[Federal Register Volume 63, Number 172 (Friday, September 4, 1998)]
[Notices]
[Pages 47337-47340]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-23879]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-40382; File No. SR-NASD-98-59]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the National Association of Securities Dealers, Inc. Relating
To Trade Reporting
August 28, 1998.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
[[Page 47338]]
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that
on August 10, 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'') the
proposed rule change as described in Items I, II, and III below, which
Items have been prepared by the NASD. The Commission is publishing this
notice to solicit comments on the proposed rule change from interested
persons.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
Nasdaq is proposing to amend the trade reporting rules of the NASD,
to extend to market makers an exception to the reporting of riskless
principal transactions in Nasdaq National Market, Nasdaq SmallCap,
Nasdaq convertible debt, and non-Nasdaq OTC equity securities. Below is
the text of the proposed rule change. Proposed new language is in
italics; proposed deletions are in brackets.
4632. Transaction Reporting
(a) through (c) No Change
(d) Procedures for Reporting Price and Volume
(1) through (3)(A) No Change
(B) Exception: A ``riskless'' principal transaction in which a
member [that is not a market maker in the security] after having
received [from a customer] an order to buy a security, purchases the
security as principal [from another member or customer] at the same
price to satisfy the order to buy or, after having received [from a
customer] an order to sell, sells the security as principal [to another
member or customer] at the same price to satisfy the order to sell,
shall be reported as one transaction in the same manner as an agency
transaction, excluding the mark-up or mark-down, commission-equivalent,
or other fee.
(e) through (f) No Change
* * *
4642. Transaction Reporting
(a) through (c) No Change
(d) Procedures for Reporting Price and Volume
(1) through (3)(A) No Change
(B) Exception: A ``riskless'' principal transaction in which a
member [that is not a market maker in the security] after having
received [from a customer] an order to buy a security, purchases the
security as principal [from another member or customer] at the same
price to satisfy the order to buy or, after having received [from a
customer] an order to sell, sells the security as principal [to another
member or customer] at the same price to satisfy the order to sell,
shall be reported as one transaction in the same manner as an agency
transaction, excluding the mark-up or mark-down, commission-equivalent,
or other fee.
(e) through (f) No Change
* * *
4652. Transaction Reporting
(a) through (c) No Change
(d) Procedures for Reporting Price and Volume
(1) through (3)(A) No Change
(B) Exception: A ``riskless'' principal transaction in which a
member [that is not a market maker in the security] after having
received [from a customer] an order to buy a security, purchases the
security as principal [from another member or customer] at the same
price to satisfy the order to buy or, after having received [from a
customer] an order to sell, sells the security as principal [to another
member or customer] at the same price to satisfy the order to sell,
shall be reported as one transaction in the same manner as an agency
transaction, excluding the mark-up or mark-down, commission-equivalent,
or other fee.
(e) through (f) No Change
* * *
6620. Transaction Reporting
(a) through (c) No Change
(d) Procedures for Reporting Price and Volume
(1) through (3)(A) No Change
(B) Exception: A ``riskless'' principal transaction in which a
member [that is not a market maker in the security] after having
received [from a customer] an order to buy a security, purchases the
security as principal [from another member or customer] at the same
price to satisfy the order to buy or, after having received [from a
customer] an order to sell, sells the security as principal [to another
member or customer] at the same price to satisfy the order to sell,
shall be reported as one transaction in the same manner as an agency
transaction, excluding the mark-up or mark-down, commission-equivalent,
or other fee.
(e) No Change
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, Nasdaq included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. Nasdaq has prepared summaries, set forth in Sections A,
B, and C below, of the most significant aspects of such statements.
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
The rules for reporting trades in Nasdaq securities have long
existed in their current form. The rules were broadly designed to
capture all trading activity by broker-dealers, both dealer to dealer
trades and trades with customers. These rules, and the trade reports
that result, serve several important purposes. They form the basis for
public dissemination of ``last sale'' transaction prices to the tape,
thus providing transparency. Trade reports also are an integral part of
the audit trail used by the NASD in its regulatory efforts to surveil
and regulate firms' activities. Given the historical structure of the
dealer markets and the need to provide a comprehensive view of all
trading, and because market makers were always deemed to be ``at risk''
when trading from their principal accounts, NASD trade reporting rules
have required the reporting of all principal trades by market makers.
