[Federal Register Volume 64, Number 237 (Friday, December 10, 1999)]
[Notices]
[Pages 69305-69311]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-32060]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-42201; File No. SR-NASD-99-65]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the National Association of Securities Dealers, Inc. Relating
to the Creation of a Corporate Bond Trade Reporting and Transaction
Dissemination Facility and the Elimination of Nasdaq's Fixed Income
Pricing System (``FIPS'')
December 3, 1999.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(``Act''), 15 U.S.C. 78s(b)(1), notice is hereby given that on October
28, 1999 the National Association of Securities Dealers, Inc. (``NASD''
or ``Association'') 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.\1\ The Commission is publishing this notice to solicit comments
on the proposed rule change from interested persons.
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\1\ The NASD also agreed to extend the comment period to 60 days
and the time within which the Commission must approve the filing or
institute proceedings to determine whether the proposed rule change
should be disapproved to 120 days. Telephone call to Thomas Moran,
Office of General Counsel, The Nasdaq Stock Market, Inc., from Kevin
Ehrlich, Attorney, Division of Market Regulation, SEC, November 22,
1999.
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I. Self Regulatory Organization's Statement of the Terms of
Substance of the Proposed Rule Change
NASD is proposing to amend, delete and create numerous rules of the
Association to establish a corporate bond trade reporting and
transaction dissemination facility. Below is the text of the proposed
changes. Proposed new language is in italics; proposed deletions are in
brackets.
[6200. FIXED INCOME PRICING SYSTEM (FIPS) Rules 6210. Through 6260]
6200. TRADE REPORTING AND COMPARISON ENTRY SERVICE (TRACE)
6210. Definitions.
The terms used in this paragraph shall have the same meaning as
those defined in the Association's By-Laws and Rules unless otherwise
specified.
The term ``TRACE Eligible Security'' shall mean all United States
dollar denominated debt securities that are registered with the
Securities and Exchange Commission and issued by United States and/or
foreign private corporations and that are depository eligible
securities as defined in Rule 11310(d); all debt securities qualified
as PORTAL securities pursuant to Rule 5000 Series; all investment-grade
rated debt securities that are issued pursuant to Section 4(2) of the
Securities Act of 1933 and that are depository eligible securities
pursuant to Rule 11310(d).
(b) the term ``Trade Reporting And Comparison Entry Service'' or
``TRACE'' shall mean the automated system owned and operated by The
Nasdaq Stock Market, Inc. that, among other things, accommodates
reporting, comparison, and dissemination of transaction reports where
applicable in TRACE Eligible Securities and which may submit ``locked-
in'' trades to National Securities Clearing Corporation for clearance
and settlement and provide participants with monitoring and risk
management capabilities to facilitate a ``locked-in'' trading
environment.
(c) The term ``reportable TRACE transaction'' shall mean all
transactions in a TRACE Eligible Security as required by this rule.
(d) the term ``time of execution'' for a transaction in a TRACE-
eligible security shall be the time when all of the terms of the
transaction are agreed to which are sufficient to calculate the dollar
price of the trade. The time of execution for transactions involving
TRACE-eligible securities that are trading ``when issued'' on a yield
basis shall be when the yield for the transaction has been agreed to by
the parties.
(e) The term ``Parties to the Transaction'' shall mean the
executing broker/dealer, introducing broker/dealer, and clearing
brokers, if any.
(f) The term ``TRACE Participant'' shall mean any NASD member in
good standing that uses the TRACE system.
(g) The term ``TRACE Reporting Party'' shall mean a member of the
Association that is registered as a TRACE participant with the
Association and obligated to report a TRACE transaction pursuant to
TRACE system rules and who is member of a registered clearing agency
for clearing or comparison purposes or has a clearing arrangement with
such a member.
(h) The term ``TRACE Non-Reporting Party'' shall mean a member of
the Association that is registered as a TRACE participant with the
Association who is not obligated to report under TRACE system rules for
a particular transaction to which it is a party and who is a member of
a registered clearing agency for clearing or comparison purposes or has
a clearing arrangement with such a member. it shall also mean
[[Page 69306]]
any customer who is not a member of the Association.
(i) The term ``Clearing Broker/Dealer'' or ``Clearing Broker''
shall mean the member firm that has been identified in the TRACE system
as principal for clearing and settling a trade, whether for its own
account or for a correspondent firm.
(j) The term ``Correspondent Executing Broker/Dealer'' or
``Correspondent Executing Broker'' shall mean the member firm that has
been identified in the TRACE system as having a correspondent
relationship with a clearing firm whereby it executes trades and the
clearing function is the responsibility of the clearing firm.
