Proposed Guidance on Short Sale and Short-Marking Exempt Order Designations

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1 Rules Notice Request for Comments UMIR Please distribute internally to: Legal and Compliance Trading Contact: Kent Bailey Senior Policy Analyst, Market Regulation Policy Telephone: Fax: March 2, 2012 Proposed Guidance on Short Sale and Short-Marking Exempt Order Designations Executive Summary This Rules Notice requests comments on revised draft guidance that IIROC would propose to issue related to the marking of orders pursuant to UMIR to include short sale or shortmarking exempt order designations ( Revised Proposed Guidance ). 1 The Revised Proposed Guidance should be reviewed in conjunction with the Rules Notice regarding the approval of various amendments to UMIR respecting short sales and failed trades ( Short Sale Amendments ). 2 The Short Sale Amendments, including the short-marking exempt order designation, will become effective on September 1, IIROC would expect to issue the final Guidance Note approximately 60 days before the Short Sale Amendments become effective. 1 2 Draft guidance (the Original Proposed Guidance ) was published in IIROC Notice Rules Notice Request for Comments UMIR Proposed Guidance on Short Sale and Short-Marking Exempt Order Designations (February 25, 2011). For details of the amendments to UMIR respecting short sales and failed trades which will become effective on September 1, 2012, see IIROC Notice Rules Notice Notice of Approval UMIR Provisions Respecting Regulation of Short Sales and Failed Trades (March 2, 2012).

2 Rules Notice Table of Contents 1. Policy Development Process Background to the Revised Proposed Guidance Amendments Respecting Short Sale Regulation Short-Marking Exempt Order Designation Summary of Revisions from the Original Proposed Guidance Questions... 5 Appendix A - Text of Revised Proposed Guidance... 6 Appendix B - Comments Received in Response to Rules Notice Request For Comments - UMIR - Proposed Guidance on Short Sale and Short-Marking Exempt Order Designations Policy Development Process IIROC has been recognized as a self-regulatory organization by each of the Canadian provincial securities regulatory authorities (the Recognized Regulators ) and, as such, is authorized to be a regulation services provider for the purposes of National Instrument ( Marketplace Operations Instrument ) and National instrument As a regulation services provider, IIROC administers and enforces trading rules for the marketplaces that retain the services of IIROC. 3 IIROC has adopted, and the Recognizing Regulators have approved, UMIR as the integrity trading rules that will apply in any marketplace that retains IIROC as its regulation services provider. The Market Rules Advisory Committee ( MRAC ) of IIROC reviewed the Revised Proposed Guidance. MRAC is an advisory committee comprised of representatives of each of; the marketplaces for which IIROC acts as a regulation services provider; Participants; institutional investors and subscribers, and the legal and compliance community. The text of the Revised Proposed Guidance is set out in Appendix A. Comments are requested on all aspects of the Revised Proposed Guidance, including any matter not addressed specifically in the Revised Proposed Guidance. Comments should be in writing and delivered by May 2, 2012 to: 3 Presently, IIROC has been retained to be the regulation services provider for: the Toronto Stock Exchange ( TSX ), TSX Venture Exchange ( TSXV ) and Canadian National Stock Exchange ( CNSX ), each as an exchange for the purposes of the Marketplace Operation Instrument ( Exchange ); and for Alpha Trading Systems, Bloomberg Tradebook Canada Company, Chi-X Canada ATS Limited, Instinet Canada Cross Ltd., Liquidnet Canada Inc., Omega ATS Limited, Sigma X Canada, TMX Select and TriAct Canada Marketplace LP (the operator of MATCH Now ), each as an alternative trading system ( ATS ). CNSX presently operates an alternative market known as Pure Trading that is entitled to trade securities that are listed on other Exchanges and that presently trades securities listed on the TSX and TSXV. Exempt Order Designations 2

3 Kent Bailey, Senior Policy Analyst, Market Regulation Policy, Investment Industry Regulatory Organization of Canada, Suite King Street West, Toronto, Ontario. M5H 3T9 Fax: Commentators should be aware that a copy of their comment letter will be made publicly available on the IIROC website ( under the heading Policy and sub-heading Market Proposals/Comments ) upon receipt. A summary of the comments contained in each submission will also be included in a future IIROC Notice. After considering the comments on the Revised Proposed Guidance received in response to this Request for Comments, IIROC may make revisions to the Revised Proposed Guidance prior to the issuance of the final Guidance Note Background to the Revised Proposed Guidance 2.1 Amendments Respecting Short Sale Regulation Concurrent with the issuance of this Request for Comments on the Revised Proposed Guidance, IIROC has published a Rules Notice regarding the approval of the Short Sale Amendments. 5 The Revised Proposed Guidance should be reviewed in conjunction with the Short Sale Amendments, which will become effective on September 1, IIROC would expect to issue the final Guidance Note approximately 60 days before the Short Sale Amendments become effective. In particular, the Short Sale Amendments provide for the repeal of the restriction that a short sale of a security may only be made at a price not less than the last sale price ( tick test ). With the absence of the tick test or other restriction on the price at which a short sale may be made, the ability of IIROC to effectively monitor short selling activity for potentially manipulative or other abusive activity becomes increasingly important. Effective supervision and surveillance is dependent on an accurate, complete and timely audit trail. 4 5 IIROC intends to convene a meeting of marketplaces and service providers to discuss and agree on various implementation matters related to the UMIR amendments to short sales and failed trades. IIROC will take these consultations into account in preparing the final Guidance Note. IIROC Notice Rules Notice Notice of Approval UMIR Provisions Respecting Regulation of Short Sales and Failed Trades (March 2, 2012). Exempt Order Designations 3

