[Federal Register Volume 64, Number 146 (Friday, July 30, 1999)]
[Notices]
[Pages 41478-41480]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-19488]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41647; File No. SR-NASD-98-61]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Granting Approval to Proposed Rule Change Relating 
to Reporting Transactions in Exchange-Listed Securities

July 23, 1999.

I. Introduction

    On August 12, 1998, the National Association of Securities Dealers, 
Inc. (``NASD'' or ``Association''), through its wholly-owned 
subsidiary, Nasdaq Stock Market, Inc. (``Nasdaq''), filed with the 
Securities and Exchange Commission (``SEC'' or ``Commission''), 
pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Exchange Act''

[[Page 41479]]

or ``Act'') \1\ and Rule 19b-4 thereunder,\2\ a proposed rule change to 
eliminate an unnecessary provision of an NASD rule relating to the 
reporting of transactions in exchange-listed securities traded in the 
third market.
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    \1\ 15 U.S.C. 78s (b)(1).
    \2\ 17 CFR 240.19b-4.
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    The proposed rule change was published for comment in Exchange Act 
Release No. 40360 (August 25, 1998), 63 FR 46267 (August 31, 1998). No 
comments were received on the proposal.\3\ This order approves the 
proposed rule change.
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    \3\ Although the Commission did not receive any comments on this 
specific proposed rule change, the Chicago Stock Exchange (``CHX'') 
submitted a comment letter on the Commission's proposal to expand 
the Intermarket Trading System linkage to all listed securities. The 
CHX's letter questioned the practical effect of the NASD's proposed 
rule change. Specifically, CHX questioned whether the NASD's 
proposed rule change truly eliminated the discretionary nature of 
the current rule. See Letter to Jonathan G. Katz, Secretary, 
Commission, from Robert H. Forney, President and Chief Executive 
Officer, CHX, dated August 28, 1998. The NASD responded in December 
1998. See Letter to Jonathan G. Katz, Secretary, Commission, from 
Richard G. Ketchum, President and Chief Operating Officer, NASD, 
dated December 17, 1998.
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II. Description

    The NASD proposes to eliminate an unnecessary provision of its 
rules applicable to the reporting of transactions in exchange-listed 
securities. Specifically, NASD Rule 6420(d)(3)(A), which is the general 
rule requiring NASD members to report all principal transactions in 
exchange-listed securities in the third market, currently contains 
language requiring members to report transactions in a manner 
``reasonably related to the prevailing market taking into 
considerations all relevant circumstances * * *.'' Although this 
provision accompanied a change to the trade reporting rules approved in 
1980 (which was intended to make comparable the reporting of third 
market trades with exchange transactions), Nasdaq believes that this 
particular language is superfluous in the context of exchange-listed 
securities and does not serve any meaningful purpose with respect to 
the trade reporting of these securities.
    Nasdaq believes that the language has served only to promote the 
misperception that the rule provides flexibility in the manner in which 
NASD members may report third market transactions. The rule was 
intended to require third market trades to be reported on a ``gross'' 
basis, exclusive of any mark-up or mark-down charged to the 
customer.\4\ Nasdaq believes that this has led to inaccurate trade 
reporting, and has been used by ITS Participants \5\ as a reason for 
not extending the NASD's Intermarket Trading System/Computer Assisted 
Execution System (``ITS/CAES'') link to all exchange-listed securities. 
Accordingly, Nasdaq believes that the best practice would be to remove 
the unclear language from the rule.
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    \4\ See Exchange Act Release No. 16960 (July 7, 1980), 45 FR 
47291 (July 14, 1980) (approving SR-NASD-80-03).
    \5\ ITS is a communications and order routing network linking 
eight national securities exchanges and the electronic over-the-
counter market operated by the NASD. ITS was designated to 
facilitate intermarket trading in exchange-listed equity securities 
based on current quotation information emanating from the linked 
markets. The NASD's computer assisted execution system (``CAES'') 
enables participating firms to route their orders for listed 
securities through ITS to obtain executions against quotations of 
third market makers participating in Nasdaq. The ITS/CAES interface 
allows participant exchanges and Nasdaq market makers to route 
commitments to other participant exchange markets for execution.
    Participants to the ITS Plan include the American Stock Exchange 
LLC, the Boston Stock Exchange, Inc., the Chicago Board Options 
Exchange, Inc., the CHX, the Cincinnati Stock Exchange, Inc., the 
NASD, the New York Stock Exchange, Inc. (``NYSE''), the Pacific 
Exchange, Inc., and the Philadelphia Stock Exchange, Inc. 
(collectively, ``Participants'').
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III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to the Association and, in particular, with the 
requirements of Section 15A(b)(6).\6\ Section 15A(b) requires that the 
rules of the 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; and are not designed to 
permit unfair discrimination between customers, issuers, brokers, and 
dealers.\7\
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    \6\ 15 U.S.C. 78o-3(b)(6).
    \7\ See 15 U.S.C. 78o-3. In approving this rule change, the 
Commission notes that it has considered the proposal's impact on 
efficiency, competition, and capital formation, consistent with 
Section 3 of the Act. Id. at 78c(f).
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    The Commission also finds that the proposed rule change is 
consistent with Section 11A of the Act.\8\ Specifically, the Commission 
finds that the proposed rule change should facilitate the further 
development of the National Market System by eliminating any confusion 
regarding the trade reporting responsibilities of third market makers.
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    \8\ 15 U.S.C. 78k-1.
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    Prior to July 1980, the NASD required that third market makers 
report transactions to the tape at the ``net'' price to the customer--
that is, inclusive of mark-ups, mark-downs, commission equilavents, or 
service charges (collectively, ``charges''). In contrast, exchange 
rules have always required a trade to be reported to the tape at the 
``gross'' transaction price--that is, exclusive of charges. In July 
1980, the Commission approved an NASD rule change providing that 
members would be required to report transactions to the tape exclusive 
of charges. The NASD's rule also allowed members to report prices 
``reasonably related to the market, taking into consideration all 
relevant circumstances. * * *''
    The NASD's proposed rule change deletes the ``reasonably related to 
the market'' language. The Commission believes that the proposed rule 
change clarifies that third market makers will no longer have the 
perceived latitude to determine the price at which exchange-listed 
securities transactions are reported. The proposed rule change further 
promotes the comparability of transaction prices reported in the 
consolidated system and improves the manner in which transaction prices 
are disclosed to public investors.
    The Commission notes that the ITS Participants have expressed 
concern that the perceived lack of comparability between the trade 
reporting require- ments in the third market and those in the exchange 
markets results in dispa- rate prices and obligations regarding the 
protection of quotations under the ITS Trade-Through Rule and Block 
Policy.\9\ The Participants note that the

