Introduction

Clients holding short stock positions (including short positions resulting from option assignments or exercises) are at risk of having these positions bought-in and closed out by us, with no advance notice. This is a risk which is inherent in short selling and generally outside the control of the client. “Buy-ins” are conducted in accordance with regulatory rules that dictate how and when buy-ins are processed.

While similar in their effect, the term “buy-in” refers to an action taken by a third party and a “close-out” refers to an action taken by us. These actions typically result from one of three events:

1.     The shares required to be delivered when a short sale settles cannot be borrowed;

2.     The shares which were borrowed and delivered at settlement are later recalled; or

3.     A fail to deliver with the clearinghouse occurs.

An overview of each of these three events and their considerations is provided below.

1. Short Sale Statement

When stock is sold short, the broker must arrange for the shares to be borrowed for delivery by the settlement date, which in the case of U.S. securities is the first business day following the date of the trade (T+1). Prior to executing the short sale, the broker must have reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due. This is accomplished by verifying the current availability of the shares for borrowing. Note that there is no assurance that shares available to borrow on the date of trade will remain available to borrow one day later for delivery at settlement, and the short sale may be subject to forced close-out if the shares can no longer be borrowed for delivery. If the client “pre-borrows” shares to deliver at settlement (i.e., actually borrows shares before selling short) the client will not be subject to a close-out as long as the borrowed shares remain available. The processing timeline for determination of a close-out is as follows:

T+1

If we are unable to borrow shares to deliver on settlement date (T+1), we have until market open of the following day, T+2, to cover the delivery obligation and prevent close-outs.

T+2 

09:20 Eastern Time (ET)

If we were unable to borrow shares to meet settlement, a communication will be sent, on a best efforts basis, notifying the client that a close-out will occur.

09:30 Eastern Time (ET)

We initiate the close-out by placing an order prior to the open of regular trading hours. The close-out quantity will be reflected within the TWS Trades window. Since the final close-out price may not be known until the end of the day, the previous trading day’s closing price is used as a placeholder price on TWS. The placeholder price will be updated with the actual execution price upon completion of the close-out order.

It is possible that under certain circumstances, due to limited liquidity in the market, that the close-out order may not be executed or may be only partially executed. In that case, the initial close-out quantity will be corrected down to the executed quantity. The remaining quantity will remain subject to close-out at the start of regular trading hours the following business day.

2. Loan Recall

Once a short sale has settled (i.e., stock has been borrowed and used to deliver the shares sold short to the buyer), the lender of the shares reserves the right to request their return at any time. Should a recall occur, we will attempt to replace the recalled shares with those from another lender. If the recalled shares cannot be replaced within one or two days (depending on the time) of the recall notice, the lender can issue a formal Buy-In Warning which allows for a buy-in to take place that day. While the issuance of this formal warning provides the lender the option to buy-in, the proportion of recall notices that actually result in a buy-in are low (typically due to our ability to source shares elsewhere). 

Once a counterparty issues a Buy-In Warning to us, the counterparty may buy-in the shares we are borrowing at any time for that trade date. In the event the recall results in a buy-in, the lender executes the buy-in transaction and notifies us of the execution price. We vet counterparty buy-in prices for appropriateness with the day's trading activity.

In turn, we allocate the buy-in to clients based upon their settled short stock position. Unsettled trades are not considered when determining liability. Recall buy-ins are viewable within the TWS Trades window once they are posted to the account by approximately 17:30 ET.

3. Fail to Deliver

A fail to deliver occurs when a broker has a net short settlement obligation with the clearinghouse and does not have the shares available within its own inventory or cannot borrow them from another broker in order to meet the delivery obligation. A fail to deliver can result from a long or short sale.

In the case of US stocks, brokers are obligated to close the fail position by no later than the start of regular trading hours on the day following the settlement day. This can be accomplished by delivering purchased or borrowed shares. If available stock borrow transactions prove insufficient to satisfy the delivery obligation, we will close-out clients holding short positions by placing an order prior to the open of regular trading hours. It is possible that under certain circumstances, due to limited liquidity in the market, that the close-out order may not be executed or may be only partially executed. In that case, the initial close-out quantity will be corrected down to the executed quantity. The remaining quantity will remain subject to close-out at the start of regular trading hours the following business day.

Net Purchase Requirement

Clients should note that on any day on which they have been closed out, they are required to end the day as a net purchaser—in aggregate across all of their accounts with the Firm—of at least the number of shares they were closed out on (in the security they were closed out on). As a result, for the remainder of the trading day on which a client was closed out, that client will not be permitted to (i) sell short the stock they were closed out in, (ii) write in-the-money call options on the stock they were closed out in, or (iii) exercise put options on the stock they were closed out in (the "Trading Restrictions"). If a client nevertheless does not end the day as a net purchaser of the required number of shares for the stock they have been closed out in (for example, as the result of being assigned on call options previously written)—in aggregate across all of the client's accounts with the Firm—the Firm will perform another close-out in the account on the next trading day for the number of shares that, when added to the client's aggregate net trading activity in such stock on the close-out date, would have been required to make the client a net purchaser of the required number of shares of such stock that day, and the client will again be required to remain a net purchaser across all of their accounts of that many shares and again subject to the Trading Restrictions for the remainder of that day.

