[Federal Register Volume 64, Number 159 (Wednesday, August 18, 1999)]
[Notices]
[Pages 44983-44985]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-21443]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-41731; File No. SR-NASD-99-39]
August 11, 1999.


Self-Regulatory Organizations; Notice of Filing and Immediate 
Effectiveness of Proposed Rule Change by the National Association of 
Securities Dealers, Inc. Regarding Riskless Principal Trade Reporting 
Rules

    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on August 5, 1999, 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 Nasdaq. Nasdaq has designated this proposal as one 
constituting a stated policy and interpretation with respect to the 
meaning of an existing rule under Section 19(b)(3)(A)(i) of the Act \3\ 
and Rule 19b-4(f)(1) \4\ thereunder, which renders the rule effective 
upon the Commission's receipt of this filing. 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.
    \3\ 15 U.S.C. 78s(b)(3)(A)(i).
    \4\ 17 CFR 240.19b-4(f)(1).
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    Nasdaq filed with the SEC an interpretation to NASD Rules 4632, 
4642, 4652, and 6620, regarding riskless principal trade-reporting. The 
interpretation, which will be issued as a Notice to Members, addresses 
how mark-ups and other fees will be treated for determining whether 
trades are executed at the ``same'' price, for purposes of the 
aforementioned NASD rules. The text of the proposed rule change is 
available at the NASD, and at the Commission.

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
    Background. On March 24, 1999, the Commission approved a proposal 
to amend the trade reporting rules relating to riskless principal 
transactions in Nasdaq National Market, The Nasdaq SmallCap Market, 
Nasdaq convertible debt, and non-Nasdaq OTC equity securities.\5\ When 
the SEC approved the rule change, the Commission asked Nasdaq to submit 
an interpretation providing examples of how mark-ups, mark-downs, and 
other fees will be excluded for purposes of the amended riskless 
principal rules.\6\ As requested, Nasdaq is distributing Notice to 
Members 99-65,\7\ which provides examples of how mark-ups and other 
fees will be excluded for purposes of the riskless principal trade-
reporting rules, as an interpretation to existing NASD Rules 4632, 
4642, 4652, and 6620.
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    \5\ See Securities Exchange Act Release No. 41208 (March 24, 
1999) 64 FR 15386 (March 31, 1999) (SR-NASD-98-59).
    \6\ See id. at footnote 15.
    \7\ The NASD has submitted Notice to Members 99-65 as Exhibit 2 
to this rule filing. The Notice is available for inspection at the 
NASD and at the Commission.

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[[Page 44984]]

    Substance of the Interpretation. Under the riskless principal trade 
reporting rules approved by the Commission, a market maker reports as 
``riskless'' principal once if the market maker receives an order to 
buy (sell) a security, and then purchases (sells) the security as 
principal at the same price as the order in hand to satisfy the order 
to buy (sell). As stated in the interpretation contained in Notice to 
Members 99-65, to determine whether two transactions are executed at 
the same price, a market maker must compare the price reported to the 
Automated Confirmation Transaction Service (``ACT'') \8\ pursuant to 
NASD trade reporting rules, which require members to exclude any mark-
up or mark-down, commission-equivalent, or other fee when trade 
reporting (``tape price''), and the price of the offsetting trade with 
the customer, exclusive of any mark-up or mark-down, commission-
equivalent, or other fee (``net price''). If the tape price and the net 
price to the customer are the same, then the transaction must be 
reported as riskless principal to the NASD and the offsetting leg with 
the customer should not be reported to the NASD. If a market maker is 
executing a large order through a series of trades and has an 
arrangement to charge the customer an average price based on the 
various executions received, the net price to the customer and the 
volume weighted average price (``VWAP'') of the trades must be the same 
for the transaction to receive riskless principal treatment.
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    \8\ See NASD Rule 4651(b).
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    Notice to Members 99-65 also states that the riskless principal 
trade reporting rules do not mandate the prices at which market makers 
must execute the various legs of ``riskless principal'' transactions. 
Nor do the rules prohibit market makers from trading on a net basis. 
Thus, a market maker is not precluded from accumulating a position at 
one price and executing the offsetting trade with the customer at 
another price (with no mark-up, mark-down, commission-equivalent or 
other fee), provided such arrangement satisfies the member's best 
execution obligation and is consistent with SEC and NASD statements 
regarding the matching of limit and market orders.\9\
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    \9\ See Securities Exchange Act Release No. 37619A (September 6, 
1996), 61 FR 48290 (September 12, 1996) (Order Handling Rules 
Adopting Release); NASD Notice to Members 96-65 (October 1996); NASD 
Notice To Members 97-57 (September 1997).
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    Nasdaq recognizes that there are times when a market maker will, 
while holding a customer's order, effect a buy (sell) at one price and 
an offsetting sell (buy) with the customer at another price, such as 
when a market maker is trading ``net'' with an institution. If what 
otherwise would appear to be a riskless principal trade is effected at 
two different net prices, a market maker is required to report both 
legs of the transaction to the tape.\10\ Notice to Members 99-65 
instructs, however, that if a member is working an order for an 
institutional account or a block size and the member finds the other 
side of the order, the presumption will be that the orders will be 
matched off at the same price (exclusive of any mark-up or mark-down, 
commission equivalent or other fee) and reported as riskless principal, 
unless the customer has specifically requested that the order be traded 
on a net basis, at a different price. The Notice to Members 99-65 
further notes that, while net trading is not impermissible, market 
makers should endeavor to trade at one price when executing riskless 
principal transactions because this will provide greater transactional 
integrity and will have the corollary benefit of reducing SEC 
transaction fees (commonly known as ``Section 31 fees'').\11\
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    \10\ The NASD and Nasdaq currently are examining whether trade 
reporting rules should be further amended to cover market makers 
reporting riskless principal trades at different prices.
    \11\ See Section 31 of the Act, 16 U.S.C. 78ee.
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    The following provides an example of how Nasdaq believes the 
riskless principal trade reporting rules will operate:

Nasdaq Inside Market: $10--10\3/8\, 10  x  10

    Question--MMA receives a not-held order from an institutional 
customer to sell 6,000 shares, with instructions to obtain the best 
price available with a ``bottom'' of $10\1/8\. Using the phone, MMA 
sells 4,000 shares at $10\3/8\ to MMB and 2,000 shares at $10 to 
MMC. What are MMA's trade reporting obligations?
    Answer--MMA must report to ACT the sell to MMB of 4,000 shares 
at $10\3/8\ and the sell to MMC of 2,000 shares at $10. (Note that 
the volume weighted average price for this trade is $10\1/4\.) If 
MMA buys 6,000 shares from his customer at a volume weighted average 
price (VWAP) of $10\1/4\, she/he will not be required to report to 
the tape the offsetting buy with the customer. The NASD believes 
that it would be consistent with the SEC No Action Letter Regarding 
SEC Rule 10b-10 \12\ for MMA to disclose on the confirmation a 
reported price of $10\1/4\--the VWAP--instead of a reported price 
for each individual transaction. The confirmation must contain a 
notation that the disclosed price is an average price, ad must note 
that details regarding the actual price are available to the 
customer upon request.\13\ If market maker charged a mark-down, 
commission-equivalent, or other fee on top of the $10\1/4\, it also 
would be permissible for the confirmation to disclose the fee as a 
single amount.
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    \12\ See, e.g., SEC No-action letter from Catherine McGuire, 
SEC, to Eugene Lopez, Nasdaq, 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).
    \13\ See id.
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    Alternatively, if MMA trades on a net basis and buys 6,000 
shares from his customer at $10 (or another price different than the 
VWAP of $10\1/4\), MMA would also report the buy with its customer 
to the tape because the VWAP and the buy from the customer are 
different prices. The confirmation would disclose a reported price 
of $10, a price to the customer of $10, and no differential.
2. Statutory Basis
    The NASD and Nasdaq believe that the new interpretation increases 
investor protection and clarifies a member's obligations under the NASD 
trade reporting rules. Accordingly, the NASD and Nasdaq believe that 
the proposed rule change is consistent with the provisions of Section 
15A(b)(6) of the Act,\14\ in that it is designed to prevent fraudulent 
and manipulative acts and practices, to promote just and equitable 
principles of trade, to remove impediments to, and perfect the 
mechanism of a free market and a national market system, and, in 
general, to protect investors and the public interest.
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    \14\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Completion

    Nasdaq does not believe that the proposed rule change will result 
in any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act, as amended.

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

    The foregoing rule change has become effective pursuant to Section 
19(b)(3)(A)(i) of the Act \15\ and Rule 19b-4(f)(1) \16\ in that it 
constitutes a stated policy and interpretation with respect to the 
meaning of an existing rule.
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    \15\ 15 U.S.C. 78s-(b)(3)(A).
    \16\ 17 CFR 240.19b-4(f)(1).
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    At any time within 60 days of the filing of a rule change pursuant 
to Section 19(b)(3)(A) of the Act, the Commission may summarily 
abrogate the rule change if it appears to the Commission that such 
action is necessary or appropriate in the public interest, for the 
protection of investors,

[[Page 44985]]

or otherwise in furtherance of the purposes of the Act.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change 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 20549-0609. 
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 in 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 number SR-NASD-99-39 and 
should be submitted by September 8, 1999.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\17\
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    \17\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-21443 Filed 8-17-99; 8:45 am]
BILLING CODE 8010-01-M