Rule 204-PRA Supporting Statement - 2015

SUPPORTING STATEMENT
for the Paperwork Reduction Act Information Collection Submission for
Rule 204

A.

JUSTIFICATION
1.

Information Collection Necessity
i.

Allocation Notification Requirement

Rule 204(d) of Regulation SHO imposes a notification requirement on a broker-dealer
that has been allocated responsibility for complying with the rule’s requirements that is designed
to help ensure that participants will be on notice if a broker-dealer for which they clear and settle
trades has become subject to the rule’s borrowing requirements.
ii.

Demonstration Requirement for Fails to Deliver on Long Sales

Rule 204(a)(1) of Regulation SHO allows a participant an additional two settlement days
in which to close out the fail to deliver position that resulted from a long sale, provided that the
participant can demonstrate on its books and records that the fail to deliver position resulted from
a long sale.
iii.

Pre-Borrow Notification Requirement

Rule 204(c) of Regulation SHO requires that a participant notify all broker-dealers from
which it receives trades for clearance and settlement if it has a fail to deliver position that has not
been closed out in accordance with Rule 204. This notification requirement is designed to help
ensure that all broker-dealers that submit trades for clearance and settlement to a participant that
has a fail to deliver position in a security that has not been closed out in accordance with Rule
204 will be on notice that short sales in that security to be cleared or settled through that
participant will be subject to the borrow requirements of Rule 204(b) until the fail to deliver
position has been closed out, or unless the broker-dealer can demonstrate, as specified in Rule
204(b), that it is not responsible for the fail to deliver position.
iv.

Certification Requirement

Rule 204(b) of Regulation SHO includes an exception from the rule’s borrowing
requirements for any broker-dealer that can demonstrate that it was not responsible for any part
of the fail to deliver position of the participant. The information collected will help ensure that a
broker-dealer will not be subject to the borrowing requirements of the rule if the broker-dealer
can demonstrate that it did not incur a fail to deliver position in the security on settlement date, or
if it has taken steps, in accordance with Rule 204(e), to close out the fail to deliver position.

v.

Pre-Fail Credit Demonstration Requirement

Rule 204(e)’s pre-fail credit provision requires, among other things, that the broker-dealer
demonstrate that it has a net long position or net flat position on its books and records on the
settlement day for which the broker-dealer is claiming credit. The information collected will
enable the Commission and self-regulatory organizations (“SROs”) to monitor more effectively
whether or not a broker-dealer has complied with the requirements of Rule 204(e).
2.

Information Collection Purpose and Use

The information collected will help further the Commission’ s goal of reducing fails to
deliver by maintaining the reductions in fails to deliver achieved by, among other actions, the
adoption of Interim Final Temporary Rule 204T (“ temporary Rule 204T” ), which had been
implemented via emergency order on September 17, 2008 and adopted as an interim final
temporary rule on October 14, 2008.1 Rule 204 makes permanent amendments contained in
temporary Rule 204T, with some limited modifications to address commenters’ concerns.
The information collected under Rule 204 will continue to be retained and/or provided to
other entities pursuant to the specific rule provisions and will be available to the Commission and
SRO examiners upon request. The information collected will continue to aid the Commission
and SROs in monitoring compliance with these requirements. In addition, the information
collected will aid those subject to Rule 204 in complying with its requirements.
In addition, Rule 204 is intended to help further the Commission’s goal of addressing
potentially abusive “naked” short selling in all equity securities. By strengthening the close-out
requirements of Regulation SHO and promoting the prompt and accurate clearance and
settlement of transactions involving equity securities, Rule 204 is intended to help restrict the
practice of “naked” short selling.
3.

Consideration Given to Information Technology

The compilation of this information must be done on an individual basis by each respondent
subject to any of the requirements discussed in item 1, above. Thus, improved information
technology would not reduce the burden.
4.

Duplication

We are not aware of duplication of this information.

1

Exchange Act Release No. 58733 (Oct. 14, 2008), 73 FR 61706 (Oct. 17, 2008) (‘‘Rule 204T Adopting
Release’’).

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5.

Effects on Small Entities

The collection of information necessary to ensure compliance with Rule 204’s requirements
is not unduly burdensome on smaller entities.
6.

Consequences of Not Conducting Collection

In order to ensure compliance with Rule 204, a participant or broker-dealer subject to any of
the requirements discussed in item 1, above, must collect the required information on a daily basis.
Less frequent or less individualized collection would impede the ability to verify compliance with
Rule 204.
7.

Inconsistencies with Guidelines in 5 CFR 1320.5(d)(2)

There are no special circumstances. This collection is consistent with the guidelines in 5
CFR 1320.5(d)(2).
8.

