The 'Short Exempt' Tag: When and How to Use It

When a short sale order is sent to the market, it must be marked as either 'short' or 'short exempt'. The 'short exempt' tag is a special designation that indicates that the order is not subject to the price test restrictions of the short sale circuit breaker.

When Can the 'Short Exempt' Tag Be Used?

The 'short exempt' tag can only be used in a limited number of circumstances. The most common reasons for using the 'short exempt' tag include:

• Bona Fide Market Making: As we have already discussed, bona fide market makers are exempt from the price test restrictions of the short sale circuit breaker.
• Riskless Principal Transactions: A riskless principal transaction is a transaction where a broker-dealer, after having received an order to buy a security, purchases the security as principal for the purpose of filling the order. In this case, the broker-dealer can mark the sell order as 'short exempt'.
• Arbitrage: The 'short exempt' tag can also be used for certain types of arbitrage transactions, such as when a trader is buying a convertible security and selling the underlying stock.

The Impact on Order Execution

When an order is marked as 'short exempt', it can be executed at a price that is at or below the current national best bid, even when the short sale circuit breaker has been triggered. This can give traders who are able to use the 'short exempt' tag a significant advantage over other traders.

However, it is important to remember that the 'short exempt' tag can only be used in a limited number of circumstances. If a trader uses the 'short exempt' tag improperly, they could be subject to disciplinary action from the SEC or FINRA.

The Potential for Misuse

The 'short exempt' tag has been a source of controversy, with some critics arguing that it has been used to facilitate abusive short selling. In particular, there have been concerns that the 'short exempt' tag has been used to circumvent the short sale circuit breaker and to drive down the price of a security.

In response to these concerns, the SEC has taken a number of steps to crack down on the misuse of the 'short exempt' tag. In 2010, the commission issued a guidance paper that clarified the circumstances in which the 'short exempt' tag can be used. The commission has also brought a number of enforcement actions against traders who have been found to have misused the 'short exempt' tag.