Part 5
Securities Exchange Act of 1934
The Securities Exchange Act of 1934 stipulates a settlement period up to three business days before a stock needs to be delivered,[13] generally referred to as "T+3 delivery."
Regulation SHO
The SEC enacted Regulation SHO in January 2005 to target abusive naked short selling by reducing failure to deliver securities, and by limiting the time in which a broker can permit failures to deliver.[26] In addressing the first, it stated that a broker or dealer may not accept a short sale order without having first borrowed or identified the stock being sold.[27] The rule had the following exemptions:
Broker or dealer accepting a short sale order from another registered broker or dealer
Bona fide market making
Broker-dealer effecting a sale on behalf of a customer that is deemed to own the security pursuant to Rule 200[28] through no fault of the customer or the broker-dealer.[27]
To reduce the duration for which fails to deliver are permitted to sit open, the regulation requires broker-dealers to close out open fail-to-deliver positions in threshold securities that have persisted for 13 consecutive settlement days.[26] The SEC, in describing Regulation SHO, stated that failures to deliver shares that persist for an extended period of time "may result in large delivery obligations where stock settlement occurs."[26]
Regulation SHO also created the "Threshold Security List", which reported any stock where more than 0.5% of a company's total outstanding shares failed delivery for five consecutive days. A number of companies have appeared on the list, including Krispy Kreme, Martha Stewart Omnimedia and Delta Air Lines. The Motley Fool, an investment website, observes that "when a stock appears on this list, it is like a red flag waving, stating 'something is wrong here!'"[13] However, the SEC clarified that appearance on the threshold list "does not necessarily mean that there has been abusive naked short selling or any impermissible trading in the stock."[26]
In July 2006, the SEC proposed to amend Regulation SHO, to further reduce failures to deliver securities.[29] SEC Chairman Christopher Cox referred to "the serious problem of abusive naked short sales, which can be used as a tool to drive down a company's stock price" and that the SEC is "concerned about the persistent failures to deliver in the market for some securities that may be due to loopholes in Regulation SHO".[30]
