A Locate Letter, a Threshold List, and a Customer's 'Long' Mark
On Monday a customer instructs you to sell short 25,000 shares of SMCP, a small-cap trading at $7.12 that has appeared on the threshold securities list for the last six consecutive settlement days. The customer's prime broker supplies a locate letter covering 25,000 shares, but the letter is dated the prior Friday and does not identify the lending source. Your clearing firm reports an existing fail to deliver of 9,000 shares in SMCP that has been open for 11 consecutive settlement days. The order ticket shows the capacity as long, because the customer says it holds 4,000 shares at another broker-dealer.
1. Can the order be accepted as marked, and what does the locate actually need to be?
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No - the ticket is wrong on both marking and locate.
- Marking: a sale may be marked long only if the seller owns the securities and will deliver them by settlement. The customer holds 4,000 shares at another broker; at most those 4,000 could be treated as long, and only after the firm verifies they are deliverable from that account. The remaining 21,000 must be marked short. Splitting the order into correctly marked tickets is required; one ticket marked long cannot cover mixed inventory.
- Locate: a short sale requires a locate before the order is accepted, and the firm must reasonably believe the source will deliver. A Friday-dated letter with no identified lender, covering a name that has been on the threshold list all week, does not meet that standard. Obtain a fresh, specific locate for the short portion from a source the firm can identify, and record the locate, the source, and the time on the order.
- The firm's own 9,000-share fail does not help; it makes the position worse.
2. What changes when the fail reaches 13 consecutive settlement days?
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Everything about the firm's ability to keep taking short orders in SMCP changes.
- If a participant has a fail to deliver in a threshold security for 13 consecutive settlement days, it must immediately close out the fail by purchasing securities of like kind and quantity. You are at day 11, so the desk has roughly two settlement days of runway, and the clock is running whether or not the customer trades again.
- Until the fail is closed, the firm may not effect further short sales in SMCP for any customer unless it has borrowed or arranged to borrow the securities and can document that pre-borrow. The ordinary Friday locate letter will not satisfy this; the standard is borrowing, not a promise to locate.
- Operationally: coordinate with clearing now, stop accepting new short orders in SMCP when the threshold is hit, and consider whether the buy-in is best executed before the forced close-out. This is the firm's obligation, not the customer's, and the customer's desire to short does not create an exception.
3. Does the customer's claim to hold 4,000 shares elsewhere change how much of the order can be marked long?
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Only if the firm actually verifies ownership, and probably not even then for the full 4,000.
- 'I hold it at another broker' is a representation, not verification. The firm should confirm the position - a statement, a clearing record, or reliance within a documented procedure - and consider whether the shares sit in a margin account, are pledged, or are already committed to another sale.
- Even if verified, the long marking only works for shares that will be delivered by settlement. If the transfer cannot be completed in time, the sale is short for Reg SHO purposes regardless of what the customer believes it owns. The firm's marking obligation is independent of the customer's intent.
- The safe and defensible route is to mark the entire 25,000 short unless and until the 4,000 shares are confirmed deliverable, then adjust the ticket. Under-marking is easy to defend; over-marking as long is a violation that surfaces the moment delivery fails.