On December 23, 2025, the Securities and Exchange Commission published a notice in the Federal Register regarding a proposed rule change by MEMX LLC, a self-regulatory organization. The filing, dated December 11, 2025, seeks to amend Rule 4.7 of MEMX's compliance rule related to the Consolidated Audit Trail, known as the CAT. This update requires broker-dealers to report whether an order to sell an equity security is a short sale claiming the bona fide market making exception under Rule 203(b)(2)(iii) of Regulation SHO. The change became effective immediately upon filing, as it qualifies under provisions for non-controversial rule changes. This development reflects ongoing efforts to strengthen transparency in securities trading by integrating specific short sale exemptions into the CAT reporting framework, potentially aiding regulators in monitoring market integrity and preventing manipulative practices.
Background on the CAT NMS Plan and Regulation SHO
The Consolidated Audit Trail is a comprehensive database designed to track orders and transactions in U.S. securities markets. Established under the CAT NMS Plan, approved by the SEC in 2016, it requires national securities exchanges and the Financial Industry Regulatory Authority to mandate reporting from their members, referred to as Industry Members. The plan's goal is to enable regulators to reconstruct market events, detect abuses, and ensure fair trading practices.
Regulation SHO, implemented in 2005, governs short selling to curb potential market manipulation. A short sale involves selling a security not owned by the seller, with the expectation of buying it back later at a lower price. Rule 203(b) of Regulation SHO includes a 'locate' requirement, mandating that sellers locate securities to borrow before executing a short sale. However, Rule 203(b)(2)(iii) provides an exception for market makers engaged in bona fide market making activities, allowing them to short sell without a prior locate if it facilitates liquidity provision.
In 2023, the SEC amended the CAT NMS Plan to incorporate reporting of this exception. As detailed in SEC Release Nos. 98738 and 98739, published in the Federal Register on November 1, 2023, the amendment added paragraph (D) to Section 6.4(d)(ii) of the plan. This requires exchanges to update their compliance rules, ensuring Industry Members report reliance on the bona fide market making exception, or BFMM Locate Exception, for original short sale orders in equity securities.
MEMX's proposal directly responds to this amendment, ensuring its rules align with the updated plan. MEMX, which operates as a national securities exchange focused on equities trading, must enforce these reporting obligations to maintain consistency across the industry.
Key Details of the Proposed Rule Change
MEMX proposes adding subparagraph (G) to Rule 4.7(a)(2) of its CAT Compliance Rule. This new provision states that each Industry Member must record and report to the Central Repository: 'for the original receipt or origination of an order to sell an equity security, whether the order is for a short sale effected by a market maker in connection with bona fide market making activities in the security for which the exception in Rule 203(b)(2)(iii) of Regulation SHO is claimed.'
This language mirrors the CAT NMS Plan amendment, emphasizing precision in reporting. The Central Repository is the CAT's core database, managed by a plan processor. By mandating this data point, the rule enhances the granularity of audit trail information, allowing regulators to distinguish between standard short sales and those exempted for market making purposes.
The filing asserts that the change is consistent with Section 6(b)(5) of the Securities Exchange Act of 1934, which requires exchange rules to promote just and equitable principles of trade, prevent fraudulent practices, and protect investors. MEMX notes that the proposal furthers the CAT NMS Plan's objectives, as outlined in the SEC's 2016 approval order (Release No. 79318), which described the plan as essential for maintaining fair and orderly markets.
Additionally, MEMX states that the rule will not impose undue burdens on competition, as it applies uniformly to all relevant Industry Members and parallels similar updates by other exchanges and FINRA.
Regulatory and Industry Perspectives
From a regulatory standpoint, this amendment addresses gaps in short sale oversight. The SEC has long emphasized the need for robust data to monitor exemptions like the BFMM Locate Exception, which could be misused to facilitate abusive trading. For instance, in its 2023 releases, the SEC highlighted how enhanced reporting would aid in surveillance, quoting the plan amendment's intent to 'improve the ability of regulators to monitor compliance with Regulation SHO.'
Industry participants, including broker-dealers and market makers, may view the change as an added compliance burden but one that aligns with broader transparency goals. Trade groups have previously commented on CAT implementations, often advocating for phased rollouts to minimize disruptions. No specific comments were solicited or received on this MEMX filing, as noted in the Federal Register notice, but the immediate effectiveness suggests minimal controversy.
Critics of expansive reporting requirements argue they increase operational costs without proportional benefits, potentially affecting smaller firms disproportionately. Proponents, however, point to precedents like the SEC's 2010 enhancements to Regulation SHO, which tightened short sale rules post-financial crisis, underscoring the value of detailed audit trails in preventing market volatility.
Implications for Market Oversight
Short-term implications include updated reporting protocols for Industry Members. Firms must adjust systems to capture and transmit BFMM exception data, likely requiring software updates and training. Non-compliance could result in enforcement actions, as CAT rules are enforceable under exchange disciplinary procedures.
Long-term, this could lead to more effective regulatory analytics. By flagging exempted short sales, the CAT may help identify patterns of potential abuse, such as excessive reliance on the exception without genuine market making intent. This aligns with ongoing SEC initiatives, like those in the 2022 proposed amendments to Regulation SHO, which aimed to further restrict short selling in certain scenarios.
Different perspectives emerge on balancing innovation and regulation. Market makers argue the exception is vital for liquidity, while investor advocates push for stricter controls to protect against downward price manipulation.
In summary, MEMX's rule change integrates a critical reporting element into the CAT framework, enhancing oversight of short sales. Potential next steps include monitoring compliance timelines and assessing the data's utility in regulatory examinations. Ongoing debates may focus on refining exemption criteria or expanding CAT scope, as markets evolve with new technologies and trading strategies. Challenges could arise from implementation complexities, but the uniform application across exchanges fosters a cohesive national market system.
