Regulation SHO
Regulation SHO is the SEC's primary regulatory framework governing short selling in equity securities, establishing uniform locate requirements to prevent naked short selling, delivery requirements to address failures-to-deliver, and threshold security rules that impose enhanced close-out obligations on broker-dealers when a stock accumulates persistent settlement failures.
Short selling — the practice of selling borrowed shares with the intention of repurchasing them at a lower price — is a legitimate market activity that contributes to price discovery and liquidity. However, abusive short-selling practices, particularly naked short selling (selling short without first locating shares to borrow), can artificially depress prices and create systemic settlement failures. Regulation SHO, which became effective in 2005, was designed to address these harms while preserving the legitimate role of short selling.
The locate requirement is the foundational rule. Before executing a short sale, a broker-dealer must have reasonable grounds to believe that the security can be borrowed and delivered on the settlement date. The broker-dealer must either borrow the security, enter into a bona fide arrangement to borrow it, or have reasonable grounds to believe it can be borrowed. This locate requirement applies to essentially all short sales, with a narrow exception for market makers and bona fide hedging activities.
The close-out requirement addresses persistent failures-to-deliver (FTDs). When a short sale fails to settle — meaning the seller does not deliver the shares on the required settlement date — the failure creates a persistent FTD that undermines settlement system integrity. Under Regulation SHO, when a broker-dealer has a failure-to-deliver in a threshold security (an equity that appears on the threshold securities list maintained by self-regulatory organizations because it has experienced persistent FTDs exceeding 0.5 percent of outstanding shares for five consecutive settlement days), the broker-dealer must close out the position by purchasing or borrowing shares within specified time limits.
The 2008 amendments to Regulation SHO eliminated the grandfather exception that had allowed preexisting FTDs to remain open indefinitely, substantially tightening the close-out regime. The 2010 amendments introduced the alternative uptick rule (Rule 201), which restricts short selling when a stock has declined ten percent or more during a single trading day, imposing a price test for the remainder of that day and the next trading day to prevent short sellers from piling on during severe intraday declines.
Enforcement of Regulation SHO has been a sustained SEC priority. The agency has brought actions against broker-dealers for failing to maintain adequate locate records, for permitting repetitive FTDs in threshold securities, and for enabling patterns of trading that appeared to constitute naked short selling. FINRA also conducts examinations of its member firms for Regulation SHO compliance.
For investors, Regulation SHO is most relevant as context for understanding short interest data, the threshold securities list, and the dynamics that can trigger short squeezes when poorly located short positions are forcibly closed out in illiquid or fast-moving stocks.