Elsewhere in the same subsection the number 11850 simply does not appear, with no adoption, amendment or deletion history. How does FINRA Rule 11830 differ?

It was reserved at the subsection's adoption for a provision that was never afterwards written

It was an operative rule for roughly seventeen years before being deleted

It was renumbered into a different subsection, its old number being retained as a pointer

It has always been reserved, the designation having been carried across from the predecessor rulebook

Two rule filings took effect on the same day in December 2010 and both reached FINRA Rule 11830. What did each do?

Both transferred it, the second correcting an error in the first filing's text

Both deleted it, the second removing a cross-reference the first had left behind

One amended it as part of the rulebook transfer, the other deleted it

One deleted it and the other reinstated it under a different number in the same series

FINRA Rule 11830 was deleted as part of the reorganisation that moved the Uniform Practice Code into the Consolidated FINRA Rulebook. What does that suggest became of whatever substantive content the rule then held?

It was moved to another rule number, folded into another provision, or judged unnecessary as a standalone Code rule

It was struck out at the SEC's direction as inconsistent with the Exchange Act, the Code keeping nothing in its place

It was placed in abeyance under the same number, to be restored once the Consolidated Rulebook's close-out rules were settled

It passed into the Incorporated NYSE Rules, which continued to govern members' close-outs alongside the Consolidated Rulebook

FINRA Rule 11830 now carries a Reserved designation. What does that designation do?

It preserves the rule's last text in force for transactions entered into before the rule's deletion took effect

It keeps the rule's number in the Uniform Practice Code's numbering sequence while no operative rule text corresponds to it

It holds the number for a replacement rule that FINRA has filed with the SEC and is still awaiting approval

It directs readers to the next rule in the subsection, which took over the deleted rule's provisions

The Uniform Practice Code's Close-Out Procedures subsection is built around two principal close-out remedies. What are they?

The reclamation and the mark to the market

The sell-out and the mark to the market

Under the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71), a covered short sale remained undelivered past the period the provision allowed. On whom did the obligation to close out the contract fall?

The clearing corporation, which closed out aged fails for the accounts of its participants

The buying firm, which had to issue a buy-in notice before the contract could be closed

The NASD, which closed the contract against the seller once the stock appeared on its list

The broker-dealer representing the seller, whether or not the buying firm took any step

A covered short sale fails to deliver within the period allowed by the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71). How was the contract to be closed?

By purchasing securities of like kind and quantity, for cash or guaranteed delivery

By cancelling the contract and returning the buyer's payment, with interest for the delay

By delivering securities borrowed through the clearing corporation's stock loan program

By paying the buyer the difference between the contract price and the current market price

A broker-dealer sells a stock on the NASD's restricted list short from its own proprietary account to another broker-dealer, and delivery fails past the period allowed. Did the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71) apply to the contract?

No, since the provision reached customers' short sales, a member's own being left to net capital rules

Yes, since the provision reached short sales for a member's own account just as for a customer's

No, since a sale between two broker-dealers settled outside the clearing corporation and so outside the provision

Yes, but only if the firm's own short position in the stock exceeded its customers' combined short positions

Under the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71), a covered short sale's normal settlement date is a Friday, and no holidays intervene. The securities are delivered twelve calendar days later, on the Wednesday of the second following week. Was a close-out required?

Yes, since the period was 10 calendar days, which had run out two days before delivery

Yes, since a short sale had to be delivered by the third business day after settlement

No, since that is the eighth business day and the period was 10 business days

Yes, since the period was five business days, which ran out on the following Friday

Under the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71), a customer's short sale is executed while the stock is on the NASD's restricted list. Two days later the stock is dropped from the list, and the sale then goes undelivered past the permitted period. Must the contract be closed out?

No, since coverage was tested on the day the delivery period expired

No, since removal from the list released every open short sale in the stock

Yes, provided the stock was back on the list before the delivery period expired

Yes, since the list's status when the trade was executed governed that trade

A customer is short 100 shares of a stock on the NASD's restricted list and holds a long call on 100 shares of the stock that can be exercised only after 120 days. Under the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71), how much of the short was exempt as fully hedged?

