Section 4 Trading Practices and Prohibited Activities

Transcription

1 The goal of this section is to Section 4 Trading Practices and Prohibited Activities Understand written supervisory procedures, application, and adherence thereto Understand the mechanics and ramifications of the tendering of exercise notices for options; exercise by exception and same day exercise Understand the effect of exercise prior to ex-dividend date Understand OCC assignment procedure and firm/market maker assignment Understand the compliance requirements for delivery, payment, and settlement Understand relevant position/exercise limits Understand reporting related to position limits 4.1 Supervisory Procedures All procedures of registered firms should be documented. Also, there are strict procedures spelled out that involve maintaining ongoing documentation. Many of these procedures apply to customer accounts, as well as the updating of Forms U4 and U SRO Rules Regarding Supervisory Procedures As a reminder SROs are the National Exchanges and FINRA. There are small differences in the registration requirements of SROs but the following is general guideline that adheres to the rules of the SROs. All registered persons shall be registered with an SRO. This is provided that the Exchange may waive this requirement or may permit a short-form registration or notification in the case of an individual who is properly registered with another selfregulatory organization. This alternate SRO will have registration and examination procedures acceptable to the Exchange. Every other employee and person associated with a Participant must also be acceptable to the Exchange. The acceptance often relates directly to a statutory disqualification in the past. Registered persons are Participants and persons associated with a Firm who are engaged or will be engaged in the securities business of a Participant. This may also include the management of such securities business, including the functions of supervision, solicitation, conduct of business or the training of persons associated with a Participant for any of these functions. Series 56 Section 4 1

2 The following is a list of persons to be registered: Sole Proprietors Officers Partners Principal Stockholders Directors Branch office managers Persons acting as Institutional Broker Representatives Persons acting as Market Maker Traders Representatives Persons engaged in any of the following functions on behalf of a Firm: 1. Underwriting, trading or sales of securities; 2. Research or investment advice, other than general economic information or advice. 3. Activities that involve communication, directly or indirectly, with public investors in securities in connection with activities described in above. The following persons associated with a Participant are not required to be registered with an SRO Persons associated with a Participant whose functions are solely and exclusively clerical or ministerial Persons associated with a Participant not actively engaged in the securities business. A Participant shall not make application for the registration of any person associated with the Participant where there is no intent to employ such person in the securities business of the Participant. Registration of an Option Principal No person shall be approved to transact options business with the public until those associated persons who are designated as Options Principals have been approved by and registered with an SRO. Persons engaged in the supervision of options sales practices or a person to whom the designated general partner or executive officer or another Registered Options Principal delegates the authority to supervise options sales practices shall be designated as Options Principals. Series 56 Section 4 2

3 Opening of Customer Accounts No firm shall accept an order from a customer to purchase or write an options contract unless the customer s account has been approved for options transactions. In approving a customer s account for options transactions, a firm shall exercise due diligence to learn the essential facts as to the customer and his investment objectives and financial situation, and shall make a record of such information. Based upon such information, the branch office manager or other Options Principal shall approve in writing the customer s account for options transactions; provided, that if the branch office manager is not an Options Principal, his approval shall within a reasonable time be confirmed by an Options Principal. Customers should also be furnished with a copy of the Options Disclosure Document. Branch Offices firms approved to do options business with the public under this shall file with the proper SRO and keep current a list of each of its branch offices showing the location of each such office and the name of the manager of each such office. No branch office shall transact options business with the public unless the manager of such branch office has been qualified as an Options Principal. This requirement shall not apply to branch offices in which not more than three representatives are located so long as the Member can demonstrate that the options activities of such branch offices are appropriately supervised by an Options Principal. Supervision of Accounts - The general partners or directors of each firm that conducts non-member customer business shall provide for appropriate supervisory control. The firm shall designate a general partner or executive officer, who shall be identified to an SRO, to assume overall authority and responsibility for internal supervision and control of the organization and compliance with securities laws and regulations. Additionally supervision may 1. Be delegated to qualified employees responsibilities and authority for supervision and control of each office, department or business activity, and shall provide for appropriate written procedures of supervision and control. 2. Be established as a separate system of follow-up and review to determine that the delegated authority and responsibility is being properly exercised. 3. Should involve developing and implementing written policies and procedures reasonably designed to independently supervise the activities of accounts serviced by branch office managers, sales managers, regional/district sales managers or any person performing a similar supervisory function. Series 56 Section 4 3

