SECURITIES COMPLIANCE | 2026-09-30
Regulation SHO: The Rules That Govern Short Selling and Naked Shorts
The SEC’s Regulation SHO sets the framework for legitimate short selling — the locate and close-out requirements, order-marking rules, and the measures aimed at curbing abusive naked short selling.
Short selling — selling borrowed securities in the expectation of buying them back at a lower price — is a legitimate and important part of the securities markets. But abusive practices, especially <strong>naked short selling</strong> (selling without having borrowed or arranged to borrow the securi
Regulation SHO is the SEC’s core framework for short selling.
What Short Selling Is — and the Problem SHO Addresses
In a short sale, a seller borrows a security, sells it, and hopes to buy it back later at a lower price to return to the lender. Legitimate short selling adds liquidity and helps price discovery. The abuse Regulation SHO targets is naked short selling — selling a security the seller has not borrowed and has not reasonably arranged to borrow — which can lead to a failure to deliver the security at settlement and can be used to manipulate prices.
The Locate Requirement (Rule 203)
A cornerstone of Regulation SHO is the locate requirement. Before effecting a short sale, a broker-dealer generally must have reasonable grounds to believe that the security can be borrowed and delivered by the settlement date — a “locate.” The broker must document the locate. This requirement is aimed squarely at preventing naked short sales by ensuring that a source for the borrowed shares has been identified before the short sale is executed.
The Close-Out Requirement
Regulation SHO also imposes close-out obligations to address fails to deliver. When a fail to deliver persists, the responsible participant is generally required to close out the position by purchasing or borrowing securities of like kind and quantity within specified timeframes. Failure to close out can trigger further restrictions — including a prohibition on additional short sales in that security until the fail is cured (the “penalty box” concept). These provisions are designed to prevent the persistent settlement failures associated with abusive shorting.
Threshold Securities
Regulation SHO uses the concept of threshold securities — securities with a significant, persistent level of fails to deliver that meet defined criteria. When a security appears on a threshold list, heightened close-out and other requirements apply. The threshold-security framework focuses regulatory attention on the securities where settlement failures are most concentrated.
Order-Marking Rules (Rule 200)
Regulation SHO requires that orders be properly marked. Under Rule 200, a seller must identify each order as:
- “long” — where the seller owns the security and it will be delivered;
- “short” — where it is a short sale; or
- “short exempt” — where a specified exemption applies.
Accurate order marking is essential to the operation of the regulation, and mismarking can itself be a violation. Rule 200 also defines when a person is deemed to own a security and to have a net long position.
The Alternative Uptick Rule (Rule 201)
Regulation SHO includes a short-sale price restriction — the “alternative uptick rule” (Rule 201). When a security’s price declines by a specified percentage from the prior day’s close, a circuit-breaker is triggered, and for a defined period short sales generally may be executed only at a price above the current national best bid. The rule is designed to prevent short selling from accelerating a declining price while still permitting legitimate short selling.
Why Compliance Matters
Regulation SHO violations — failing to obtain or document locates, failing to close out fails to deliver, or mismarking orders — can lead to SEC and self-regulatory enforcement, penalties, and remedial undertakings. For broker-dealers and trading firms, robust locate documentation, close-out monitoring, and order-marking controls are essential. For issuers concerned about abusive shorting of their stock, understanding the regulation clarifies both the protections it provides and its limits.
Frequently Asked Questions
What is Regulation SHO?
The SEC’s framework governing short selling, including locate and close-out requirements, order-marking rules, and measures addressing naked short selling.
What is the locate requirement?
Before a short sale, a broker-dealer generally must have reasonable grounds to believe the security can be borrowed and delivered by settlement, and must document that locate.
What is naked short selling?
Selling a security the seller has not borrowed or reasonably arranged to borrow, which can cause fails to deliver.
What are threshold securities?
Securities with significant, persistent fails to deliver that meet defined criteria, triggering heightened close-out requirements.
How must orders be marked?
As “long,” “short,” or “short exempt” under Rule 200; accurate marking is required and mismarking can be a violation.
What is the alternative uptick rule?
A price restriction (Rule 201) that, after a security drops a specified percentage in a day, generally limits short sales to prices above the national best bid for a period.
Related Securities & Governance Guides
Talk to a Securities Attorney About Short-Selling Compliance
Regulation SHO’s locate, close-out, and marking rules carry real enforcement exposure. Trembach Law Firm advises California market participants on short-selling compliance. Call (818) 514-7680.
Contact Trembach Law Firm at (818) 514-7680 for a confidential consultation.
Trembach Law Firm | 27001 Agoura Road, Suite 350, Calabasas, CA 91301