None of it, since the call had to be exercisable within 90 calendar days

All 100 shares, since any long call on the same stock offset the short

Half of it, since a longer-dated call hedged part of the short and not the whole

All 100 shares once the call became exercisable, the exemption running from then

An issue has 20,000,000 shares outstanding and a clearing short position of 60,000 shares. Did the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71) cover short sales in it?

Yes, since a clearing short position of 10,000 shares or more was enough by itself for coverage

No, since 60,000 shares is 0.3 percent, below the half-percent condition that also had to be met

Yes, since 60,000 shares is 3 percent of the issue, well above the half-percent condition for coverage

No, since a clearing short position had to reach 100,000 shares before an issue was covered

A member enters a short sale for a customer in a security on the NASD's restricted list, under the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71). What did the member owe that customer?

It had to obtain the customer's written consent before any close-out was executed

It had to post the customer's short sale proceeds with the NASD until delivery

It had to tell the customer about the mandatory close-out requirement

It had to refuse the order unless the customer already held a qualifying hedge

A stock is listed only on the New York Stock Exchange. Its clearing short position is 2,000,000 shares, 5 percent of shares outstanding, and a short sale in it goes undelivered for three weeks after normal settlement. Did the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71) require a close-out?

Yes, since the provision reached any short sale that stayed undelivered past its period

Yes, since its clearing short position was well above the threshold the provision set for coverage

No, since three weeks after settlement was still within the period the provision allowed

No, since the provision reached short sales in Nasdaq securities, whatever the clearing short position

Which of these failed short sales in a stock on the NASD's restricted list was taken out of the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71)?

A short sale a market maker made as part of bona fide market making in the stock

A short sale made by a member firm whose net capital well exceeded its required minimum amount

A short sale made for an institutional customer, the provision being aimed at retail accounts

A short sale for which the member had located borrowable shares before the sale was executed

Under the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71), a customer sells short 100 shares of a stock on the restricted list. Five days later, before delivery is due, the customer buys a long position that would otherwise have qualified as a full hedge. Is the short sale exempt?

Yes, since the hedge was in place before the delivery period ran out

No, since whether a full hedge existed was judged on the short sale's transaction date

Yes, since hedges were measured at month-end, when members reported their short positions

No, since a hedged short sale had to be approved by the NASD before its execution

A trader buys 100 shares of a stock on the London Stock Exchange and at the same moment sells 100 shares of the same stock, which is on the NASD's restricted list, short in the United States, to profit from the price difference between the two markets. How did the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71) treat the short?

It was covered, since the long leg sat in a different market and could not be delivered against it

It was covered unless the London shares were delivered to the buyer within the delivery period

It was exempt, the two legs forming a bona fide fully arbitraged position

It was covered, since arbitrage exemptions reached convertible securities and not the same stock

A customer is short 100 shares of a stock on the NASD's restricted list trading at 30, and holds one long call on 100 shares of the stock, struck at 35 and exercisable within the next month. Under the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71), was the short exempt?

Yes, since a higher strike made the call a stronger hedge against a rise in the stock

Yes, since a call on the same number of shares fully hedged a short at any strike

No, since a call hedged a short only when its strike exactly equalled the market price

No, since the call was out of the money, its strike above the market price

A firm is short 100 shares of a stock on the NASD's restricted list trading at $26. It is long one debenture convertible immediately into 40 shares at $25 a share. Under the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71), how much of the short position was exempt?

40 shares, the number the debenture converted into, the other 60 not being exempt

All 100 shares, a single convertible debenture hedging the whole of the short position

None of it, since a debenture that is not the short security itself could not hedge it

The shares the debenture's market value would buy at $26, the rest not being exempt

A trader is short 400 shares of a stock on the NASD's restricted list trading at $2 and is long 200 warrants, each exercisable immediately into one share at $3 and each worth $0.70. Under the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71), how much of the short was exempt?

200 shares, one long warrant standing against each share sold short

70 shares, the warrants' $140 market value divided by the $2 share price

None of it, the warrants being out of the money and so no hedge at all

330 shares, the part of the short left over once the warrants' value is deducted

A trader holds 300 shares of a target company that is being acquired, each target share to be exchanged for 0.5 of an acquirer share within six weeks. The trader is also short acquirer shares, which are on the NASD's restricted list. Under the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71), how large a short in the acquirer was exempt?