4 4.1.2 Options Price Reporting Authority The Options Price Reporting Authority (OPRA) provides, through Market Data Vendors, last sale information and current options quotations from a committee of Participant Exchanges. Current OPRA participants include: AMEX, ARCA, BATS, BSE, C2, CBOE, ISE, NASDAQ, NYSE, and PHLX. The participants act as a policy committee composed of representatives from each participant exchange and they implement and, subject to Commission approval, amend the policies and procedures set forth in the OPRA Plan. OPRA is not involved in the settlement of option trades. Also, OPRA has no role in the exercise and assignment process. 4.2 Applicable Federal Regulations Securities Exchange Act of 1934 The Securities Exchange Act of 1934 established laws governing the secondary trading of securities. Also, this act established the Securities and Exchange Commission (SEC) Section 3 Definitions and Application of Title The following terms are taken directly from the Securities Exchange Act of 1934 text. There are several other definitions that are not included in the outline provided by the examiners. These definitions come directly from the outline. Exchange - any organization, association, or group of persons, whether incorporated or unincorporated, which constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange as that term is generally understood, and includes the market place and the market facilities maintained by such exchange. Series 56 Section 4 4

5 Member (Permit Holder) with respect to a national securities exchange a member means 1. Any natural person permitted to effect transactions on the floor of the exchange without the services of another person acting as broker 2. Any registered broker or dealer with which such a natural person is associated 3. Any registered broker or dealer permitted to designate as a representative such a natural person. 4. Any other registered broker or dealer which agrees to be regulated by such exchange and with respect to which the exchange undertakes to enforce compliance with the provisions of this title, the rules and regulations there under, and its own rules. Broker the term broker means any person engaged in the business of effecting transactions in securities for the account of others. Dealer The term dealer means any person engaged in the business of buying and selling securities (not including security-based swaps, other than security-based swaps with or for persons that are not eligible contract participants) for such person s own account through a broker or otherwise. Issuer The term issuer means any person who issues or proposes to issue any security. Security The term security means any note, stock, treasury stock, security future, security-based swap, bond, debenture, certificate of interest or participation in any profit-sharing agreement or in any oil, gas, or other mineral royalty or lease, any collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or in general, any instrument commonly known as a security; or any certificate of interest or participation in, temporary or interim certificate for, receipt for, or warrant or right to subscribe to or purchase, any of the foregoing; but shall not include currency or any note, draft, bill of exchange, or banker s acceptance which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited. Series 56 Section 4 5

6 Equity Security The term equity security means any stock or similar security; or any security future on any such security; or any security convertible, with or without consideration, into such a security, or carrying any warrant or right to subscribe to or purchase such a security; or any such warrant or right; or any other security which the Commission shall deem to be of similar nature and consider necessary or appropriate, by such rules and regulations as it may prescribe in the public interest Buy-Purchase The terms buy and purchase each include any contract to buy, purchase, or otherwise acquire. For security futures products, such term includes any contract, agreement, or transaction for future delivery. For security-based swaps, such terms include the execution, termination (prior to its scheduled maturity date), assignment, exchange, or similar transfer or conveyance of, or extinguishing of rights or obligations under, a security-based swap, as the context may require. Sale-Sell The terms sale and sell each include any contract to sell or otherwise dispose of. For security futures products, such term includes any contract, agreement, or transaction for future delivery. For security-based swaps, such terms include the execution, termination (prior to its scheduled maturity date), assignment, exchange, or similar transfer or conveyance of, or extinguishing of rights or obligations under, a security-based swap, as the context may require. Clearing Agency The term clearing agency means any person who acts as an intermediary in making payments or deliveries or both in connection with transactions in securities or who provides facilities for comparison of data respecting the terms of settlement of securities transactions, to reduce the number of settlements of securities transactions, or for the allocation of securities settlement responsibilities. Such term also means any person, such as a securities depository, who 1. Acts as a custodian of securities in connection with a system for the central handling of securities whereby all securities of a particular class or series of any issuer deposited within the system are treated as fungible and may be transferred, loaned, or pledged by bookkeeping entry without physical delivery of securities certificates, or 2. Otherwise permits or facilitates the settlement of securities transactions or the hypothecation or lending of securities without physical delivery of securities certificates Prohibition Against the Manipulation of Securities Prices The manipulation of securities prices shall be unlawful for any person, directly or indirectly, by the use of the mails or any means or instrumentality of interstate commerce, or of any facility of any national securities exchange, or for any member of a national securities exchange. The following examples of price manipulation come directly from Section 9 of the Securities and Exchange Act of Updated exchange related rules follow in the next section. Series 56 Section 4 6