4 2.2 Short-Marking Exempt Order Designation The Short Sale Amendments provide that orders from particular accounts for the purchase or sale of a security be designated as short-marking exempt on entry on a marketplace. Orders would be marked as short-marking exempt if the order is from an account that is: an arbitrage account which makes a usual practice of buying and selling securities in different markets to take advantage of differences in prices; the account of a person with market making, odd lot and other marketplace trading obligations in respect of a security for which that person has obligations( Marketplace Trading Obligations ); 6 a client, non-client or principal account: o for which order generation and entry is fully-automated, and o which, in the ordinary course, does not have at the end of each trading day more than a nominal position, whether short or long, in a particular security; or a principal account that has acquired during a trading day a position in a particular security in a transaction with a client that is unwound during the balance of the trading day such that, in the ordinary course, the account does not have, at the end of each trading day, more than a nominal position, whether short or long, in a particular security. Use of the short-marking exempt designation relieves the account from having to mark the order as short. Given the high volume and speed of orders generated by arbitrageurs, market makers and high-frequency traders coupled with the fact that these types of accounts may have orders on both sides of the market on various marketplaces at the same time, determining whether such orders are made from a long or short position at the time of the entry of additional sell orders is problematic. Use of the short-marking exempt designation in the manner proposed will allow IIROC to monitor separately the trading activities of those accounts which are actively buying and selling the same security without taking a directional position in that security and which have a finite time horizon of a trading day or less to effectively balance purchases and sales of the particular security. Further, this revised order marking requirement will permit IIROC to focus monitoring of short sale activity on accounts that have adopted a directional position with respect to particular securities. Additionally, IIROC has introduced an alert in its surveillance system that is triggered when there is an increase in the level of short selling of an individual security (based on historic levels of short selling activity for that particular security) combined with a significant price decline in the market price of the security. Removing much of the noise in the short sale 6 IIROC Notice Rules Notice Request for Comments UMIR Provisions Respecting Market Maker, Odd Lot and Other Marketplace Trading Obligations (April 23, 2010). Exempt Order Designations 4

5 data flowing from trades by persons who are not taking a directional position regarding the security should permit the alert to operate more effectively. The Proposed Guidance will remind Participants and Access Persons of their obligations to correctly designate all orders entered on a marketplace as required by Rule 6.2 of UMIR. The Proposed Guidance is also intended to provide guidance on various questions relating to the correct use of the short sale and short-marking exempt designations. 2.3 Summary of Revisions from the Original Proposed Guidance The Revised Proposed Guidance incorporates certain changes to the Original Proposed Guidance made in response to comments received on the Original Proposed Guidance and to revisions to the Short Sale Amendments from that which was initially proposed. 7 In particular, the Revised Proposed Guidance: recognizes that any client, non-client or principal account (and not just institutional customer accounts) can qualify to have orders marked as short-marking exempt provided the account has fully-automated order generation and is non-directional in its trading activity; recognizes that certain principal facilitation accounts may qualify to use the shortmarking exempt designation if the trading activity conducted in the account is nondirectional ; and recognizes that the short-marking exempt designation will be a separate new marker (and will not involve a change in use of the existing short exempt marker) 3. Questions While comment is sought on all aspects of the Revised Proposed Guidance, IIROC would specifically request response on the following questions: 1. Are there any additional matters which should be addressed in the final Guidance Note? In particular, are there any questions which should be added to the Question and Answer section of final Guidance Note? 7 See Appendix B for a summary of comments received on the Original Proposed Guidance and Appendix B of IIROC Notice for revisions to the Short Sale Amendments from those proposed in IIROC Notice Exempt Order Designations 5

6 Appendix A Text of Revised Proposed Guidance Rules Notice Guidance Note UMIR Please distribute internally to: Legal and Compliance Trading Contact: Kent Bailey Senior Policy Analyst, Market Regulation Policy Telephone: Fax: kbailey@iiroc.ca 12-00** **, 2012 Guidance on Short Sale and Short-Marking Exempt Order Designations Executive Summary This Rules Notice provides guidance on the marking of orders pursuant to UMIR to include short sale and short-marking exempt order designations. Any order to sell a security which the seller does not own either directly or through an agent or trustee must be marked short at the time of entry to a marketplace. An exception to this requirement is when the order is from an account for which purchase and sell orders are designated as short-marking exempt. If an account qualifies for the use of the short-marking exempt order designation, an order will only carry the short-marking exempt designation and should not also carry the short sale designation, even though the sale order may be from a short position. Exempt Order Designations 6 IIROC Notice 12-00** Rules Notice Request for Comments UMIR Proposed Guidance on Short Sale and Short-Marking Exempt Order Designations