300 shares, one acquirer share counted for each target share held long

600 shares, the target shares multiplied by the inverse of the exchange ratio

150 shares, the number of acquirer shares the 300 target shares exchange into

None, an acquisition exchange not being a conversion privilege that hedges a short

The NASD's 1986 study of short-sale practices, which led to the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71), identified a gap. What was it?

Buyers left undelivered had no remedy against the seller until the contract was cancelled

Clearing corporations closed out aged short positions automatically, too harshly in stressed markets

Short sales settled on a longer cycle than long sales, which delayed every delivery

Nothing automatically prevented short positions from building up at clearing corporations

Which kind of failed delivery was the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71) designed to address?

Persistent fails, rather than temporary ones that resolve themselves in the ordinary course

Every fail on a short sale, however brief, from the first day after normal settlement

Fails arising at settlement between two clearing corporations in different markets

Fails in securities newly issued in a public offering, before their trading settled down

A stock has trades unsettled at the clearing corporation. In the NASD's analysis behind the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71), why did such fails not by themselves establish short selling?

Fails at the clearing corporation were netted away daily, so no fail stayed on its books for long enough to measure

Other causes, such as segregation under SEC Rule 15c3-3, transfer delays or a feature of the security, also leave trades unsettled

Short sales settled outside the clearing corporation, directly between the two broker-dealers to the trade

Naked short sales were delivered on time as a rule, the seller borrowing the shares at settlement from a lender

Naked short sellers already had to deposit margin with a broker-dealer or a clearing corporation. Why did the NASD still see a need for the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71)?

Margin was held by the clearing corporation, beyond the reach of the buyer left without delivery

Margin was set as a fixed sum per trade, not rising with the size of the short position taken

Margin still left them more leverage than a timely close-out would, leverage usable for bear raids

Margin requirements lapsed once a short position had stayed open beyond one settlement cycle

Commenters asked the NASD for easier exemptions for short positions hedged with warrants under the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71). What danger did the NASD cite in keeping the warrant exemption narrow?

Issuers could cancel outstanding warrants at will, removing the hedge after the short sale

Warrants could be exercised at expiry and not before, so no stock arrived within the period

Warrant exercise diluted the issuer's shares, so exempting the shorts would depress the price

A warrant priced near zero would permit virtually unlimited short selling with no delivery

A firm tracing a former NASD rule into the consolidated FINRA Uniform Practice Code relies on FINRA's Rule Conversion Charts. What did Regulatory Notice 10-49 say about relying on them?

They are a reference aid, and do not replace diligent review of the new rule language

They are binding, a mapping shown on them controlling where it differs from a new rule's text

They may be relied on in place of the new rules until FINRA publishes its interpretations

They are advisory for NYSE-derived rules but binding for the rules derived from NASD rules

When the NASD adopted its 1993 mandatory close-out for short sales (Uniform Practice Code Section 71), it cited an analysis of the factors behind fails-to-deliver at the National Securities Clearing Corporation. Which combination of conditions did that analysis find pointed towards fails developing in a stock?

High average daily volume in the stock, together with a large float in the security

High average daily volume in the stock, together with a small float in the security

Low average daily volume in the stock, together with a small float in the security

Low average daily volume in the stock, together with a large float in the security

Under the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71), a customer is short 100 shares of a stock on the NASD's restricted list trading at $55. The customer holds one long call on 100 shares of the stock with a strike price of $55, exercisable within 45 days. Was the short exempt as fully hedged?

No, since a call at the money has no value above its strike and so offset none of the short position

Yes, but only for the shares the call's premium would buy at the $55 market price, the rest not being exempt

Yes, the whole short, since the guideline accepted a call whose strike price equalled the stock's current price

No, since a long call hedged a short only once it was exercised and the shares were received before delivery fell due

Under the NASD's 1993 mandatory close-out for short sales (Uniform Practice Code Section 71), a firm is short 250 shares of a stock on the NASD's restricted list trading at $50. It holds convertible preferred stock, convertible within 20 days into a total of 250 shares of that stock at a conversion price of $42 a share. How much of the short was exempt as fully hedged?

Only the shares the preferred's market value would buy at the $50 share price, the rest not being exempt

None of it, since among convertible securities only debentures, and not preferred stock, could hedge a short

None of it, since a preferred stock ranks ahead of the common and so stood outside the hedging guidelines

All of it, since a convertible preferred with an in-the-money conversion price was an accepted hedge

FINRA Rule 11830: Reserved Rule and Short Sale Close-Out

What Does Reserved Mean for FINRA Rule 11830?

