Replies to post #992 on GLUV Corp (fka GVRP)

[Mr. Bill]

WTMHouston, Rule 203 requires a "Hard to Borrow" list. Why would GVRP with 11 shares not be on that list? Why would any broker or MM allow a SHORT position in the magnitude that was seen here EVER to develop? One can make a strong case that ONE share was sold TWO-HUNDRED-and-FIFTY-THOUSAND times in the market place. One might also argue that all 11 shares were sold TWENTY-FIVE-THOUSAND times each in the market place.

I agree with you that the problem is hard to solve. Those who are responsible for the problem should not benefit from the problem they created however. In my opinion, the brokers and market makers which participated with the seller, as well as the transfer agent bear some of the responsibility here.

Rule 203 — Locate and Delivery Requirements for Short Sales

http://www.sec.gov/rules/final/34-50103.htm

V. Rule 203 — Locate and Delivery Requirements for Short Sales
A. "Locate" Requirement

We are adopting proposed Rule 203, with some modifications, after considering the comments received.53 As adopted, Rule 203(b) creates a uniform Commission rule requiring a broker-dealer, prior to effecting a short sale in any equity security, to "locate" securities available for borrowing. For covered securities, Rule 203 supplants current overlapping SRO rules. Specifically, the rule prohibits a broker-dealer from accepting a short sale order in any equity security from another person, or effecting a short sale order for the broker-dealer's own account unless the broker-dealer has (1) borrowed the security, or entered into an arrangement to borrow the security, or (2) has reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due.54 The locate must be made and documented prior to effecting a short sale, regardless of whether the seller's short position may be closed out by purchasing securities the same day.55 The rule provides for some limited exceptions, including for short sales effected in connection with bona-fide market making, as discussed in further detail below.

As proposed, Rule 203(b) would have allowed the "person for whose account the short sale is executed" to perform a locate.56 We agree with commenters that the locate requirement should apply to a regulated entity -- the broker-dealer effecting the sale -- and have modified the adopted rule accordingly.57 Therefore, the rule as adopted makes clear that the broker-dealer effecting the short sale has the responsibility to perform the locate.58

We requested comment in the Proposing Release on the manner in which persons could satisfy the "reasonable grounds" determination in the proposed rule. In particular, we asked whether blanket assurances that stock is available for borrowing, i.e., "Easy to Borrow" or "Hard to Borrow" lists, provide an accurate assessment of the current lending market in a manner that would not impede liquidity and the ability of market participants to establish short positions, while at the same time guarding against potential problems inherent with large extended settlement failures. 59 After considering the comments received, we believe that, absent countervailing factors, "Easy to Borrow" lists may provide "reasonable grounds" for a broker-dealer to believe that the security sold short is available for borrowing without directly contacting the source of the borrowed securities.60 In order for it to be reasonable that a broker-dealer rely on such lists, the information used to generate the "Easy to Borrow" list must be less than 24 hours old, and securities on the list must be readily available such that it would be unlikely that a failure to deliver would occur.61 Therefore, absent adequately documented mitigating circumstances, repeated failures to deliver in securities included on an "Easy to Borrow" list would indicate that the broker-dealer's reliance on such a list did not satisfy the "reasonable grounds" standard of Rule 203.62

Broker-dealers create "Hard to Borrow" lists to identify securities that are in limited supply. Thus, locates for securities on "Hard to Borrow" lists are likely to be difficult. However, the fact that a particular lender placed certain securities on a "Hard to Borrow" list cannot be taken to mean that the lender represents that securities that are not on the "Hard to Borrow" list are easy to borrow. Commenters viewed "Hard to Borrow" lists with circumspection,63 and we understand that such lists are not widely used by broker-dealers. Therefore, the fact that a security is not on a hard to borrow list cannot satisfy the "reasonable grounds" test of Rule 203(b)(1)(ii).
1. Exceptions from the Locate Requirement
a. Broker-Dealer Accepting Short Sale Order from Another Broker-Dealer — Rule 203(b)(2)(i)

Rule 203(b)(2)(i) provides a new exception from the uniform locate requirement of Rule 203(b)(1) for a registered broker or dealer that receives a short sale order from another registered broker or dealer that is required to comply with 203(b)(1). For example, where an introducing broker-dealer submits a short sale order for execution, either on a principal or agency basis, to another broker-dealer,64 the introducing broker-dealer has the responsibility of complying with the locate requirement. The broker-dealer that received the order from the introducing broker-dealer would not be required to perform the locate. However, a broker or dealer would be required to perform a locate where it contractually undertook to do so or the short sale order came from a person that is not a registered broker-dealer.65
b. Bona-fide Market Making

