Short on Short Selling: Global Regulators Take Action

September 23, 2008

Responding to current market conditions, the U.S. Securities and Exchange Commission (the "SEC" or "Commission") and other regulatory and governmental authorities around the globe have taken dramatic steps to address the current market turmoil resulting from potentially manipulative short selling.  These initiatives include emergency actions prohibiting short sales in certain securities of financial institutions, banning naked short selling directly and by tightening pre-borrow and close-out requirements, and requiring disclosure by certain investment managers of short positions.  In addition, sweeping investigations of abusive short selling, market manipulation and rumor mongering have been launched by the SEC, and the New York State Attorney General, the Financial Industry Regulatory Authority ("FINRA") and NYSE Regulation ("NYSER").

Similarly, and with a view to U.S. market conditions, the U.K.’s Financial Services Authority ("FSA"), German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – "BaFin") and other financial services regulators around the globe have taken emergency action to prohibit certain short selling and require disclosure of certain short positions.  On Friday, the Committee of European Securities Regulators ("CESR") published a statement announcing that European Union ("EU") securities regulators had stepped up monitoring of financial markets and that some national authorities in the block have implemented or are considering short selling controls.  Paris-based CESR coordinates the actions of market authorities from the 27 EU countries.

These initiatives are discussed below and in the attached chart summarizing recent global short sale-related developments.

I.  Short Selling prohibitions

            A.  United States

                        1.  Ban on Short Sales of Certain Publicly Traded Securities

On September 18, 2008, the SEC issued an emergency order ("September 18, 2008 Order") pursuant to Section 12(k)(2) of the Securities Exchange Act of 1934 (the "Exchange Act") prohibiting any person from effecting a short sale in the publicly traded securities of 799 financial firms, as identified by the ticker symbols listed in Appendix A to the order.[1]  The SEC subsequently delegated to the relevant listing markets responsibility for posting on their respective websites their individual listed companies that are banks, savings associations, broker-dealers, investment advisers, and insurance companies, whether domestic or foreign, and the owners of any of these entities  ("Included Financial Firms").[2]  An issuer may elect to opt-out of being an Included Firm. 

This prohibition took effect September 19, 2008 at 11:59 p.m., and is currently scheduled to expire on October 2, 2008, unless further extended by the SEC.  The SEC has authority under the Exchange Act to extend the September 18, 2008 Order until midnight on October 18, 2008.

The SEC provided certain limited exceptions from the prohibition on short sales in the publicly traded securities of Included Financial Firms.  In particular, the following activity has been excepted from the ban:

  • Short sales by registered market makers, block positioners, and other market makers obligated to quote in the over-the-counter market who sell short as part of bona fide market making in the public-traded securities of an Included Financial Firm;
  • Short sales as a result of the automatic exercise or assignment of an equity option or futures contract held prior to the effectiveness of the order due to expiration of the option or futures contract.  Writers of call options who effect short sales due to assignment following exercise by the holder of the call can rely on this exception;
  • Short sales by market makers as part of a bona fide market making and hedging activity related directly to bona fide market making in derivatives on the publicly-traded securities of any Included Financial Firm.  The market maker may not know that the customer or counterparty effecting the trade will establish or increase an economic net short position in an Included Financial Firm’s shares.  Market makers relying on this exception must post notice of such condition on their internet websites as soon as operationally practicable;
  • Syndicate short transactions;
  • Sales of Rule 144 securities;
  • Short sales in corporate bonds, preferred securities, convertible securities, and shares of exchange traded funds; and
  • Buying put options or selling call options.

            2.  Temporary Rule 204T

On September 17, 2008, the SEC issued an emergency order ("September 17, 2008 Order") pursuant to Section 12(k)(2), effective September 18, 2008 at 12:01 a.m., adopting Exchange Act Rule 204T.[3]  Rule 204T requires a participant of a registered clearing agency (i.e., a clearing broker) to deliver securities for clearance and settlement on long and short sale transactions in any equity security after the September 17, 2008 Order’s effectiveness by close of business on settlement date.  If the clearing broker has a fail to deliver on a long or short sale in an equity security, it must, by no later than the beginning of regular trading hours on the settlement date following the transaction’s settlement date (i.e., "T+6"), immediately close out the fail to deliver by borrowing or purchasing securities of like kind and quantity. 