 Note on Execution

Clients should be aware that based on the manner in which we are required to execute a close-out and a third party is allowed to execute a buy-in, significant differences between the price at which the transaction was executed and the prior day's close may result. These differences may be especially pronounced in the case of illiquid securities. Clients should be aware of these risks and manage their portfolio accordingly.

An account will be subject to interest charges despite maintaining an overall net long or credit cash balance under the following circumstances: 

1. The account maintains a short or debit balance in a given currency.

For example, an account maintaining a net cash credit balance equivalent to USD 5,000 comprised of a long USD balance of 8,000 and a short EUR balance equivalent to USD 3,000 would be subject to an interest debit based upon the short EUR balance.  There would be no offsetting credit on the long USD balance as it is less than the USD 10,000 Tier I level above which interest is earned.  

Account holders should note that in the event they purchase a security which is denominated in a currency that they do not hold in their account, IBKR will create a loan in that currency in order to settle the trade with the clearinghouse. If one wishes to avoid such loans and their associated interest charges, they would need to either deposit funds denominated in that particular currency or convert existing cash balances via the Ideal Pro (for balances of USD 25,000 or above) or odd lot (for balances less than USD 25,000) venue prior to entering into your trade. 

2. The credit balance is comprised  principally of proceeds from the short sale of securities. 

For example, an account maintaining a net cash credit balance of USD 12,000 which is comprised of a USD debit of 6,000 in the security sub-account (less the market value of any short stock positions) and a short stock market value credit of USD 18,000 would be charged interest on the Tier 1 debit of USD 6,000 and would earn no interest on the short stock credit as it falls below the USD 100,000 Tier I level.

3. The credit balance includes unsettled funds.

IBKR determines interest debits and credits solely based upon settled funds. Just as an account holder is not assessed interest charges on funds borrowed to purchase a security until such time that purchase transaction settles, the account holder will not receive an interest credit, or offset against a debit balance, on funds originating from the sale of a security until such time the transaction has settled (and IBKR has been credited funds by the clearinghouse).

Regulation SHO, adopted by the SEC in January 2005, sets forth the regulatory framework governing short sales.  Two key provisions, intended to address problems associated with persistent fails to deliver and potentially abusive naked short selling, involve locate and close-out requirements.

Under the locate requirement, a broker-dealer must have reasonable grounds to believe that the security can be borrowed so that it can be delivered on the delivery due date before effecting a short sale order.  

The close-out requirement requires that the clearing broker take immediate action to close out a fail to deliver position in a threshold security that has persisted for 13 consecutive settlement days by purchasing securities of like kind and quantity. Until the position is closed out, the broker may not effect further short sales in that threshold security without borrowing or entering into a bona fide agreement to borrow the security (known as the "pre-borrowing" requirement)

IMPORTANT NOTE:

In October 2008, the SEC amended Regulation SHO with temporary Rule 204T (in place until July 31, 2009) which requires that any broker having a fail to deliver position at NSCC on the settlement date immediately borrow or purchase securities to close out the amount of the fail to deliver position by no later than the beginning of regular trading hours on the following settlement date (the “Close-Out Date”). This close-out requirement requires that the broker take affirmative action to purchase or borrow securities and not offset the fail to deliver position with shares it will receive on the Close-Out Date. Rule 204T applies to all securities not just threshold securities.

Procedurally, to sell short, all you need to do is specify your order Action as 'Sell' at the point you create your order. Note that we do not allow you to be both long and short the same security, so if you maintain a long position and enter a sell order, you will close out any long positions to the extent of your sell order and open a short position to the extent, if any, your sell order exceeds a long position. Please note that you must maintain a "Margin" type account with net liquidating equity of at least USD 2,000 for a short sale order to be accepted. Short sales are not allowed in "Cash" type accounts.

Also note, that in addition to your account having sufficient equity to meet the margin requirement associated with the transaction, IBKR is required to meet its regulatory obligation of making a reasonable determination that we can locate the stock for borrowing purposes when the transaction settles (typically T+2). If we are unable to locate the stock based upon our inventory and the availability lists provided to us by other brokers, you will see an Order Status color in the TWS Shortable column of dark green. This indicates that there are no shares available to sell at the moment and that the system is searching for shares. The order will remain in this status until the we are able to locate the shares or the time which you specify for your order to remain in force expires, whichever occurs first. You may wish to review the Shortable Stocks link to our website below which provides a listing of stocks available for shorting. A list of shortable stocks searchable by symbol or CUSIP along with their indicative borrow rates may be found through the Short Stock Availability Tool accessible through the Tools link within Client Portal.

Finally, you should be aware that one of the risks of borrowing stock to support your short sale is being bought in with little or no notice. Even though a reasonable determination that the shares can be borrowed will be made prior to effecting your sale transaction, there is no assurance that those shares will actually be available at the time of settlement or any day thereafter. The supply and demand of borrowable inventory for any given security is dynamic by nature and regulations require brokers to force-close any short position having a delivery obligation subject to fail with the clearinghouse on any given day. We will make every effort to provide you with advance notice if this appears to be the case in order to provide you with the opportunity to buy in your own position, however, this is done on a best-efforts basis. Other risks to keep in mind are the special charges which tend to be associated with hard-to-borrow securities that, in aggregate may exceed any rebate or interest paid on the short stock proceeds, as well as your obligation to pay to the lender any dividends which are paid throughout the duration of the loan period.