7 Misleading Appearance of Active Trading For the purpose of creating a false or misleading appearance of active trading in any security other than a government security, or a false or misleading appearance with respect to the market for any such security 1. To effect any transaction in such security that involves no change in the beneficial ownership. 2. To enter an order or orders for the purchase of such security with the knowledge that an order or orders of substantially the same size, at substantially the same time, and at substantially the same price, for the sale of any such security, has been or will be entered by or for the same or different parties. 3. To enter any order or orders for the sale of any such security with the knowledge that an order or orders of substantially the same size, at substantially the same time, and at substantially the same price, for the purchase of such security, has been or will be entered by or for the same or different parties. Inducing Purchase or Sale by Others To effect, alone or with one or more other persons, a series of transactions in any security other than a government security, any security not so registered, or in connection with any security-based swap or securitybased swap agreement with respect to such security creating actual or apparent active trading in such security, or raising or depressing the price of such security, for the purpose of inducing the purchase or sale of such security by others. Dissemination of Information as to Rise or Fall of Securities Prices An attempt to manipulate or influence the price of a security through the circulation or dissemination of information. This would be in the ordinary course of business of information to the effect that the price of any such security will or is likely to rise or fall because of market operations of any one or more persons conducted for the purpose of raising or depressing the price of such security. Making False or Misleading Statements making any statement which was at the time and in the light of the circumstances under which it was made, false or misleading with respect to any material fact, and which that person knew or had reasonable ground to believe was so false or misleading. Dissemination of Information for Consideration For a consideration (payment), circulation or dissemination of information to the effect that the price of any such security will or is likely to rise or fall because of the market operations of any one or more persons conducted for the purpose of raising or depressing the price of such security. Series 56 Section 4 7

8 Pegging, Fixing, or Stabilizing Prices To effect either alone or with one or more other persons any series of transactions for the purchase and/or sale of any security other than a government security for the purpose of pegging, fixing, or stabilizing the price of such security in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors Use or Employment of Deceptive Devices It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange. The following example of deceptive devices comes directly from Section 10 of the Securities and Exchange Act of Updated exchange related rules follow in the next section. Employment of manipulative and deceptive devices by brokers or dealers To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors Tender Offers The following example of rules regarding tender offers comes directly from Section 14 of the Securities and Exchange Act of Updated exchange related rules follow in the next section. Prohibited transactions in connection with partial tender offers Any solicitation or recommendation to the holders of such a security to accept or reject a tender offer or request or invitation for tenders shall be made in accordance with such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. Series 56 Section 4 8

9 Regulation FD Regulation FD refers to Regulation Fair Disclosure. The basis is that when an issuer (public company) discloses material nonpublic information to certain persons (such as, securities market professionals and holders of the issuer s securities) who may well trade on the basis of the information, it must also make public disclosure of that information. With respect to Regulation to FD, if information may have been disclosed to a select number of individual erroneously, an issuer (company) should make every effort to publicly disclose this information as quickly as possible. 4.3 Prohibited Activities Anti-Manipulation Rules Each SRO has their own specific rules regarding manipulative practices. The following is a guideline of rules based on multiple SRO documents. No individual shall effect or induce the purchase, sale or exercise of any security for the purpose of creating or inducing a false, misleading, or artificial appearance of activity in such security or in the underlying security, or for the purpose of unduly or improperly influencing the market price of such security or of the underlying security or for the purpose of making a price which does not reflect the true state of the market in such security or in the underlying security. No person or organization shall directly or indirectly participate in or have any interest in the profit of a manipulative operation or knowingly manage or finance a manipulative operation. Specifics Applied to This Rule The creation of any pool, syndicate or joint account, whether in corporate form or otherwise, organized or used intentionally for the purpose of unfairly influencing the market price of any security by means of options or otherwise and for the purpose of making a profit thereby shall be deemed to be a manipulative operation; The soliciting of subscriptions to any such pool, syndicate or joint account or the accepting of discretionary orders from any such pool, syndicate or joint account shall be deemed to be managing a manipulative operation; and The carrying on margin of either a long or a short position in securities for, or the advancing of credit through loans of money or of securities to, any such pool, syndicate or joint account shall be deemed to be financing a manipulative operation. Series 56 Section 4 9