7 Rules Notice Table of Contents 1. General Order Marking Requirement Short Sale Order Designation Short-Marking Exempt Order Designation Questions and Answers Impact on Existing Guidance General Order Marking Requirement Correct order designations are essential to maintaining an accurate and complete audit trail. A complete audit trail allows IIROC to effectively monitor trading activity on Canadian marketplaces and provides the supervisory personnel of each Participant with information that is necessary to enable them to carry out their supervisory obligations as required by Rule 7.1 of UMIR. IIROC has issued guidance on the procedures to be followed to correct the markers on executed trades. In particular, see IIROC Notice Rules Notice- Guidance Note UMIR User Guide for the Regulatory Marker Correction Form (July 30, 2008). Rule 6.2 of UMIR requires each order entered on a marketplace contain certain designations acceptable to IIROC, including the obligation of a Participant or Access Person to correctly designate whether an order is either: a short sale order; OR a short-marking exempt order. If an account qualifies for the use of the short-marking exempt order designation, as described below, the entry of orders by the account will only carry the short-marking exempt designation and should not also carry the short sale designation, even though the sale order may be from a short position. 1.1 Short Sale Order Designation UMIR defines a short sale as a sale of a security, other than a derivative instrument, which the seller does not own either directly or through an agent or trustee. A seller is considered to own a security if the seller: has purchased or has entered into an unconditional contract to purchase the security, but has not yet received delivery of the security; has tendered such other security for conversion or exchange or has issued irrevocable instructions to convert or exchange such other security; has an option to purchase the security and has exercised the option; Exempt Order Designations 7

8 has a right or warrant to subscribe for the security and has exercised the right or warrant; or has sold a security that trades on a when issued basis and the seller has entered into a contract to purchase such security, which is binding on both parties and subject only to the condition of issuance or distribution of the security. A seller is considered not to own a security if: the seller has borrowed the security to be delivered on the settlement of the trade and the seller does not otherwise own the security (e.g. none of the five circumstances listed above apply to the seller); the security held by the seller is subject to any restriction on sale imposed by applicable securities legislation or by an Exchange or QTRS as a condition of the listing or quoting of the security; or the settlement date or issuance date pursuant to: o an unconditional contract to purchase, o a tender of a security for conversion or exchange, o an exercise or an option, or o an exercise of a right or warrant would, in the ordinary course, be after the date for settlement of the sale. 1.2 Short-Marking Exempt Order Designation UMIR defines a short-marking exempt order as an order for the purchase or sale of a security from an account that is: an arbitrage account; 1 the account of a person with Marketplace Trading Obligations in respect of a security for which that person has obligations; 2 or 1 2 Rule 1.1 of UMIR provides that an arbitrage account means an account in which the holder makes a usual practice of buying and selling: (a) securities in different markets to take advantage of differences in prices available in each market; or (b) securities which are or may become convertible or exchangeable by the terms of the securities or operation of law into other securities in order to take advantage of differences in prices between the securities. Rule 1.1 of UMIR provides that Marketplace Trading Obligations means obligations imposed by: (a) Marketplace Rules on a member or user or a person employed by a member or user to guarantee: (i) a two-sided market for a particular security on a continuous or reasonably continuous basis, or Exempt Order Designations 8

9 a client, non-client or principal account: o for which order generation and entry is fully-automated, and o which, in the ordinary course, does not have, at the end of each trading day, more than a nominal position, whether short or long, in the particular security; or a principal account that has acquired during a trading day a position in a particular security in a transaction with a client that is unwound during the balance of the trading day such that, in the ordinary course, the account does not have, at the end of each trading day, more than a nominal position, whether short or long, in a particular security.. Given the exemptions which currently exist under UMIR that are available to arbitrage accounts and accounts with Marketplace Trading Obligations for particular securities, IIROC would expect that Participants are able to readily identify such accounts and trading activity. IIROC expects that the category of client, non-client or principal accounts would include accounts operating algorithms and classified as high-frequency traders. 3 In order for Participants to be able to properly identify accounts which would be required to designate orders as short-marking exempt, IIROC would expect the Participant to adopt compliance policies and procedures to regularly review the status of each account. As a general guideline, IIROC would accept that an account with automated order generation and entry would satisfy the requirements necessary to designate orders as short-marking exempt if the sole strategy of the account is to be directionally neutral on the price of securities traded. IIROC would accept this to be the case if on 90% of the trading days in the previous month, the aggregate net position of the account in respect of any security at the end of the trading day, whether short or long, did not exceed 5% of the volume of that security traded by the account on that trading day. For principal accounts which are used exclusively for facilitation purposes, there is no requirement that order generation and entry be automated but IIROC would expect that the account be directionally neutral such that on 90% of the trading days in the previous month, the aggregate net position of the account in respect of any security at the end of the trading day, whether short or long, did not exceed 5% of the volume of that security traded by the account on that trading day. 3 (ii) the execution of orders for the purchase or sale of a particular security which are less than a minimum number of units of the security as designated by the marketplace; or (b) contract between a marketplace and a member, user or subscriber to guarantee the execution of orders for the purchase or sale of a particular security which are less than a minimum number of units of the security as stipulated by the terms of the contract provided such number is less than one standard trading unit and the orders for the member, user or subscriber are automatically generated by the trading system of the marketplace. The term high frequency trader is not defined in UMIR. However, IIROC would expect that a high frequency trader would have direct electronic access to more than one marketplace to execute fully-automated trading strategies that seek to benefit from liquidity imbalances or other short-term pricing inefficiencies and the trading strategy is generally market-neutral or closed out by the end of each trading day. Exempt Order Designations 9

