Reg SHO: Locates, Fails to Deliver and the 13-Day List

A short sale begins with a borrow

The intuitive description of short selling — selling what you do not own — hides the operational step that makes the sale possible. Before the sale, someone has to make the shares available.

Rule 203(b) states the requirement in three parts. A broker or dealer “may not accept a short sale order in an equity security from another person, or effect a short sale in an equity security for its own account, unless the broker or dealer has”:

1. “Borrowed the security, or entered into a bona-fide arrangement to borrow the security”; or
2. “Reasonable grounds to believe that the security can be borrowed so that it can be delivered on the date delivery is due”; and
3. “Documented compliance with this paragraph (b)(1).”

The third clause is the one that turns the rule from an intention into a record. A broker that believed a borrow was available but cannot show how it reached that belief has not complied, because the rule asks for documentation as an element rather than as evidence produced afterwards.

The SEC’s investor page puts the same point in plain language: the locate “must be made and documented prior to effecting the short sale.”

The exceptions are written, not implied

Rule 203(b)(2) lists the cases where the locate requirement does not apply. One is a broker that has accepted the order from another registered broker-dealer that is itself subject to the requirement — the obligation does not disappear, it moves to the firm that took the order first. Another covers a sale of a security the seller is deemed to own under Rule 200, provided the broker has been reasonably informed that the seller intends to deliver it once restrictions are lifted; if delivery does not happen within 35 days of the trade date, the broker must borrow or close out.

Bona fide market makers have a limited exception when acting in that capacity. The qualifier matters: the exception is for the market-making function, not for a proprietary position that happens to be filed under a market-maker’s name.

Marking: long, short or short exempt

Rule 200 requires every order to be marked. A sale may be marked long “only if the seller owns the security and it is, or is expected to be, in the physical possession or control of the broker-dealer by settlement; otherwise it is short.”

Marking is where a surprising amount of the rule’s force sits. A customer who holds shares in a different account at a different firm, and sells at the first firm, is not automatically making a long sale — the question is whether the shares will be in the selling broker’s possession or control by settlement. A sale that is marked long and then fails to deliver becomes a different kind of problem from a sale that was marked short from the start.

Fails to deliver and the close-out clock

A fail to deliver occurs when a clearing participant does not deliver securities to the clearing agency by settlement date. Rule 204 then sets a deadline to close the position out by “borrowing or purchasing securities of like kind and quantity.”

The deadlines differ by the origin of the fail:

The short-sale deadline is the tighter of the two, and that asymmetry is deliberate: a fail that follows a short sale is the case the rule is most concerned with, because it is the case in which the seller never had the shares to begin with.

The threshold list

A single fail is a settlement problem. A persistent fail is a market-structure problem, and the rules treat it as one.

The SEC describes the threshold criteria as an aggregate fail position lasting “five consecutive settlement days”, totalling “at least 10,000 shares and 0.5% of outstanding shares”. Self-regulatory organisations publish the resulting list, which is why it is often called the threshold list.

Once a security is on the list, the close-out obligation tightens. The SEC summarises the escalation: if a fail persists “for 13 consecutive settlement days”, Rule 203(b)(3) requires an immediate purchase to close it out. Thirteen consecutive settlement days is roughly three trading weeks — long enough for a temporary operational problem to be resolved, short enough that a structural shortage cannot persist indefinitely.

Why the mechanism is about delivery, not opinion

Arguments about short selling tend to be about whether the practice is good or bad. Reg SHO does not adjudicate that question. It regulates one thing: whether a sale that was made can be delivered.

That focus explains the shape of the rule. The locate requirement ensures that a short sale is backed by an actual or reasonably expected borrow. The marking requirement ensures that the sale is labelled honestly at the point of entry. The close-out requirement ensures that a failure to deliver has a deadline. None of the three says a short position is wise, and none of them limits the size of a short position.

The consequence is that a short seller can be entirely within the rules and still lose more than the position was worth, because the rule governs delivery rather than risk.

Where the crypto analogy fails

Crypto venues offer short exposure through perpetual futures and margin products, and they use the language of borrowing. The mechanism is different in almost every respect.

A perpetual futures short is not a sale of a borrowed asset; it is a contract that is marked to market and funded through periodic payments. A margin short on a spot venue borrows from the venue’s own lending pool, at rates the venue sets, with liquidation rules the venue writes. There is no clearing agency, no settlement date, and no threshold list.

The one thing the two systems share is the asymmetry that makes short positions dangerous: the loss on a short is unbounded as the price rises, and the position can be closed by the counterparty before the trader chooses to act.

Risk note. The locate, marking and close-out requirements in this article were read from the SEC’s Regulation SHO investor page and the published text of 17 CFR 242.203 and 242.204 on 2026-10-27. Rule text and threshold criteria change; check the current rule before relying on a specific number. Nothing here is investment advice.