“Fails to Deliver” Plummet at Nasdaq

Nasdaq Stock Market has seen its list of securities with large amounts of fail-to-deliver shares resulting from short sales plummet in the wake of the Securities and Exchange Commission’s mid-September penalty on broker-dealers that allow fails.

According to Robert Greifeld, president and CEO of Nasdaq OMX Group, Nasdaq had reached a high of 443 stocks on its “threshold list” of securities prior to the SEC’s September 17 Emergency Order laying out the Commission’s new requirements. The threshold list includes stocks with failures to deliver for at least five settlement days exceeding 10,000 shares and half of one percentage point of the stock’s outstanding shares.

Earlier this week there were 95 stocks on that threshold list, Greifeld said, and the “full impact” of the SEC’s rule has not yet been felt. (Nasdaq’s threshold list yesterday included 59 names.) Greifeld noted that he expected the threshold list to drop to the “low single digits” in the coming weeks. The exchange executive made these comments at the Securities Industry and Financial Markets annual meeting in New York on Tuesday.

Greifeld told reporters after his talk that the “rules put in place are working with respect to [naked] short selling.” Naked short selling refers to short sales executed with no intention to borrow the shares needed to settle the transaction on the settlement date, which is T+3. The SEC has said repeatedly in recent months that potentially abusive naked short selling can disrupt and harm the securities markets.

Duncan Niederauer, CEO of NYSE Euronext, also commented on the SEC’s new T+3 requirements at the SIFMA conference. Referring to the SEC’s introduction of a penalty, Niederauer he said that “that alone is the best thing we could have done” to reduce potentially abusive naked short selling. He added that the T+3 delivery requirements, which had been on the books for some time, previously “were not adequately enforced.”

Both Greifeld and Niderauer said they supported the SEC’s new T+3 penalty. That penalty is due to expire next July.

On September 18, a day before it temporarily banned short selling in financial stocks, the SEC implemented Rule 204T of Reg SHO, which it had announced the prior day in an Emergency Order. Rule 204T imposed a penalty on brokers with fail-to-deliver positions resulting from short sales. Those brokers cannot execute new short sales in stocks that fail to settle by 9:30 a.m. on T+4 without first borrowing or “pre-borrowing” the shares needed for those transactions, until the existing failed position is settled. At a minimum, that would be T+6. The pre-borrow penalty therefore makes future trades more costly and cumbersome for brokers.

The Emergency Order lapsed on October 17, but the SEC implemented Rule 204T as an immediately effective “interim final temporary rule” that expires on July 31, 2009. In its interim final temporary rule, the SEC commented that “notice and public procedure in advance of effectiveness of the rule are impracticable, unnecessary, and contrary to the public interest.” The SEC is now accepting comments on this rule and will have to decide, before next July, whether to continue the rule, modify it or scrap it altogether.

The SEC’s stringent September 17 Emergency Order, Greifeld said, “is the right philosophical market structure in place today” to address naked short selling. He told reporters that he thought the SEC should keep the penalty in place after next July. He added that he did not think the SEC should extend the time before the penalty is imposed to T+4 or T+5, as some in the industry have suggested.