Consultations Outside the Agency

The required Federal Register notice with a 60-day comment period soliciting comments
on this collection of information was published. No public comments were received.
9.

Payment or Gift

No payment or gift is provided to respondents.
10.

Confidentiality

No assurance of confidentiality is provided.
11.

Sensitive Questions

No questions of a sensitive nature are asked. The information collection does not collect
any Personally Identifiable Information (PII).
12.

Information Collection Burden
i. Allocation Notification Requirement

We estimate that it will take a broker-dealer no more than approximately 0.16 hours (10
minutes) to notify a participant that the broker-dealer has become subject to the requirements of
Rule 204(b) of Regulation SHO. We base this estimate in part on the fact that, in accordance
with Rule 203(b)(3)(vi) of Regulation SHO, participants are permitted to allocate responsibility
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to close out a portion of a fail to deliver position to a broker-dealer that is responsible for the fail
to deliver position; that most broker-dealers already have the necessary communication
mechanisms in place and are already familiar with notification processes and procedures to
comply with the borrowing requirements of Rule 203(b)(3)(iv) of Regulation SHO for threshold
securities; and that broker-dealers will be able to continue to use the same communication
mechanisms, processes and procedures to comply with the notification requirement of Rule
204(d). 2 On average, participants estimate that currently it takes approximately 0.16 hours (10
minutes) to notify broker-dealers pursuant to Rule 203(b)(3)(vi) of Regulation SHO. 3
As of December 31, 2014, there were 4,184 registered broker-dealers. Each of these
broker-dealers could clear trades through a participant of a registered clearing agency and,
therefore, become subject to the notification requirements of Rule 204(d). If a broker-dealer has
been allocated a portion of a fail to deliver position in an equity security and after the beginning
of regular trading hours on the applicable close-out date, the broker-dealer has to determine
whether or not that portion of the fail to deliver position was closed out in accordance with Rule
204(a). We estimate that a broker-dealer will have to make such determination with respect to
approximately 2.44 equity securities per day. 4
We estimate a total of 2,572,657 notifications in accordance with Rule 204(d) across all
broker-dealers (that will be allocated responsibility to close out a fail to deliver position) per year
(4,184 broker-dealers notifying participants once per day5 on 2.44 securities, multiplied by 252
trading days in a year). The total estimated annual burden hours per year will be approximately
411,625 burden hours (2,572,657 multiplied by 0.16 hours/notification). We estimate that the
paperwork compliance for the allocation notification requirement for each broker-dealer will be
approximately 98 burden hours per year (411,625 ÷ 4,184).
ii.

Demonstration Requirement for Fails to Deliver on Long Sales

We estimate that it will take a participant of a registered clearing agency no more than
approximately 0.16 hours (10 minutes) to demonstrate in its books and records that it has a fail to
deliver position at a registered clearing agency in an equity security that resulted from a long sale.
We base this estimate on the fact that, to comply with Regulation SHO’s marking requirements,
2

Additionally, participants should already have in place mechanisms to comply with this requirement under
temporary Rule 204T.

3

We base this estimate on information provided to our staff by three small, three medium, and three large
registered clearing agency participants.

4

The Commission’s Division of Economic and Risk Analysis (“DERA”) estimates that there are approximately
10,208 fail to deliver positions per settlement day as of January 2015. Across 4,184 broker-dealers, the number
of securities per broker-dealer per day is approximately 2.44 equity securities.

5

Because failure to comply with the close-out requirements of Rule 204(a) is a violation of the rule, we believe
that a broker-dealer would make the notification to a participant that it is subject to the borrowing requirements
of Rule 204(b) at most once per day.

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broker-dealers are already required to ascertain whether a customer is “deemed to own” the
securities being sold before marking a sell order “long” and, if the securities are not in the
broker-dealer’s physical possession or control, whether the broker-dealer reasonably expects that
the shares will be in the broker-dealer’s physical possession or control by settlement date. 6 This
reasonableness determination includes consideration of whether or not a prior sale resulted in a
fail to deliver position. In addition, broker-dealers already must comply with the documentation
requirement contained in the “locate” requirement of Rule 203(b)(1) of Regulation SHO. 7
Participants will be able to use similar mechanisms, processes and procedures to demonstrate
compliance with the rule’s close-out requirement for fails to deliver resulting from long sales as
they use for compliance with the current requirements of Regulation SHO.
As of December 31, 2014, there were 175 participants of NSCC, the primary registered
clearing agency responsible for clearing U.S. transactions that were registered as broker-dealers. 8
If a participant of a registered clearing agency has a fail to deliver position in an equity security at
a registered clearing agency and determined that such fail to deliver position resulted from a long
sale, we estimate that a participant of a registered clearing agency will have to make such
determination with respect to approximately 35 securities per day. 9
We estimate a total of 1,675,800 demonstrations in accordance with Rule 204(a)(1)
across all participants per year (175 participants checking for compliance once per day on 38
securities, multiplied by 252 trading days in a year). The total approximate estimated annual
burden hour per year will be approximately 268,128 burden hours (1,675,800 multiplied by 0.16
hours/documentation). We estimate that the paperwork burden for the temporary demonstration
provision for each participant will be approximately 1,532 burden hours per year (268,128 ÷
175).
iii.