10 4.3.2 Anti-Money Laundering Rules Each SRO has their own anti-money laundering rules that are specific to the exchange or agency. All money laundering rules should be consistent with the Bank Secrecy Act rules on Money Laundering. The following is a compilation of those rules. Each firm shall develop and implement a written anti-money laundering program reasonably designed to achieve and monitor the firm or individual s compliance with the requirements of the Bank Secrecy Act and the implementing regulations promulgated thereunder by the Department of the Treasury. Each firm's antimoney laundering program must be approved, in writing, by the firm s senior management. The anti-money laundering programs shall, at a minimum 1. Establish and implement policies and procedures that can be reasonably expected to detect and cause the reporting of potentially illegal transactions. 2. Establish and implement policies, procedures, and internal controls reasonably designed to achieve compliance with the Bank Secrecy Act. 3. Provide for independent testing for compliance to be conducted by the Member s personnel or by a qualified outside party. 4. Designate and identify to the Exchange (by name, title, mailing address, e- mail address, telephone number, and facsimile number) an individual or individuals responsible for implementing and monitoring the day-to-day operations and internal controls of the program, and provide prompt notification to the Exchange regarding any change in such designation(s). 5. Provide ongoing training for appropriate personnel. Series 56 Section 4 10

11 4.3.3 Insider Trading Every firm, other than a lessor that is neither registered, nor required to be registered, as a broker-dealer shall establish, maintain and enforce written policies and procedures reasonably designed, taking into consideration the nature of the firm s business, to prevent the misuse of material nonpublic information by such firm or persons associated with such firm in violation of the established rules. Material non-public information. Information is considered material if there is a substantial likelihood that a reasonable investor would consider it important in deciding to buy or sell a security. If this information would have a direct impact on a security s price it should be considered material. Misuse of material non-public information includes, but is not limited to 1. Direct trading in a security based on knowledge of material non-public information. 2. Trading in any derivative security that has value based on the security related to non-public information. 3. Disclosing to an individual any material non-public information or facilitating in the use of material non-public information. Each firm shall establish, maintain and enforce the following policies and procedures as appropriate for the nature of each firm s business 1. All associated persons must be advised in writing of the prohibition against the misuse of material nonpublic information; 2. Firm should have signed attestations from the member and all associated persons affirming their awareness of, and agreement to abide by, the aforementioned prohibitions must be maintained for at least three (3) years, the first two (2) years in an easily accessible place. 3. Records of all brokerage accounts maintained by the Member and all associated persons must be acquired and maintained for at least three (3) years, the first two (2) years in an easily accessible place, and such brokerage accounts must be reviewed periodically by the Member for the purpose of detecting the possible misuse of material nonpublic information. 4. Any business dealings the Member may have with any corporation whose securities are publicly traded, or any other circumstances that may result in the Member receiving, in the ordinary course of business, material nonpublic information concerning any such corporation, must be identified and documented. Series 56 Section 4 11

12 Firm that are required that are required to do so shall, contemporaneously with those submissions shall annually file attestations signed by firms stating that the procedures mandated have been established, enforced and maintained. Any Member or associated person who becomes aware of a possible misuse of material nonpublic information must promptly notify the Exchange. Firms should establish internal controls (Chinese Walls) that limit the flow of information that could result in confidential information being shared and possibly misused. Two types of Chinese Wall violations are a breach of an information barrier or lack of information barriers Anti-Competitive Trading Practices No individual or firm shall engage in acts or practices inconsistent with just and equitable principles of trade. The following specific definitions are cited Collusion A non-competitive agreement between rivals that attempts to disrupt the market's equilibrium. By collaborating with each other, rival firms look to alter the price of a good to their advantage. The parties may collectively choose to restrict the supply of a good, and/or agree to increase its price in order to maximize profits. Groups may also collude by sharing private information, allowing them to benefit from insider information Price/size/spread convention Any collusion by market participants to alter or control publicly quoted prices, indicated bid or offer sizes, or the width of the bid ask spreads shall be deemed conduct inconsistent with just and equitable principles of trade. Harassment and Intimidation Practices involving harassment, threats, intimidation, collusion, refusals to deal, or retaliation that have the intended purpose or effect of discouraging a member (permit holder) or other market participant from acting, or seeking to act, competitively are prohibited under this Rule and shall be deemed conduct inconsistent with just and equitable principles of trade. Series 56 Section 4 12