FINRA Rule 11830 is currently a Reserved rule number within the FINRA Rule 11800 Close-Out Procedures subsection — but, unlike a number that has simply never been populated, FINRA Rule 11830 has a confirmed substantive history: it was approved by the SEC on July 14, 1993, the date FINRA’s rule page lists for its adoption, took effect October 12, 1993 according to Notice to Members 93-53, was amended by SR-NASD-2004-175 effective January 3, 2005, and then amended by SR-FINRA-2010-030 effective December 15, 2010 — on which same date it was deleted by SR-FINRA-2010-060.

FINRA Rule 11830’s FINRA.org page now returns no operative rule text, consistent with this deletion.

Two selected notices remain associated with the rule’s history — Notice to Members 93-53 and Regulatory Notice 10-49.

FINRA Rule 11830 sits within the 11800 Close-Out Procedures subsection of the 11000 Uniform Practice Code, immediately following FINRA Rule 11820’s selling-out framework and immediately preceding FINRA Rule 11840’s rights and warrants framework.

What “Reserved” Means Here: A Deleted Rule, Not an Unused Number

FINRA Rule 11830’s Reserved status is meaningfully different from, for example, the gap this dictionary identified between FINRA Rules 11840 and 11860 — where FINRA Rule 11850 simply does not appear in the numbering sequence at all, with no adoption, amendment, or deletion history of its own.

FINRA Rule 11830, by contrast, occupied an active position in the Uniform Practice Code for roughly seventeen years — from its July 14, 1993 adoption, through a 2005 amendment, up to the December 15, 2010 Consolidated FINRA Rulebook transfer — before being deleted as part of that 2010 transfer.

This pattern — a rule amended by SR-FINRA-2010-030 (the general Consolidated Rulebook transfer amendment this dictionary has traced throughout its coverage) and simultaneously deleted by SR-FINRA-2010-060 — suggests that whatever substantive content FINRA Rule 11830 contained as of 2010 was, as part of the broader 2010 Consolidated Rulebook reorganization, either relocated to a different rule number elsewhere in the rulebook, consolidated into another provision, or determined to be no longer necessary as a standalone Uniform Practice Code provision — with the Reserved designation simply marking that FINRA Rule 11830’s number remains part of the Uniform Practice Code’s numbering sequence (positioned, as confirmed, between FINRA Rule 11820 and FINRA Rule 11840) without currently corresponding to any operative rule text.

The 1993 Adoption and Notice 93-53

FINRA Rule 11830’s 1993 adoption date — and its associated Notice to Members 93-53 — situates its original adoption within a period this dictionary has not previously encountered in its coverage of the Uniform Practice Code’s amendment history.

The other 1990s-era provisions this dictionary has examined trace to either the SR-NASD-91-13 wave effective November 1, 1991 (FINRA Rules 11120, 11320, 11530, 11560, 11571, 11720, 11820), the SR-NASD-94-56 amendment effective June 7, 1995 (FINRA Rule 11150, FINRA Rule 11620), or FINRA Rule 11580’s 1996 origin under SR-NASD-95-53.

FINRA Rule 11830’s July 14, 1993 adoption falls between these two clusters, and its 2005 amendment under SR-NASD-2004-175 represents a further refinement this dictionary has not encountered associated with any other rule examined to date.

Notice 93-53 shows that the provision the SEC approved on July 14, 1993 was a new Section 71 of the Uniform Practice Code requiring the close-out of certain short sales in Nasdaq securities (described in the sections below), but without the rule’s pre-deletion text available, this dictionary cannot identify how FINRA Rule 11830 read after its 2005 amendment, nor where (if anywhere) its substantive content may have been relocated as part of the 2010 Consolidated Rulebook transfer.

This dictionary notes the confirmed adoption, amendment, and deletion dates, and the two associated notices, without speculating further as to content this dictionary cannot verify.