Non-market makers, however, generally do not report all principal
trades under current rules, to the extent the trades are defined as
``riskless''--that is, they involve a trade with another member,
usually a market maker, which is used to offset a trade with a
customer. This riskless principal exception to the general rule of
reporting all principal trades results in one trade report even though
the non-market maker firm is involved in two separate trades against
its principal account.
In light of the growth and evolution of the structure of the Nasdaq
market, and in particular the recent implementation of the SEC Order
Handling Rules, which require market makers to match certain orders in
an agency-like fashion, it is believed appropriate to extend this
riskless
[[Page 47339]]
principal exception to market makers as well. Thus, certain matching
principal trades involving a market maker would be explicitly included
within the riskless definition, and reported to the public tape only
once.
For example, under the SEC Order Handling Rules, market makers now
display customer limit orders in their public quotes. Those orders are
often filled by the market maker when that quote is accessed by another
market participant.\3\ Because market makers generally trade
exclusively from a principal account, it is necessary to engage in two
separate principal trades: one with the other market participant, and
then another directly with the customer. Both of these trades are
reported by market makers under current rules. In effect, however,
these two trades can be viewed as one event--the execution of a
customer order upon the execution of an offsetting transaction obtained
by the market maker. Under the proposed rule change, these two trades
are reported only once.
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\3\ In fact, NASD Rule IM-2110-2 (Limit Order Protection Rule)
requires market makers to execute customer limit orders (regardless
of whether the customer is theirs or that of another member) when
trading as principal at prices that would satisfy the customer's
limit order. In addition, pursuant to best execution obligations
articulated by the SEC under the SEC Order Handling Rules, market
makers generally must pass along any price improvement obtained when
executing an incoming order at its published quote while holding an
undisplayed limit order priced better than that quote.
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A riskless principal trade can also be viewed as one that involves
two orders, the execution of one being dependent upon the receipt or
execution of the other, hence there is no ``risk'' in this particular
transaction. Only when that condition or dependency has been satisfied
is there a transaction and hence a singly reported trade. Such
condition may involve an institutional customer order, the execution of
which is dependent upon finding the other side, in whole or in part, or
a transaction dependent upon the execution of all or a part of the
order placed with another firm or market. To the extent that any of the
order is offset with another principal execution, that portion is
deemed riskless and should be reported only once.
The effect of the proposed rule change can be illustrated in the
following examples. A market maker (MM1) holds a customer limit order
that is displayed in its quote to buy 1000 shares of ABCD at $10. MM2
sells 1000 shares to MM1 at $10. MM2 reports the sale of 1000 shares as
required under current rules.\4\ MM1 then fills its customer order for
1000 shares. Under the proposal, the first trade would continue to be
reported (by the selling firm MM2 in this case, as required under
current rules), but the second leg between MM1 and the customer would
not be reported again, as it is deemed riskless. If the first execution
were through a Nasdaq facility which automatically generates a trade
report to the tape, such as SOES or SelectNet, no member would report
at all. Of course, members may still need to submit a ``clearing only''
entry into ACT to complete the transaction with the customer, but these
submissions are not to be entered for reporting purposes and thus there
will be no public trade report for this leg of the transaction.
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\4\ See, e.g., NASD Rule 4632(b), which requires the selling
market maker to report in a transaction between two market makers.
