[Federal Register Volume 64, Number 135 (Thursday, July 15, 1999)]
[Notices]
[Pages 38226-38227]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-18111]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41606; File No. SR-NASD-98-08]


Self-Regulatory Organizations; Order Granting Approval of 
Proposed Rule Change and Amendment No. 1 Thereto, and Notice of Filing 
and Order Granting Accelerated Approval to Amendment No. 2 to the 
Proposed Rule Change, by the National Association of Securities 
Dealers, Inc. Relating to Trade Reporting Rules

July 8, 1999.

I. Introduction

    On February 2, 1998, the National Association of Securities 
Dealers, Inc. (``NASD'' or ``Association'') through its wholly owned 
subsidiary, the Nasdaq Stock Market, Inc. (``Nasdaq'') filed with the 
Securities and Exchange Commission (``SEC'' or ``Commission'') a 
proposed rule change pursuant to section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder. \2\ 
Nasdaq filed Amendment No. 1 to the proposed rule change on May 19, 
1998. \3\ On June 5, 1998, the proposed rule change, including 
Amendment No. 1, was published for comment in the Federal Register. \4\ 
The Commission received one comment letter in response to the 
solicitation of comments. \5\ On March 1, 1999, Nasdaq filed Amendment 
No. 2 to the proposed rule change. \6\ For the reasons discussed below, 
the Commission is granting partial approval of the proposed rule change 
and Amendment No. 1 (as requested in Amendment No. 2), and accelerated 
approval of Amendment No. 2 to the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Letter from Robert E. Aber, Senior Vice President and 
General Counsel, The Nasdaq Stock Market, Inc., to Katherine A. 
England, Assistant Director, Division of Market Regulation 
(``Division''), SEC, May 13, 1998(``Amendment No. 1'').
    \4\ Securities Exchange Act Release No. 40047 (May 29, 1998), 63 
FR 30791.
    \5\ The original filing proposed that every electronic 
communications network (``ECN'') be required to report all trades 
executed within the ECN on behalf of its subscribers. The Commission 
received one comment letter, which addressed the original filing's 
proposed ECN reporting requirements. See letter from Charles R. 
Hood, Senior Vice President and General Counsel, Instinet, to 
Jonathan Katz, Secretary, SEC, dated June 25, 1998.
    \6\ Letter from Robert Aber, Senior Vice President and General 
Counsel, Nasdaq, to Katherine England, Assistant Director, Division, 
SEC, March 1, 1999 ``(Amendment No. 2''). Amendment No. 2 requests 
that the Commission grant a partial approval of the original filing. 
Specifically, Amendment No. 2 requests approval of all the proposed 
changes in the original filing with the exception of the proposed 
ECN trade reporting requirements. Amendment No. 2 states that the 
NASD intends to submit a separate response to the Commission 
regarding the Instinet comment letter received on the proposed ECN 
trade reporting requirements.
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II. Description of the Proposal

    Nasdaq proposes to amend various trade reporting rules of the 
Association. Specifically the proposal would: (1) Implement a new trade 
report modifier to identify trades effected at a prior reference price; 
(2) eliminate the 10,000 share limitation on individual trades that may 
be ``bunched'' for trade reporting purposes; and (3) address riskless 
principal trades involving exchange-listed securities traded in the 
Third Market.\7\
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    \7\ The text of the proposed rule change is in the form of an 
amendment to Rule 6420(d)(3)(B).
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A. New Modifier for Trades Based on Prior Reference Price

    Recently, there have been situations where NASD members execute 
certain transactions that, although reported timely, actually relate to 
an obligation to trade that arose at an earlier point in the day or 
that refer to a prior reference price. These situations may include 
obligations to trade arising from a preferenced SelectNet order that 
was not executed timely, orders that are owed the opening or closing 
price (``market on open'' or ``market on close'') but that are not 
executed within 90 seconds of the open or close, respectively, and 
orders that may have been lost or misplaced. In effect, these trades 
are late executions, not late reports of executions. Nasdaq, therefore, 
proposes to implement a trade report modifier for firms to append to 
certain trade reports to more accurately identify transactions that are 
at a price which is based on a prior reference point in time. \8\ The 
modifier would apply to trade reports in Nasdaq securities (both Nasdaq 
National Market and SmallCap) as well as non-Nasdaq OTC Equity 
Securities (e.g., OTC Bulletin Board and Pink Sheets). The modifier 
would not, however, apply to exchange-listed securities traded in the 
Third Market.\9\
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    \8\ The text of the proposed rule change to implement the new 
modifier is contained in NASD Rules 4632(a)(9), 4642(a)(9), 
4652(a)(8), and 6620(a)(6).
    \9\ The NASD intends that the modifier would not apply to 
``stopped'' stock situations. Moreover, by using the modifier, a 
member would not be absolved of its obligation to provide best 
execution, in terms of both price and timely execution. The modifier 
would not be required if the report was made within 90 seconds of 
the prior reference time.
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B. Eliminating the 10,000 Share Limitation on Aggregating Trades in 
Nasdaq Securities That May Be Bunched for Trade Reporting

