Close-Out Requirement

A NASDAQ-listed security has appeared on Fictional Clearing Corp's threshold securities list because a broker-dealer's fails-to-deliver position in that security has persisted beyond the standard close-out deadline. The firm's trading desk continues to accept new short sale orders in the security, reasoning that its bona fide market maker status exempts it from any close-out obligation. Which statement best evaluates this reasoning?

1. A.The reasoning is flawed, the bona fide market making exception is narrow and does not excuse the firm's separate, stricter obligation to close out the aged fail now that the security is on the threshold list.Correct. The market maker exception addresses specific trading conduct; it does not override the mandatory close-out that threshold securities status triggers for an aged, unresolved fail.
2. B.The reasoning is correct, bona fide market makers are permanently excluded from Regulation SHO's close-out requirements.Wrong. There is no permanent close-out exclusion for market makers; the exception is limited and does not eliminate the obligation to resolve aged fails.
3. C.The reasoning is correct, because threshold securities list status applies only to over-the-counter securities, not NASDAQ-listed stock.Wrong. Threshold securities list status is not limited to over-the-counter names; a NASDAQ-listed security with a sufficiently persistent fail pattern can appear on the list.
4. D.The reasoning is flawed, but only because bona fide market maker exceptions never apply to short sales, only to long sales.Wrong. The bona fide market making exception specifically addresses short sale and fail-related relief for genuine market-making activity; it is not a long-sale concept.

Why: The bona fide market making exception in Regulation SHO provides only narrow, temporary relief tied to genuine market-making activity; it can excuse certain locate or timing requirements in the ordinary course of making a market, but it does not create a blanket exemption from the close-out regime. Once a security is placed on the threshold securities list because a firm's fails-to-deliver have persisted beyond the standard deadline, that firm faces an additional, more stringent close-out obligation aimed specifically at resolving aged fails in threshold names. A firm cannot use its market maker status to indefinitely avoid closing out the aged position; the exception addresses new bona fide market-making trades, not the unresolved legacy fail. Continuing to accept new short orders without addressing the aged fail compounds, rather than excuses, the firm's exposure under the rule.

A clearing participant has a fail to deliver position in an equity security and reasonably allocates part of it to a correspondent broker-dealer, sized to that correspondent's own short position. Who carries the close-out and pre-borrow obligations for the allocated part?

1. A.The correspondent broker-dealer the portion was allocated to, and not the participant.Correct. A reasonable allocation relocates the rule's obligations for that portion to the firm whose short position caused it.
2. B.The participant, because only a clearing agency participant can be subject to the rule at all.Wrong. The rule expressly contemplates obligations landing on a non-participant broker-dealer through allocation.
3. C.Both firms jointly, until the allocated portion has been closed out.Wrong. No joint-and-several construction appears here; the obligation sits in one place at a time.
4. D.The correspondent for the close-out, while the participant stays subject to the pre-borrow restriction.Wrong. Splitting the two apart is the appealing error, since they travel together with the allocated portion.

Why: The short sale close-out rule normally places the obligation on the participant of the registered clearing agency, because the participant is the one that fails to deliver at the clearing agency. The rule also lets the participant reasonably allocate a fail to deliver position to a broker-dealer whose short position gave rise to it, and where the allocation is reasonable the rule's obligations for that portion move to the allocated broker-dealer and away from the participant. The obligations move as a package, so both the duty to close out and the pre-borrow consequence follow the allocation. An unreasonable allocation would leave the obligations with the participant.

Fictional Bridge Securities is registered as a bona fide market maker in XYZ Corp, a security currently on the threshold securities list due to a persistent, aging fail-to-deliver position at the firm. The market making desk receives a new customer short sale order in XYZ and, citing its bona fide market maker status, executes the order without obtaining a locate, reasoning that market makers are exempt from the locate requirement when engaged in bona fide market making. Separately, the firm's existing aged fail in XYZ has not yet been closed out. Which statement correctly evaluates the firm's position?

1. A.The firm is correct on both counts, bona fide market maker status suspends both the locate requirement and any close-out obligation until the market making activity ends.Wrong. This incorrectly extends the narrow locate exception into a suspension of the separate close-out obligation, which the market maker exception does not touch.
2. B.The firm is incorrect on both counts, bona fide market makers never receive a locate exception, and the threshold close-out obligation is unaffected.Wrong. A bona fide market maker engaged in genuine market-making activity can properly be excepted from the ordinary locate requirement, so denying that exception outright is incorrect.
3. C.The firm is incorrect only about the locate, market makers must obtain a locate for every short sale, but the close-out obligation was correctly identified as still applying.Wrong on the locate point. Genuine bona fide market-making short sales can be excepted from the ordinary locate requirement, so requiring a locate in every case misstates the rule, even though the close-out conclusion is right.
4. D.The market maker locate exception may properly excuse the new short sale from a fresh locate, but it does not excuse the firm's separate, independent obligation to close out the pre-existing aged fail, which must still be resolved under the stricter threshold close-out requirement.Correct. The two obligations are independent; relief on the new order's locate does not touch the separate, ongoing duty to close out the aged threshold fail.

Why: Two distinct Regulation SHO provisions are in play here and they do not excuse one another. The bona fide market maker exception can properly relieve a genuine market-making short sale from the ordinary locate requirement, so the firm's handling of the new order can be defensible on its own. But that exception has nothing to do with the firm's separate, independent obligation to close out its pre-existing aged fail in XYZ, which arose from earlier, unrelated fails and must still be resolved under the stricter close-out requirement that applies once a security is on the threshold list. A firm can be correct about one obligation and simultaneously in violation of the other, because the two rules govern different conduct and neither one's relief carries over to the other.