Key Takeaways
- Certain “covered persons” will be required to report specified information about securities loans to a registered national securities association within specified time periods.
- Institutional investment managers will be required to report certain data on short sales on new Form SHO to be aggregated and published on the SEC’s website.
- Together these changes are intended to increase the transparency and efficiency of the securities lending market.
- With the changes to securities lending and short sale rules, firms should review their policies and procedures as well as any agreements relating to securities lending and short sales to ensure compliance.
Introduction
The Securities and Exchange Commission on October 13, 2023, adopted two new rules under the Securities Exchange Act of 1934 expanding reporting requirements for securities lending and short sales and amending rules regarding reporting firm short sale requirements.1 The new rules and related amendment are a response to Congressional mandates in the Dodd-Frank Wall Street Reform and Consumer Protection Act to bolster the data publicly available to investors. These changes are intended to increase the transparency and efficiency of the securities lending market and seek to provide the public with more information, particularly during periods of market volatility.
Securities Lending Reporting
The SEC has adopted Exchange Act Rule 10c-1a, which requires certain “covered persons” to report specified information about securities loans to a registered national securities association (RNSA) in the format and manner required by the RNSA, and within specified time periods. The RNSA would then make certain information reported to it available to the public on the SEC’s Electronic Data Gathering, Analysis, and Retrieval System (EDGAR).
The scope of persons required to report under Rule 10c-1a includes any “covered person” who agrees to a “covered securities loan.” Rule 10c-1a defines a “covered person” as: (i) a person who agrees to a covered securities loan on behalf of a lender other than a clearing agency; (ii) a person who agrees to a covered securities loan as a lender when an intermediary is not used, unless the borrower is a broker or dealer borrowing fully paid or excess margin securities; or (iii) a broker or dealer when borrowing fully paid or excess margin securities. The defined term “covered person” did not exist in the rule as originally proposed but was added in the final rule to provide clarity.2
Accordingly, under the final rule, the lender has the obligation to report unless the lender is using an intermediary (i.e., a securities lending agent), in which case the intermediary is required to report.3 Likewise, where there is no intermediary, the lender will have to report unless the borrower is a broker-dealer of whom the lender is a customer and the broker-dealer is borrowing fully-paid or excess margin securities. The practical impact of the final rule on investment companies that engage in securities lending transactions depends on the structure of the securities lending program. Where an investment company uses its custodian bank or another provider as the securities lending agent (which is, by far, the most common structure), the lending agent will have the reporting obligation. Where an investment company’s securities lending program is not run through a securities lending agent, the investment company itself (or its relevant service provider) will have the reporting obligation.
A “covered securities loan” is defined by the final rule as “a transaction in which any person on behalf of itself or one or more other persons, lends a reportable security to another person.” The definition provides exclusions for registered clearing agencies and the use of margin securities by broker dealers.4
The reporting requirements of the rule encompass the general terms of the covered securities loan including, but not limited to: legal name of the issuer of the securities being borrowed; ticker symbol; time and date of the loan; rates, fees, charges and rebates for the loan; type of collateral provided; and termination date of the loan. The RNSA would then make certain information publicly available no later than the morning of the business day after the transaction is effected.5
A lender may rely on a “reporting agent” to fulfill its reporting obligations provided certain conditions are met, including that the agreement is in writing and that the reporting agent is either a registered broker-dealer or a clearing agency. Lenders are not prohibited from using third-party service providers that are not qualified reporting agents under the rule to fulfill their reporting obligations. Nevertheless, the Securities Lending Adopting Release clarifies that the use of a reporting agent versus a third-party service provider is an issue of liability as the use of a reporting agent enables the lender to rely on the reporting agent to fulfill its reporting obligations. Using a third-party service provider, although not prohibited, would not relieve the lender from its obligations to report under the final rule.
As a rationale for Rule 10c-1a, the SEC explained that increased security lending reporting will serve the dual purpose of providing regulators with information to enhance the SEC’s market oversight abilities and will provide market participants with timely access to pricing and other material information regarding securities lending transactions.