FINRA Rule 11830’s Position Within the FINRA Rule 11800 Subsection

FINRA Rule 11830’s position — immediately following FINRA Rule 11820’s Selling-Out framework and immediately preceding FINRA Rule 11840’s Rights and Warrants framework — places it within the close-out-procedures portion of the FINRA Rule 11800 subsection, between the two principal close-out remedies (buy-in under FINRA Rule 11810, sell-out under FINRA Rule 11820) and the more specialized categories (rights and warrants under FINRA Rule 11840, and the further specialized rules this dictionary anticipates examining) that follow.

Given FINRA Rule 11830’s 1993 origin — falling after FINRA Rule 11820’s 1969/1991 history but using a number positioned between FINRA Rule 11820 and FINRA Rule 11840 — Notice 93-53 bears out that FINRA Rule 11830 was originally adopted in 1993 to address an aspect of close-out procedures that arose as a discrete addition to the framework FINRA Rules 11810 and 11820 had already established: a mandatory close-out of certain short sales, occupying the available 11830 slot between those two established rules and the subsequent FINRA Rule 11840.

The numbering itself remains context rather than confirmed history, since neither selected notice states the rule number that Section 71 later carried.

Connection to FINRA Rules 11800, 11810, 11820, and 11840

FINRA Rule 11830 connects to FINRA Rule 11800 as its parent series marker, occupying a position within that subsection’s organized entry list notwithstanding its currently-empty content.

It connects to FINRA Rule 11810 and FINRA Rule 11820 — the two principal close-out remedies (buy-in and sell-out) immediately preceding FINRA Rule 11830 in the subsection’s sequence, both of which this dictionary has now examined in full.

And it connects to FINRA Rule 11840 — the next rule in the subsection, Rights and Warrants, which this dictionary anticipates examining next.

What Notice to Members 93-53 Announced

FINRA lists two selected notices for Rule 11830.

The earlier one, Notice to Members 93-53, is titled “SEC Approves Amendments Relating to Close Outs of Short Sales and Bona Fide Fully Hedged or Arbitraged Positions”.

It announced that on July 14, 1993, the date FINRA’s rule page gives for Rule 11830’s adoption, the SEC approved a new Section 71 of the Uniform Practice Code, “Mandatory Close-Out for Short Sales”. Section 71 is the only new Uniform Practice Code section the Notice announces.

The same approval amended the NASD Board of Governors’ Interpretation on the Prompt Receipt and Delivery of Securities. That amendment added guidelines on what counts as a “bona fide fully hedged” or “bona fide fully arbitraged” position for Section 71’s exemption.

The Notice gave October 12, 1993 as the date the amendments took effect.

Neither selected notice states the later rule number of Section 71. The rule was amended again by SR-NASD-2004-175, effective January 3, 2005, and neither notice sets out that amendment.

The sections below therefore describe Section 71 as Notice 93-53 prints it, the provision as adopted in 1993. They do not describe the text in force when the rule was deleted in 2010.

The Close-Out Obligation: Who, When and How

Section 71 put the close-out duty on the seller’s side of the trade.

A contract involving a short sale in a covered Nasdaq security that “has not resulted in delivery by the broker-dealer representing the seller within 10 business days after the normal settlement date” had to be closed by the broker-dealer representing the seller.

The duty did not wait on anything the buying firm did. The provision says the contract “must be closed” by the seller’s broker-dealer, and it names no step for the buyer to take.

The close-out was a purchase. The seller’s broker-dealer closed the contract by buying, for cash or guaranteed delivery, securities of like kind and quantity. Cancelling the contract was not the method the provision gave, and neither was waiting for the buyer to buy in.

The clock ran in business days from the normal settlement date.

Suppose a short sale in a covered security settles normally on a Monday, and the seller’s broker-dealer delivers on the sixth business day after that date. No close-out is required, because delivery occurred within the 10 business days. If nothing has been delivered when the tenth business day after normal settlement has passed, the seller’s broker-dealer must close the contract by purchase.

The provision applied whoever the short seller was. It reached short sales “for the account of a customer or for a member’s own account”.

A firm that sold a covered security short from its proprietary account to another broker-dealer and failed to deliver within the period was bound to close out, just as it was when it made the same sale for a customer.

Which Securities Were Covered: The Threshold and the Restricted List

Section 71 did not reach every short sale. It applied to short sales in Nasdaq securities, and only to those Nasdaq securities, “as published by the Association”, that had clearing short positions of 10,000 shares or more and equal to at least one-half of one percent of the issue’s total shares outstanding. Both conditions had to be met.