13 4.3.5 Additional Prohibited Activities The following are terms specifically pointed out by the material outline Front Running The illegal practice of a broker executing orders on a security for its own account while taking advantage of advance knowledge of pending orders from its customers. When orders previously submitted by its customers will predictably affect the price of the security, purchasing first for its own account gives the broker an unfair advantage, since it can expect to close out its position at a profit based on the new price level. The front running broker either buys for his own account (before filling customer buy orders that drive up the price), or sells (where the broker sells for its own account, before filling customer sell orders that drive down the price). Trading Ahead A practice that is similar to front running. This may be done by any market participant who has knowledge of a large order that may be pending in the marketplace and would influence the future price of a security. Marking-the-Close attempting to influence a security s closing price through buying or selling of that security near the market close. This may be done by placing a large number of buy or sell orders near the close of business. Painting-the-Tape An illegal action by a group of market manipulators buying and/or selling a security among themselves to create artificial trading activity, which, when reported on the ticker tape, lures in unsuspecting investors as they perceive an unusual volume. Spreading Market Rumors attempting to influence a security s price through the spreading of unsubstantiated or false information. Wash-Sale Rule An Internal Revenue Service (IRS) rule prohibiting taxpayers from claiming a loss on the sale of an investment. The long term benefit is not valid when the same investment was purchased within 30 days before or after the sale date. Also know as the "30-day wash-sale rule". Information Barriers Also known as a Chinese Wall. The goal of this barrier is keep non-public inside information within the proper division of a firm. If confidential work is being done by a banking division that would influence security prices it should solely remain in that division. Breach of Information Barriers A situation where non-public information has been shared with a division of a company where it may result in illegal trading activity. This information has been shared as the result of circumventing any information barrier that has been properly implemented. Series 56 Section 4 13

14 Lack of Information Barriers A situation where a company has not established proper procedures to avoid information being shared with a division that should not be privy to such information. The information has been shared with a department or individuals that should not have access in the regular course of business. If a firm has not implemented proper information barriers to avoid this occurring the result is a lack of information barriers. Pre-Arranged Trading Trading activity that may be the result of collusion. The pre-arranged trade may be agreed upon with the goal of creating the illusion of an increase in volume (painting the tape) or in order to manipulate the price of the security. Trade Shredding the practice of breaking orders into smaller, multiple trading solely for the purpose of generating market data revenue Short Sales and Mandatory Buy-Ins In 2005 Regulation SHO (Reg SHO) was implemented to update legislations concerning short sale practices. Regulation SHO established "locate" and "close-out" standards that are primarily aimed at preventing the opportunity for traders to engage in unethical naked short selling practices. Specific definitions that come under this section are Aggregation a broker dealer may aggregate all long and short positions to determine a net firm position. In order to qualify for aggregation regarding short selling a broker-dealer should meet the following requirements 1. The broker-dealer has a written plan of organization that identifies each aggregation unit, specifies its trading objective(s), and supports its independent identity. 2. Each aggregation unit within the firm determines at the time of each sale its net position for every security that it trades. 3. all traders in an aggregation unit pursue only the trading objectives or strategy(ies) of that aggregation unit. 4. Individual traders are assigned to only one aggregation unit at any time. Series 56 Section 4 14

15 Marking Requirements a sale should be correctly registered as a short sale if the seller does not have a legitimate long position in the security. Locate Requirements a short seller should have reasonable grounds that a security that is to be sold short may be borrowed and delivered by the date of delivery before a short sale is executed. Close-Out Requirement Regulation SHO imposes additional delivery requirements on broker-dealers for securities in which there are a relatively substantial number of extended delivery failures at a registered clearing agency. Additional short sales may not be enacted in these securities. Threshold Securities stocks that are on the Threshold Security List which is a daily public accounting of market settlement system failures (or 'fails') published daily. A market settlement failure occurs when delivery on a security is not made within the alloted settlement period. Threshold Security Lists are published daily by national securities exchanges. A security will make the threshold list if it meets the following criteria over five consecutive settlement days: 1. The total share number of fails to deliver exceed 10,000 shares. 2. The total number of shares that have failed to deliver exceed 0.5% of the outstanding shares. 3. The security is listed on a similar list by a self-regulatory organization (another exchange s threshold list). Once a company is added to the list it remains there until the 'fails' fall beneath the benchmark standards for five consecutive trading days. Buy-Ins A contract which has not been completed by the seller according to its terms may be closed by the buyer not sooner than the third business day following the date delivery was due Series 56 Section 4 15