Short Sale Disclosure
The SEC also adopted new Exchange Act Rule 13f-2 and related Form SHO as well as an amendment to the national market system plan (NMS Plan) governing the consolidated audit trail (CAT) to provide greater transparency of short sale-related data.
Rule 13f-2 will require all “institutional investment managers” (Managers) to file Form SHO within 14 calendar days after the end of each calendar month for equity securities registered pursuant to Section 12 of the Exchange Act or for which the issuer is required to file reports pursuant to Section 15(d) of the Exchange Act. The information required to be reported on Form SHO includes the Manager’s end-of-month gross short position and for each individual settlement date the Manager’s “net” activity, including activity in derivatives. The SEC will then aggregate and publish on EDGAR certain short sale related information.6
In conjunction with new Rule 13f-2, the SEC amended the CAT NMS Plan to require CAT reporting firms that report short sales to indicate when they are using the bona fide market making exception in Rule 203(b)(2)(iii) of Regulation SHO.7 The SEC stated that requiring industry members to identify use of this narrow exception would provide regulators with an additional tool to determine if such activity qualifies for the exception.
Effective Dates of the Rules
Rule 10c-1a will become effective 60 days following the date of publication of its adopting release in the Federal Register (Effective Date). The compliance date for RNSAs to propose rules to implement Rule 10c-1a is four months after the Effective Date, with such rules required to be effective no later than 12 months after the Effective Date. The compliance date for covered persons to report the information required by the rule is on the first business day 24 months after the Effective Date.
Rule 13f-2 will also become effective 60 days following the date of publication of its adopting release in the Federal Register. The compliance date for Rule 13f-2 and Form SHO will be 12 months after the Effective Date and the compliance date for the amendment to the CAT NMS Plan will be 18 months after the Effective Date.
Conclusion
Firms should review their policies and procedures to ensure the requirements of the new rules and related amendments are captured. It also will be important to review agreements relating to securities lending and short sales to make any needed adjustments for the new requirements.
Footnotes
1) Reporting of Securities Loans, Release No. 34-98737 (Oct. 13, 2023) (Securities Lending Adopting Release); Short Position and Short Activity Reporting by Institutional Investment Managers, Release No. 34-98738 (Oct. 13, 2023) (Short Sale Adopting Release). At times, this OnPoint tracks the Securities Lending Adopting Release and Short Sale Adopting Release without the use of quotation marks.
2) See Reporting of Securities Loans, 86 FR 69802 (Dec. 8, 2021) (Proposing Release).
3) The Securities Lending Adopting Release points out that “[a]lthough the [SEC] is not limiting who can act as an intermediary for the purposes of this rule, other regulatory requirements may apply to persons who intermediate transactions such as loans of securities,” thus reminding market participants that acting as a securities lending agent may implicate broker-dealer registration requirements. See Securities Lending Adopting Release, supra note 1, at n. 120.
4) The SEC reasoned that because clearing agencies do not lend or borrow shares on their own behalf, but instead are novating or processing the loans of other lenders or borrowers (which are already being reported) and further, as the key terms of the loans are not being modified, requiring the reporting of such loans would mislead the consumer by providing duplicative information. See Securities Lending Adopting Release, supra note 1, at 30.
5) Loan terms that are required to be provided to the RNSA but will not be made public include: legal names of the parties to the loan; whether the security loaned is from a broker-dealer’s inventory; and whether the loan will be used to close out a fail to deliver (pursuant to Rule 204 of Regulation SHO or outside of Regulation SHO). See Securities Lending Adopting Release, supra note 1, at 111-112.
6) The short sale data reported on Form SHO will only be published on EDGAR aggregated across all reporting Managers for each reported equity security. The SEC reasoned that the individual identity of each reporting Manager was not necessary for achieving their goal of increasing public transparency for short sales. See Short Sale Adopting Release, supra note 1, at 104.
7) See 17 CFR 242.203(b)(2)(iii).
