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The Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (OCIE) has issued a Risk Alert regarding options trading that may circumvent Regulation SHO. Regulation SHO tightened requirements for short sales, which involve sales of borrowed securities. Regulation SHO aims to ensure that trades settle promptly, thereby reducing settlement failures. Under Regulation SHO, short sellers who fail to deliver securities after the settlement date are required to close out their position immediately, unless they qualify as bona fide market makers, which are entitled to a limited amount of extra time to close out. OCIE examiners have observed certain trading strategies that, while seeming to comply with such close-out requirement, effectively evade the requirement. In addition, the Risk Alert includes a list of indicators that may alert market participants to attempts to circumvent Regulation SHO, including: (i) trading exclusively or excessively in hard-to-borrow securities or threshold list securities, or in near-term listed options on such securities; (ii) large short positions in hard-to-borrow securities or threshold list securities; (iii) large failure to deliver positions in an account, often in multiple securities; (iv) continuous failure to deliver positions; (v) using buy-writes, married puts or both, particularly deep in-the-money buy-writes or married puts, to satisfy the close-out requirement; (vi) using buy-writes with little to no open interest aside from that trader’s activity, resulting in all or nearly all of the call options being assigned; (vii) trading in customizable FLexible EXchange (FLEX) Options in hard-to-borrow securities or threshold list securities, particularly very short-term FLEX Options; (viii) purported market makers trading in hard-to-borrow or threshold list securities claiming the exception from the locate requirement of Regulation SHO (often these traders do not make markets in these securities, but instead effect trades only to take advantage of the option mispricing); and (ix) multiple large trades with the same trader acting as a contra party in several hard-to-borrow or threshold list securities (often traders assist each other to avoid having to deliver shares).
Click here to read the Risk Alert.
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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
© Katten Muchin Rosenman LLP
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