[[Page 41480]]

price at which a transaction is reported to the Consolidated Tape 
System determines whether or not a member in one Participant market who 
has displayed a better bid or offer within the linked ITS market is 
entitled to satisfaction as a consequence of an inferior priced 
transaction reported to the tape in another market. The ITS 
Participants believe that the current NASD trade reporting rule, 
containing the ``reasonably related to the market'' provision, provides 
latitude to NASD members to report a price to the tape different from 
the execution price confirmed to customers, thereby creating the 
potential to avoid the Trade-Through Rule.
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    \9\ See, e.g., CHX letter; Letter to Jonathan G. Katz, Secretary 
Commission, from James E. Buck, Senior Vice President and Secretary, 
NYSE, dated August 31, 1998 (comment letter to File No. 4-208, 
Exchange Act Release No. 40260 (July 24, 1998), 63 FR 40748 (July 
30, 1998) nn.63, 67) (``NYSE letter'').
    A ``trade-through'' occurs when a transaction is effected at a 
price below the best bid, or above the best prevailing offer. The 
ITS Trade-Through Rule requires that members of ITS Participant 
markets avoid initiating a trade-through when purchasing or selling, 
either as principal or agent, any ITS security on the Participant 
market or when sending a commitment to trade through ITS. The ITS 
Block Trade Policy provides that the member who represents a block-
size order(s) shall, at the time of execution of the block trade, 
send, or cause to be sent, through ITS to each participating ITS 
market center displaying a bid (or offer) superior to the execution 
price, a commitment to trade at the execution price and for the 
number of shares displayed with that market center's better-priced 
bid (or offer). This policy is intended to enable other markets to 
derive the benefit of the block without breaking it up.
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    In its letter to the Commission, CHX asserts that the NASD's 
proposed rule change does not address the discretionary nature of the 
NASD's current trade reporting rule because it ``would merely eliminate 
the standard articulating how to calculate the markup or markdown.'' 
The NASD responds that it ``fails to see the relevance of the argument 
that a third market maker could avoid a trade-through by reporting a 
price within the national best bid and offer while providing a 
different price to its customer, when that difference must be disclosed 
to the customer and assessed as a cost of trading on the same basis as 
any other charge or commission.'' \10\ The NASD further disagrees with 
the CHX's assertion that the NASD's proposed rule change limits the 
value of a trade-through rule. CHX argues that a market maker's 
discretion to report a trade at a prevailing market price at the time 
of the trade, as long as the customer is made aware of the difference 
between the reported price and the net price (the markup), enables a 
market maker to avoid a trade-through. In response, the NASD states 
that its trade reporting rule emphasizes the value of a trade-through 
rule by encouraging market participants to provide an execution at a 
better price than the national best bid or offer. The NASD further 
believes that such an execution would be ``exactly comparable with 
orders executed on an exchange where the reported price does not 
include the broker's commission.'' \11\
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    \10\ See NASD letter.
    \11\ See NASD letter.
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    The Commission finds that eliminating the ``reasonably related to 
the market'' language helps to clarify the NASD's trade reporting rule. 
As the NYSE stated, removal of the ``reasonably related to the 
prevailing market'' language would resolve its long-standing concern 
\12\ with the trade reporting issue.\13\ Furthermore, effective 
surveillance and confirmation disclosure of the charges to the customer 
should help to enforce these trade reporting obligations.\14\ 
Specifically, in the event a broker-dealer is acting as principal in a 
transaction in a reporting security, the confirmation disclosure rule, 
Exchange Act Rule 10b-10, requires a broker-dealer to disclose to a 
customer the trade price reported to the Consolidated Tape, the net 
price to the customer in the transaction, and the difference, if any, 
between the reported price and the price to the customer. If a broker-
dealer is acting as agent for a customer, the member must confirm to 
the customer the gross trade price (which is the price reported to the 
Consolidated Tape), and the commission equivalent as well as the net 
price to the customer.
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    \12\ See, e.g., Letter to Jonathan G. Katz, Secretary, 
Commission, from James E. Buck, Senior Vice President and Secretary, 
NYSE, dated June 25, 1997.
    \13\ See NYSE letter.
    \14\ See Exchange Act Release No. 18713 (May 6, 1982), 47 FR 
20413, 20415 n.13 (May 12, 1982).
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IV. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\15\ that the proposed rule change (SR-NASD-98-61) is approved.

    \15\ 15 U.S.C. 78s(b)(2).
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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-19488 Filed 7-29-99; 8:45 am]
BILLING CODE 8010-01-M