The Price Test

The price test is written as a duty on the venue rather than on the seller. It never bans a short sale in a falling stock; it prices one, by pushing the order above the current national best bid.

Which Securities and Firms Does the Price Test Reach?

Five defined terms decide the rule's reach, and each is worth reading closely.

• Covered security. Any national market system (NMS) stock, which Regulation NMS definitions make any NMS security other than an option.
• Listing market. The primary listing exchange, which is the exchange identified as such in the effective national market system plan or plans.
• Trading center. A national securities exchange or national securities association that operates a self-regulatory organization trading facility, an alternative trading system, an exchange market maker, an OTC market maker, or any other broker or dealer that executes orders internally by trading as principal or crossing orders as agent.
• Regular trading hours. The time between 9:30 a.m. and 4 p.m. Eastern Time, or such other time as is set forth in the procedures established under the order execution disclosure rule.
• Riskless principal. A transaction in which a broker or dealer, after having received an order to buy, purchases the security as principal at the same price to satisfy that order, or, after having received an order to sell, sells as principal at the same price to satisfy that order, exclusive of any explicitly disclosed markup or markdown, commission equivalent, or other fee.

Two of those five carry traps. The trading center definition ends with a catch-all that reaches an ordinary broker-dealer internalizing orders, so a firm with no exchange and no alternative trading system can still be a trading center.

The riskless principal definition classifies the transaction, not the firm. A desk is not a riskless principal; a particular trade is done on a riskless principal basis.

Covered security is defined that way for this rule alone. Regulation M gives the same term a different meaning, any security that is the subject of a distribution or any reference security, so the two definitions do not travel between the rules.

Exam Tip: Gotchas

• The price test reaches a covered security only. That means an NMS stock, so an OTC equity security sits outside this rule entirely and has no price test of this kind.
• An option is never a covered security. The definition of an NMS stock excludes options by its own terms, which is why the price test never reaches an options order.
• A broker-dealer that crosses orders as agent is a trading center. The definition's final clause pulls internalizers in, so the written policies and procedures duty is not limited to exchanges.

What Triggers the Restriction, and How Long Does It Last?

A trading center shall establish, maintain, and enforce written policies and procedures reasonably designed to do two things.

The first is to prevent the execution or display of a short sale order of a covered security at a price that is less than or equal to the current national best bid, if the price of that covered security decreases by 10% or more from the covered security's closing price as determined by the listing market as of the end of regular trading hours on the prior day.

The second is to impose that requirement for the remainder of the day and the following day when a national best bid for the covered security is calculated and disseminated on a current and continuing basis pursuant to an effective national market system plan. SEC staff call the resulting restriction the alternative uptick rule.

The restriction can fire again while it is already running. SEC staff guidance states that if the price of a covered security declines intra-day by at least 10% on a day on which the security is already subject to the restriction, the restriction is re-triggered and continues for the remainder of that day and the following day. The rule places no limit on how often that can happen.

Exam Tip: Gotchas

• The trigger measures against the prior day's close, not the intra-day high. The comparison is to the covered security's closing price as determined by the listing market at the end of regular trading hours on the prior day.
• The restriction covers two days, not one. It runs for the remainder of the trigger day and the following day, while a national best bid is calculated and disseminated under an effective national market system plan, so an answer stopping the restriction at the closing bell is short by a session.
• A second decline extends the restriction rather than replacing it. A further intra-day drop of at least 10% while the stock is already restricted re-triggers the restriction for that day's remainder and the next day, with no cap on repeats.
• The duty sits on the trading center, not on the short seller. The obligation is to have written policies and procedures reasonably designed to prevent the execution or display, which is why a venue can be at fault where the seller is not.

Which Executions Must the Policies and Procedures Still Permit?

The rule then adds a proviso, and it is a requirement rather than a permission. The policies and procedures must be reasonably designed to permit two things.

• The above-the-bid displayed order. The execution of a displayed short sale order of a covered security by a trading center if, at the time of initial display of the short sale order, the order was at a price above the current national best bid.
• The short exempt order. The execution or display of a short sale order of a covered security marked "short exempt" without regard to whether the order is at a price that is less than or equal to the current national best bid.

The first permission is measured once, at initial display. An order priced above the national best bid when it was first displayed keeps the permission as the bid moves, because the rule fixes the test to that moment.

Exam Tip: Gotchas

• The above-the-bid test is taken at the time of initial display. A displayed order that was above the current national best bid when first displayed stays executable, and an answer re-testing the price at execution misreads the clause.
• The proviso is a "must permit", not a "may permit". A trading center whose procedures block every short sale in a restricted stock has failed the rule as surely as one that blocks none.
• Short exempt orders run without regard to the bid comparison. Their permission sets aside only whether the order is at or below the current national best bid, which is what makes the short exempt mark worth having.

Who Decides That the Trigger Was Hit, and Who Must Surveil the Procedures?

The listing market makes the determination whether the price of a covered security has decreased by 10% or more from the prior day's close as it determined it. If such decrease has occurred, the listing market shall immediately make such information available as provided in the market data distribution and display rule.

The trading center's own duty does not end when it writes the procedures. A trading center shall regularly surveil to ascertain the effectiveness of those policies and procedures, and shall take prompt action to remedy deficiencies in them.

That determination and notification also does work in the lesson on short sale exemptions. Both routes to a short exempt mark open only after it has happened.

Exam Tip: Gotchas

• The listing market decides, and the trading center enforces. A trading center does not make its own finding that a stock has fallen 10%. An exchange can hold both roles, because a national securities exchange that operates a self-regulatory organization trading facility is itself a trading center, so it can owe the determination and the order-handling procedures at once.
• Surveillance and remediation are a standing duty. Regularly surveilling for effectiveness and taking prompt action on deficiencies sits alongside the requirement to establish, maintain and enforce the procedures.

What Should You Check on Exam Day?

• Confirm the security is a covered security, that is, an NMS stock. An option or an OTC equity security is outside this rule.
• Measure the 10% decline against the prior day's listing-market close at the end of regular trading hours, not against any intra-day level.
• Run the restriction through the remainder of the trigger day and the whole following day, while a national best bid is disseminated, and re-trigger it on a further intra-day 10% decline.
• On a displayed order, test the price against the national best bid at the time of initial display, not at execution.
• Put the duty on the trading center, and the 10% determination and its immediate publication on the listing market.