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, oftentimes with little or no advance notice. This isrisk 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 conducted.

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 second business day following the date of the trade (T+2). 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 2 days 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+2

If we are unable to borrow shares to deliver on settlement date (T+2), we have until market open of the following day, T+3, to cover the delivery obligation and prevent close-outs.

T+3 (all times in ET)

09:20

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

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 two days 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). Given the volume of formal recalls which we receive but are not later acted upon by the lender, we do not provide clients with advance warning of these recall notices.

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 conduct vetting of 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 EST.

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.

Important Notes

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.

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.