(k) The term ``Introducing Broker/Dealer'' or ``introducing
broker'' shall mean the member firm that has been identified in the
TRACE system as a party to the transaction, but does not execute or
clear trades.
(l) The term ``Browse'' shall mean the functions of TRACE that
permit a Participant to review (or query) for trades in the system
identifying the Participant as a party to the transaction, subject to
the specific uses contained in the TRACE Users Guide.
(m) The term ``Gross Dollar Thresholds'' in the risk management
application of TRACE shall mean the daily dollar amounts for purchases
and sales that a clearing broker establishes in the TRACE system for
each correspondent executing broker that may be raised or lowered on an
inter-day or intra-day basis. If the value of a correspondent's trades
equals or exceeds the gross dollar thresholds, the system will alert
the clearing broker.
(n) The term ``Pre-alert'' shall mean the alert notifying the
correspondent executing broker and the clearing broker that the
correspondent executing broker has equaled or exceeded 70% of the
purchase or sale gross dollar limits established by the clearing
broker. The Association reserves the right to modify the percentage of
the pre-alert as necessary and upon prior notification to the TRACE
Participants.
(o) The term ``Single Limit'' shall mean the dollar amount
established by the Clearing Broker for a single trade that enables a
TRACE clearing firm to review the trade before it is obligated to clear
the trade. When a correspondent executing broker negotiates a trade
that equals or exceeds the Single Trade Limit, its clearing broker
shall have a period of thirty (30) minutes to review and agree or
decline to act as principal for clearing that trade. If a Clearing
Broker fails to set a single trade limit the TRACE system will
automatically set a default single trade limit of $0 for the
Correspondent Broker. The Association reserves the right to modify the
minimum/maximum dollar amount of the Single Trade Limit as well as the
time frame for clearing broker review as necessary and upon prior
notification to the TRACE Participants.
(p) For purposes of these rules, the term ``Investment Grade''
shall mean any TRACE-eligible security rated by a nationally recognized
statistical rating organization in one of its four highest generic
rating categories.
(q) For purposes of these rules, the term ``Non-Investment Grade''
shall mean any TRACE-eligible security that is unrated, non-rated,
split-rated (where one rating falls below investment grade), or does
not meet the definition of investment grade in paragraph (p), above.
6220. Participation in TRACE
(a) Mandatory Participation for Clearing Agency Members
(1) Pursuant to Article VII, Section 1(a)(vi) and (vii) of the By-
Laws, participation in TRACE is mandatory for all brokers/dealers that
are members of a clearing agency registered with the Commission
pursuant to Section 17A of the Act, and for all brokers that have a
clearing arrangement with such a broker. Such participation shall
include the reconciliation of all over the counter clearing agency
eligible transactions involving TRACE securities.
(2) Participation in TRACE shall be conditioned upon the TRACE
Participant's initial and continuing compliance with the following
requirements:
(A) execution of, and continuing compliance with, a TRACE
Participation Application Agreement and all applicable rules and
operating procedures of the Association and the Commission;
(B) membership in, or maintenance of, an effective clearing
arrangement with a member of a clearing agency registered pursuant to
the Act;
(C) maintenance of the physical security of the equipment located
on the premises of the TRACE Participant to prevent unauthorized entry
of information into TRACE; and
(D) acceptance and settlement of each trade that TRACE identifies
as having been effected by such TRACE Participant, or if settlement is
to be made through a clearing member, guarantee the acceptance and
settlement of each TRACE identified trade by the clearing member on the
regularly scheduled settlement date.
(3) Participation in TRACE as a Clearing Broker shall be
conditioned upon the Clearing Broker's initial and continuing
compliance with the following requirements:
(A) execution of, and continuing compliance with, a TRACE
Participant Application agreement and all applicable rules and
operating procedures of the Association and the Commission;
(B) membership in a clearing agency registered pursuant to the Act;
(C) maintenance of the physical security of the equipment located
on the premises of the TRACE Clearing Broker to prevent the
unauthorized entry of information into TRACE; and
(D) acceptance and settlement of each trade that TRACE identifies
as having been effected by itself or any of its correspondents on the
regularly scheduled settlement date.
(4) Each TRACE Participant shall be obligated to inform the
Association of non-compliance with, or changes to, any other
participation requirements set forth above.
(b) Participant Obligations in TRACE
(1) Access to TRACE
Upon execution and receipt by the Association of the TRACE
Participant application agreement, a TRACE Participant may commence
input and validation of trade information in TRACE eligible securities.
TRACE Participants may access the service via a NASD-approved facility
during the hours of operation.
(2) Clearing Obligations
If at any time a TRACE Participant fails to maintain a clearing
arrangement, it shall be removed from the TRACE system until such time
as a clearing arrangement is re-established and notice of such
arrangement is provided to the Association. If, however, the
Association finds that the TRACE participant's failure to maintain a
clearing arrangement is voluntary, the withdrawal will be considered
voluntary and unexcused.