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In another example, an institutional customer presents a large
order to a market maker (MM1) to sell 100,000 shares of XYZZ, with
instructions to work the order, subject to a price limit, rather than
execute it immediately in its entirety. The market maker may attempt to
solicit interest from other parties to fill the institutional order, in
whole or in part. The market maker may find a willing buyer, but for
only 75,000 shares, at a price of $12 per share. The market maker may
determine to fill the entire customer order for 100,000 shares at $12
per share at that time (exclusive of any markdown, commission
equivalent, or other fee), by trading the 25,000 share balance out of
inventory. Here, there will still be two separate trade reports under
the proposal because only a portion of the customer execution is deemed
riskless. The size of the trade reports, however, will be adjusted to
exclude the riskless portion. Specifically, instead of MM1 reporting
these as a market maker sell transaction of 75,000 shares and then a
market maker buy from the customer for 100,000 shares, these trades
would be reported under the proposal as a market maker sell transaction
of 75,000 shares and then a market make buy from the customer of only
25,000 shares.\5\
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\5\ It should be noted that in this particular example, the
market maker with the order is responsible for reporting both legs
of the transaction. If the customer were buying stock in the same
example, and the market maker first buys 75,000 shares from another
market maker, the 75,000 share trade would be reported by the
selling market maker under current NASD rules (i.e., seller reports
in a trade between two market makers). The market maker with the
customer order would still report the 25,000 share trade.
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In another variation of the previous example, market maker MM1,
while holding the institutional customer order and working it on their
behalf, may obtain several executions to satisfy the order by selling
to other market participants at varying prices throughout the trading
day. In this example, assume that the entire order is filled with these
individual executions. Because market maker MM1 is the seller in these
executions, it has the trade reporting responsibility and will continue
to report under current rules each individual ``component'' trade with
other market participants as they occur. Under the proposal, however,
MM1 would not report a transaction with the customer, as the execution
used to satisfy the order already have been reported to the tape,
although the transactions may be confirmed out to the customer at an
average price of the component executions, to the extent permissible
under Exchange Act Rule 10b-10.\6\
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\6\ See, e.g., SEC No-action letter from Catherine McGuire, SEC,
to Eugene Lopez, The Nasdaq Stock Market, dated May 6, 1997
(permitting the issuance of a single confirmation at an average
price and with multiple capacities for a single customer order
effected with multiple executions).
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In addition, the NASD also is clarifying the riskless principal
trade reporting provision to ensure its consistent application to any
order received by a member, regardless of the person or entity that it
was received from. Specifically, while the current rule refers to
orders received from a ``customer'', the proposed rule simply refers to
``an order.'' Thus a transaction can be defined as riskless when the
market maker is holding an order from a customer, another member, the
customer of another member, or any other entity including non-member
broker-dealers. Furthermore, the text of the rule is being amended to
more clearly provide that such trades are reported exclusive of any
fee.
2. Statutory Basis
Nasdaq believes that the proposed rule change is consistent with
the provisions of Section 15A(b)(6) of the Act \7\ in that the proposed
rule change will result in more accurate, reliable, and informative
information regarding last sale transaction reports. 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 principals 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;
and are not designed to
[[Page 47340]]
permit unfair discrimination between customers, issuers, brokers, or
dealers.
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\7\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition
Nasdaq does not believe that the proposed rule change will impose
any inappropriate burden on competition.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
Written comments were neither solicited nor received.
III. Date of Effectiveness of the Proposed Rule Change and Timing
for Commission Action
Within 35 days of the publication of this notice in the Federal
Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) By order approve the proposed rule change, or
(B) Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposal is
consistent with the Act. Persons making written submissions should file
six copies thereof with the Secretary, Securities and Exchange
Commission, 450 Fifth Street, NW, Washington, DC 20549. Copies of the
submission, all subsequent amendments, all written statements with
respect to the proposed rule change that are filed with the Commission,
and all written communications relating to the proposed rule change
between the Commission and any person, other than those that may be
withheld from the public in accordance with the provisions of 5 U.S.C.
552, will be available for inspection and copying at the Commission's
Public Reference Room. Copies of such filing will also be available for
inspection and copying at the principal office of the NASD. All
submissions should refer to File No. SR-NASD-98-59 and should be
submitted by September 25, 1998.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\8\
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\8\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-23879 Filed 9-3-98; 8:45 am]
BILLING CODE 8010-01-M