There are consequences to failing to close out a fail to deliver as prescribed by the September 17, 2008 Order:   the clearing broker and all of its introducing brokers, including market makers, are not allowed to accept any short sale order in the equity security from another person or to effect a short sale for their own accounts with out pre-borrowing the security or entering into a bona-fide arrangement to borrow the security.  If the clearing broker takes steps to immediately close out the transaction by purchasing the relevant securities, the pre-borrow requirements are stayed, at least to settlement date on the close-out transaction.

In the case of long sales, the clearing broker is required to close out the fail to deliver by purchasing securities on the third consecutive settlement date following the transaction’s settlement date.  In the case of a fail to deliver in an equity security sold pursuant to Securities Act Rule 144, the clearing broker is not required to close out the transaction until the 36th consecutive settlement date from the transaction’s settlement date.

The clearing broker and its introducing brokers stay in the penalty box until the clearing broker closes out the fail to deliver by purchasing the relevant securities, and that purchase transaction has cleared and settled.  If a clearing broker becomes subject to these penalties, it must notify its introducing firms.

Although the rule took immediate effect, it was adopted on an interim final basis, subject to a 30-day comment period.

                        3.  Rule 10b-21

The SEC also announced in the September 17, 2008 Order that it had adopted Rule 10b-21, which it had proposed for public comment in March 2008.[4]  Rule 10b-21 specifically provides that it is "manipulative or deceptive device or contrivance" for any person who sells an equity security if that person fails to deliver the subject security on or before settlement date, and deceives a person about its intention or ability to deliver the security by settlement date. this rule is in addition to the SEC’s authority under the general antifraud provisions of the federal securities laws, particularly Exchange Act section 10(b) and Rule 10b-5 thereunder.

Unlike Regulation SHO, Rule 10b-21 gives the SEC direct authority over short sellers who are not broker-dealers.

            B.  United Kingdom

The FSA issued an order of its board dated September 18, 2008, the Short Selling (No. 2) Instrument 2008 (the "Instrument"), which came into force on September 19, 2008, banning the creation of or increases in net short positions in U.K. financial sector companies (U.K. banks and U.K. insurance entities or U.K. incorporated parents of U.K. banks or U.K. insurance companies).  Only positions created or increased by market makers are exempt, together with positions created or increased before September 19, 2008.

No active increases in positions created before September 19, 2008 are permitted from that date until the expiration, repeal, or amendment of the Instrument.  The FSA advised that a net short position that arises after September 18, 2008, but not as a result of any new transaction being entered into, is not caught by the prohibition.  However, the new short position can trigger the disclosure requirements described below.

The Instrument applies to "uncovered short positions" which are prohibited (and to which the disclosure obligation below will apply), and it also bans intraday trading, when a short position is generated and then closed in the same day.  Unlike an earlier FSA order on disclosure of short positions, convertible bonds are covered by the FSA’s action on Friday.

The FSA used this emergency order and its powers under the Financial Services and Markets Act 2000 (as it first did in June 2008) to amend the Market Abuse regime in the FSA’s Market Conduct sourcebook to ensure an orderly market as the U.K. regulator sees it.  FSA Chief Executive Hector Sants said in a statement that "while we still regard short-selling as a legitimate investment technique in normal market conditions, the current extreme circumstances have given rise to disorderly markets."

The September 19, 2008 restrictions and the disclosure requirements (described below) will expire on January 16, 2009, but will also be subject to review 30 days after the order was made. The FSA will continue to review the market conditions and the short selling restrictions.

The regulator also published an indicative list of 32 U.K. incorporated banks and insurers, as at September 19, 2008, in connection with the Instrument.[5]  The FSA stated that this list was prepared on a "best endeavours" basis and it is therefore not authoritative.  Market participants will have to check whether entities in which they hold short positions would be U.K. financial sector companies for the purpose of the FSA’s Market Conduct sourcebook. The Instrument covers all U.K. financial sector companies admitted to prescribed markets (which include not only the Main Market of the London Stock Exchange, but also its junior market AIM).[6]

The definition of a U.K. financial sector company in the Market Conduct sourcebook, means that U.K. listed fund managers, like RAB Capital Plc, are not included and neither is ICAP Plc, the world’s largest broker of transactions between banks, or the London Stock Exchange Group Plc.