10 Participants may wish to encourage clients who conduct both high frequency trading and traditional directional investment, to do so in separate accounts. Similarly, if a Participant undertaking a client facilitation trade may carry a significant proportion of the position for more than one trading day, the trade should be conducted through an account which does not apply the short-marking exempt order designation. 2. Questions and Answers The following is a list of questions regarding when an order must be designated as a short sale or short-marking exempt upon entry to a marketplace: 1. Must an order be marked as a short sale if it is a bundled order that is comprised of orders from accounts that are both long and short the security? Yes. Orders are sometimes bundled when a Participant is working several orders for the same security for different clients and any executions are allocated proportionately among the clients. If at least one of the clients is a short-seller, each bundled order must contain the short sale designation. While bundling is generally not encouraged, IIROC is of the view that, in this particular situation, it would be appropriate to designate the entire order as a short sale upon entry to a marketplace. However, the Participant would be required to submit to IIROC a Regulatory Marker Correction Form 4 to un-bundle the long portion of any quantity executed which was allocated to any account which was long the security. The Regulatory Marker Correction Form should be filed as soon as practicable after the execution of the trade, and in any case, by the later of 5:00 p.m. and 15 minutes following the close of trading on the marketplace on which the trade was executed. 2. Can a short-marking exempt order be bundled with other orders including a short sale order? Yes. However, given the role of the short-marking exempt designation in IIROC s monitoring of trading activity, the bundling of a short-marking exempt order with other orders is generally discouraged. Having said that, if such bundling becomes necessary IIROC is of the view that: 4 For details on the use of the Regulatory Marker Correction Form, see IIROC Notice Rules Notice- Guidance Note UMIR User Guide for the Regulatory Marker Correction Form (July 30, 2008). Exempt Order Designations 10

11 upon entry to a marketplace, the entire order should be designated as short if the bundle contains a short sale and short-marking exempt if the bundle does not; and the Participant would be required to submit to IIROC a Regulatory Marker Correction Form to un-bundle the non- short-marking exempt portion of any quantity executed, which was allocated to any account which was not eligible to use the short-marking exempt designation. The Regulatory Marker Correction Form should be filed as soon as practicable after the execution of the trade, and in any case, by the later of 5:00 p.m. and 15 minutes following the close of trading on the marketplace on which the trade was executed. For details on the use of the Regulatory Marker Correction Form, see IIROC Notice Rules Notice- Guidance Note UMIR User Guide for the Regulatory Marker Correction Form (July 30, 2008). 3. If an account operates an inter-listed arbitrage strategy, should sell orders entered when the account is in a short position be designated as short sales? No. UMIR stipulates that the activity which occurs in an arbitrage account will be marked as short-marking exempt. Accordingly, all orders from an arbitrage account, either for the purchase or sale of a security, would be designated as short-marking exempt upon entry to a marketplace. 4. If a Participant has agreed to buy a block of stock from a client and is moving the market down to the agreed print price, should an order entered for the purpose of displacing the market be designated as a short sale? No. These orders are not required to be designated as short sales. In this situation, the Participant is considered to be long as the Participant committed to purchase the position from the client prior to displacing the market 5. Is a client who accesses a marketplace through a dealer-sponsored access arrangement subject to the order designation requirements? Yes. All orders entered on a marketplace must be properly designated. A Participant that provides clients with dealer-sponsored access to a marketplace must ensure that orders entered through such sponsored access arrangement are correctly designated. IIROC expects the Participant to review the designation of orders by clients with Exempt Order Designations 11

12 sponsored access as part of the Participant s supervisory procedures required by Rule 7.1 of UMIR. If the client is an institutional customer, the Participant should determine if the trading pattern of the account of the institutional customer is such that orders for the purchase or sale of a particular security should carry the designation short-marking exempt. The Participant should review periodically, and no less frequently than monthly, whether an account should be designating purchase and sale orders for particular securities as short-marking exempt. Similarly, if an institutional customer maintains an account with a Participant for which order entry is fully-automated (but does not have dealer-sponsored access to a marketplace), the Participant should review periodically, and no less frequently than monthly, whether the account should be designating purchase and sale order for particular securities as short-marking exempt. 6. Should all orders entered by a person with Marketplace Trading Obligations be designated as short-marking exempt? No. A person with Marketplace Trading Obligations should only designate purchase and sale orders for securities for which that person has responsibility as short-marking exempt. Orders for other securities would not be designated as short-marking exempt. An order for the short sale of a security for which the person does not have Marketplace Trading Obligations should be designated as a short sale. 7. A person holds an option and intends to pay the exercise price of the option from the proceeds of the sale of the securities that will be issued on the exercise of the option. Must the sell order be designated as a short sale? Yes. The definition of short sale in Rule 1.1of UMIR states that a seller shall be considered to own a security if the seller has an option to purchase the security and has exercised the option. Since the holder of the option has not done everything required to exercise the option (including the payment of the exercise price) at the time of the proposed sale, any sell order for the underlying securities must be designated as short upon entry to a marketplace. 8. Is there any difference in the order designation requirements if the order is entered on a marketplace prior to the marketplace opening for execution of trades? Exempt Order Designations 12

