Rule Atlas
FINRA Rule 3110: Supervisory Controls for Regulation SHO Locate Requirements and Exceptions
Under FINRA Rule 3110 (FINRA / SEC Supervision & Net Capital), supervisory Controls for Regulation SHO Locate Requirements and Exceptions establishes the authoritative rules tested on the FINRA Series 24. This lesson covers the specific supervisory controls and procedures necessary to ensure compliance with Regulation SHO's locate requirement, including permissible methods for obtaining a locate and the applicable exceptions. VoraPrep verifies every, verified against VoraPrep's FINRA Series 24 blueprint.
Core Statutory Concepts
| Feature | Locate Requirement (Rule 203(b)(1)) | Bona Fide Market Making Exception | Other Exceptions (e.g., Error Correction) |
|---|---|---|---|
| Purpose | Prevent naked short selling | Facilitate market liquidity | Address operational necessities |
| Requirement | Reasonable grounds to believe shares can be borrowed | Not required for legitimate market making | Specific conditions apply |
| Documentation | Required for each short sale | Not required for market making trades | Required if applicable |
| Supervision | Strict WSPs and recordkeeping | WSPs to ensure bona fide activity | WSPs for error identification/correction |
| Applicability | All short sales (unless exception applies) | Market makers only, for specific activities | Limited, specific scenarios |
A principal responsible for trading supervision discovers a pattern of repeated Regulation SHO 'locate' violations by an experienced registered representative. The representative frequently enters short sale orders without proper documentation of a borrow or reasonable belief of ability to borrow. The firm's existing Written Supervisory Procedures (WSPs) clearly outline the 'locate' requirements. What is the most appropriate initial action for the principal to take, consistent with FINRA Rule 3110 and 3120?
Practitioner Application: Supervisory Controls for Regulation SHO Locate Requirements and Exceptions
A principal at a broker-dealer receives an urgent request from a hedge fund client to execute a significant short sale in a thinly traded stock. The firm's automated locate system shows no available shares. The trader, under pressure, suggests using a previous, unrelated locate from three days ago for a different client, arguing that the shares are 'likely still available.' The principal must decide whether to approve the short sale, knowing the firm's supervisory procedures require a current and valid locate. What is the principal's obligation here, and what are the potential regulatory consequences of approving the trade without a fresh locate?
- Regulation SHO, specifically Rule 203(b)(1), mandates that a broker-dealer must have reasonable grounds to believe that the security can be borrowed and delivered on settlement date before executing a short sale. This is known as the locate requirement. The purpose is to prevent 'naked' short selling, which can lead to settlement failures and market manipulation. Firms must establish and maintain supervisory controls to ensure compliance with this rule.
- Reasonable Grounds for Belief To satisfy the locate requirement, a broker-dealer must have a current and valid basis for believing the shares can be borrowed. This is not merely an informal inquiry but requires documented evidence. Acceptable methods for obtaining a locate include: Bona fide loan of securities: The firm has entered into an agreement to borrow the securities, or has reasonable assurance that it can borrow them. Arrangement to borrow: The firm has an arrangement with a customer or another broker-dealer to borrow the securities. Easy to borrow list: The security appears on an 'easy to borrow' list, provided the list is updated daily and reflects actual availability. Proprietary inventory: The firm itself holds the securities in its own inventory and intends to deliver them.
Common FINRA Series 24 Distractors on FINRA Rule 3110
- 1Test questions often focus on the nuances of what constitutes a valid locate and the limitations of exceptions.
- 2⚠️ Exam trap: Assuming an 'easy to borrow' list is always sufficient. The trap is that the list must be updated daily and reflect current availability. An outdated list is not a valid locate.
- 3⚠️ Exam trap: Confusing the locate requirement with the close-out requirement. While related, the locate requirement is pre-trade (before executing the short sale), while the close-out requirement (Rule 204) is post-trade and applies to failures-to-deliver.
- 4⚠️ Exam trap: Overlooking the recordkeeping requirements. Principals must ensure that all locates and related documentation are maintained for the specified period (three years, first two easily accessible).
- 5Locate Requirement: Before a short sale, a broker-dealer must have reasonable grounds to believe the security can be borrowed and delivered.
Frequently Asked Questions: FINRA Rule 3110
What is the core rule under FINRA Rule 3110 (Supervisory Controls for Regulation SHO Locate Requirements and Exceptions)?
Under FINRA Rule 3110 (FINRA / SEC Supervision & Net Capital), supervisory Controls for Regulation SHO Locate Requirements and Exceptions establishes the authoritative rules tested on the FINRA Series 24. This lesson covers the specific supervisory controls and procedures necessary to ensure compliance with Regulation SHO's locate requirement, including permissible methods for obtaining a locate and the applicable exceptions. VoraPrep verifies every, verified against VoraPrep's FINRA Series 24 blueprint.
How is FINRA Rule 3110 tested on the FINRA Series 24?
Test questions often focus on the nuances of what constitutes a valid locate and the limitations of exceptions. ⚠️ Exam trap: Assuming an 'easy to borrow' list is always sufficient. The trap is that the list must be updated daily and reflect current availability. An outdated list is not a valid locate.
Where can I practice FINRA Series 24 questions on Supervisory Controls for Regulation SHO Locate Requirements and Exceptions?
Test yourself instantly with the free playable FINRA Series 24 question on this page, or launch VoraPrep's full FINRA Series 24 adaptive question bank, interactive lessons, and 1:1 exam simulator at voraprep.com/series24.