Regulation SHO Rule 204 Under T+1: Close-Out Deadlines and What a Fail Costs

Updated October 2026, after T+1 took effect. First published March 2024.

Regulation SHO Rule 204 doesn't name a settlement cycle. Its deadlines count from settlement date, so when U.S. settlement moved from T+2 to T+1 on May 28, 2024, almost every close-out deadline moved a day earlier. The SEC considered changing the time frames when it adopted T+1 and decided not to.

This post covers the deadlines as they stand, the recall problem the shorter cycle created, and what a fail to deliver costs a broker-dealer now.

The Close-Out Deadlines

Rule 204(a) applies to a participant of a registered clearing agency with a fail to deliver position in an equity security at that clearing agency. For a short sale, the participant has to close out the fail by borrowing or purchasing securities of like kind and quantity "by no later than the beginning of regular trading hours on the settlement day following the settlement date." Other kinds of fail get more time.

Virtu Financial asked the SEC to look again at the deadlines, arguing that a shorter cycle would cut the time bona fide market makers have to close out. The SEC said in the T+1 adopting release that most Rule 204 time frames "automatically adjust" to a new cycle, that it had weighed that when it adopted Rule 204, and that it didn't think a reevaluation was needed "at this time."

Recalls Got Tighter

A firm that sells a security it has lent out depends on getting it back in time to deliver. The SEC's guidance on when a firm can mark the sale of a loaned but recalled security "long" under Rule 200(g)(1) assumed that recalled shares would come back within three business days. Commenters pointed out that T+1 shortens that window again.

The SEC kept its guidance and said some broker-dealers "may need to initiate a bona fide recall as early as trade date or may choose to modify securities lending agreements to shorten the recall period." The industry set 11:59 p.m. ET on trade date as the "leading practice" recall cutoff, according to the T+1 After Action Report. Our securities lending post covers the lending side.

What a Fail Costs Now

The Buy at the Open

The close-out has to happen by the start of regular trading hours, so the firm buys or borrows at whatever the market offers that morning. How the order is entered matters. In FINRA's 2022 action against UBS Securities, FINRA said a VWAP order can satisfy the close-out only if it's received by the start of regular trading hours and is irrevocable. Limit orders and other delayed orders don't count.

The Penalty Box

If the participant doesn't close out on time, Rule 204(b) bars it from accepting or effecting short sales in that security without first borrowing or arranging to borrow it. The bar also reaches any broker-dealer that clears through the participant, including market makers that would otherwise rely on the locate exception. It lasts until the participant buys securities of like kind and quantity and that purchase clears and settles. A borrow doesn't get the firm out. Rule 204(c) requires the participant to tell the broker-dealers that clear through it when a fail goes unclosed and when the closing purchase settles.

Net Capital

Under SEC Rule 15c3-1(c)(2)(ix), a broker-dealer takes a capital deduction on each failed to deliver contract that has been outstanding five business days or longer, or 21 business days for municipal securities. The deduction is the haircut that would apply to the underlying security, adjusted for any difference between contract price and market value.

The Customer Side

Rule 15c3-3(m) still requires a broker that hasn't received a customer's securities within ten business days after settlement date on a long sale to buy them in. Under T+1, that date comes a day sooner.

Enforcement

The UBS action shows how the costs stack up. FINRA censured UBS Securities and fined it $2.5 million. The violations ran from 2009 to 2018. For about three years, the firm's use of revocable VWAP orders and limit orders to close out fails led to about 5,300 violations of Rule 204(a) and at least 71,000 violations of the penalty box and pre-borrow requirements in Rule 204(b). Four order management systems failed to block short sales in securities with an open close-out requirement, which added at least 2,567 more Rule 204(b) violations. For about seven years, the firm also counted shares released from segregation for customer long sales as available to close out fails, which understated what it had to buy or borrow. FINRA also found that from 2009 to August 2022 the firm's supervisory system wasn't reasonably designed to achieve compliance with Rule 204.

What the Fail Numbers Show

Fails stayed at T+2 levels. The CNS fail rate averaged 2.12% in July 2024 and the DTC fail rate outside CNS averaged 3.31%, both "consistent with T+2," according to the after-action report. What happened in go-live week has the first-day numbers. The rate held, but each fail now has one less day between settlement date and the close-out.

What to Check

We'd test the penalty-box block first. It's an automated control that fails without anyone noticing, and in the UBS case it failed on four systems.

• Confirm that every order management system blocks short sales in a security with an open close-out requirement, unless the order has a pre-borrow.
• Confirm that close-out orders go in before the open and can't be revoked.
• Check how the fail calculation treats shares released from segregation.
• Check that your securities lending agreements and recall process allow a recall on trade date.
• If you clear for other broker-dealers, make sure the Rule 204(c) notices and any 204(d) allocations of fails go out before the open on the close-out date.

For the other rules the T+1 release left unchanged, see our reference to the T+1 rules.

This post is for informational purposes only and does not constitute legal advice. For guidance on specific regulatory obligations, consult your counsel or compliance advisor.