13 No. A short sale order entered on a marketplace in the pre-opening is required to be designated as a short sale. Orders entered on a marketplace during the preopening by an account that meets the definition of short-marking exempt order, whether a buy order or a sell order, must be designated as short-marking exempt. 9. I own shares of an issuer which are subject to a regulatory hold period that has not yet expired. While I am not able to sell the particular shares that are subject to the hold period, is any order to sell this security required to be designated as a short sale? Yes, assuming that the seller does not also hold a long position in the security which is not restricted. For the purposes of the UMIR definition of a short sale, a person will not be considered to own a security if the security is subject to a restriction on the sale imposed by applicable securities legislation or by a marketplace as a condition of listing or quoting the security. As such, a holder of a security which is subject to such a sale restriction who enters an order on a marketplace for the sale of a security before the expiration of the sale restriction must designate the sale order as a short sale. This obligation to mark the order as short sale applies even if the regulatory hold period will expire prior to the settlement of the trade. 10. I am long warrants and wish to hedge my exposure by selling the underlying securities. Is the order required to be designated as a short sale? Yes. The order would be required to be designated as a short sale upon entry to a marketplace. For the purposes of the UMIR definition of short sale, a long position in a warrant does not constitute a deemed long position of the underlying security unless irrevocable instructions to exercise the warrants have been submitted and the shares received through the exercise of the warrants would, in the ordinary course, settle prior to or on the settlement date of any sale affected through a marketplace. Similar marking requirements would apply to a person holding rights or convertible securities. Any sale of the underlying securities would have to be marked as a short sale unless the rights have been exercised or instructions to convert or exchange the convertible securities have been submitted and the person would, in the ordinary course, expect to receive the securities prior to or on the settlement date of the sale. Exempt Order Designations 13

14 3. Impact on Existing Guidance This Rules Notice repeals and replaces, effective as of September 1, 2012, the guidance set out in: Market Integrity Notice Guidance Short Sales Made in Furtherance of Market Maker Obligations (July 27, 2005); Market Integrity Notice Guidance Bundling Orders from a Long and Short Position (July 27, 2005); and Market Integrity Notice Guidance Short Sale Designations and Restrictions (April 7, 2006). Exempt Order Designations 14

15 Appendix B - Comments Received in Response to Rules Notice Request For Comments - UMIR - Proposed Guidance on Short Sale and Short-Marking Exempt Order Designations On February 25, 2011, the Investment Industry Regulatory Organization of Canada ( IIROC ) issued a notice requesting comments on proposed guidance respecting Short Sale and Short-Marking Exempt Order designations ( Proposed Guidance ). 1 IIROC received comments on the Proposed Guidance from: Alpha Group ( Alpha ) Canadian Securities Traders Association ( CSTA ) CNSX Markets Inc. ( CNSX ) The Investment Industry Association of Canada ( IIAC ) ITG Canada Corp. ( ITG ) Scotia Capital Inc. ( Scotia ) A copy of each comment letter in response to the Proposed Guidance is publically available on the website of IIROC ( under the heading Policy and sub-heading Market Proposals/Comments ). The following table presents a summary of each of the comments received on the Proposed Guidance together with the responses of IIROC to those comments. Column 1 of the table highlights the revisions to the Proposed Guidance made by IIROC in response to these comments. Text of Proposed Guidance (Suggested Revisions Highlighted) General Order Marking Requirement Correct order designations are essential to maintaining an accurate and complete audit trail. A complete audit trail allows IIROC to effectively monitor trading activity on Canadian marketplaces and provides the supervisory personnel of each Participant with information that is necessary to enable them to carry out their supervisory obligations as required by Rule 7.1 of UMIR. IIROC has issued guidance on the procedures to be followed to correct the markers on executed trades. In Commentator and Summary of Comment IIROC Response to Commentator and Additional IIROC Commentary 1 IIROC Notice Rules Notice Request for Comments UMIR Proposed Guidance On Short Sale and Short-Marking Exempt Order Designations (February 25, 2011). Exempt Order Designations 15 IIROC Notice 12-00** Rules Notice Request for Comments UMIR Proposed Guidance on Short Sale and Short-Marking Exempt Order Designations 15

