Regulation SHO

Definition

Regulation SHO is a rule implemented by the U.S. Securities and Exchange Commission (SEC) to regulate short selling activities in the securities markets. 

What is Regulation SHO?

Regulation SHO imposes requirements and restrictions on short selling to promote market integrity, transparency, and investor protection. Regulation SHO seeks to enhance regulatory control of short selling activities and reduce the risks associated with failure to deliver securities.

Regulation SHO defines a short sale as any sale of a security that the seller does not own or has not borrowed at the time of the sale, or any sale that is consummated by delivering a security borrowed by or for the account of the seller.

Furthermore, it requires broker-dealers engaging in short sales to locate and borrow securities before effecting a short sale, ensuring that they have reasonable grounds to believe that the securities can be borrowed and delivered to the buyer on the settlement date. Additionally, Regulation SHO imposes close-out requirements for fail-to-deliver positions, requiring broker-dealers to close out failed trades within specified timeframes to reduce the risk of persistent failures to deliver.

When a security exceeds certain threshold levels of fails to deliver over consecutive settlement days, it becomes designated as a “threshold security.” Enhanced regulatory requirements apply to threshold securities, including mandatory buy-ins and additional disclosure obligations for broker-dealers.

Example of Regulation SHO

ABC Hedge Fund engages in short selling activities, borrowing shares of Company XYZ from a brokerage firm and selling them in the market with the expectation that the share price will decline. However, under Regulation SHO, ABC Hedge Fund is subject to certain rules and requirements related to short selling.

ABC Hedge Fund must have reasonable grounds to believe that it can borrow the shares needed for short selling before executing the trade. This ensures that there are actual shares available to borrow and deliver to the buyer at settlement.

By complying with Regulation SHO, ABC Hedge Fund can engage in short selling activities responsibly, reduce risks associated with naked short selling, and contribute to fair and orderly markets.