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 FinancialBulletin April 4, 2008 A naked short sale, or short short sale, occurs when the seller does not borrow or arrange to borrow securities in time to deliver stock to the buyer within the standard three-day settlement period for trades. Hence, the seller fails to deliver the stock to the buyer when the delivery is due (known as "failure to deliver"). The proposed rule targets failures to deliver because they can have a negative effect on shareholders, potentially depriving them of benefits of ownership, may create a misleading impression of the market for an issuer's securities, and can create a situation in which sellers who fail to deliver are subject to fewer rule restrictions. The proposed rule would specify that it is unlawful for broker-dealers and purchasers to deceive others about their intention or ability to deliver securities in time for settlement and fail to deliver securities by settlement date. Broker-dealers may only accept orders for naked short sales when they have determined the locate for the security. If a security is generally hard to locate, it is listed as a threshold security. It is the broker-dealer's responsibility to perform the locate prior to accepting the order, but the broker-dealer may have been relying on representations of customers on the locate. This proposed rule will have consequences for customers who misrepresent information on the locate. As a matter of course, customers and broker-dealers should engage in fair business practices or they will be held liable under this rule. Compliance departments should monitor any representations made by trading desks to broker-dealers. For additional questions on this matter, contact Financial Services Partner Richard Flowers at 212.620.5340.
Richard Flowers
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