16 Text of Proposed Guidance (Suggested Revisions Highlighted) particular, see IIROC Notice Rules Notice- Guidance Note UMIR User Guide for the Regulatory Marker Correction Form (July 30, 2008). Rule 6.2 of UMIR requires each order entered on a marketplace contain certain designations acceptable to IIROC, including the obligation of a Participant or Access Person to correctly designate whether an order is either: a short sale order; OR a short-marking exempt order. If an account qualifies for the use of the short-marking exempt order designation, as described below, the entry of orders by the account will only carry the shortmarking exempt designation and should not also carry the short sale designation, even though the sale order may be from a short position. Short Sale Order Designation UMIR defines a short sale as a sale of a security, other than a derivative instrument, which the seller does not own either directly or through an agent or trustee. A seller is considered to own a security if the seller: has purchased or has entered into an unconditional contract to purchase the security, but has not yet received delivery of the security; has tendered such other security for conversion or exchange or has issued irrevocable instructions to convert or exchange such other security; has an option to purchase the security and has exercised the option; has a right or warrant to subscribe for the security and has exercised the right or warrant; or has sold a security that trades on a when issued basis and the seller has entered into a contract to purchase such security, which is binding on both parties and subject only to the condition of issuance or distribution of the security. A seller is considered not to own a security if: the seller has borrowed the security to be delivered on the settlement of the trade and the seller does not otherwise own the security (e.g. none of the five circumstances listed above apply to the seller); the security held by the seller is subject to any restriction on sale imposed by applicable securities legislation or by an Exchange or QTRS as a condition of the listing or quoting of the security; or Commentator and Summary of Comment IIROC Response to Commentator and Additional IIROC Commentary Exempt Order Designations 16

17 Text of Proposed Guidance (Suggested Revisions Highlighted) the settlement date or issuance date pursuant to: o o o o an unconditional contract to purchase, a tender of a security for conversion or exchange, an exercise or an option, or an exercise of a right or warrant would, in the ordinary course, be after the date for settlement of the sale. Short-Marking Exempt Order Designation UMIR defines a short-marking exempt order as an order for the purchase or sale of a security from an account that is: an arbitrage account; 2 the account of a person with Marketplace Trading Obligations in respect of a security for which that person has obligations; 3 or Commentator and Summary of Comment CSTA Is supportive of the short-marking exempt order designation. Suggested that all sales from participants who employ a directionally neutral strategy be marked short exempt. CNSX Does not support the repurposing of an existing regulatory marker. Suggests that it is preferable to require the designation at the account level. IIROC Response to Commentator and Additional IIROC Commentary The amendments to UMIR which become effective September 1, 2012 expand the categories of accounts that would qualify for the use of the short-marking exempt order designation. IIROC agrees with the suggestion. 2 3 Rule 1.1 of UMIR provides that an arbitrage account means an account in which the holder makes a usual practice of buying and selling: (a) securities in different markets to take advantage of differences in prices available in each market; or (b) securities which are or may become convertible or exchangeable by the terms of the securities or operation of law into other securities in order to take advantage of differences in prices between the securities. Rule 1.1 of UMIR provides that Marketplace Trading Obligations means obligations imposed by: (a) Marketplace Rules on a member or user or a person employed by a member or user to guarantee: (i) a two-sided market for a particular security on a continuous or reasonably continuous basis, or (ii) the execution of orders for the purchase or sale of a particular security which are less than a minimum number of units of the security as designated by the marketplace; or (b) contract between a marketplace and a member, user or subscriber to guarantee the execution of orders for the purchase or sale of a particular security which are less than a minimum number of units of the security as stipulated by the terms of the contract provided such number is less than one standard trading unit and the orders for the member, user or subscriber are automatically generated by the trading system of the marketplace. Exempt Order Designations 17

