On June 4, 2021, the Financial Industry Regulatory Authority (FINRA) issued Regulatory Notice 21-19 (Notice), which asks for comment on some material proposed changes to reporting on short positions and equity loans. Currently, FINRA Rule 4560 generally requires clearing firms / primary brokers that are members of FINRA to report to FINRA twice a month on aggregate settled short positions in the accounts of firms and clients, with some exceptions. Short interest rate data compiled by FINRA includes the reporting firm’s current cumulative settled short positions for each security and any changes in the firm’s short positions since the previous reporting period. FINRA has solicited comments on proposals that, inter alia, (i) will increase the frequency of reporting short-term interest rates from bi-monthly to weekly or even daily; (ii) require clearing firms to report synthetic short positions (eg long puts / short calls) in firm and client accounts; (iii) require clearing firms to report credit obligations arising from organized financing and expanded lending programs; (iv) require clearing firms to report to FINRA for regulatory purposes a daily allocation of outstanding positions in accordance with Rule 204 (d) of the SHO Rules; and (v) consider requiring FINRA member firms to disclose to FINRA (for regulatory purposes, but with a view to possible public dissemination) certain information about equity loans.
While FINRA did not state this in the Notice, these proposed changes are likely in response to all of the extensive market volatility reviews involving Gamestop, AMC and other stocks that have occurred since January 2021.
Summary of Proposed Changes
Publication of information on short interest on exchange-traded equity securities. FINRA is considering the possibility of consolidating the publication on FINRA’s website of the short-term interest rate data reported to FINRA for both listed and unlisted securities. This should not require changes to companies’ short-term interest reporting requirements.
Interest summary content. FINRA is considering the following changes to reported and shared data of short-term interest, including whether to publish additional data that is proposed to be collected or used for regulatory purposes only:
- Classification of own accounts and customer accounts. FINRA is considering requiring firms to separate (i) short interest held in their own accounts, and (ii) short interest held in customer accounts, in addition to reporting total short interest in securities. FINRA believes that this information will provide useful regulatory information regarding the type of market participant who has accumulated a short position of interest (for example, a firm or non-broker-dealer client).
- Account-level position information. Alternatively, FINRA is considering requiring firms to report (for regulatory purposes only, not for public dissemination) information on short interest positions in greater detail, reporting at the account level for all equity securities. FINRA will use this to improve its checks for compliance with both the Securities and Exchange Commission (SEC) SHO Regulations and FINRA’s short selling rules.
- Synthetic short positions. In addition, FINRA is considering requiring firms to report synthetic short positions (such as selling calls and buying puts) in short interest rate reports.
- Loan liabilities arising from organized financing (extended lending, short-term lending). FINRA is considering requiring members to report short-term interest-bearing outstanding loans to clients under financing programs to better reflect actual short-term stock sentiment.
- Total Number of Shares Outstanding (TSO) and Public Circulation. FINRA is also considering the possibility of including short interest rates, if any, TSOs and public offerings in FINRA’s disseminated data.
- Safety threshold field. FINRA is considering adding a new field to FINRA’s short interest rate data that will indicate whether a security is a Reg SHO Threshold Security as of the settlement date for a short interest position. This change will not affect the reporting requirements of companies.
Frequency and timing of short interest position reporting and data dissemination. FINRA is considering shortening the reporting period to a daily or weekly submission, and in order to enable FINRA to disseminate collected information to the market in a more timely manner, such reports must also be provided to FINRA at a shorter time frame after the applicable settlement date. For example, if FINRA requires daily submissions, short interest rate reports may be submitted by 6:00 pm ET, one business day after the due date, and for weekly submissions, short interest rate reports may be submitted by 6:00 pm ET. Eastern Time, one business day after the assigned weekly settlement reporting date (instead of the current requirement of two working days after the assigned reporting reporting date).
Information about the distribution of outstanding items. FINRA is considering expanding its short selling reporting program by adopting a new rule requiring members to submit to FINRA (for regulatory purposes only, not for public dissemination) a report on the daily allocation of outstanding positions to correspondent broker dealers in accordance with Rule 204 (d) SHO Regulations. Receiving daily information on the distribution of outstanding obligations will allow FINRA to directly identify the introducing / correspondent broker-dealer who is responsible for the closure obligation (without first requesting this information from the clearing firm), and therefore enable FINRA to conduct more effective investigations. The proposed allocation report may include the following fields:
- name of the correspondent firm
- amount allocated to the correspondent firm (number of shares)
- date (s) of the transaction
- distribution date
- closing date
- applicable commitment to close the trade (T + 3, T + 5, or T + 35)
Request for comments on other equity lending initiatives. FINRA asks for comment on whether a reporting structure for equity lending should be created. For example, member firms that engage in equity lending operations may be required to communicate to FINRA the terms of the loan – for example, the discount rate (for new loans, open daily loans and rate revisions), loan amount and counterparty information. Once it has gained experience with the reporting regime and the resulting data, FINRA may consider a phased approach to ensuring transparency to the public regarding share loan discount rates and other agreed terms.
What does this mean to you
Clearing Firms / Prime Brokers: The proposed changes will clearly have the most significant impact on clearing firms / prime brokers, which are primarily responsible for reporting on short-term interest rates. Even under the current reporting regime, clearing firms / prime brokers have significant resources to collect short positions, identify reportable and unreported positions, send short positions to FINRA, and participate in follow-up surveys to respond to FINRA inquiries. The increase in the amount of data to be reported, as well as the increase in the frequency of reporting to weekly or even daily, will place a significant burden on clearing firms / major brokers to ensure accurate and timely reporting, especially in light of the significant fines imposed by FINRA. usually charged for inaccurate reporting. Clearing firms / prime brokers are likely to need a significant programming effort to capture information in their short interest rate reports that is not currently being collected, such as synthetic short positions and loans due to organized finance. Disclosure of distribution under Rule 204 (d) also enhances the efficiency of clearing firms’ procedures for determining that their distribution of failures is “reasonable” under Rule 204.
Introducing / Correspondent Brokers: While clearing firms are responsible for reporting short interest rates, the proposed changes will increase the transparency of accounts with short positions, as well as provide FINRA with greater transparency in situations where introducing brokers defaults on their clearing firms and therefore in those cases , when it is necessary. Introducing brokers (not clearing firms) are responsible for closing trades under Rule 204. Thus, it is likely that designated unsuccessful introducing / correspondent broker-dealers will receive more requests from FINRA to demonstrate proper closure under Rule 204.
Hedge funds and other clients of clearing firms / prime brokers: While primary brokers will be directly responsible for short-term reporting, FINRA’s proposals could increase the transparency of short positions existing in primary broker’s client accounts, including synthetic short positions created through derivatives and organized financing / extended leverage programs. Separately, the SEC announced that it is considering whether to require market participants to disclose short positions directly to the SEC.
The full text of the Notice is available. here… FINRA accepts comments until August 4, 2021.