    Nasdaq proposes to eliminate the 10,000 share limitation on the 
maximum number of shares in an individual trade that can be aggregated 
for purposes of reporting a ``bunched'' trade in Nasdaq securities, but 
only in the context of IPOs.
    Rules governing the reporting of transactions in Nasdaq securities 
(both National Market and SmallCap) currently permit the aggregation of 
transactions into a ``bunched'' trade report in a variety of 
situations. Most notably, there is a provision whereby a firm may 
aggregate transactions at the same price that would be impractical to 
report individually, provided that no individual order of 10,000 shares 
or more may be aggregated.\10\ These reports have a ``.B'' modifier 
appended by the reporting firm and disseminated to the Nasdaq tape and 
vendors.
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    \10\ This rule was originally adopted in 1982 with a limitation 
of 5,000 shares. See Securities Exchange Act Release No. 18602 
(March 26, 1982), 47 FR 14642 (April 5, 1982) (notice of filing and 
order granting accelerated approval of File No. SR-NASD-82-4). The 
rule was subsequently increased to 10,000 shares in 1984, but has 
remained at that level ever since. See Securities Exchange Act 
Release No. 21202 (August 3, 1984), 49 FR 31971 (August 9, 1984) 
(order approving File No. SR-NASD-84-12).
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C. Trade Reporting Rules for Riskless Principal Trades in the Third 
Market

    Nasdaq proposes to amend the trade reporting rules for exchange 
listed securities traded in the Third Market to ensure that all 
riskless principal trades, including those effected by market makers, 
are reported only once.\11\
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    \11\ In addition to the amendment to Rule 6420, Nasdaq proposes 
the corresponding interpretations:
    (1) Nasdaq notes that a riskless principal trade generally is 
one that involves a conditional order rather than one immediately 
executable by the firm as principal. This condition may involve a 
customer order, the execution of which is dependent upon finding the 
other side, or a transaction dependent upon the execution of a part 
of the order placed with another firm or market; and
    (2) Nasdaq notes that, in certain situations, a ``marker'' order 
may be a riskless principal trade. Marker orders, usually of nominal 
size, are used to trigger obligations to other orders the firm may 
be holding. Under the interpretation of a riskless principal trade, 
a marker order appears to merit riskless principal treatment for the 
size of the marker order. Nasdaq, however, believes that, given the 
purpose for which marker orders are used, the order need not be 
broken into two separate components to distinguish between a risk 
and riskless portion, provided, however, that the marker order is no 
larger than 10% of the size of an execution or group of executions 
that it would trigger. Nasdaq believes that the nominal size of the 
marker order does not, to any material extent, change the overall 
risk profile of the order.
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    Nasdaq believes that the exception applicable to non-market makers 
(which

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treats riskless principal trades as one trade for reporting purposes) 
should be extended to market makers in exchange-listed stocks. For 
example, if a market maker in an exchange-listed security does not 
assume a risk position on an Intermarket Trading System (``ITS'') 
commitment sent to another market, the market maker should not be 
reprinting it in its own market when it receives confirmation of an 
execution on the commitment. The fact that the firm is a market maker 
is irrelevant. Nasdaq also believes that this analysis should apply to 
transactions that result from orders sent to the floor even when sent 
outside of the ITS linkage (e.g., through a floor broker or other 
automated execution system of the exchange).

