] the order is

taken which reflects [his] the conversation with the customer as to

the present location of the securities in question, whether they are

in good deliverable form and [his] the customer's ability to deliver

them to the member within five (5) business days.

(B) To satisfy the requirement for an ``affirmative

determination'' contained in subsection (b)(2) above for customer

and proprietary short sales, the member or person associated with a

member must keep a written record which includes:

(i) if a customer assures delivery, the present location of the

securities in question, whether they are in good deliverable form

and the customer's ability to deliver them to the member within five

(5) business days; or

(ii) if the member of person associated with a member locates

the stock, the identity of the individual and firm contacted who

offered assurance that the shares would be delivered or that were

available for borrowing by settlement date and the number of shares

needed to cover the short sale.

(C) The manner by which a member or person associated with a

member annotates compliance with the ``affirmative determination''

requirement contained in subsection (b)(2) above (e.g., marking the

order ticket, recording inquiries in a log, etc.) is not specified

by this Interpretation and, therefore, shall be decided by each

member. However, an affirmative determination and annotation of that

affirmative determination must be made for each and every

transaction since a ``blanket'' or standing assurance that

securities are available for borrowing is not acceptable to satisfy

the affirmative determination requirement.

(5) No change.

II. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

In its filing with the Commission, the NASD included statements

concerning the purpose of and basis for the proposed rule change and

discussed any comments it received on the proposed rule change. The

text of these statements may be examined at the places specified in

Item IV below. The NASD has prepared summaries, set forth in sections

(A), (B), and (C) below, of the most significant aspects of such

statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule Change

The NASD is proposing an amendment to the Interpretation dealing

with affirmative determinations made by members, or those persons

associated with such members, in connection with short sales. The

proposed amendment to the Interpretation establishes a requirement for

a member to annotate the affirmative determination made before

effecting a short sale. The affirmative determination requirement

already appears in the Interpretation and requires members or

associated persons to assure that securities are available to cover the

short position. The Interpretation currently requires the executing

member or an associated person, in connection with any sale, to make an

affirmative determination that delivery will be received from the

customer or that the securities will be able to be borrowed by

settlement date. For long sales, the affirmative determination is

required to be noted on the order ticket at the time the order is

placed. However, the rule does not require that such determination be

evidenced in any specific manner for short sales.

The new rule would require members or associated persons to

annotate, on the trade ticket or on some other record maintained for

that purpose by the member firm, the following information:

1. If a customer assures delivery, the member or associated person

must annotate that conversation noting the present location of the

securities; whether the securities are in good deliverable form; and

whether they will be delivered to the firm within time for settlement;

or

2. If the member or associated person locates the stock, an

annotation must be made that identifies the individual and firm

contacted who offered assurance that the shares would be delivered or

were available for borrowing by settlement date; and the number of

shares needed to cover the short sale.

The manner by which a member or person associated with a member

annotates compliance with the ``affirmative determination'' requirement

contained in subsection (b)(2) above (e.g., marking the order ticket,

recording inquiries in a log, etc.) is not specified by this

Interpretation and, therefore, shall be decided by each member.

However, an affirmative determination and annotation of that

affirmative determination must be made for each and every transaction

since a ``blanket'' or standing assurance that securities are available

for borrowing is not acceptable to satisfy the affirmative

determination requirement.\2\

\2\Pursuant to Rule 440C, The New York Stock Exchange (``NYSE'')

also requires NYSE members to make affirmative determinations prior

to effecting short sales and to annotate such determinations. NYSE

Information Memo 91-41 (October 18, 1991).

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The NASD believes that requiring such annotations will enhance

member compliance with affirmative determination requirements already

imposed by the Interpretation and will enable the NASD to examine

member compliance with the requirements more effectively. Requiring

firms to annotate each and every affirmative determination also will

make clear the NASD's longstanding policy that firms cannot rely on

daily facsimile sheets of ``borrowable stocks'' to satisfy their

affirmative determination requirements under the Interpretation. The

annotation requirement will preclude this practice as members or their

associated persons will have to annotate the name of the person

contacted and number of shares for each short sale.

Requiring annotation of affirmative determinations will also

enhance the NASD's ability to examine for compliance with various other

NASD short sale rules including those found in Article III, Section 21

of the Rules of Fair Practice (record keeping) and in the Uniform

Practice Code, Section 71 (mandatory delivery requirements for certain

restricted securities). Further, the annotation requirement will assist

in examining for compliance with the short sale rule or ``bid test,''

recently approved by the SEC.\3\ Accordingly, the NASD is proposing to

amend the Interpretation to require that members or their associated

persons maintain a written record evidencing their compliance with the

affirmative determination requirement for each customer or proprietary

short sale.

\3\Securities Exchange Act Rel. No. 34277 (June 29, 1994).

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The NASD believes the proposed rule change is consistent with

Section 15A(b)(6) of the Act. Section 15A(b)(6) requires that the rules

of a national securities association be designed to prevent fraudulent

and manipulative acts and practices, to promote just and equitable

principles of trade, to foster cooperation and coordination with

persons engaged in regulating, clearing, settling, processing

information with respect to, and facilitating transactions in

securities, to remove impediments to and perfect the mechanism of a

free and open market and a national market system, and in general to

protect investors and the public interest. The proposal will enable the

NASD to more effectively enforce an already existing provision of the

Prompt Receipt and Delivery Interpretation requiring members or their

associated persons to affirmatively determine that shares relating to a

short sale are available for delivery to a purchaser.

B. Self-Regulatory Organization's Statement on Burden on Competition

The NASD believes that the proposed rule change will not result in

any burden on competition that is not necessary or appropriate in

furtherance of purposes of the Act.

C. Self-Regulatory Organization's Statement on Comments on the Proposed

Rule Change Received From Members, Participants, or Others

Comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for

Commission Action

Within 35 days of the date of publication of this notice in the

Federal Register or within such longer period (i) as the Commission may

designate up to 90 days of such date if it finds such longer period to

be appropriate and publishes its reasons for so finding or (ii) as to

which the NASD consents, the Commission will:

A. By order approve such proposed rule change, or

B. Institute proceedings to determine whether the proposed rule

change should be disapproved.

IV. Solicitation of Comments

Interested persons are invited to submit written data, views, and

arguments concerning the foregoing. Persons making written submissions

should file six copies thereof with the Secretary, Securities and

Exchange Commission, 450 Fifth Street NW., Washington, DC 20549. Copies

of the submission, all subsequent amendments, all written statements

with respect to the proposed rule change that are filed with the

Commission, and all written communications relating to the proposed

rule change between the Commission and any person, other than those

that may be withheld from the public in accordance with the provisions

of 5 U.S.C. 552, will be available for inspection and copying in the

Commission's Public Reference Room. Copies of such filing will also be

available for inspection and copying at the principal office of the

NASD. All submissions should refer to file number SR-NASD-94-32 and

should be submitted by August 31, 1994.

For the Commission, by the Division of Market Regulation,

pursuant to delegated authority.\4\

\4\17 CFR 200.30-3(a)(12).

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Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 94-19523 Filed 8-9-94; 8:45 am]

BILLING CODE 8010-01-M