(3) Clearing Broker Obligations
(A) Clearing brokers may cease to act as principal for a
correspondent executing broker at any time provided that notification
has been given to, received and acknowledged by the TRACE Operations
Center and affirmative action has been completed by the Center to
remove the correspondent broker from TRACE. The clearing broker's
obligation to accept and clear trades for its correspondents shall not
cease prior to the completion of all the steps detailed in this
subparagraph (3)(A).
(B) TRACE Clearing brokers shall establish for each correspondent
executing broker daily Gross Dollar Thresholds and may raise or lower
the thresholds on an inter-day or intra-day
[[Page 69307]]
basis. TRACE clearing brokers will receive a system alert when a
correspondent executing broker equals or exceeds its gross dollar
thresholds and will also receive a system pre-alert when a
correspondent executing broker equals or exceeds 70% of the daily
thresholds.
(C) For trades effected by a correspondent executing broker that
equal or exceed the correspondent's Single Trade Limit set by the
clearing broker in TRACE, clearing brokers have 30 minutes from the
time of trade report input to TRACE to review the trade and accept or
decline to act as principal to the trade. If the clearing broker does
not make an affirmative acceptance or declination of the trade report
within 30 minutes, the trade report will be subject to normal TRACE
processing and the clearing broker will be obligated to act as
principal for the trade.
6230. Transaction Reporting
(a) When and How Transactions are Reported
(1) All NASD members shall, within 1 Hour after trade execution,
transmit through TRACE during system hours, or if TRACE is unavailable
due to system or transmission failure, by telephone to the TRACE
Operations Center, reports of transactions in TRACE Securities executed
between 8:00 a.m. and 6:30 p.m. Eastern Time or shall utilize the
Browse function in TRACE to accept or decline trades within 30 minutes
after execution according to paragraph (b) of this rule. Transactions
not reported within 1 hour after execution shall be designated as late
unless inadequate time remains prior to system close to allow a timely
report. In this situation, the report must be made the next day at
system open designated ``as/of.''
(2) Transaction Reporting Between 6:30 p.m. and 8:00 a.m. Eastern
Time
(A) Reports of transactions in TRACE Securities executed after 6:30
p.m. Eastern Time and before 12:00 a.m. Eastern Time shall be reported
on the next day and be designated ``as/of''. Such trade reports will
not be included in daily market aggregates and will be disseminated
beginning at 8:00 a.m. Eastern Time on the day of receipt.
(B) Reports of transactions in TRACE Securities executed after
12:00 a.m. Eastern Time and before 8:00 a.m. Eastern time shall be
reported that same day beginning at 8:00 a.m. Eastern Time within the
maximum time frame mandated. Such trade reports will be included in
that day's market aggregates and disseminated upon receipt.
A pattern or practice of late reporting without exceptional
circumstances may be considered inconsistent with high standards of
commercial honor and just and equitable principles of trade, in
violation of Rule 2110.
(b) Which Party Reports Transaction
Both parties executing a transaction shall, subject to the input
requirements below, either input trade reports into the TRACE system or
utilize the Browse feature to accept or decline a trade within the
applicable time frames as specified in paragraph (a)(1) of this Rule.
Trade data input obligations are as follows:
(1) in transactions between two TRACE Participants, the member
representing the sell side shall be required to submit a trade report
to TRACE;
(2) in transactions between a NASD member and a non-member
including a customer, the NASD member shall be required to submit a
trade report to TRACE.
(c) Trade Information To Be Reported
Each TRACE trade report shall contain the following information:
(1) CUSIP number or NASD symbol;
(2) Number of bonds as required by paragraph (d) below;
(3) Price of the transaction as required by paragraph (d) below;
(4) A symbol indicating whether the transaction is a buy, sell or
cross;
(5) Date of Trade Execution (as/of trades only);
(6) Contra-party's identifier;
(7) Capacity--Principal or Agent (with riskless principal reported
as principal) as required by paragraph (d) below;
(8) Time of trade execution;
(9) Reporting side executing broker as ``give-up'' (if any);
(10) Contra side introducing broker in case of ``give-up'' trade;
(11) Stated commission;
(12) Such trade modifiers as required by either: (a) the TRACE
System Rules; and/or (b) the TRACE Users Guide.
(d) Procedures for Reporting Price, Capacity, Volume
(1) For agency and principal transactions, report the price
including the mark-up, mark-down or commission (commission entered
separately). Do not include accrued interest.
(2) For agency and principal transactions, report the actual number
of bonds traded. Baby bonds (those with a face value of less than
$1,000) should be reported expressed as a decimal.