            C.  France

On September 19, 2008, the French Autorité des Marchés Financiers took exceptional measures in order to ban unsecured transactions on equity securities of credit institutions and insurance companies traded on French markets (Euronext Paris, Matif and Monep). 

These rules apply from September 22, 2008, for a minimum duration of 3 months, and affect 15 credit institutions and insurance companies.[7]

The rules apply to market and off-the-market transactions, and to spot, forward, and option transactions. They do not apply to transactions made by investment service providers acting as market makers, liquidity providers or as counterparties for block trades in equity.

The main rules are that:

1.      any investor giving a sell order for one of the concerned securities with instructions for deferred settlement and delivery (service de règlement et livraison différés) must hold 100% of the securities to be sold on its account with its financial intermediary. In other words, these rules require that investors borrow a loan prior to short selling.

2.      when any person holds a net short position that represents an economic interest (taking into account calls, puts, warrants) of at least 0.25% of the share capital of one of the concerned issuers, it must disclose its position to the AMF and the market by any appropriate means on the following trade day, at the latest. The AMF is working on the technicalities regarding such disclosure.

3.      Financial institutions are requested to refrain from lending any of the concerned securities in order to reduce the causes of market disruption. This does not apply to (a) securities lending to cover existing positions as of September 19, 2008, (b) meeting commitments taken before the AMF measures were implemented (September 19, 2008, included) or (c) transactions that are not related to creating short positions.

It is expected that the AMF will provide further guidance, including with respect to the definition of "net short positions representing an economic interest" for the purposes of disclosure obligations and technicalities regarding market information.

        D.  German 

On September 19, 2008, BaFin issued a generally binding order (Allgemeinverfügung) temporarily banning short selling in any shares (Aktien) issued by certain listed German financial services providers.[8]

The order took effect September 20, 2008 and is currently scheduled to expire on December 31, 2008.  BaFin, however, clearly stated, that, at anytime, it may revoke the ban or amend it by imposing obligations on market participants.

According to the order, the following transactions are exempt:

  • Transactions of persons which are contractually obligated to make binding purchase or sale offers (e.g., Designated Sponsors, Market Makers) to the extent the transactions are necessary for them to fulfill their contractual obligations.
  • Short sales that are aimed at hedging against already existing positions.
  • Transactions entered into by trading participants in order to fulfill their obligations vis-à-vis customers which arise from transactions providing for a fixed or determinable price.[9]
  • Name-to-follow transactions (Aufgabegeschäfte) of lead-brokers (Skontroführer).

Further exceptions may be granted by BaFin upon request.

The order is based on BaFin’s general authority to counteract undesirable developments that may adversely affect the orderly conduct of trading with financial instruments or the provision of investment services (or non-core investment services), or that may result in serious disadvantages for the capital market.[10]  BaFin refers to similar bans in other jurisdictions, in particular the United States and Great Britain.  Given the interconnectivity of the world’s financial markets, a ban of short selling in Germany was deemed necessary to avoid substantial negative effects on the domestic market.

On September 22, 2008, BaFin clarified on its website[11] that

  • the ban only applies to naked short selling (short sales which are not covered by borrowed shares);
  • the shares must be borrowed at least simultaneously to the short sale;
  • the ban also applies to intraday transactions;
  • the ban does not apply to short positions already existing prior to September 20, 2008.

            E.  Other Jurisdictions

As summarized on the attached chart, other jurisdictions have taken unprecedented actions to address the current market crisis.


Pursuant to the September 17, 2008 Order, the SEC also adopted previously proposed amendments to Rule 203(b)(3) of Regulation SHO.   These amendments eliminated the options market maker exception from Regulation SHO’s close-out requirement such that options market makers no longer have an exception for short sales to hedge options positions established before the underlying cash securities became threshold securities.  Accordingly, options market makers are now treated the same as other market participants. 

