On July 27, 2009, the U.S. Securities and Exchange Commission (the “SEC”) adopted a permanent rule intended to curb “naked” short selling. Final Rule 204 of Regulation SHO under the Securities Exchange Act of 1934 (SEC Release No. 43-60388) (“Rule 204”) supersedes interim final temporary Rule 204T (“Rule 204T”) in its entirety effective July 31, 2009. We have outlined the provisions of Rule 204T in prior memoranda.

In response to a large number of public comments to Rule 204T, the SEC adopted Rule 204 in a form substantially similar to Rule 204T, with the following modifications that are intended to extend greater flexibility to broker-dealers in closing out fail to deliver positions:

• Fail to deliver positions may be closed out by purchasing or borrowing securities in a number of circumstances that Rule 204T permitted to be closed out only by purchasing securities.
• Rule 204 provides a period of thirty-five days from the trade date for the broker-dealer to close out fail to deliver positions resulting from the sale of a security a person is deemed to own pursuant to Rule 200 of Regulation SHO. This period is intended to provide the seller time to deliver the sold security, for example, by providing time for a restrictive legend to be removed from a restricted (or formerly restricted) security.  Rule 204T provided a period of thirty-six days from the settlement date for the broker-dealer to close out fail to deliver positions resulting from the sale of a security under Rule 144 under the Securities Act of 1933.
• Rule 204 has eliminated an exception to the sanction for persistent fails to deliver applicable to market makers – putting all broker-dealers on the same footing. Prior Rule 204T allowed a market maker to continue to accept short sale orders if it could demonstrate that it did not have an open short position in the equity security at the time of an additional short sale.
• A new provision has been added providing that a broker-dealer will not be deemed to have satisfied the requirement to close out a fail to deliver position by purchasing or borrowing securities if the broker-dealer knows or has reason to know that another person will not deliver such securities upon settlement.

If you have any questions concerning these matters please contact an attorney in the investment management or capital markets groups at Seward & Kissel.