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1 BEIJING BRUSSELS CHICAGO DALLAS FRANKFURT GENEVA HONG KONG LONDON LOS ANGELES NEW YORK SAN FRANCISCO SHANGHAI SINGAPORE TOKYO WASHINGTON, D.C. This presentation has been prepared by Sidley Austin LLP for informational purposes only and does not constitute legal advice. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. Readers should not act upon this without seeking professional counsel. Rule 204T and Uptick Rule Developments IMN Beneficial Owners Conference – June 2009

2 2 Background Rule 204T - if a participant of a registered clearing agency (Participant) has a fail-to-deliver (FTD) position at a registered clearing agency in any equity security caused by a short sale transaction, the Participant shall, by no later than the beginning of regular trading hours (e.g., 9:30 am ET) on the settlement day following the settlement date (i.e., T+4), immediately close out the FTD position by borrowing or purchasing securities of like kind and quantity. If the Participant can demonstrate on its books and records that such FTD position resulted from a long sale, or a short sale by a market maker engaged in bona-fide market making, then the Participant shall by no later than the beginning of regular trading hours (e.g., 9:30 am ET) on the third consecutive settlement day following the settlement date (i.e., T+6), immediately close out the fail to deliver position by purchasing securities of like kind and quantity (borrowing securities on T+6 to close-out the FTD position is not permissible).

3 3 Background If Participant unable to close-out its FTD position pursuant to requirements, Participant and any broker-dealer from which it receives trades for clearance and settlement (including any market maker) may not accept a short sale order in that equity security from another person, or effect a short sale order in such equity security for its own account without first (i) borrowing the security, or (ii) entering into a bona-fide arrangement to borrow the security (i.e., rather than just obtaining a locate). Rule 204T is currently set to expire on July 31, 2009, however the SEC is expected to take action, prior to such date, to impose a permanent form of the Rule, perhaps with some modifications.

4 4 SEC Study re. Impact of 204T The SECs Office of Economic Analysis (OEA) has published studies examining FTDs before and after the elimination of the options market maker exception from the former Rule 203 close-out requirement and the implementation of interim final temporary Rule 204T. In summary, the most recent results indicate that FTDs decreased significantly after the elimination of the OMM exception and the implementation of the T+3 Close-out Rule, including the following: Fails declined by 56.6% across all securities and 73.5% for threshold stocks. Average daily number of threshold securities decreased by 77.5%, with those threshold securities with listed options decreasing by 82.1%.

5 5 SRO Observations of Rule At the March 2009 SIFMA Compliance and Legal Conference, representatives from FINRA and the NYSE indicated that the Rule has drastically decreased the number of threshold securities on their markets, as well as the length of time securities were remaining on the Threshold Security Lists, as follows: FINRA indicated that on 9/16/08, there were 255 issuers on the Threshold Security List; on 3/17/09, there were 33 issuers on the List FINRA also indicated that as of 9/30/08, stocks were remaining on the Threshold Security List for 70 days; as of the end of 2008, stocks were remaining on the List for 12 days.

6 6 SIFMA Firms Observations of the Rule Rule 204T requires Participants to take mandatory close-out action with respect to transactions that would otherwise settle in the normal course, regardless of the amount or cause of the open fail, or potential market ramifications that might flow from closing out at market open. In this manner, evidence has shown that the Rule has inadvertently contributed to, among other things, increased market volatility, dramatic price spikes, and instability in the securities lending markets.

7 7 SIFMA Firms Impacts and Observations of the Rule Price Spikes: Evidence has shown instances of price spikes at the open caused by buy-ins mandated by the Rule, only to be followed by an abrupt decline once all the close-out purchases are effected. Securities Lending: Although the purpose of the Rule was clearly described as addressing naked short selling, many market participants have often experienced that fails to deliver mandating action under Rule 204T are caused by sales of securities that a person owns but that have been loaned out, and where there is a temporary delay in recalling the securities. While the sale of securities on loan is considered a long sale (a fact reaffirmed by the SEC in the 204T Release) due to the difficulty that broker-dealers have in delineating their net CNS delivery requirements into the portion that are attributable to long sales, as opposed to short sales, the lenders of shares are often being faced with a buy-in by the opening of regular trading on T+4, as if the sale was executed as a short sale.

8 8 SIFMA Comment Letter Recommendations on the Rule Extend the Timeframe for Close-Out: Providing several days beyond T+4 (e.g., T+6) would: (i) allow normal-course fails due to operational or processing delays to be resolved without mandating needless buy-ins; (ii) allow lenders to issue recalls with sufficient time to obtain securities and make delivery, or to pass buy-in costs under the relevant contracts should the recalled securities not be returned as required. Allow Participants Flexibility to Close-Out Throughout Trading Session: Participants should be allowed to close-out FTD positions throughout the trading day, which should help to significantly alleviate the observed instances of price spikes occurring at the opening. Moreover, since transactions effected throughout the trading day would settle in the same manner as purchases effected at the open, there should be no impact from a practical processing perspective, in terms of resolving the FTD positions.

9 9 SEC Reactions to SIFMA Recommendations At the SIFMA Compliance and Legal Conference, a SEC Associate Director indicated that, while it is still too early to determine what action the Commission will take, the Staff overall has sympathy with allowing participants more time to take close-out action. It is unclear at this point whether the Staff favors maintaining the existing close-out structure (T+4 for shorts, T+6 for longs and market makers) and simply allowing the close-out to be effected throughout the respective day, or supports the approach of extending the close-out timeframe to a uniform T+6.

10 10 Uptick Rule In April 2009, the SEC proposed amendments to Regulation SHO that would impose price test restrictions on short selling, which were previously eliminated in SEC requested comment on whether, in light of recent market conditions and events, one of 5 general alternative price test restrictions should be adopted. Alternatives generally focus on a market-wide price tests based on the last sale versus the best bid, or a circuit breaker that would apply to securities that experienced price decline (e.g., 10%).

11 11 Uptick Rule Observations of commenters to the proposed amendments have been mixed. Some commenters (mostly individual investors) appear to support additional price test restrictions on short sales, believing that, among other things, they will help promote confidence in the markets. Many industry participants believe that there is not sufficient evidence that price test restrictions are necessary, especially considering the other recent regulatory actions taken, and the positive impacts of those actions.

12 12 Pre-Borrow Requirement Some commenters, as well as some members of Congress, have recently been requesting the SEC adopt a requirement to pre-borrow shares prior to effecting short sales, as opposed to current requirement to only obtain a locate. Most industry firms believe that there would be serious unintended consequences associated with a pre-borrow requirement, including significantly affecting the liquidity of the securities lending market, and fundamentally impacting securities lending operations.

13 13 Pre-Borrow Requirement SEC Study on the July Emergency Order, which had required borrowing or arranging to borrow before shorting 19 financial stocks, had found the following: Fails reduced, but also significant costs imposed on short sellers, even those whose actions unrelated to fails. Large and statically significant decreases in short selling volume. Dramatic, and in some cases temporary, initial increases in stock lending rates, followed by rates still higher than before the Emergency Order.


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