The following day, the staff of the SEC’s Division of Trading and Markets and the Office of Compliance Inspections and Examination, as well as FINRA and NYSER, published tips to assist broker-dealers in averting failures to deliver.[12]

Although the regulators were careful to say that these are not required practices, they encouraged firms conducting short sales to implement methods that would prevent delivery failures.  These tips include:

  • borrowing and obtaining control of the securities before settlement, rather than entering into an agreement to borrow such securities;
  • entering into an agreement to borrow securities to ensure that a transaction will settle on time;
  • requesting earmarking of shares for which the broker-dealer does not obtain control pursuant to a pre-borrow arrangement;
  • maintaining an inventory of securities in which the firm frequently executes short sales sufficient to cover anticipated short sales and any pre-borrowed shares;
  • documenting the source of the shares and testing that locates provided by customers are valid;
  • monitoring the performance of customer-provided locates;
  • encouraging timely customer affirmations of delivery versus payment (DVP) trades; and
  • reviewing practices for sponsored and direct market access customers, including procedures for documenting the source of pre-borrowed shares.

III.  Disclosure of Short Positions

            A.  United States

On September 18, 2008, the SEC issued an emergency order pursuant to Section 12(k)(2) (the “Disclosure Order”) requiring certain “institutional investment managers”[13] to report information on daily short sales of certain publicly-traded securities.[14]   The Disclosure Order specifically requires that any institutional investment manager exercising investment discretion with respect to accounts holding Exchange Act section 13(f) securities having an aggregate fair market value on the last trading day of any month of any calendar year of at least $100,000,000 must file new Form SH with the Commission.  Information about short sales in options is not required.

Beginning on September 29, 2008, any institutional investment manager who filed or was required to file a Form 13F for the calendar quarter ended June 30, 2008 must file Form SH on the first business day of every calendar week immediately following a week in which it effected short sales.  The first Form SH will be for short sales effected during the week of September 22, 2008.

Otherwise reportable short positions need not be reported if (1) the short position constitutes less than 0.25% of the class of the issuer’s section 13(f) securities issued and outstanding as reported on its most recent annual or quarterly report, and any subsequent current report filed with the SEC, absent the manager knowing or having reason to believe the information contained therein is inaccurate; and (2) the fair market value of the short position is less than $1,000,000.

Form SH must be filed electronically through the SEC’s EDGAR system and after two weeks, will be publicly available.[15]  The SEC specifically stated that no confidential treatment procedures is available to information filed on Form SH.  The requirements under the Disclosure Order will terminate at 11:59 p.m. on October 2, 2008 unless further extended by the Commission.

            B.  United Kingdom

                       1.  Disclosure of Net Short Positions

The Instrument that came into force on September 19, 2008 also requires the disclosure of net short positions of 0.25% or more in the share capital of U.K. financial sector companies. The first disclosure required under this provision is to be made by 3:30 pm (London time) on September 23, 2008, which should relate to positions held on September 19 and 22.  The FSA has published a form (TR 4) on its website for making such disclosures.[16]  The disclosure must be made by making the announcement on an FSA approved Regulatory Information Service in the U.K. (such as RNS).

The FSA has also published guidance on the precise calculations used to determine the disclosable short position, as it did in June 2008 for the FSA’s first Short Selling instrument (discussed below). Disclosure is also required where a previously disclosed short position of 0.25% or above falls below 0.25%.          

                        2.  Short Positions Held by Fund Managers

The FSA stated in its guidance on the Instrument that in the case of short positions held by fund managers on behalf of non-discretionary clients, the obligations under this Instrument apply to the client.  In the case of short positions held by fund managers on behalf of discretionary clients, the fund manager itself should comply with the obligations.

Where a fund manager has a mandate to manage more than one individual fund, the fund manager should aggregate the positions of all of its discretionary funds for the purposes of determining whether it has a disclosable short position. This is consistent with the FSA’s view that the person who exercises discretion over holdings of economic interests in U.K. financial sector companies should be required to make such disclosures.

                        3.  Previous FSA Short Selling Instrument Requiring Disclosures

This is the second emergency order the FSA board has passed this year targeting short selling, and the second FSA short selling instrument this year.  The FSA’s first emergency rules that came into force on June 20, 2008 require disclosure of short positions of 0.25 per cent or more in interests in the share capital of companies engaged in rights offers – during a rights offer period.  (The form for this disclosure (TR 3) is also available from the FSA website.[17])  These rules were criticized in June for being rushed, and the FSA had to issue amended guidance on the first short selling instrument four times in the week between its publication and the requirements coming into force.