(3) In-house cross transactions should be reported as follows:
Agency cross--report once as an agency trade; Principal cross--report
twice, once as an individual principal buy and once as an individual
principal sell.
(e) Transactions Not Required To Be Reported
The following types of transactions shall not be reported:
(1) Transactions which are part of a primary distribution by an
issuer;
(2) Transactions made in reliance on Section 4(2) of the Securities
Act of 1933;
(3) Transactions in listed securities that are both executed on,
and reported to, a national securities exchange;
(4) Transactions where the buyer and the seller have agreed to
trade at a price substantially unrelated to the current market for the
TRACE security (e.g., to allow the seller to make a gift).
6240. TRACE Processing
Locked-in trades may be determined in the TRACE system by matching
the trade information submitted by the reporting parties through one of
the following methods:
(a) Trade by Trade Match
Both parties to the trade submit transaction data and the TRACE
system performs an on-line match;
(b) Trade Acceptance
The TRACE reporting party enters its version of the trade into the
system and the TRACE non-reporting contra party reviews the trade
report and accepts or declines the trade. An acceptance results in a
locked-in trade; a declined trade report is purged from the TRACE
system at the end of trade data processing;
(c) Post Trade Date Processing
T+N entries may be submitted during system hours each business day.
At the end of daily matching, all declined trade entries will be purged
from the TRACE system. TRACE will not purge any open trade (i.e.,
unmatched or unaccepted) at the end of its entry day, but will carry-
over such trades to the next business day for continued comparison and
reconciliation. TRACE will automatically lock in and submit to NSCC as
such any carried-over T to T+21 (calendar day) trade if its remains
open as of 2:30 p.m. on the business day. TRACE will not automatically
lock in T+22 (calendar day) or older open ``as-of'' trades that were
carried over from the previous business day; these will be purged by
TRACE at the end of the carry-over day if they remain open. Members may
re-submit these T+22 or older ``as-of'' trades as a comparison-only
entry into TRACE on the next business day for continued comparison and
reconciliation for up to one calendar year.
[[Page 69308]]
6250. TRACE Risk Management Functions
The TRACE system will provide the following risk management
capabilities to clearing brokers:
(a) Trade File Scan
Clearing brokers will be able to scan the trading activities of
their correspondent executing brokers through the TRACE system.
(b) Gross Dollar Threshold
Clearing brokers will be able to establish, on an inter-day or
intra-day basis, gross dollar thresholds for purchases and sales for
their correspondent executing brokers, and the TRACE system will alert
the clearing broker and its correspondent if the correspondent's
trading activity equals or exceeds either threshold.
(c) Gross Dollar Threshold Per-Alert
In addition to the gross dollar threshold alert, the TRACE system
will also alert the clearing broker and its correspondent when the
correspondent's trading activity equals or exceeds 70% of either gross
dollar threshold.
(d) On-line Review
Clearing brokers that access TRACE through a computer interface
will be able to receive intra-day activity of their correspondents as
it is reported.
(e) Single Trade Limit
Clearing brokers will have 30 minutes from trade report input to
TRACE to review any single trade executed by their correspondent
executing brokers that equals or exceeds an amount set by the clearing
broker for that correspondent in order to decide to act as principal.
If, however, the clearing broker does not affirmatively accept or
decline the trade, at the end of 30 minutes, the system will subject
the trade to normal TRACE processing and the clearing broker will be
obligated to act as principal to clear the trade.
(f) Super Cap
The Super Cap will be set at an amount to be determined by the
Clearing Broker, but in no event less than the gross dollar threshold.
When a correspondent's Super Cap is reached, notice will be furnished
to TRACE participants, and no trade in excess of an amount set by the
clearing broker for that correspondent will be accepted for TRACE
processing unless the clearing broker accepts the trade within 30
minutes of execution.
6260. Obligation to Honor Trades
If a TRACE Participant is reported by TRACE as a party to a trade
that has been treated as locked-in and sent to NSCC, notwithstanding
any other agreement to the contrary, that party shall be obligated to
act as a principal to the trade and shall honor such trade on the
scheduled settlement date.
6261. Compliance with TRACE Rules and Trade Reporting Requirements
Failure of an NASD member, or person associated with a member, to
comply with any of the rules or requirements of TRACE, or failure of a
member or associated person to comply with any of the transaction
reporting requirements for TRACE-Eligible Securities may be considered
conduct inconsistent with high standards of commercial honor and just
and equitable principals of trade, in violation of Rule 2110.
6270. Audit Trail Requirements
The data elements specified in Rule 6220(c) are critical to the
Association's compilation of a transaction audit trail for regulatory
purposes. As such, all member firms utilizing the TRACE Service have an
ongoing obligation to input 6220(c) information accurately and
completely.
