IB Short Stock Buy-In Procedures

SEC regulations implemented in September 2008 require that short sellers comply with their delivery obligations on the standard settlement date, generally three business days after the trade date. The regulations additionally require a repurchase of securities that are not delivered ("fail") by the next trading session for the securities. This contrasts with previous practice wherein a trade could "fail" for several days after the target settlement date, permitting brokers more time to make delivery by finding lenders for the stock(s).

As a result of the more stringent regulatory enforcement of the delivery rules, lenders have generally become more conservative in their lending activities leading to a decline in the general availability of inventory in many less widely held stocks. This creates an additional effect on the securities borrow/loan market by causing dealers to more readily recall existing loans rather than establishing new borrows to manage their inventory needs. For a fuller discussion of short sale and stock borrow and lend ("SLB") mechanics, please click here.

IB's implementation of the SEC regulations is as follows:

1. On the standard settlement date, at approximately 14:30 EST, IB will make an estimate of the transactions that have actually settled, including any borrow transactions required. Historically, stock borrowing activity is completed early in the morning of settlement day. With the 9/2008 rules, we observe settlement activity continuing right up to the DTC cutoff at 15:10 EST. Accordingly, our 14:30 estimation is a compromise which, while it does not include the last 40 minutes of settlement activity (typically less than 10% of the total activity), it does provide a longer time period to provide notification and to allow clients to make trading decisions before the end of the trading session at 16:00.
2. IB will disseminate an indication of possible buy-ins at about 14:50. Clients should recognize that these notifications communicate only the possibility, not the certainty, that we will be unable to make timely delivery thereby necessitating a buy-in. The purpose of the communication is to allow clients an opportunity to repurchase the short securities themselves thereby retaining greater control over their portfolios.
3. At about 17:00, IB will reconcile any late settlements as well as client transactions up to the end of the regular trading session at 16:00 EST. IB will consider the net of all trades on the day when determining the position, including any new short sales. Trades after 16:00 will not be included in our position reconciliation. IB will then calculate the expected buy-in requirement based on complete information. IB applies, on a best efforts basis, last in, first out (LIFO) logic when determining buy-in allocations.
4. On the morning of the next business day (generally the fourth day after trade date, also called "T+4"), and prior to the start of trading, IB will make a final attempt to locate and borrow the required securities. In the event we are able to do so, IB will send a notification reporting on an late borrow activity. The notification will confirm positions to be bought in.
5. IB will attempt to post the bookings prior to the start of trading at 09:30. Occasionally, it may take longer to correct the positions visible via the TWS but the adjustments will be visible in the trades window so it should be evident to clients for whom this real-time information is important.
6. On T+4, IB will execute transactions in the open market to effect the actual buy-in, as required by the SEC rules. In case the buy-in transactions occur at multiple prices, we will calculate the volume weighted average price for the buy-ins.
7. On the statement of the 4th day, IB will book the buy-in trades with the code B.

In order to ensure compliance with SEC regulations, for Execution-Only accounts where receipt on a long sale is pending, IB will proceed with a buyin transaction under the above guidelines in the event the settlement is not received by 09:15 New York time.

The above procedure refers to transactions that fail to settle directly resulting from a short sale. A nearly identical procedure will be applied for existing stock borrows that are recalled by lenders. Recalls can occur at any time so in many cases little, and sometimes no, adequate notification can be distributed to clients. For recalls made in the morning, IB will be able to provide notification as described above. For late recalls after 13:00, IB will attempt to provide notification on a best efforts basis.

http://www.interactivebrokers.com/en/p.php?f=shortableStocks&p=overview1

Information on Exceptional Short Sale Regulations

Limitation on Short Sales in Financial Services Companies (SEC Emergency Order 34-58592)

The SEC emergency order 34-58592 expired on 9 October 2008.

