*SHORT v. BOX**
Quite simply, it now has no functional value. It used to have a few tanglible interests; one that was sincere and one that was speculative, if not a violation of SEC rules, at best.
1st, The IRS let you go ShortvBox and avoid taxes on gains. ie. You buy MSFT at 12, Short sale it at 250. You are net zero to the market, yet you have avoided paying taxes as no gain was realized until you sent a wire to firm to close the position. It the scenario above, clients of our firm kept the profits of their trades in their account rather than turning them over to the government by April 15.
2ndly, investors perceived you could avoid a) borrowing stock and b) upbid/tick rules by "selling the long and keeping the short" when you were short vs. box. Infact, if this were permissible, it would be a tremendous benefit. You would not have to wait to borrow shares and could smack and sell at any price, unphased by upbid or uptick rules which can often stymie the best execution efforts. Unfortunately, this was never explicitly permitted and has recently been explicitly considered a violation.
There have been other I have heard investors try to justify its value in that it lets you "cover a short moving against you and yet you can short it again at any time, avoiding (Something)".
Simply put, if you are short a stock, when you buy the position, whether it be in a long account or a short account, you are net flat to the market. You are not effected by the move one way or the other. Any gain in your long is directly offset by losses in the short.
The NASD and SEC require you to net position under common control. To our firm, this would even extend to positions in different accounts if not at different firms. If you are long 1000 ABCD and your wife's account is short 1000 abcd, a sale in your acccount would be considered short for upbid/uptick and borrowing purposes.
Thus, our firms' position is that shorting against the box has no actual value. Infact, there is a disadvantage to this in that you must maintain 5% margin on the two positions, reducing buying power.
See below:
NASD Notice to Members 99-28
NASD Reminds Members Of Obligations Relating To The Short-Sale Rule
Executive Summary
This Notice to Members supersedes Notice to Members 98-65, restates the views of
NASD Regulation, Inc. (NASD RegulationSM) and The Nasdaq Stock Market®
(Nasdaq®) concerning National Association of Securities Dealers, Inc. (NASD®)
Rule 3350 (Short-Sale Rule) that were discussed in Notice to Members 98-65, and
corrects a statement concerning the use of cross-guaranteed accounts for
Regulation T purposes.
In 1994, the Short-Sale Rule was adopted to stop market-destabilizing
speculative short sales in Nasdaq National Market® (NNM) securities. To prevent
this conduct, the Short-Sale Rule prohibits member firms from executing
customer short sales and non-Market Maker proprietary short sales in an NNM
security at or below the current inside bid when the current inside bid is lower
than the previous inside bid.
It has come to the attention of NASD Regulation and Nasdaq that certain NASD
members may be assisting customers in the circumvention of this Rule.
Specifically, these members are failing to net security positions of accounts for
customers who maintain accounts in their name and exercise control over, or
operate in concert with, other accounts with a strategy designed to circumvent the
Short-Sale Rule. The failure to net these positions has permitted these
customers, who operate the two accounts with a single investment strategy, to
avoid application of the Short-Sale Rule. Members are expected to establish and
maintain supervisory procedures to detect and deter this improper trading activity.
The purpose of this Notice is to highlight for members that, depending on the facts
and circumstances, they may be required to net positions for accounts that are
related or under common control to determine whether a sale is long or short and
subject to the Short-Sale Rule requirements. NASD Regulation is committed to
ensuring strict adherence to the Short-Sale Rule and will carefully review whether
firms have engaged in the conduct described in this Notice in examinations and
investigations. Violations of the Short-Sale Rule will be vigorously pursued.
Questions concerning this Notice should be directed to the Office of General
Counsel, The Nasdaq Stock Market, Inc., at (202) 728-8294; or the Legal Section,
Market Regulation, NASD Regulation, at (301) 590-6410.