The FSA has learned from its experience and used the June system as a model for the outright ban on shorting U.K. financial sector companies.

IV.  Investigations and Enforcement Actions; Litigation

            A.  United States

On September 19, 2008, the SEC announced a sweeping expansion of its ongoing investigation into possible market manipulation in the securities of certain financial institutions, which will include requiring hedge fund managers, broker-dealers, and institutional investors with significant trading activity in financial issuers or positions in credit default swaps to disclose those positions under oath.[18]  The SEC also approved a formal order of investigation that will allow its enforcement staff to obtain additional documents and testimony by subpoena.   Linda Thomsen, the SEC’s Director of Enforcement, said that hedge funds and other significant traders who are requested to provide past trading positions in specified securities will be required to secure all of their communication records in anticipation of subpoenas for these records.[19]

In coordination with the SEC, FINRA and NYSE Regulation will conduct parallel investigations by means of on-site visits to various broker-dealers regarding recent short-selling activity. The regulators’ efforts follow on their previously announced enforcement actions relating to abusive short selling and false rumor mongering. [20]

Separately,  on September 18, 2008, New York Attorney General Andrew Cuomo announced that he was launching a “wide-ranging” investigation into short-selling on Wall Street.  Cuomo will use New York’s Martin Act to prosecute any short sellers engaging in any improper conduct, including, but not limited to, the spreading of false rumors.  One of Cuomo’s objectives is to stabilize the markets by “root[ing] out short sellers who spread false information.”[21] 

B.  United Kingdom

Failure to comply with the requirements of this Instrument constitutes the offence of Market Abuse which would be subject to enforcement action by the FSA. The penalties for this civil offence include fines and public censure by the FSA and the burden of proof on the regulator is only the balance of probabilities. Although the FSA has not announced any specific enforcement or investigatory actions relating to short selling, it has been reported in national newspapers in the U.K. that the FSA may find itself as the defendant in an action that may be brought by a group of the world’s largest hedge funds claiming that the FSA’s short selling order was ultra vires.

There is no doubt that this will be a hot topic for enforcement action by the FSA if the regulator feels that the requirements of the Instrument are not being followed by market participants. The U.K. rules will have global reach although they apply to U.K. financial sector companies. The restriction and disclosure requirements would cover a shorting of Barclays shares in New York.

            C.  France

The AMF board recently sent a statement of complaint to an investment services provider suspected of naked short selling.


In light of regulatory developments and the potential effects of market conditions on publicly traded securities, the following are a few steps clients may wish to consider:

            A.  Short Sales – Broker-Dealers

  • Review processes and tools for reviewing marking, locate, and pre-borrow information provided by customers;
  • Review customer agreements, including electronic trading, direct market, and sponsored access agreements, to determine if they cover new requirements and obligations; and
  • Consult with direct market and sponsored access clients regarding their systems and processes for transmitting information about pre-borrows and locates.

            B.  Short Sales – Hedge Funds and Other Investment Managers

  • Inventory stock borrowing agreements to make sure that you have sources of shares available;
  • Consider whether certain securities that are borrowed should be earmarked;
  • Review procedures for recording locates and preborrows; and
  • Determine if necessary to secure communications records in anticipation of SEC subpoena on trading. 

            C.  Communications Policies – Controlling Rumors

  • Review existing compliance policies to make sure they clearly prohibit the initiation and circulation of rumors, and include attribution, if appropriate;
  • Remind personnel of existing policies or, if needed, update policies to make sure such prohibition is clear;
  • Consider whether all or certain personnel should receive supplementary communications training on oral and written communications;
  • Train personnel on how to handle the receipt of rumors and other potentially problematic information.  Sensitize personnel to raise their hands and not go it alone;
  • Consider the use of rumor lists for names that are the subject of rumors, and use as a spot check for any suspicious trading in proprietary, customer, or employee accounts in names on the list;
  • Spot check relevant emails, instant messages, chat rooms, bulletin boards, and other communications for suspicious terms.  Review lexicons to determine if additional words or terminology should be included;
  • Review sales literature, advertisements, radio and television presentations, and seminar presentations to ensure that they are free of statements that are misleading, exaggerated or based on rumor;
  • Review trading surveillance protocols for inclusion of the securities of issuers who are the subject of rumors to catch potentially manipulative trading through your shop;
  • Update your written supervisory procedures to reflect any changes made in procedures; and
  • Keep records of how and when any of these steps are taken.