An issue with 20,000,000 shares outstanding and a clearing short position of 60,000 shares meets the share condition. It fails the percentage condition, because 60,000 shares is 0.3 percent. It was not covered.

An issue with 1,000,000 shares outstanding and a clearing short position of 8,000 shares is at 0.8 percent. It fails the 10,000-share condition and was not covered either.

The provision was framed around short sales in Nasdaq securities. A failed long sale was not a contract involving a short sale, and a short sale in a security that was not a Nasdaq security was outside the provision, whatever its clearing short position.

Members did not work out coverage for themselves.

The NASD identified the covered securities daily from National Securities Clearing Corporation data and compiled a “restricted list”. Nasdaq workstations showed a short-sale restriction indicator for listed securities, and the list was available on request.

A firm’s own estimate that a stock had crossed, or had not crossed, the threshold did not decide the matter. The published list did.

The list’s status when the trade was executed controlled. If a security was on the restricted list when a short sale was executed, the trade had to be closed out even if the security was later dropped from the list. If the security was placed on the list only after the trade was executed, close-out was not required for that trade.

A member that entered a short sale in a restricted security for a customer had a duty to that customer. It had to inform the customer of the mandatory close-out requirement.

Exemptions: Market Making, Hedged and Arbitraged Positions

Section 71(b) took two kinds of transaction out of the close-out requirement: bona fide market making transactions, and transactions resulting in bona fide fully hedged or bona fide fully arbitraged positions. A market maker’s short sale made as part of bona fide market making in a restricted security was therefore not subject to the mandatory close-out.

The guidelines adopted with Section 71 gave examples of each hedged or arbitraged position. The Interpretation said they applied both to Section 71’s exemption and to the exemption in Section 2(b) of the Interpretation on Prompt Receipt and Delivery of Securities.

Call options. A short position was fully hedged by a long call with a strike price at or in the money, exercisable within 90 calendar days into the short security.

Convertibles. It was fully hedged by a long convertible security with a conversion price at or in the money, convertible within ninety days into the short security.

Warrants or rights. It was fully hedged by long warrants or rights exercisable within 90 days into the short security.

Cross-market arbitrage. A position was fully arbitraged when a security was bought in one market and the same security sold short in a different market “at as nearly the same time as practicable” to take advantage of a price difference.

Exchange arbitrage. A position was also fully arbitraged when the holder was long a security exchangeable or convertible within 90 calendar days into a second security, and short the second security, to take advantage of a concurrent price disparity.

The date that mattered was the short sale’s transaction date. Whether a fully hedged or fully arbitraged position existed was judged as of the date the short sale was made, so the exemption turned on the position the seller held on that date.

Worked Scenarios: Hedges That Did and Did Not Qualify

A customer is short 100 shares of a restricted stock trading at 30 and holds one call on the stock with a strike price of 25, exercisable within 90 calendar days.

The call is in the money and within the window, so the 100-share short position is exempt.

Had the strike been 35, above the market price, the short would not have been exempt. Had the call been exercisable only after more than 90 days, the short would not have been exempt at any strike price.

A convertible hedged only as many shares as it converted into.

Suppose a firm is short 100 shares of a stock trading at $26 and long one debenture convertible within ninety days into 40 shares at $25 a share. The conversion price is in the money, so 40 shares of the short position are exempt and the other 60 are not.

Warrants in the money hedged in full, and warrants out of the money hedged only up to their market value.

Consider a short position in a stock trading at 4 against 100 long warrants, each exercisable within 90 days into one share at $2. The warrants are in the money and a 100-share short position is exempt.

Now take a short position of 200 shares in a stock trading at $2 against 200 long warrants, each exercisable within 90 days into one share at $3 and each worth $0.50. The warrants are out of the money. Their market value is $100, which covers 50 shares at $2, so 50 shares of the short are exempt and 150 are not.

An exchange arbitrage was exempt to the extent of the exchange ratio.

Suppose a trader is long 200 shares of a company being acquired at 0.5 acquirer shares per share, with the exchange to take place within 90 days, and is short acquirer shares. A short of 100 acquirer shares is exempt. If the exchange were to take place more than 90 days out, all of the short position would be subject to the mandatory close-out.