Limitation on Short Sales in Certain UK Financial Services Companies (FSA/PN/102/2008)

The UK Financial Services Authority ("FSA") has issued a prohibition on short sales in approximately 40 UK-listed Financial Services Companies. The prohibition is complex and refers to any trading strategy that is economically equivalent to a short sale, and therefore applies as well to derivative strategies such as put option purchases or call option sales. The rule was scheduled to remain in effect, subject to FSA review, until January 2009. More information regarding UK short sale regulations can be found on the FSA website, and also at:
http://www.fsa.gov.uk/Pages/Library/Communication/PR/2008/index.shtml

Other Restrictions on Short Selling

Many countries have imposed special restrictions on short selling. IB has respected the regulations where the restriction is consistent with IB's existing systems. Where the regulations define security lending practices not currently supported by IB, we have restricted short sale activities altogether.

Pre-Borrow Restriction (short sales allowed only with pre-borrow prior to the actual sale): IB does not support pre-borrow services⁽¹⁾. All stocks are therefore effectively restricted: Australia, Japan, Hong Kong.

Restrictions on Specific Stocks: UK, Germany, France, Netherlands, Switzerland, Belgium, Sweden, Canada, Norway, Italy.

Special Deliver and Buy-In Regulations for US Securities (SEC Emergency Order 34-58572)

SEC Emergency Order 34-58572 expired on October 17, 2008.

Securities and Exchange Commission Release No. 34-58773

Amendments to Regulation SHO

Interim final temporary rule and request for comments.

SUMMARY: The Securities and Exchange Commission ("Commission") adopted an interim final temporary rule under the Securities Exchange Act of 1934 ("Exchange Act") to address abusive "naked" short selling in all equity securities by requiring that participants of a clearing agency registered with the Commission deliver securities by settlement date, or if the participants have not delivered shares by settlement date, immediately purchase or borrow securities to close out the fail to deliver position by no later than the beginning of regular trading hours on the settlement day following the day the participant incurred the fail to deliver position. Failure to comply with the close-out requirement of the temporary rule is a violation of the temporary rule. In addition, a participant that does not comply with this close-out requirement, and any broker-dealer from which it receives trades for clearance and settlement, will not be able to short sell the security either for itself or for the account of another, unless it has previously arranged to borrow or borrowed the security, until the fail to deliver position is closed out.

Effective Date: October 17, 2008 except §242.204T which is effective October 17, 2008 until July 31, 2009.

http://www.interactivebrokers.com/en/p.php?f=shortableStocks&p=overview2

Regulation SHO

The "Alternative Uptick Rule"

The Securities and Exchange Commission (SEC) has adopted amendments to Regulation SHO with a compliance date of February 28, 2011. Among the rule changes, the SEC is introducing Rule 201 (also known as the "Alternative Uptick Rule"). The predecessor of the alternative uptick rule was Rule 10a-1 under the Securities Exchange Act of 1934, as amended, commonly known as the "Uptick Rule". Rule 10a-1 was repealed by the SEC in July 2007 after years of empirical study of the impact of short-selling on the markets and the implementation of a pilot program to test the effects of rescinding Rule 10a-1.

After eliminating the Uptick Rule, and in response to the extreme market volatility that occurred during the 2007-2008 financial crises, the SEC took a number of emergency actions targeting short selling activity. These actions included temporary bans on short sales of certain financial stocks and rules regarding delivery of shares and other measures designed to prevent "naked" short selling. In response to these events, the SEC has implemented a circuit breaker rule that, when triggered by a significant price decline in a particular security, would trigger a temporary short sale price test for that security.

Covered Securities

Rule 201 applies to any security or class of securities, except options, for which transaction reports are collected, processed and made available pursuant to an effective transaction reporting plan. As a result, Rule 201 generally will cover all securities, except options, listed on a national securities exchange (whether traded on an exchange or in the OTC market). Rule 201 will not apply to non-NMS stocks quoted on the OTC Bulletin Board or elsewhere on the OTC market. However, the SEC noted that it may reconsider whether to apply Rule 201 to these securities at a later date.