6280. Termination of TRACE Service
The Association may, upon notice, terminate TRACE service to a
Participant in the event that a TRACE Participant fails to abide by any
of the rules or operating procedures of the TRACE service or the
Association, or fails to honor contractual agreements entered into with
the Association or its subsidiaries, or fails to pay promptly for
services rendered by the TRACE Service.
6290. Dissemination of Corporate Bond Trade Information
Trade reports entered into TRACE will be collected, processed and
disseminated on a real-time basis between 8:00 a.m. and 6:30 p.m.
Eastern Time. All trade reports submitted to TRACE prior to 5:15 will
be included in the calculation of market aggregates and last sale
except 1). trades reported on an ``as of'' basis, 2) ``when issued''
trades executed on a yield basis, or 3) trades in baby bonds with a par
value of less than $1000.
6291. Lead Underwriter Information Obligation
In order to facilitate trade reporting of secondary transactions in
TRACE securities, the lead underwriter of any newly-issued TRACE
security shall provide to the TRACE Operations Center the CUSIP number
of any debt issue no later than on the effective date of the offering.
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Purposed Rule Change
In its filing with the Commission, NASD 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. NASD 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 Purposed Rule Change
The NASD is proposing to establish a mandatory trade reporting,
dissemination and comparison facility for corporate bonds. Under the
proposal, beginning in the spring of the year 2000, NASD members would
be obligated, for regulatory purposes, to report trades to Nasdaq's
Trade Reporting And Comparison Entry Service (``TRACESM'')
all secondary transactions in specified U.S. corporate bonds within 1
hour of trade execution. After an initial 6 month period for an
information integrity review, Nasdaq will in turn disseminate trade
reports to the public through market data vendors. Under the proposal,
the initial 1 hour maximum trade reporting time frame will be
subsequently reduced to 15 minutes six months after corporate bond
trade reporting begins. Simultaneously with the effectiveness of the
new rules governing corporate bond trade reporting, the NASD will also
eliminate Nasdaq's FIPS system and its related rules.
1. Background
Early in 1998, the SEC began reviewing the debt markets in the
United States with a particular emphasis on price transparency. This
review concluded that in the area of corporate bonds, transparency was
lacking and needed improvement. Subsequently, the Chairman of the SEC
again highlighted the problem of the lack of transparency in the
corporate bond market and called on the NASD to take the following
actions:
First, adopt rules requiring dealers to report all transactions
in U.S. corporate bonds and preferred stocks to the NASD and to
develop systems to receive and distribute transaction prices on an
immediate basis.
[[Page 69309]]
Second, create a database of transactions in corporate bonds and
preferred stocks to enable regulators to take a proactive role in
supervising the corporate debt market.
Third, create a surveillance program, in conjunction with the
development of a database, to better detect fraud and foster
investor confidence in the fairness of the corporate debt market.
In response to this mandate, the NASD is proposing a phased-in approach
to corporate bond trade reporting, starting first with high yield and
convertible debt instruments followed by all other eligible U.S.
corporate bonds. Initially, the maximum time period for timely
reporting after trade execution will be 1 hour which will subsequently
be compressed to 15 minutes. All corporate bond trade reports received,
with the exception of Rule 144A restricted issues, will then be
immediately disseminated to the investing public through market data
vendors. The NASD expects to initiate mandatory corporate bond trade
reporting and comparison for all NASD members in two phases. Currently,
the target start date for mandatory reporting is the spring of 2000,
with TRACE comparison service commencing in the summer of that same
year, after the securities industry has successfully met the Y2K
challenge.\2\ The NASD's corporate bond trading and dissemination
initiative is to be accomplished in the following phases:
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\2\ Fees for this initiative will be the subject of a separate
rule filing at a later date.
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2. Corporate Bond Trade Reporting Implementation--Phase I
Under the NASD's proposal, mandatory trade reporting for high yield
\3\ and convertible corporate bonds will commence in the spring of the
year 2000, after the NASD has assessed industry readiness. For the
first month of reporting, these securities will be subject to a maximum
1 hour trade reporting window. At the end of the first month, an
alphabetical phase-in of remaining reportable corporate bonds, lasting
two months, will then begin.\4\ These corporate bonds will also be
subject to a 1 hour maximum trade reporting window. While eligible
corporate bonds are being incorporated into the mandatory trade
reporting system, NASD will once again undertake a review of industry
technological and operational readiness and compliance with the new
corporate bond trade reporting rules. With the exception of reports in
FIPS 50 bonds, (See Section 9 below), during Phase I no trade reports
will be disseminated.