16 Regulation SHO Short Sales Three Violations of Regulation SHO related to selling short 1. Selling stock short without having located stock for delivery at settlement. 2. Selling stock short and failing to deliver shares at the time of settlement. 3. Selling stock short and failing to deliver shares at the time of settlement with the purpose of driving down the security s price. A public customer should locate shares to borrow for delivery before executing a short sale. The following Reg SHO Rules are specifically cited in the outline Regulation SHO Rule 200 The term short sale shall mean any sale of a security which the seller does not own or any sale which is consummated by the delivery of a security borrowed by, or for the account of, the seller. A person shall be deemed to own securities only to the extent that he has a net long position in such securities. Aggregation independent trading units may aggregate positions to determine a net long or short position. In order to determine its net position, a broker or dealer shall aggregate all of its positions in a security unless it qualifies for independent trading unit aggregation, in which case each independent trading unit shall aggregate all of its positions in a security to determine its net position. Independent trading unit aggregation is available only if: 1. The broker or dealer has a written plan of organization that identifies each aggregation unit, specifies its trading objective(s), and supports its independent identity; 2. Each aggregation unit within the firm determines, at the time of each sale, its net position for every security that it trades; 3. All traders in an aggregation unit pursue only the particular trading objective(s) or strategy(s) of that aggregation unit and do not coordinate that strategy with any other aggregation unit; and 4. Individual traders are assigned to only one aggregation unit at any time. Series 56 Section 4 16

17 A broker or dealer must mark all sell orders of any equity security as "long, "short, or "short exempt." Marking of Sell Orders Long a sell order may be marked long sale only if the seller is an owner of the security. Short of a security which the seller does not own or any sale which is consummated by the delivery of a security borrowed. Short Exempt a sell order may be marked as short exempt if the seller is relying on an exception from the tick test or other rules in place that allow an exemption as spelled out under Regulation SHO Rule 201. Regulation SHO Rule 201 Definition of short sale and Marking Requirements Covered Security NMS stock means any NMS security other than an option. Effective Transaction Reporting Plan for a Covered Security any transaction reporting plan approved by the Commission pursuant to SEC rules. plan. Listing Market will be the market that is defined in the transaction reporting National Best Bid and National Best Offer with respect to quotations for an NMS security, the best bid and best offer for such security that are calculated and disseminated on a current and continuing basis by a plan processor pursuant to an effective national market system plan provided, that in the event two or more market centers transmit to the plan processor pursuant to such plan identical bids or offers for an NMS security, the best bid or best offer (as the case may be) shall be determined by ranking all such identical bids or offers (as the case may be) first by size (giving the highest ranking to the bid or offer associated with the largest size), and then by time (giving the highest ranking to the bid or offer received first in time). Odd Lot an order for the purchase or sale of an NMS stock in an amount less than a round lot. A stock round lot is considered 100 shares. Plan Processor any self-regulatory organization or securities information processor acting as an exclusive processor in connection with the development, implementation and/or operation of any facility contemplated by an effective national market system plan. Series 56 Section 4 17

18 Regular Trading Hours the time between 9:30 a.m. and 4:00 p.m. Eastern Time, or such other time as is set forth in the regulatory procedures. Riskless Principal a transaction in which a broker or dealer, after having received an order to buy a security, purchases the security as principal at the same price to satisfy the order to buy, exclusive of any explicitly disclosed markup or markdown, commission equivalent, or other fee, or, after having received an order to sell, sells the security as principal at the same price to satisfy the order to sell, exclusive of any explicitly disclosed markup or markdown, commission equivalent, or other fee. Trading Center means a national securities exchange or national securities association that operates an SRO trading facility, an alternative trading system, an exchange market maker, an OTC market maker, or any other broker or dealer that executes orders internally by trading as principal or crossing orders as agent. Short Sale Rules A trading center shall establish, maintain, and enforce written policies and procedures reasonably designed to: 1. Prevent the execution or display of a short sale order of a covered security at a price that is less than or equal to the current national best bid if the price of that covered security decreases by 10% or more from the covered security's closing price. 2. Impose the requirements of this section for the remainder of the day and the following day when a national best bid for the covered security is calculated and disseminated on a current and continuing basis by a plan processor pursuant to an effective national market system plan. 3. Provided, however, that the policies and procedures must be reasonably designed to permit the execution of a displayed short sale order of a covered security by a trading center if, at the time of initial display of the short sale order, the order was at a price above the current national best bid and the execution or display of a short sale order of a covered security marked "short exempt" without regard to whether the order is at a price that is less than or equal to the current national best bid. Series 56 Section 4 18