A trader who buys 100 shares of a stock on the London Stock Exchange and at the same time sells 100 shares of the same stock short on Nasdaq, to take advantage of the price difference between the two markets, holds a fully arbitraged position. The 100-share short is exempt.

Why the NASD Required the Close-Out

The provision grew out of the NASD’s 1986 study of short-sale practices in Nasdaq securities, the Pollack study. That study found that no automatic mechanism prevented short positions from building up at clearing corporations, with the potential for serious problems in times of market stress. Section 71 supplied such a mechanism for the securities on the restricted list.

The provision was aimed at persistent fails, not temporary ones.

The NASD noted that short selling is not the only reason trades stay unsettled at a clearing corporation. Other reasons include a member’s segregation requirements under SEC Rule 15c3-3, transfer delays, and some characteristic of the security that prevents delivery.

Its analysis found that fails-to-deliver at the clearing corporation confirm little or nothing about short sales unless the condition is large and persistent.

Because the rule focuses on persistent fails, the NASD concluded that nearly all stocks developing large, persistent fails would be covered.

The concern was leverage and manipulation.

Naked short sellers must deposit margin with their broker-dealer or a clearing corporation. Even so, they enjoy greater leverage than if they had to close out their short positions within a reasonable time. That leverage can be used for “bear raids”, and the close-out requirement imposed additional discipline on naked short selling.

The Notice also pointed to public customers’ reasonable expectation that their securities have been delivered.

The warrant exemption was deliberately narrow.

Commenters asked for easier warrant-hedging exemptions. The NASD answered that a warrant priced near zero would then permit virtually unlimited short selling with no delivery requirement. It also said that a hedge ratio would be inefficient to calculate for the mostly thinly traded securities subject to the rule and would complicate surveillance.

It kept the out-of-the-money warrant exemption limited to the warrants’ value.

What Notice 10-49 Shows About the 2010 Transfer

Regulatory Notice 10-49 announced that the FINRA Rule 11000 Series (Uniform Practice Code), approved in rule filing SR-FINRA-2010-030, would take effect on December 15, 2010.

Its list of the approved rules shows “Rule 11830 Reserved” between FINRA Rule 11820 (Selling-Out) and FINRA Rule 11840 (Rights and Warrants). The Notice does not say where the content of the former provision went.

It points firms to FINRA’s Rule Conversion Charts, which show how the new rules relate to the NASD and Incorporated NYSE rules they replace. It also warns that the charts are a reference aid only and do not substitute for diligent review of the new rule language.

Common Errors in Applying the 1993 Close-Out

Treating the close-out as the buyer’s remedy. Section 71 placed the duty on the broker-dealer representing the seller, and that firm had to close by purchase.

Counting calendar days. The period was 10 business days after the normal settlement date. The 90-day windows in the hedging guidelines are a separate test for whether an offsetting position qualifies.

Applying one threshold condition. A security was covered only if its clearing short position was both at least 10,000 shares and at least one-half of one percent of shares outstanding, and only as published on the NASD’s list.

Reading list status at the wrong time. A later removal from the list did not release a trade, and a later addition did not capture one.

Treating any long option or warrant as a full hedge. A call hedged only at or in the money and within 90 calendar days. A convertible hedged only the shares it converted into. An out-of-the-money warrant hedged only up to its market value.

Further Hedges Under the Guidelines: Preferred Stock, Rights and the At-the-Money Strike

The convertible guideline was not limited to debentures. A short position was fully hedged by a long convertible debenture, preferred or other security with a conversion price at or in the money, convertible within ninety days into the short security.

Suppose a firm is short 200 shares of a stock on the restricted list trading at $30.

It holds convertible preferred stock convertible within 30 days into a total of 200 shares of that stock at a conversion price of $24 a share. The conversion price is in the money and conversion is available within ninety days, so the preferred hedges the whole 200-share short, and the short is exempt from the mandatory close-out.

The text of the call guideline accepted a strike price “at or in the money”, so a call struck exactly at the market price qualified, as well as one struck below it. A customer who is short 100 shares of a restricted stock trading at $40, and who holds one call on 100 shares with a strike price of $40 exercisable within 60 calendar days, holds a call at the money, and the 100-share short is exempt.

The third guideline named rights as well as warrants. A short position was fully hedged by long warrants or rights exercisable within 90 days into the short security, and where the long warrants or rights were out of the money the short was exempt up to their market value.