Pre-Borrow Notification Requirement

6

See 17 CFR 242.200(g)(1).

7

17 CFR 242.203(b)(1). Additionally, participants should already have in place mechanisms to comply with this
requirement under temporary Rule 204T.

8

Those participants not registered as broker-dealers include such entities as banks, U.S.-registered exchanges,
and clearing agencies. Although these entities are participants of a registered clearing agency, generally these
entities do not engage in the types of activities that will implicate the close-out requirements of the rule. Such
activities of these entities include creating and redeeming Exchange Traded Funds, trading in municipal
securities, and using NSCC’s Envelope Settlement Service or Inter-city Envelope Settlement Service. These
activities rarely lead to fails to deliver and, if fails to deliver do occur, they are small in number and are usually
closed out within a day.

9

DERA estimates approximately 65.1% of trades are long sales and applies this percentage to the number of fail
to deliver positions per day as of March 2014. DERA estimates that there are approximately 10,208 fail to
deliver positions per settlement day as of January 2015. Across 175 broker-dealer participants of the NSCC, the
number of securities per participant per day is approximately 58 equity securities. 65.1% of 51 securities per
day is 38 securities per day.

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We estimate that it will take a participant of a registered clearing agency no more than
approximately 0.16 hours (10 minutes) to notify all broker-dealers from which the participant
receives orders for clearance and settlement (1) that the participant has a fail to deliver position
in an equity security at a registered clearing agency that has not been closed out in accordance
with the requirements of Rule 204(a), and (2) when the purchase that the participant has made to
close out the fail to deliver position has cleared and settled at a registered clearing agency. 10
We base this estimate in part on the fact that most participants already notify brokerdealers for which they receive orders for clearance and settlement that the participant has a fail to
deliver position in a threshold security that has not been closed out in order to comply with the
borrow requirements of Rule 203(b)(3)(iv) of Regulation SHO for threshold securities; that most
participants already have the necessary communication mechanisms in place and are already
familiar with notification processes and procedures to comply with the borrow requirements of
Rule 203(b)(3)(iv) of Regulation SHO for threshold securities; and that participants will be able
to continue to use the same communication mechanisms, processes and procedures to notify any
broker-dealers from which they receive trades for clearance and settlement of the information
required by the rule’s notification requirement as they use for compliance with Regulation
SHO. 11
As of December 31, 2014, there were 175 participants of NSCC, the primary registered
clearing agency responsible for clearing U.S. transactions that were registered as brokerdealers. 12 If a participant of a registered clearing agency has a fail to deliver position in an equity
security and after the beginning of regular trading hours on the applicable close-out date the
participant has to determine whether or not the fail to deliver position was closed out in
accordance with Rule 204(a), we estimate that a participant of a registered clearing agency will
have to make such determination with respect to approximately 58 equity securities per day. 13
We estimate a total of 2,557,800 notifications in accordance with Rule 204(c) across all
participants per year (175 participants notifying broker-dealers once per day on 58 securities,
multiplied by 252 trading days in a year). The total estimated annual burden hours per year will
be approximately 409,248 burden hours (2,557,800 @ 0.16 hours/documentation). We estimate
that the paperwork burden for the notification requirement for each participant will be
approximately 2,338 burden hours per year (409,248 ÷ 175).

10

We base this estimate on information provided to our staff by three small, three medium, and three large
registered clearing agency participants.

11

Additionally, participants should already have in place mechanisms to comply with this requirement under
temporary Rule 204T.

12

See supra note 8.

13

See supra note 9.

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iv.