            D.  Issuers of Publicly-Traded Securities

  • Monitor trading patterns in your securities for indications of abusive short selling;
  • Monitor short interest in your security;
  • Be alert for false market rumors; and
  • If you have concerns about manipulative short selling or failures to deliver in your securities, consider consulting with investment managers and other market participants with whom you have a relationship regarding securities lending and borrowing practices. 
 [1]   See Emergency Order, Exchange Act Release No. 58592 (Sept. 18, 2008), [].

 [2]   See Exchange Act Release No. 58611 (Sept. 21, 2008), [].

 [3]   See Exchange Act Release No. 58572 (Sept. 17, 2008), [].

  [4]   See “Naked” Short Selling Antifraud Rule, Exchange Act Release No. 57511 (Mar. 17. 2008), [].

  [5]   FSA Amended List of U.K. Incorporated Banks and Insurers in Connection with Short Selling (No. 2) Instrument 2008, [].

  [6]   Short Selling (No. 2) Instrument 2008 – Amended FAQs 23 September 2008, [].

  [7]          AMF List of concerned credit institutions and insurance companies, available at

  [8]   Available at the following link

  [9]   See BaFin’s separate order dated September 21, 2008, available at the following link.

[10]   Sec. 4 para 1 of the German Securities Trading Act (Wertpapierhandelsgesetz – WpHG).

[11]   See the list of frequently asked questions available (in German) at the following link.

[12]   Regulators Provide “Tips” for Broker-Dealers, available at []. 

[13]   Terms used in connection with Form SH have the same meaning as section 13(f) of the Exchange Act and Rule 13 f-1 thereunder and Regulation SHO.

[14]   See Exchange Act Release No. 58591 (Sept. 18, 2008), [].

[15]   See Exchange Act Release No. 58591A (Sept. 21, 2008), [].

[16]   Disclosure of Short Position relating to U.K. Financial Sector Company, [].

[17]   Disclosure of Disclosable Short Position relating to Securities, [].

[18]   SEC Expands Sweeping Investigation of Market Manipulation; Measure Will Require Statements Under Oath by Market Participants. 2008-214 (Sept. 19, 2008), available at [].

[19]   Statements of SEC Chairman Christopher Cox and Enforcement Division Director Linda Thomsen Regarding Immediate Commission Actions to Combat Market Manipulation, 2008-209 (Sept. 17, 2008) available at []. 

[20]   See Regulatory Crackdown on the Spreading of False Rumors — 10 Preventative Steps to Consider (July 15, 2008), [].  

[21]   A. Lucchetti, A. Efrati, and K. Schannel, Cuomo Plans Short-Selling Probe, Wall St. J. (Sept. 18, 2008), article available at ["mod=googlenews_wsj]

Gibson, Dunn & Crutcher LLP

Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have about these developments.  Please contact the Gibson Dunn attorney with whom you work, or any of the following:  


Washington, D.C.
K. Susan Grafton
(202-887-3554, [email protected])
Barry R. Goldsmith
(202-955-8580, [email protected])
Brian J. Lane (202-887-3646, [email protected]
Ronald O. Mueller (202-955-8671, [email protected]
John F. Olson (202-955-8522, [email protected])
John H. Sturc (202-955-8243, [email protected]

James J. Moloney (949-451-4343, [email protected])

New York
Dennis J. Friedman (212-351-3900, [email protected])
Adam H. Offenhartz (212-351-3808, [email protected])
Eduardo Gallardo (212-351-3847, [email protected])

Selina Sagayam (+44 20 7071 4263, [email protected])
James Barabas (+44 20 7071 4253, [email protected]
Alan Samson (+44 20 7071 4222 , [email protected]

Benoît Fleury (+33 1 56 43 13 00, [email protected])  
Mylène Blanc-Gallaud
(+33 1 56 43 13 00, [email protected]

Philip Martinius (+49 89 189 33-121, [email protected])


Peter L. Baumbusch (+971 4 365 0470, [email protected])


Jai S. Pathak (213-229-7657, [email protected])
Emad H. Khalil
(+65 6507 3682, [email protected])

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