We are adopting the proposed exception from the uniform "locate" requirement, as Rule 203(b)(2)(iii), for short sales executed by market makers, as defined in Section 3(a)(38) of the Exchange Act,66 including specialists and options market makers, but only in connection with bona-fide market making activities.67 Bona-fide market making does not include activity that is related to speculative selling strategies or investment purposes of the broker-dealer and is disproportionate to the usual market making patterns or practices of the broker-dealer in that security. In addition, where a market maker posts continually at or near the best offer, but does not also post at or near the best bid, the market maker's activities would not generally qualify as bona-fide market making for purposes of the exception.68 Further, bona-fide market making does not include transactions whereby a market maker enters into an arrangement with another broker-dealer or customer in an attempt to use the market maker's exception for the purpose of avoiding compliance with Rule 203(b)(1) by the other broker-dealer or customer.69
c. Additional Exception from the Locate Requirement — Rule 203(b)(2)(ii)

Pursuant to the suggestions of other commenters, we are including an additional exception from the uniform locate requirement of Rule 203(b)(1) for situations where a broker-dealer effects a sale on behalf of a customer that is deemed to own the security pursuant to Rule 200, although, through no fault of the customer or the broker-dealer, it is not reasonably expected that the security will be in the physical possession or control of the broker-dealer by settlement date, and is thus a "short" sale under the marking requirements of Rule 200(g) as adopted.70 Such circumstances could include the situation where a convertible security, option, or warrant has been tendered for conversion or exchange, but the underlying security is not reasonably expected to be received by settlement date.71 Rule 203(b)(2)(ii) as adopted provides that in all situations, delivery should be made on the sale as soon as all restrictions on delivery have been removed, and in any event no later than 35 days after trade date, at which time the broker-dealer that sold on behalf of the person must either borrow securities or close out the open position by purchasing securities of like kind and quantity.72

Two commenters advocated maintaining the current exception from the "affirmative determination" requirements of NASD Rule 3370 for short sales that result in fully hedged or arbitraged positions.73 One comment letter requested an exception from the proposed locate and delivery requirements of Rule 203 in a situation where a market participant has a long position in warrants or rights which are exercisable within 90 days and are subject to a fixed price per share conversion ratio.74 The other comment letter requested an exception from the proposed locate and delivery requirements in the situation where a market participant is long in-the-money call options.75 The commenter argued that excepting short sales in such situations promotes the ability of smaller issuers to acquire financing.

We have decided not to incorporate an exception from the locate and delivery requirements of Rule 203 for short sales that result in bona-fide fully hedged or arbitraged positions. Because "bona-fide" hedging and arbitrage can be difficult to ascertain, we are concerned about including a blanket exception for some activity that may have the potential to harm issuers and shareholders.76 During the period of the pilot, we prefer instead to address the situations noted by the commenters, and other similarly situated entities, through the exemptive process, to the extent warranted.77 This will allow us to consider the particular facts and circumstances relevant to each request, as well as any potentially negative ramifications, and, should we gain comfort with the described transaction(s), fashion appropriate relief.

Additionally, we have declined at this time to include an express exception from the locate requirements of Rule 203(b)(1) for transactions in exchange traded funds ("ETFs").78 We have observed high levels of fails in some ETFs. Rather than providing a blanket exception from the requirements of Rule 203, we would prefer instead to address the treatment of ETFs through the exemptive process, which would be consistent with the prior treatment of ETFs.79 In considering any exemptive request, the Commission would evaluate the causes of large fails in certain ETFs, as well as potential remedies to resolve such fails, if necessary.

[Sec 10]

Excellent post, WTM. Two additional observations:

There were almost certainly statutory violations regarding the sale of unregistered stock. However, those go only to the original sellers of the securities. Once they have entered the marketplace resellers of those shares are held harmless absent scienter.

There is a fairly extensive phone log and e-mail history that would make it very difficult for the original sellers to maintain a defense of misunderstanding of fact, although an interesting liability theory could be developed around the TA's transfer of unrestricted shares to the 11 remaining shareholder accounts prior to the ex date.

As they say: bad cases make good law.

[Jim Bishop]

Great musings and most interesting. Bottom line... it's a mess.

[BullNBear52]

Someone can only sell you what they own. If they do not own it, they cannot legally sell it to you -- at least not as against a claim of those who do lawfully own it. The people or brokers who sold restricted post split shares into the presplit market had no legal right to do so and the buyers acquired no more than the sellers had a right to sell -- regardless of what they thought when they bought.

The problem lies in the fact that someone sold prior to having a legal right to do so. Which triggered this whole mess.

I suspect the SEC will unwind all the trades and slap a few people on the wrist.