III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
applicable to the NASD and, in particular, with the requirements of 
Section 15A(b)(6) of the Act.\12\ Section 15A(b)(6) requires that the 
rules of a registered national securities association be designed to 
prevent fraudulent and manipulative acts and practices, to promote just 
and equitable principles of trade, to foster, cooperation and 
coordination with persons engaged in regulating, clearing, settling, 
processing information with respect to, and facilitating transactions 
in securities, to remove impediments to and perfect the mechanism of a 
free and open market and a national market system, and, in general, to 
protect investors and the public interest. Most specifically, the 
Commission finds that this rule change will result in more accurate and 
reliable, information regarding last sale transaction reports 
consistent with the requirements of Section 15A(b)(6).
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    \12\ 15 U.S.C. 78o-3(b)(6).
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    The Commission finds that requiring a separate identifier to 
accurately reflect ``out of sequence'' trades would provide better 
information to market participants and the public as to what these 
trades actually represent. The new modifier would inform the market 
that the price of the trade is based on an earlier reference point and 
may bear no relationship to the current market price. In addition, the 
Commission finds that the removal of the 10,000 share limitation for 
bunching on the first day of secondary market trading following an IPO 
will facilitate more efficient and timely reporting of large numbers of 
trades in the IP aftermarket.
    The Commission agrees with the NASD that, for reporting purposes, 
it is appropriate to treat riskless principal trades as one trade. The 
Commission finds that discontinuing the distinction between market 
makers and non-market makers in the context of exchange-listed 
securities, and thus extending the riskless principal exception to 
market makers, will provide more accurate trade reporting.\13\ The 
Commission believes that because this proposal would ensure that only 
one trade report results for transactions that are clearly one trade, 
transaction reports will be more accurate.
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    \13\ The Commission recently approved a proposed rule change to 
allow an NASD member acting as a market maker to report riskless 
principal transactions in Nasdaq securities as one transaction. See 
Securities Exchange Act Release No. 41208 (March 24, 1999), 64 FR 
15386 (March 31, 1999).
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    The Commission notes that Rule 10b-10 under the Act \14\ requires a 
broker-dealer acting as market maker in a riskless principal 
transaction in an exchange-listed security to confirm to its customer 
the reported trade price, the price to the customer in the transaction, 
and the difference, if any, between the reported trade price and the 
price to the customer. Under Rule 10b-10, the broker-dealer is required 
to report, as the reported trade price, the price at which the security 
was reported to the tape when the member purchased the security for, or 
sold the security to, its customer. This requirement remains in effect 
regardless of the fact that there is no corresponding requirement in 
the NASD rules to report that second leg of a riskless principal 
transaction to the tape. For example, when a market maker receives an 
execution report from an exchange in a listed security, through ITS or 
otherwise, and completes a riskless principal transaction by filling a 
customer order, the market maker must conform to its customer the price 
of the transaction that was reported to the CTA by the exchange and any 
mark-up or mark-down charged by the market maker. A failure by a 
broker-dealer to confirm to its customer the price of the security that 
was reported to the tape would constitute a violation of Rule 10b-10.
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    \14\ 17 CFR 240.10b-10.
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    The Commission finds good cause for approving Amendment No. 2 to 
the proposed rule change prior to the thirtieth day after the date of 
publication of notice of filing of this amendment in the Federal 
Register. Amendment No. 2 asks only that the Commission approve all of 
the proposed changes in the original filing and Amendment No.1, with 
the exception of the proposed ECN trade reporting requirements. 
Furthermore, Amendment No. 2 states that the NASD will submit a 
separate response to the Commission regarding the Instinet comment 
letter addressing the proposed ECN trade reporting requirements. The 
Commission does not believe that Amendment No. 2 raises any new 
regulatory issues. The original proposal and Amendment No. 1 were 
published for the full 21-day comment period, and the Commission 
received no comments on the proposal other than the Instinet letter 
addressing ECN trade reporting requirements. Accordingly, the 
Commission finds good cause, consistent with sections 15A(b)(6) \15\ 
and 19(b) \16\ of the Act, to approve Amendment No. 2 to the proposal 
on an accelerated basis.
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    \15\ 15 U.S.C. 78o-3(b)(6).
    \16\ 15 U.S.C. 78(b).
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IV. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change is consistent with the Act and the rules and regulations 
thereunder applicable to the NASD, and, in particular, section 
15A(b)(6). In addition, in granting a partial approval of this rule 
change, the Commission notes that it has also considered the proposed 
rule's impact on efficiency, competition, and capital formation.\17\
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    \17\ 15 U.S.C. 78c(f).
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    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\18\ that the proposed rule change (SR-NASD-98-08) be, and hereby 
is, approved with the exception of the proposed amendment to Rule 4623 
``Electronic Communication Networks.''
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    \18\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\19\
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    \19\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-18111 Filed 7-14-99; 8:45 am]
BILLING CODE 8010-01-M