NASD Notice to Members 04-03
SEC Approves NASD Rule Proposal Requiring Members to Make Affirmative
Determinations for Short Sale Orders Received from Non-Member
Broker/Dealers; Effective Date: February 20, 2004
Executive Summary
The Securities and Exchange Commission (SEC) approved amendments to
Rule 3370 (Prompt Receipt and Delivery of Securities—the "Affirmative
Determination" Rule) that expand the scope of the affirmative determination
requirement to include orders received from non-member broker/dealers.1 As
revised, Rule 3370 applies to orders received by member firms from both
customers and non-member broker/dealers, as well as most firm proprietary
orders. The revisions also add an exception for "proprietary" short sales of non-
member broker/dealers provided the member can establish that the order meets
certain conditions.
The text of the amendments as provided in Attachment A become effective on
February 20, 2004.
Questions/Further Information
Questions concerning this Notice may be directed to Gary L. Goldsholle,
Associate General Counsel, Office of General Counsel, NASD Regulatory
Policy & Oversight, at (202) 728-8104.
Discussion
NASD Rule 3370 requires, among other things, that no member or person
associated with a member shall effect 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 will receive delivery of the security
from the customer or that the member can borrow the security on behalf of the
customer by settlement date. Because NASD's definition of "customer"
excludes a "broker" or "dealer," the affirmative determination requirements did
not apply to orders from "non-member broker/dealers."2 The failure to subject
short sales by such persons to the affirmative determination requirement affects
the integrity of the marketplace by increasing the possibility of failures to deliver
and also creates regulatory disparity by allowing certain firms to effect short
sales outside the purview of NASD's affirmative determination requirements.
To address these concerns, NASD has amended Rule 3370 to apply to short
sale orders for any customer or "non-member broker/dealer."
The amendments also provide an exemption for certain proprietary orders of
non-member broker/dealers. Specifically, Rule 3370(b)(2)(B) provides
exemptions for, among others, proprietary orders of member firms that are
bona fide market making transactions, or transactions that result in bona fide
fully hedged or arbitraged positions. Proprietary orders of a non-member
broker/dealer likewise are exempt from the affirmative determination
requirements if they meet the same conditions for the exemptions applicable to
proprietary orders of member firms, and the following two conditions are
satisfied: (1) the non-member broker/dealer must be registered with the SEC;
and (2) if using the market maker exemption, the non-member broker/dealer is
registered or qualified as a market maker in the securities and is selling such
securities in connection with bona fide market making.
Endnotes
1 File No. SR-NASD-2001-85 (Nov. 27, 2001), SEC Release No. 34-
48788 (Nov. 14, 2003), 68 Fed. Reg. 65978 (Nov. 24, 2003).
2 While NASD member broker/dealers are excluded from the definition
of "customer" under NASD Rule 0120(g), such firms have an independent
obligation to comply with NASD's Affirmative Determination Rule.
©2004. NASD. All rights reserved. Notices to Members attempt to present
information to readers in a format that is easily understandable. However,
please be aware that, in case of any misunderstanding, the rule language
prevails.
Attachment A
New text is underlined; deletions are in brackets.
3370. Prompt Receipt and Delivery of Securities
(a) No Change
(b) Sales
(1) No Change.
(2) "Short Sales"
(A) Customer and non-member broker/dealer short sales
No member or person associated with a member shall accept a "short" sale
order for any customer or non-member broker/dealer in any security unless the
member or person associated with a member makes an affirmative
determination that the member will receive delivery of the security from the
customer or non-member broker/dealer or that the member can borrow the
security on behalf of the customer or non-member broker/dealer for delivery by
settlement date. This requirement shall not apply, however, to transactions in
corporate debt securities or transactions in security futures, as defined in
Section 3(a)(55) of the Act, or proprietary orders of a non-member
broker/dealer that meet one of the exceptions in subparagraph (B) below,
provided, however, that (i) the non-member broker/dealer is registered with the
Securities and Exchange Commission, and (ii) if using the market maker
exception, the non-member broker/dealer is registered or qualified as a market
maker in the securities and is selling such securities in connection with bona fide
market making.
(B) No Change
(3) No change
(4) "Affirmative Determinations"
(A) No change
(B) To satisfy the requirement for an "affirmative determination" contained in
paragraph (b)(2) above for customer, non-member broker/dealer, and
proprietary short sales, the member or person associated with a member must
keep a written record [which] that includes:
(i) if a customer or non-member broker/dealer assures delivery, the present
location of the securities in question, whether they are in good deliverable form
and the customer's or non-member broker/dealer's ability to deliver them to the
member within three (3) business days; or
(ii) No change