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\3\ Included in this category are the approximately 2900 high
yield corporate bonds already being reported through Nasdaq's Fixed
Income Pricing System (``FIPS''). As explained in Section 9 of this
filing, the NASD intends to fold all FIPS securities into the larger
corporate bond trade reporting and dissemination facility proposed
here.
\4\ While NASD is initially proposing an alphabetical phase-in,
the Association will continue to consult with bond market
participants with a view towards determining whether a different
method of phasing-in eligible bonds (e.g., by CUSIP number) is more
appropriate. Regardless of the phase in method selected, the three
month time period for completing the initial phase-in of all TRACE
bonds will remain the same.
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3. Corporate Bond Trade Reporting Implementation--Phase II
At the end of the sixth month, the 1 hour maximum trade reporting
window will be shortened to 15 minutes, and immediate dissemination of
trade reports will begin (with the exception of Rule 144A restricted
issues). During Phase II, the NASD will continue to evaluate the
industry's compliance with the new rules, and examine whether a further
reduction in the post-trade reporting window should be considered. The
NASD will also assess the impact upon liquidity and seek industry input
regarding any potential or observed negative impacts on market
liquidity attributable to the reduced post-trade time reporting window
and/or immediate dissemination of bond trade data.
4. The Trade Reporting And Comparison Entry Service
Trade reports submitted by NASD firms will be entered into Nadaq's
TRACESM Service. TRACE, which is based in part on technology
derived from Nasdaq's Automated Confirmation Transaction Service
(``Act''), is a multi-functional service designated to facilitate the
reporting and comparison of fixed-income trades. The system allows
reporting firms to enter executed trades in corporate bonds and have
these trades available for trade reporting, matching, and clearing.
Contra parties to reported corporate bond trades may accept trade
entries made by the reporting party via an acceptance function, or by
entering its version of the trade and allowing TRACE to match it.
Trades submitted through TRACE are forwarded to Nasdaq for reporting
purposes and can also be forwarded to the National Securities Clearing
Corporation (``NSCC'') for clearance and settlement as ``locked-in''
trades. NASD believes that TRACE will provide significant benefits to
corporate bond market participants by enabling faster and more
efficient trade reconciliation and confirmation, increased efficiency
in back-office operations, and a real-time trade entry status check for
every TRACE transaction. These features will also facilitate the
industry's transition toward T+1 trade settlement.
TRACE is also programmed to provide important risk management
functions to firms that clear corporate bond transactions for other
firms. For example, TRACE will allow clearing firms to monitor buy/sell
trading activity of their introducing firms, establish trading
thresholds, allow/inhibit large trades, add/delete clearing
relationships and access a real-time data base of correspondent trading
activity. Like TRACE's trade reporting and comparison features, TRACE's
risk management capabilities are designed to increase corporate bond
market participant confidence through the provision of superior, real-
time market information.
5. Corporate Bonds Subject to Mandatory Trade Reporting
The NASD is proposing that trade reporting be mandated for the
following corporate debt securities: (1) U.S. dollar denominated debt
securities issued by U.S. and private foreign corporations that are
registered with the SEC and eligible for book-entry services at The
Depository Trust Company (``DTC''); (2) Rule 144A U.S. high-yield debt
securities designated as ``PORTAL Debt Securities'' in Nasdaq's PORTAL
Market;\5\ and (3) rule 144A investment grade debt securities eligible
for book-entry services at DTC. For clarification, the securities
described above would include: (a) investment grade corporate debt
(including rule 144A/DTC eligible); (b) high-yield and unrated debt
issued by U.S. companies and foreign private companies (including
PORTAL-designated debt); (c) medium-term notes; (d) convertible bonds;
and (e) capital trust securities, floating rate notes, and global bonds
issued by U.S. companies and foreign private companies. Reportable
bonds would not include: government securities, sovereign or
development bank debt; mortgage or asset backed securities;
collateralized mortgage obligations (``CMOs''); or money market
instruments.
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\5\ See SR-NASD-99-66.
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6. Reporting Obligations
Under the rules proposed here, trade reports in eligible corporate
bond transactions between NASD members will be submitted by the NASD
member on the sell side of the transaction. If the transaction involves
an NASD member and the other party is a customer or non-member broker/
dealer, the NASD member will be obligated to report regardless of
whether the NASD
[[Page 69310]]
member represents the buy or sell side of the transaction. NASD is
proposing that the following types of trades be exempted from its
mandatory corporate bond trade reporting rules: (1) Transactions that
are part of a primary distribution by the issuer; (2) transactions made
in reliance on Section 4(2) of the Securities Act of 1933;\6\ (3)
transactions in listed debt securities that are both executed on, and
reported to, a national securities exchange; or (4) transactions in
which the buyer and seller have agreed to trade at a price
substantially unrelated to the current market for the debt security
(e.g. to enable the seller to make a gift).