19 A trading center shall regularly surveil to ascertain the effectiveness of the policies and procedures required by rules and shall take prompt action to remedy deficiencies in such policies and procedures. The determination regarding whether the price of a covered security has decreased by 10% or more from the covered security's closing price as determined by the listing market for the covered security as of the end of regular trading hours on the prior day shall be made by the listing market for the covered security and, if such decrease has occurred, the listing market shall immediately notify the single plan processor responsible for consolidation of information for the covered security pursuant to rules. The single plan processor must then disseminate this information. Following any determination and notification pursuant to rules with respect to a covered security, a broker or dealer submitting a short sale order of the covered security in question to a trading center may mark the order "short exempt" if the broker or dealer identifies the order as being at a price above the current national best bid at the time of submission; provided, however 1. The broker or dealer that identifies a short sale order of a covered security as "short exempt" in accordance with rules must establish, maintain, and enforce written policies and procedures reasonably designed to prevent incorrect identification of orders for purposes of these rules 2. The broker or dealer shall regularly surveil to ascertain the effectiveness of the policies and procedures required by rules of this section and shall take prompt action to remedy deficiencies in such policies and procedures. Series 56 Section 4 19

20 Following any determination and notification pursuant to rules with respect to a covered security, a broker or dealer may mark a short sale order of a covered security "short exempt" if the broker or dealer has a reasonable basis to believe that 1. The short sale order of a covered security is by a person that is deemed to own the covered security, provided that the person intends to deliver the security as soon as all restrictions on delivery have been removed. 2. The short sale order of a covered security is by a market maker to offset customer odd-lot orders or to liquidate an odd-lot position that changes such broker's or dealer's position by no more than a unit of trading 3. The short sale order of a covered security is for a good faith account of a person who then owns another security by virtue of which he is, or presently will be, entitled to acquire an equivalent number of securities of the same class as the securities sold; provided such sale, or the purchase which such sale offsets, is effected for the bona fide purpose of profiting from a current difference between the price of the security sold and the security owned and that such right of acquisition was originally attached to or represented by another security or was issued to all the holders of any such securities of the issuer. 4. The short sale order of a covered security is for a good faith account and submitted to profit from a current price difference between a security on a foreign securities market and a security on a securities market subject to the jurisdiction of the United States, provided that the short seller has an offer to buy on a foreign market that allows the seller to immediately cover the short sale at the time it was made. For the purposes of this rule, a depository receipt of a security shall be deemed to be the same security as the security represented by such receipt. 5. The short sale order of a covered security is by a broker or dealer effecting the execution of a customer purchase or the execution of a customer "long" sale on a riskless principal basis. In addition, for purposes of these rules, a broker or dealer must have written policies and procedures in place to assure that, at a minimum 1. The customer order was received prior to the offsetting transaction; 2. The offsetting transaction is allocated to a riskless principal or customer account within 60 seconds of execution; and 3. The broker or dealer has supervisory systems in place to produce records that enable the broker or dealer to accurately and readily reconstruct, in a time-sequenced manner, all orders on which a broker or dealer relies pursuant to this exception. Series 56 Section 4 20

21 6. The short sale order is for the sale of a covered security at the volume weighted average price (VWAP) that meets the following criteria: 1. The VWAP for the covered security is calculated by: A. Calculating the values for every regular way trade reported in the consolidated system for the security during the regular trading session, by multiplying each such price by the total number of shares traded at that price; B. Compiling an aggregate sum of all values; and C. Dividing the aggregate sum by the total number of reported shares for that day in the security. 2. The transactions are reported using a special VWAP trade modifier. 3. The VWAP matched security: A. Qualifies as an "actively-traded security" B. The proposed short sale transaction is being conducted as part of a basket transaction of twenty or more securities in which the subject security does not comprise more than 5% of the value of the basket traded. 4. The transaction is not effected for the purpose of creating actual, or apparent, active trading in or otherwise affecting the price of any security. 5. A broker or dealer shall be permitted to act as principal on the contra-side to fill customer short sale orders only if the broker's or dealer's position in the covered security, as committed by the broker or dealer during the pre-opening period of a trading day and aggregated across all of its customers who propose to sell short the same security on a VWAP basis, does not exceed 10% of the covered security's relevant average daily trading volume. No self-regulatory organization shall have any rule that is not in conformity with, or conflicts with, these Rules. Upon written application or upon its own motion, the Commission may grant an exemption from the provisions of this section, either unconditionally or on specified terms and conditions, to any person or class of persons, to any transaction or class of transactions, or to any security or class of securities to the extent that such exemption is necessary or appropriate, in the public interest, and is consistent with the protection of investors. Series 56 Section 4 21