18 Text of Proposed Guidance (Suggested Revisions Highlighted) a client, non-client or principal the account of an institutional customer 4 : (iii) (i) (ii) for which order generation and entry is fully-automated, and which, in the ordinary course, executes both purchases and sales of a particular security on one or more marketplaces on each trading day, and which, in the ordinary course, does not have, at the end of each trading day, more than a nominal position, whether short or long, in a the particular security at the end of each trading day; or a principal account that has acquired during a trading day a position in a particular security in a transaction with a client that is unwound during the balance of the trading day such that, in the ordinary course, the account does not have, at the end of each trading day, more than a nominal position, whether short or long, in a particular security. Given the exemptions which currently exist under UMIR that are available to arbitrage accounts and accounts with Marketplace Trading Obligations for particular securities, IIROC would expect that Participants are able to readily identify such accounts and trading activity. IIROC expects that the category of client, non-client or principal institutional customer accounts would include generally be limited to institutional accounts operating algorithms and classified as high-frequency traders. 5 In order for Participants to be able to properly identify accounts of institutional customers which would be required to designate orders as shortmarking exempt, IIROC would expect the Participant to adopt compliance policies Commentator and Summary of Comment ITG Requests guidance on IIROC s definition of ordinary course. Scotia Suggests that IIROC consider including proprietary facilitation trading as a market neutral strategy which is not directional. Scotia Raises a concern that high frequency trading is not defined. IIROC Response to Commentator and Additional IIROC Commentary The proposed guidance has set out a threshold of 90% of the trading days in the previous calendar month. The amendments to UMIR which become effective September 1, 2012 have been revised to remove the requirement related to continual activity in a particular security. IIROC agrees with the suggestion. The objective of IIROC is not to define high frequency traders but to limit the marker to accounts which trade with a strategy that is market neutral or closed out by the end of each trading day. 4 5 Rule 1.1 of the Dealer Member Rules of IIROC provides five broad categories of persons that would be considered institutional customers including: (a) acceptable counterparties as defined in Form 1 - Joint Regulatory Financial Questionnaire and Report ( Form 1 ); (b) acceptable institutions as defined in the Form 1; (c) regulated entities as defined in the Form 1; (d) registrants (other than individual registrants) under securities legislation; and (e) a non-individual with total securities under administration or management exceeding $10 million. In connection with these requirements, IIROC publishes annually a non-exhaustive list of entities which are acceptable counterparties and acceptable institutions. For a link to the most recent listing, see IIROC Notice Rules Notice Technical Dealer Member Rules Acceptable Institutions and Acceptable Counterparties Database (August 25, 2010). See also IIROC Notice Rules Notice Technical Dealer Member Rules List of Basle Accord Countries (November 19, 2010) which identified the 20 countries that then qualified as Basle Accord Countries and IIROC Notice Rules Notice Technical Dealer Member Rules List of Recognized Exchanges and Associations (Regulated Entities Purposes) (November 19, 2010) which identified 31 exchanges and associations the members of which would qualify as regulated entities. The term high frequency trader is not defined in UMIR. However, IIROC would expect that a high frequency trader would have direct electronic access to more than one marketplace to execute fully-automated trading strategies that seek to benefit from liquidity imbalances or other short-term pricing inefficiencies and the trading strategy is generally market-neutral or closed out by the end of each trading day. Exempt Order Designations 18

19 Text of Proposed Guidance (Suggested Revisions Highlighted) and procedures to regularly review the status of each institutional account. As a general guideline, IIROC would accept that an institutional account with automated order generation and entry would satisfy the requirements necessary to designate orders as short-marking exempt if the sole strategy of the account is to be directionally neutral on the price of securities traded. IIROC would accept this to be the case if,: on 75% of the trading days in the previous month, the account conducted both purchases and sales of a particular security; and on 90% of the trading days in the previous month, the aggregate net position of the account in respect of any security at the end of the trading day, whether short or long, did not exceed 5% of the volume of that security traded by the account on that trading day. For principal accounts which are used exclusively for facilitation purposes, there is no requirement that order generation and entry be automated but IIROC would expect that the account be directionally neutral such that on 90% of the trading days in the previous month, the aggregate net position of the account in respect of any security at the end of the trading day, whether short or long, did not exceed 5% of the volume of that security traded by the account on that trading day. Participants may wish to encourage clients institutional customers who conduct both high frequency trading and traditional directional investment, to do so in separate accounts. Similarly, if a Participant undertaking a client facilitation trade may carry a significant proportion of the position for more than one trading day, the trade should be conducted through an account which does not apply the shortmarking exempt order designation. 1. Must an order be marked as a short sale if it is a bundled order that is comprised of orders from accounts that are both long and short the security? Yes. Orders are sometimes bundled when a Participant is working several orders for the same security for different clients and any executions are allocated proportionately among the clients. If at least one of the clients is a short-seller, each bundled order must contain the short sale designation. While bundling is generally not encouraged, IIROC is of the view that, in this particular situation, it would be appropriate to designate the entire order as a Commentator and Summary of Comment ITG Notes the difficulty with reporting marker correction by 5pm EST on the day of trading. They suggest bulk reporting ability when there are more than 10 trades to report on one symbol and that IIROC extend the reporting deadline to 12pm EST on T+1. IIROC Response to Commentator and Additional IIROC Commentary The timing was established to accommodate mandated reporting by marketplaces using various order designations. In particular, marketplaces had expressed interest in making summary short sale information available each trading day. While no marketplace has moved to introduce such a data product, IIROC and the CSA have published a joint notice requesting comment on issues of transparency of short sales and failed trades and, in particular, comment on the extent and timeliness of short sale trading information. Exempt Order Designations 19

