Stock Lending and Short Sales

Quick Answer

Stock lending temporarily transfers securities to a borrower that must later return equivalent securities, supported by collateral. It enables delivery for short sales, which involve securities the seller does not own. Regulation SHO requires applicable order marking and generally requires a borrow, arranged borrow, or reasonable locate before the short sale.

Short-sale delivery depends on securities being available to borrow. Stock lending provides that operational link.

Stock Lending

  • Stock loan: Temporary lending of securities so a borrower can make delivery, including delivery on a short sale.
  • Securities lender: The party that provides securities and retains the right to receive equivalent securities back.
  • Securities borrower: The party that receives borrowed securities and must return equivalent securities to the lender.
  • Collateral: Securities lending is collateralized to protect the lender against the borrower's obligation to return equivalent securities.

Lender provides securities → borrower delivers securities → borrower returns equivalent securities. Collateral protects the lender during the loan.

Short Sale Requirements

  • Short sale: A sale of a security the seller does not own, or a sale completed by delivering securities borrowed for the seller's account.
  • Order marking: Under Regulation SHO, a broker-dealer marks an equity-security sell order as long, short, or short exempt, as applicable.
  • Locate requirement: Before accepting or effecting a short sale in an equity security, the firm generally must have borrowed the security, arranged to borrow it, or have reasonable grounds to believe it can be borrowed for timely delivery.
  • The locate supports the ability to borrow securities for delivery and is intended to prevent an avoidable failure to deliver.

Exam Tip: Gotchas

A locate is not merely an order label. The locate supports timely delivery by establishing that the security has been borrowed, arranged to be borrowed, or can reasonably be borrowed. Order marking and the locate are separate short-sale controls.