What Is Threshold Securities?

Threshold Securities are financial instruments that have failed to deliver on positions for five consecutive settlement days. This term is significant in the context of U.S. equity markets and securities regulations.

Threshold Securities are financial instruments, particularly stocks, that have consistently failed to deliver settled positions for five consecutive settlement days. This failure to deliver (FTD) is a notable event in the context of U.S. equity markets and is governed by regulations aimed at ensuring market integrity and transparency.

Definition and Key Characteristics

Threshold Securities are identified by regulatory authorities, such as the United States Securities and Exchange Commission (SEC), when they meet the following criteria:

• The security has an aggregate FTD position at a registered clearing agency of 10,000 shares or more for five consecutive settlement days.
• The FTD position is equal to at least 0.5% of the issuer’s total shares outstanding.
• The issue is included on a threshold list published by self-regulatory organizations (SROs), like the Nasdaq or NYSE.

Importance in Financial Markets

Position failures can indicate underlying issues such as short-selling abuses or liquidity problems. Securities on the threshold list are subject to specific regulatory scrutiny to prevent potential market manipulation and ensure orderly market function.

Regulatory Context

SEC Regulation SHO

Threshold Securities fall under SEC Regulation SHO, established to address concerns about abusive naked short selling. Key components include:

• Rule 203(b)(3): imposes immediate buy-in requirements for brokers and dealers who have customers with FTDs in threshold securities.
• Rule 204: outlines mandatory close-out requirements for brokers and dealers to close out FTD positions.

Implications and Compliance

Entities involved in trading threshold securities must comply with stringent rules to mitigate the risks associated with FTDs:

• Monitoring daily FTD reports.
• Ensuring timely settlement of trades.
• Implementing proper buy-in strategies to close out positions promptly.

Historical Context

Origin of Regulations

The concept of threshold securities and the subsequent regulations were introduced following increased scrutiny on market practices in the early 2000s. Scandals related to market manipulation via naked short selling and the collapse of certain high-profile firms prompted regulatory bodies to enforce stricter rules.

Evolution Over Time

Since their introduction, regulations surrounding threshold securities have evolved:

• Enhanced reporting and transparency requirements.
• Tighter enforcement mechanisms to deter non-compliance.

Real-World Examples and Applications

Case Study: Overstock.com

Overstock.com, Inc. (OSTK) was embroiled in allegations of being victimized by naked short selling, which led to significant FTDs. The prolonged failure to deliver positions on OSTK shares placed the stock on the threshold list, drawing regulatory attention and legal battles.

Broker-Dealer Actions

Broker-dealers dealing with threshold securities must be vigilant:

• Utilizing technology to track and report FTDs.
• Promptly executing buy-in procedures to rectify FTDs.

Comparisons to Related Terms

Fail to Deliver (FTD)

Fail to Deliver: Occurs when a buyer or seller does not receive or deliver the security by the settlement date.

• A broader term encompassing all delayed settlements, not just those qualifying as threshold securities.

Buy-In

Buy-In: A process where the broker purchases the securities in the market to deliver to the buyer, rectifying the FTD.

Naked Short Selling

Naked Short Selling: Selling shares without first borrowing them, often leading to FTDs.

FAQs

What triggers a stock to become a threshold security?

A stock becomes a threshold security when it has an FTD position of 10,000 shares or more for five consecutive settlement days, accounting for 0.5% or more of the total shares outstanding.

How do regulatory bodies enforce compliance for threshold securities?

Regulatory bodies enforce compliance through the SEC’s Regulation SHO, requiring brokers to close out FTD positions and imposing penalties for non-compliance.

Why are threshold securities significant?

They highlight potential market issues such as liquidity problems or short-selling abuses, prompting regulatory scrutiny to maintain market integrity.

Summary

Threshold Securities play a critical role in highlighting and regulating potential issues within equity markets. They are essential to ensuring transparency and fairness in trading by identifying and addressing persistent settlement failures. Compliance with related regulations helps maintain market stability and investor confidence.

References

• U.S. Securities and Exchange Commission. (n.d.). Regulation SHO.
• Financial Industry Regulatory Authority (FINRA). (n.d.). Threshold Securities.
• NASDAQ. (n.d.). Threshold Securities List.