Threshold Security

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.

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.

A firm's aged fail-to-deliver position in a threshold security is not closed out within the required time. Regulation SHO can respond by imposing a further restriction on that firm's ability to accept new short sale orders in that same security. What is this further restriction?

1. A.The firm loses its status as a registered broker-dealer for that security only, and must cease all trading in it entirely.Wrong. There is no security-specific loss of broker-dealer registration; the consequence is a pre-borrow requirement for short sales in that security.
2. B.A pre-borrow requirement -- the firm (and broker-dealers for which it clears) must actually pre-borrow shares of that security before accepting further short sale orders in it, rather than relying on the ordinary locate process.Correct. Failing to close out an aged threshold fail can trigger a pre-borrow requirement, stricter than the ordinary locate process.
3. C.The firm must report the failure directly to the issuer, whose consent is then required before any further short sale orders in the security may be accepted.Wrong. Issuer consent is not part of this consequence; the mechanism is a pre-borrow requirement, not issuer approval.
4. D.The firm is barred from accepting long sale orders in the security as well as short sale orders, until the aged fail is closed out.Wrong. The consequence is specific to short sale orders through a pre-borrow requirement, not a bar on long sale orders.

Why: When a firm's aged fail-to-deliver in a threshold security is not resolved within the required time, Regulation SHO can escalate the consequence beyond just the underlying close-out obligation: the firm, along with broker-dealers for which it clears, may become subject to a pre-borrow requirement for that security going forward. Instead of relying on the ordinary locate process, which only requires reasonable grounds to believe borrowing is possible, the firm must actually have the shares pre-borrowed in hand before it may accept any further short sale orders in that security.