22 Regulation SHO Rules 203 Borrowing and Delivery Requirements Market Maker means any specialist permitted to act as a dealer, any dealer acting in the capacity of block positioner, and any dealer who, with respect to a security, holds himself out (by entering quotations in an inter-dealer communications system or otherwise) as being willing to buy and sell such security for his own account on a regular or continuous basis. Participant when used with respect to a clearing agency means any person who uses a clearing agency to clear or settle securities transactions or to transfer, pledge, lend, or hypothecate securities. Such term does not include a person whose only use of a clearing agency is (A) through another person who is a participant or (B) as a pledgee of securities. Registered Clearing Agency means any person who acts as an intermediary in making payments or deliveries or both in connection with transactions in securities or who provides facilities for comparison of data respecting the terms of settlement of securities transactions, to reduce the number of settlements of securities transactions, or for the allocation of securities settlement responsibilities. Such term also means any person, such as a securities depository, who (i) acts as a custodian of securities in connection with a system for the central handling of securities whereby all securities of a particular class or series of any issuer deposited within the system are treated as fungible and may be transferred, loaned, or pledged by bookkeeping entry without physical delivery of securities certificates, or (ii) otherwise permits or facilitates the settlement of securities transactions or the hypothecation or lending of securities without physical delivery of securities certificates. Security Future a contract of sale for future delivery of a single security or of a narrow-based security index, including any interest therein or based on the value thereof. Settlement Day any business day on which deliveries of securities and payments of money may be made through the facilities of a registered clearing agency. Series 56 Section 4 22

23 Threshold Security any equity security of an issuer that is registered and for which the issuer is required to file reports for which 1. There is an aggregate fail to deliver position for five consecutive settlement days at a registered clearing agency of 10,000 shares or more and that is equal to at least 0.5% of the issue s total shares outstanding 2. is included on a list disseminated to its members by a self regulatory agency (SRO exchange) and 3. provided that a security shall cease to be a threshold security if the aggregate fail to deliver position at a registered clearing agency does not exceed the level specified in rules for five consecutive settlement days. The Threshold List is published by respective exchanges. Short Sales of Security Futures do not fall under Regulation SHO Rules. For Threshold List Stocks Long Sales a broker or dealer knows or has reasonable grounds to believe that the sale of an equity security was or will be effected pursuant to an order marked "long," such broker or dealer shall not lend or arrange for the loan of any security for delivery to the purchaser's broker after the sale, or fail to deliver a security on the date delivery is due Short Sales A broker or dealer may not accept a short sale order in an equity security from another person, or effect a short sale in an equity security for its own account, unless the broker or dealer has: 1. Borrowed the security, or entered into a bona-fide arrangement to borrow the security; or 2. Resonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due 3. Documented compliance. Series 56 Section 4 23

24 If a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in a threshold security for thirteen consecutive settlement days, the participant shall immediately thereafter close out the fail to deliver position by purchasing securities of like kind and quantity: Upon written application or upon its own motion, the Commission may grant an exemption from these provisions, either unconditionally or on specified terms and conditions, to any transaction or class of transactions, or to any security or class of securities, or to any person or class of persons. Reg SHO Rule 204 Close-Out Requirements A participant of a registered clearing agency must deliver securities to a registered clearing agency for clearance and settlement on a long or short sale in any equity security by settlement date, or if a participant of a registered clearing agency has a fail to deliver position at a registered clearing agency in any equity security for a long or short sale transaction in that equity security, the participant shall, by no later than the beginning of regular trading hours on the settlement day following the settlement date, immediately close out its fail to deliver position by borrowing or purchasing securities of like kind and quantity. Series 56 Section 4 24