20 Text of Proposed Guidance (Suggested Revisions Highlighted) short sale upon entry to a marketplace. However, the Participant would be required to submit to IIROC a Regulatory Marker Correction Form 6 to unbundle the long portion of any quantity executed which was allocated to any account which was long the security. The Regulatory Marker Correction Form should be filed as soon as practicable after the execution of the trade, and in any case, by the later of 5:00 p.m. and 15 minutes following the close of trading on the marketplace on which the trade was executed. 2. Can a short-marking exempt order be bundled with other orders including a short sale order? Yes. However, given the role of the short-marking exempt designation in IIROC s monitoring of trading activity, the bundling of a short-marking exempt order with other orders is generally discouraged. Having said that, if such bundling becomes necessary IIROC is of the view that: upon entry to a marketplace, the entire order should be designated as short if the bundle contains a short sale and short marking exempt if the bundle does not upon entry to a marketplace; and the Participant would be required to submit to IIROC a Regulatory Marker Correction Form to un-bundle the non- short-marking exempt portion of any quantity executed, which was allocated to any account which was not eligible to use the short-marking exempt designation. The Regulatory Marker Correction Form should be filed as soon as practicable after the execution of the trade, and in any case, by the later of 5:00 p.m. and 15 minutes following the close of trading on the marketplace on which the trade was executed. For details on the use of the Regulatory Marker Correction Form, see IIROC Notice Rules Notice- Guidance Note UMIR User Guide for the Regulatory Marker Correction Form (July 30, 2008). 3. If an account operates an inter-listed arbitrage strategy, should sell orders entered when the account is in a short position be designated as short sales? No. UMIR stipulates that the activity which occurs in an arbitrage account will be marked as short-marking exempt. Accordingly, all orders from an arbitrage account, either for the purchase or sale of a security, would be designated as short-marking exempt upon entry to a marketplace. Commentator and Summary of Comment IIAC Believes that the requirement to file a Regulatory Marker Correction Form by the later of 5:00 pm and 15 minutes following the close of trading does not provide enough time to ensure the information is complete and accurate. ITG Suggests that bundled trades which include both short sales and short marking exempt sales should be marked as short sales to enable better monitoring of directional short sales rather than waiting for the trades to be un-bundled. IIROC Response to Commentator and Additional IIROC Commentary See response to ITG comment above. IIROC agrees with the suggestion. 6 For details on the use of the Regulatory Marker Correction Form, see IIROC Notice Rules Notice- Guidance Note UMIR User Guide for the Regulatory Marker Correction Form (July 30, 2008). Exempt Order Designations 20

21 Text of Proposed Guidance (Suggested Revisions Highlighted) 4. If a Participant has agreed to buy a block of stock from a client and is moving the market down to the agreed print price, should an order entered for the purpose of displacing the market be designated as a short sale? No. These orders are not required to be designated as short sales. In this situation, the Participant is considered to be long as the Participant committed to purchase the position from the client prior to displacing the market. 5. Is a client who accesses a marketplace through a dealer-sponsored access arrangement subject to the order designation requirements? Yes. All orders entered on a marketplace must be properly designated. A Participant that provides clients with dealer-sponsored access to a marketplace must ensure that orders entered through such sponsored access arrangement are correctly designated. IIROC expects the Participant to review the designation of orders by clients with sponsored access as part of the Participant s supervisory procedures required by Rule 7.1 of UMIR. If the client is an institutional customer, the Participant should determine if the trading pattern of the account of the institutional customer is such that orders for the purchase or sale of a particular security should carry the designation short-marking exempt. The Participant should review periodically, and no less frequently than monthly, whether an account should be designating purchase and sale orders for particular securities as shortmarking exempt. Similarly, if an institutional customer maintains an account with a Participant for which order entry is fully-automated (but does not have dealer-sponsored access to a marketplace), the Participant should review periodically, and no less frequently than monthly, whether the account should be designating purchase and sale order for particular securities as short-marking exempt. 6. Should all orders entered by a person with Marketplace Trading Obligations be designated as short-marking exempt? No. A person with Marketplace Trading Obligations should only designate purchase and sale orders for securities for which that person has responsibility as short-marking exempt. Orders for other securities would not be designated as short-marking exempt. An order for the short sale of a security for which the person does not have Marketplace Trading Obligations should be designated as a short sale. Commentator and Summary of Comment ITG Requests guidance as to whether the seller, who has agreed upon the discounted block sale, can allow the dealer who is taking on the liability to take the sales for their inventory on the way down to the cross price. IIAC Is concerned that the guidance relating to institutional customers creates practical problems, particularly DSA clients. The detailed information required by the participant to determine whether a client should be marking sales as short-marker exempt will be difficult to obtain. ITG Is concerned that should a high frequency trading client decide to become active in a new name, it would take compliance a month to determine that the client should be marking these trades as short marker exempt. They note that this concern would equally apply to market makers who may be active in names in which they do not officially make markets. ITG suggests that Market Makers who are also active enough to meet the threshold in names they do not officially make markets should mark orders as short marker exempt. IIROC Response to Commentator and Additional IIROC Commentary The situation referenced by ITG is covered by the provisions of the frontrunning rule which permits transactions by the Participant with the objective of facilitating a principal trade with the client. Reference should be made to Rule 4.1 of UMIR and the guidance issued in respect of that rule. The rule has been drafted as principle-based and IIROC has proposed guidance as to what IIROC would generally accept. The two basic elements are: automated order generation and entry; and directionally neutral strategy. IIROC revised the requirements for the definition of an account that would use the short-exempt marking designation to allow the Participant to make the determination based on the declared strategy of the account (as a result of the deletion of the requirement that trading in the security be conducted on average on 75% of the trading days in the preceding month). The status of the account would then be monitored by the Participant based on activity during the previous calendar month. IIROC has revised the criteria which would permit such marking only if the account is directionally neutral. Exempt Order Designations 21