Requirements

Under the new Rule, a "circuit breaker" will be triggered for a covered security that declines 10% or more from the covered security's closing price as of the end of regular trading hours on the prior day, as determined by the listing market. In order to ensure compliance with the new rule, trading centers, including national securities exchanges and alternative trading systems, will be required to establish and enforce procedures designed to prevent the execution or display of a prohibited short sale.

Specifically, the Rule requires that a trading center establish, maintain, and enforce written policies and procedures reasonably designed to prevent the execution or display of a short sale order of a covered security at a price that is less than or equal to the current national best bid if the price of that covered security decreases by 10% or more from the covered security's closing price as determined by the listing market for the covered security as of the end of regular trading hours on the prior day.

Once the circuit breaker is triggered, for the remainder of the day that the circuit breaker is triggered and for the entire following day, no short sales may be displayed or executed for the security during the time that the consolidated tape is open if the order price is at or below the national best bid (subject to limited exemptions described below).

Although the Rule 201 circuit breaker can only be triggered during regular trading hours, once triggered, the short sale price test restrictions of Rule 201 apply at all times when quotation information and the national best bid are disseminated, even though this period may vary and may extend beyond regular trading hours. Rule 201 states that if the price of a covered security declines intra-day by at least 10% on a day on which the security is already subject to the short sale price test restriction of Rule 201, the restriction will be re-triggered and will continue in effect for the remainder of that day and the following day. Rule 201 does not place any limit on the frequency or number of times that the circuit breaker can be re-triggered with respect to a particular stock.

The SEC has also issued guidance for marking certain qualifying orders "short exempt" in order for market participants to utilize certain exemptions listed below. Rule 201 permits the execution and display of short sale orders that are marked "short exempt" without regard to whether these orders are priced at or below the current national best bid.

Exemptions from the Short Sale Price Test

IB may mark certain transactions as exempt from Rule 201. Orders marked short sale exempt will be accepted from US registered Broker-Dealers for the following reasons:

• a short sale order submitted by a broker-dealer that was above the national best bid at the time of submission,
• short sales where the seller may be deemed to "own" a security but who may be technically considered a short seller due to a delay in delivering the security,
• certain odd-lot transactions,
• certain domestic and foreign arbitrage transactions,
• sales resulting from over-allotments and lay-off sales, riskless principal transactions and volume weighted average priced basis trades.

Role of Trading Center

Under the amended rules, a trading center (which is defined to include any entity that may execute short sale orders) is responsible for establishing, maintaining and enforcing written policies and procedures that are reasonably designed to prevent execution or display of a short sale order of a security that has triggered the circuit breaker and impose the short sale price test restriction for the required timeframe. Also, a trading center must assess its policies and procedures regularly and take any remedial actions promptly.

Implementation of the New Rule

Though the SEC considered whether to conduct a pilot study of the new rules on only certain securities, it opted not to do so. Compliance with Rule 201 is required as of November 10, 2010.

Important Notes

1. If an exchange determines that the Short Sale Price Test for a covered security was triggered because of a clearly erroneous execution, the exchange may lift the Short Sale Price Test before the Short Sale Period ends or, for securities listed on another market, notify the other market of the exchange's determination that the triggering transaction was a clearly erroneous execution.
2. If an exchange determines that the prior day's closing price for a listed security is incorrect in its system and resulted in an incorrect determination of the Trigger Price, the exchange may correct the prior day's closing price and lift the Short Sale Price Test before the Short Sale Period ends.
3. Once the Securities Information Processor (SIP) indicates that a short sale circuit breaker is in effect for a certain security, short sale orders will only be accepted at permissible prices unless they are eligible for one of the exceptions listed above.
4. Customers who use Interactive Brokers clearing services or any non-US registered broker-dealers may not submit short exempt orders. Short exempt orders entered by these categories of customers will be rejected.

For complete details, refer to the Amendments to Regulation SHO (SEC Release 34-61595). For additional information, please refer to the SEC's responses to frequently asked questions (see SEC Rule 201 FAQ).

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