NASD Notice to Members 98-65



NASD Reminds Members Of Obligations Relating To The Short-Sale Rule



Executive Summary


In 1994, the National Association of Securities Dealers, Inc. (NASD®) Rule 3350 

(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, Inc. (NASD RegulationSM) 

that certain NASD members may be assisting customers in the circumvention of 

this Rule. Specifically, these members are failing to net security positions of 

related accounts for customers who maintain accounts in their name and exercise 

control over a second related account, usually held in a family member’s name. 

The failure to net these positions has permitted these customers, which operate the 

two accounts with a single investment strategy, to avoid application of the Short-

Sale Rule. 



Members are required to net all positions for accounts that are related or under 

common control in order 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 David Katz, Assistant 

Chief Counsel, Market Regulation, NASD Regulation, at (301) 208-3074.



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.” 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 adhere to the 

definition of a “short sale” contained in the Securities and Exchange Commission 

(SEC) Rule 3b-3, which is incorporated into the NASD’s Short-Sale Rule. 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 related or under 

common control.



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 avoiding the rule.2 With this Notice, the NASD wishes to clarify that a 

member would be deemed to be in violation of the Short-Sale Rule if the member 

or an associated person knowingly assists customers in the following scheme:



•	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 Regulation T and 

margin purposes a second account (a “short account”), usually held by a family 

member or related person. 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 is 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 view trades in accounts like those described above as 

occurring in related or controlled accounts and must be netted for purposes of 

compliance with the Short-Sale Rule. Accounts will be deemed to be related or 

controlled if the customer exercises discretion over the account, cross guarantees 

the account for Regulation T or margin purposes, or has been granted a power of 

attorney to execute transactions in the account. NASD Regulation will also 

consider other facts and circumstances such as whether the account belongs to a 

family member or related person and whether a similar pattern of activity is 

occurring in other customer accounts. 



NASD Regulation will closely watch for the above described conduct and for 

similar schemes that attempt to circumvent application of the Rule. Members 

should instruct their associated persons not to accept orders for execution where 

customers are operating two accounts in order to avoid the Rule. A finding of 

such abuses will result in possible disciplinary action.



Endnotes



1 NASD Rule 3350(a).



2 NASD Rule 3350(e).



© 1998, National Association of Securities Dealers, Inc. (NASD). All rights 

reserved.