Overview
The NASD adopted the Short-Sale Rule to prevent speculative short selling in
NNM securities from accelerating a decline in the price of a security and to stop a
form of manipulation known as “bear raiding” or “piling on.” Bear raiding or piling
on occurs when short sellers exert pressure on a stock's price, forcing the price
to drop precipitously, frequently within a single trading day. The Short-Sale Rule
prohibits member firms from executing customer short sales and non-Market
Maker proprietary short sales in an NNM security at or below the current inside
bid when the current inside bid is lower than the previous inside bid. 1
To determine whether a sale is long or short, members must look to the definition
of a “short sale” contained in Securities and Exchange Commission (SEC) Rule
3b-3, which is incorporated into the NASD's Short-Sale Rule as Rule 3350(k)(1).
Under SEC Rule 3b-3 and NASD Rule 3350, the term “short sale” means any
sale of a security that the seller does not own or any sale that is consummated by
the delivery of a security borrowed by, or for the account of, the seller. To
determine whether the seller is long or short overall, the seller must net all
positions in the security. This includes netting positions held in accounts that are
under common control or traded with a single investment strategy.
Rule Prohibits Circumvention
The Short-Sale Rule also prohibits a member from knowingly, or with reason to
know, effecting sales for the account of a customer or for its own account for the
purpose of circumventing the rule. 2
With this Notice, NASD Regulation and Nasdaq are clarifying that the following
would be a violation of the Short-Sale Rule if a member and its associated
persons were found to have assisted customers in the following manner:
• A customer maintains one account (a “long account”) that is used to buy and
sell various securities several times in a single day. The long account typically
begins and ends each day with a long position of 1,000 shares in each
security held in that account. The customer also cross guarantees for margin
purposes a second account (a “short account”), usually held by a family
member or related person. 3
That account holds offsetting short positions of
1,000 shares in the same securities that are held in the long account. In
contrast to the long account, the short account generally does not change
positions in the securities. At the beginning and end of each day, the
combined positions in both accounts for each of the securities are flat. During
the trading day, the customer buys and sells securities out of the long
account, creating the false appearance of alternating long and flat positions in
the securities in the long account. When the two accounts are appropriately
combined and treated as one, short sales occur on a regular basis and often
result in transactions occurring on down-bids in violation of the NASD's Short-
Sale Rule.
NASD Regulation will conduct a facts and circumstances analysis in making a
determination as to whether customer accounts should be netted for purpose of
compliance with the Short-Sale Rule. When conducting such analysis, NASD
Regulation will, among other things, consider:
(1) whether a single person exercises discretion over both accounts;
(2) whether the accounts are cross guaranteed for margin purposes;
(3) whether the accounts belong to a family member or related person or were
opened contemporaneously (e.g., on the same day); or
(4) whether a similar pattern is occurring in other customer accounts at a firm.
This analysis will consider all the facts and circumstances concerning the
establishment, maintenance, and trading of these accounts.
The presence or absence of any single factor reflected above does not
necessarily lead to the conclusion that such accounts should, or should not, be
netted.
NASD Regulation will closely watch for the above-described conduct and for
similar schemes that attempt to circumvent application of the Rule. Members
must take steps to develop compliance procedures to guard against such abusive
trading practices. Members should also instruct their associated persons not to
accept orders for execution where customers are operating two or more accounts
in order to circumvent the Rule. A finding of such abuses may result in the
imposition of NASD disciplinary action against the member and its associated
persons and a referral of such trading conduct by persons outside the jurisdiction
of the NASD to other appropriate regulatory authorities.
Endnotes
____________________
1 NASD Rule 3350(a).
_________________
2 NASD Rule 3350(e).
___________________
3 Cross-guaranteed accounts refer to an agreement where one account is guaranteed by
another account to enable their consolidation for the purpose of allowing the margin
that must be maintained in those accounts to be determined on the net positions of both
accounts. Such a guarantee must be in writing and permit the member carrying the account
to use the money and securities in the guaranteeing account to carry the guaranteed
account or to pay any deficit therein. See NASD Rule 2520(f)(4) and Notice to
Members 98-102 (December 1998). Notice to Members 98-65 may have led
members to believe that margin accounts may be cross guaranteed to satisfy Regulation T
requirements. This is an incorrect statement. Regulation T provides, in pertinent part,
“Guarantee of accounts. No guarantee of a customer's account shall be given any effect for
purposes of this part.” Reg. T, Section 220.3(d).
© 1999, National Association of Securities Dealers, Inc. (NASD). All rights reserved.
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