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\6\ See SR-NASD-99-66 for fuller discussion regarding the
application of exemptions (1) and (2) as they relate to Portal
securities and Rule 144A investment grade debt.
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7. Elements of the Trade Report
The NASD is recommending that corporate bond trade reports
submitted should include the following: (1) Buy/Sell/Cross; (2) CUSIP
number or NASD symbol; (3) Quantity; (4) Price--inclusive of mark-up,
mark-down, and stated commission (for agency trades stated commission
will be reported in separate field);\7\ (5) Contra-party's NASD symbol
or ``C'' for customer; (6) Date and time of Trade Execution; and (7)
Capacity--Principal (with riskless principal reported as principal),
Agent or Agency Cross. In-house crosses should be reported as follows:
Agency crosses will be reported one time as an agency cross, and
principal crosses will be reported twice as individual buy and sell
principal trades. Baby Bonds (a trade quantity of less than one bond/
$1,000 face amount) trade reports will be based on the actual
percentage of the bond traded and reported in decimal form (e.g., a
face value of $414 would be reported as .414). Given the potential for
these trades to distort both market aggregates as well as the
representative market in an individual bond, these trade reports will
not be disseminated. Mixed lot trades, consisting of a denomination of
$1,000 par or multiples thereof, plus a baby bond, will be reported as
the actual number of bonds traded (e.g., 25,414) but will be
disseminated as the lesser whole amount (e.g., 25M) after being rounded
down by TRACE. Trade reports in ``When-Issued'' bonds would be reported
on a yield basis, unless contracted on the dollar, and be specially
designated when disseminated and not included in the calculation of
daily market aggregate values.
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\7\ In order to achieve both trade reporting and comparison of
TRACE transactions, agency trades executed with a stated commission
should have that commission reported in a separate data entry field
provided for this purpose. The dollar price of the transaction
should be reported without including the commission. TRACE will
combine these two fields for dissemination of price and yield to the
public, and use the price field for comparison purposes.
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8. Determining Time of Execution for Trade Reporting Purposes
NASD is proposing that the time of execution entry on corporate
bond trade reports be established as the time when all of the terms of
the trade are agreed upon sufficient to calculate the dollar price of
the trade. NASD believes that this standard is appropriate and
consistent with the reference to time of execution if SEC Rule 17a-3(a)
(6) and (7), which governs memorandums of purchase or sale for bond
transactions.\8\
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\8\ For determining the time of execution for transactions
involving PORTAL debt and Rule 144A investment grade rated debt
securities see SR-NASD-99-66.
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9. Fixed Income Pricing System
The rules of Nasdaq's FIPS already mandate that certain high yield
bonds, known as the ``FIPS 50,'' be reported to the FIPS system within
5 minutes of trade execution, with the remainder of FIPS-reportable
corporate high yield bonds being subject to a 5:00 p.m. end-of-day
reporting deadline. In addition, Nasdaq also currently imposes a one-
sided quotation obligation on NASD members for each FIPS bond in which
they act as a dealer. In order to standardize corporate bond trade
reporting obligations and minimize industry technology burdens, NASD is
proposing to eliminate the separate FIPS system, and its related rules
and costs, in conjunction with the expansion of corporate bond trade
reporting proposed in this filing. This will be accomplished as
follows: First, FIPS quotation requirements will cease upon
commencement of high-yield corporate bond trade reporting mandated in
this filing. At the same time, the current 5 minute trade reporting
window for FIPS 50 bonds will be expanded to 1 hour and Nasdaq's
current hourly dissemination of the high, low, and volume of the FIPS
50 bonds will be shortened to immediate dissemination of actual FIPS 50
trade reports when received by Nasdaq. At the inception of mandatory
high-yield corporate bond trade reporting proposed in this filing, all
former FIPS securities, including those now reported at the end of the
day, will become governed by the same 1 hour/15 minute reporting and
immediate dissemination standards applicable to all TRACE-eligible
corporate bonds. In addition to establishing uniformity and an equality
of trade reporting burdens, NASD believes that immediate, upon-receipt
dissemination of FIPS 50 trade report will provide the fastest
opportunity to begin evaluation of the market impact of corporate bond
trade reporting and dissemination.
10. Methods of Trade Reporting
NASD is actively conferring with various market participants
including market data vendors to provide a myriad of options for market
participants to report corporate bond trades. It is the NASD's goal to
make available trade reporting options appropriate for every type of
NASD member firm. Specifically, the TRACE system will be developed in a
manner that will make it possible for vendors and service bureaus to
provide trade report data on behalf of their clients, via a Nasdaq
Computer to Computer Interface (``CTCI''). In addition, a browser-based
corporate bond software application is being developed which will allow
members to manually enter trade report information via the Internet or
other private networks. Currently, the target start date for mandatory
reporting is the spring of 2000, with TRACE comparison service
commencing in the summer of that same year.