So a holder who is short 100 shares of a restricted stock trading at $20, and who holds 100 rights each exercisable within 30 days into one share at $15, holds rights in the money, and the 100-share short is exempt.

The allowance up to market value for an out-of-the-money position appears in the warrants-and-rights guideline. The convertible guideline instead requires a conversion price at or in the money, and its own example gives an out-of-the-money convertible no exemption: with ABCD common at about $9 and the debentures convertible at $27.90 a share, a 100-share short position in ABCD would not be exempt.

Exchange Arbitrage Where the Exchange Requires a Payment

The exchange-arbitrage guideline covered a long security exchangeable or convertible into a second security “without restriction other than the payment of money”, within 90 calendar days of the purchase, together with an offsetting short sale of the second security made at or about the same time to take advantage of a concurrent disparity in the two prices.

A payment of money was therefore a condition the guideline allowed on the exchange.

Suppose a trader buys 100 units of a security that its holder may exchange, within 60 calendar days of the purchase, for 100 shares of a second company’s stock, which is on the restricted list, on paying $3 a unit. At about the same time the trader sells 100 shares of the second company short, to take advantage of a concurrent disparity between the two prices.

The $3 payment does not take the position outside the guideline. The 100-share short is part of a bona fide fully arbitraged position and is exempt from the mandatory close-out.

The Coverage Threshold at Its Exact Limits

Section 71(a)’s two figures were minimums that a security could meet exactly. The clearing short position had to be “10,000 shares or more” and “equal to at least one-half (1/2) of one percent” of the issue’s total shares outstanding.

An issue with 4,000,000 shares outstanding and a clearing short position of 20,000 shares sits exactly on the percentage figure, since 20,000 shares is one-half of one percent of 4,000,000, and it is above 10,000 shares. It met the threshold in Section 71(a).

An issue with 2,000,000 shares outstanding and a clearing short position of exactly 10,000 shares meets both figures exactly, and it met the threshold too.

Whether a short sale was covered still turned on the list the NASD published.

Fails at the Clearing Corporation and the Own-Account Borrowing Determination

An analysis of fails-to-deliver at the National Securities Clearing Corporation, cited by the NASD in Notice 93-53, found that, when fails developed in a stock, the dominant reasons were high average daily volume and the amount of float in the security, the float being inversely related. On that analysis, heavy trading pointed towards fails developing, and a large float pointed away from them.

Notice 93-53 set Section 71 beside the NASD’s other short-sale requirements.

One of them required a member to make an affirmative determination that it could borrow the security before effecting a short sale for its own account.

Certain transactions in corporate debt securities, bona fide market-making activities, and fully hedged or arbitraged positions were exempt from that determination.

A member whose proprietary short sale resulted in a bona fide fully hedged position therefore did not have to make the borrowing determination before the sale, and the same sale was outside Section 71’s mandatory close-out.

Examination Relevance and Key Takeaways

FINRA Rule 11830 is unlikely to be directly tested on the Series 7 or Series 24 examinations, given its current Reserved status with no operative text — but its confirmed history is worth noting for completeness within this dictionary’s coverage of the FINRA Rule 11800 subsection’s full numbering sequence.

The key points to retain are these: FINRA Rule 11830 is currently Reserved, with no operative rule text — but this reflects a deletion, not an unused number; the rule was approved by the SEC on July 14, 1993, the date FINRA’s rule page lists for its adoption, and took effect October 12, 1993 (Notice 93-53); it was amended by SR-NASD-2004-175 effective January 3, 2005, and amended by SR-FINRA-2010-030 effective December 15, 2010, before being deleted by SR-FINRA-2010-060 on that same December 15, 2010 date; as adopted in 1993 the provision was a mandatory close-out for short sales in Nasdaq securities meeting a clearing short-position threshold, but this dictionary cannot confirm how FINRA Rule 11830 read after its 2005 amendment, nor whether that content was relocated elsewhere in the 2010 Consolidated Rulebook transfer; and FINRA Rule 11830 occupies the position between FINRA Rule 11820 (Selling-Out) and FINRA Rule 11840 (Rights and Warrants) within the FINRA Rule 11800 Close-Out Procedures subsection’s numbering sequence.