Certification Requirement

We estimate that it will take a broker-dealer no more than approximately 0.16 hours (10
minutes) to certify to the participant that it has not incurred a fail to deliver position on
settlement date in an equity security for which the participant has a fail to deliver position at a
registered clearing agency or that it is in compliance with the requirements set forth in the prefail credit provision of Rule 204(e). We base this estimate, in part, on the fact that, to comply
with the close-out requirements of Rule 203(b)(3) of Regulation SHO, current industry practice
for some participants that are registered broker-dealers is to document purchases made on
settlement days 11, 12, and 13 to demonstrate that such participants do not have a close-out
obligation under Regulation SHO. 14 On average, participants informed us that such
documentation takes approximately 0.16 hours (10 minutes). 15
As of December 31, 2014, there were 4,184 registered broker-dealers. Each of these
broker-dealers may clear trades through a participant of a registered clearing agency. If the
broker-dealer determines that it has not incurred a fail to deliver position on settlement date in an
equity security for which the participant has a fail to deliver position at a registered clearing
agency or has purchased securities in accordance with the conditions specified in Rule 204(e), we
estimate that a broker-dealer will have to make such determinations with respect to
approximately 2.44 securities per day. We estimate that on average, a broker-dealer will have to
certify to the participant that it has not incurred a fail to deliver position on settlement date in an
equity security for which the participant has a fail to deliver position at a registered clearing
agency or, alternatively, that it is in compliance with the requirements set forth in the pre-fail
credit provision of Rule 204(e), 2,572,657 times per year (4,184 broker-dealers certifying once
per day on 2.44 securities, multiplied by 252 trading days in a year). The total approximate
estimated annual burden hour per year will be approximately 411,625 burden hours (2,572,657
multiplied by 0.16 hours/certification). We estimate that the paperwork burden for the
certification provision for each broker-dealer will be approximately 98 burden hours per year
(411,625 ÷ 4,184).
v.

Pre-Fail Credit Demonstration Requirement

We estimate that it will take a broker-dealer no more than approximately 0.16 hours (10
minutes) to demonstrate that it has a net long position or net flat position on its books and
records on the settlement day for which the broker or dealer is claiming credit. We base this
estimate on the fact that, to comply with the close-out requirement of Rule 203(b)(3) of
Regulation SHO, current industry practice for some participants that are registered broker-dealers
is to document purchases made on settlement days 11, 12, and 13 to demonstrate that such
14

Additionally, participants should already have in place mechanisms to comply with this requirement under
temporary Rule 204T.

15

We base this estimate on information provided to our staff by three small, three medium, and three large
registered clearing agency participants.

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participants do not have a close-out obligation under Regulation SHO. 16 On average, participants
informed us that such documentation takes approximately 0.16 hours (10 minutes). 17
As of December 31, 2014, there were 4,184 registered broker-dealers. If a broker-dealer
purchased or borrowed securities in accordance with the conditions specified in Rule 204(e) and
determined that it has a net long position or net flat position on the settlement day for which the
broker-dealer is claiming credit, we estimate that a broker-dealer will have to make such
determination with respect to approximately 2.44 securities per day.
We estimate that on average, a broker-dealer will have to demonstrate in its books and
records that it has a net long position or net flat position on the settlement day for which the
broker-dealer is claiming credit, 2,572,657 times per year (4,184 broker-dealers checking for
compliance once per day on 2.44 securities, multiplied by 252 trading days in a year). The total
approximate estimated annual burden hour per year will be approximately 411,625 burden hours
(2,572,657 multiplied by 0.16 hours/demonstration). We estimate that the paperwork burden for
compliance with the demonstration requirement of Rule 204(e)(4) for each broker-dealer will be
approximately 98 burden hours per year (411,625 ÷ 4,184).
The total aggregate annual record keeping and third-party disclosure burden for the
collection of information undertaken pursuant to all five provisions is thus 1,912,225 hours per
year (411,625 + 268,128 + 409,248 + 411,625 + 411,625). This is an aggregate increase of
63,001 hours from the previous burden of 1,849,224.
13.

Costs to Respondents

The mechanisms necessary to comply with Rule 204 are the same as temporary Rule 204T. Thus,
it is not anticipated that respondents will have to incur any additional one-time capital or start up costs or
ongoing operations and maintenance costs to comply with Rule 204 as participants should already have in
place the mechanisms that were necessary to comply with temporary Rule 204T.
14.

Costs to Federal Government

Not applicable.
15.

Changes in Burden

The increase in total aggregate burden hours from 1,849,224 to 1,912,225 is due to an increase
in the number of fail to deliver positions per settlement day from the prior time period combined
16

Additionally, participants should already have in place mechanisms to comply with this requirement under
temporary Rule 204T.

17

We base this estimate on information provided to our staff by three small, three medium, and three large
registered clearing agency participants.

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with a decrease in the number of registered broker-dealers and a decrease in the number of NSCC
participants, resulting in an increase in the number of securities per broker-dealer and NSCC
participant, as applicable, per day.
16.

Information Collection Planned for Statistical Purposes

Not applicable. The information collection is not used for statistical purposes.
17.

Approval to Omit OMB Expiration Date

The Commission is not seeking approval to omit the expiration date.
18.

Exceptions to Certification for Paperwork Reduction Act Submissions

This collection complies with the requirements in 5 CFR 1320.9.
B.

COLLECTIONS OF INFORMATION EMPLOYING STATISTICAL METHODS
This collection does not involve statistical methods.

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