11. Hours of System Operation
NASD's corporate bond trade reporting and dissemination system will
operate from 8:00 a.m. to 6:30 p.m. Eastern Time. Trades executed after
6:30 p.m. and before 8 a.m. the next day, will be reported that next
morning beginning at 8 a.m. in conformity with maximum trade reporting
time mandates (e.g., initially 1 hour subsequently to be reduced to 15
minutes). Trades executed after system close and before 12:00 a.m.
midnight will be reported on an ``as of'' basis and will not be
included in market aggregates but will be disseminated upon receipt
beginning at 8:00 a.m. the next trading day. Trades executed between
12:01 a.m. and system open (8:00 a.m.) that same day will be reported
starting at system open, disseminated upon receipt, and will be
included in the calculation of daily aggregates.
12. Corporate Bond Market Surveillance
In addition to the establishment of a corporate bond transaction
reporting and dissemination facility, NASD will also, in accordance
with the Commission mandate, develop a database of transactions in
corporate bonds to enable NASD Regulation and Nasdaq MarketWatch
regulators to take a proactive role in supervising the
[[Page 69311]]
corporate debt market and to better detect fraud and foster investor
confidence in the fairness of that market. As the Commission is aware,
both NASD Regulation and Nasdaq currently have in place surveillance
and examination programs covering the over-the-counter corporate debt
market, NASD Regulation will continue to investigate complaints
concerning over-the-counter corporate bond transactions and will, based
on the database of TRACE transactions reports submitted, develop
automated monitoring and oversight capabilities for the corporate debt
market to ensure the highest levels of investor protection and market
integrity.
13. Dissemination of Trade Report Information to Vendors
NASD is proposing to immediately disseminate the following trade
report information to market data vendors for public use: (1) NASD
Symbol; (2) CUSIP; (3) Date/Time of Execution of Trade; (4) Price; (5)
Yield; and (6) Actual Quantity of Bonds Traded (except high yield and
unrated (NR/NA) trades over a 1 million dollar par value will be
disseminated as ``1MM+'' and investment-grade transactions over a 5
million dollar par value will be disseminated as ``5MM+'').\9\ NASD
believes a two-tiered approach of a 1MM+ identifier for high-yield
transactions is appropriate given the lack of effective hedges in the
high-yield market and that market's potential sensitivity to a lack of
liquidity, while a 5MM+ identifier for investment-grade trades draws an
appropriate and reasonable balance between the desire for increased
transparency and any potential dangers to market function in the more
liquid investment-grade debt market.\10\ TRACE information will be
distributed to vendors in a fashion and format similar to Nasdaq's
Trade Dissemination Service (``NTDS'') which is used to disseminate
last sale transaction reports in Nasdaq securities.
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\9\ NASD will not disseminate trade report information for
transactions involving Rule 144A-eligible, privately-placed debt
securities, including PORTAL-designated and investment grade DTC-
eligible debt. Trade reports in stand-alone baby bonds will also not
be disseminated (See Section 7).
\10\ TRACE will disseminate transaction reports received during
system hours. However, only TRACE transactions executed and reported
to TRACE prior to 5:15 p.m. Eastern Time will be used to calculate
that day's high, low, last sale, and volume for individual TRACE
securities. Transaction reports submitted to TRACE after 5:15 p.m.
Eastern time will be disseminated with an ``.A'' to identify them as
transactions not affecting high, low, last sale, and volume market
aggregates.
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Based on the above, Nasdaq believes that the proposed rule changes
are consistent with the provisions of Section 15A(b)(6) of the Act in
that the proposals are designed to prevent manipulative acts and
practices, to promote just and equitable principles of trade, to foster
cooperation and coordination with persons engaged in the regulating,
clearing, settling, processing information with respect to, and
facilitating transactions in, securities.
B. Self-Regulatory Organization's Statement on Burden on Competition
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.
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 120 days of the date of 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 such 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 proposed rule
change is consistent with the Act. Commenters are specifically
encouraged to address the following issues: What information should be
reported? How immediate should reporting be? What systems changes are
required to support trade reporting to a central facility? Are there
ways to improve the proposed trade reporting system that would improve
transparency and reduce the cost of implementation? Are the proposed
methods of reporting price (i.e., inclusive of markups, markdowns, and
commissions) appropriate in light of broker-dealer confirmation
disclosure obligations for corporate debt transactions under Rule 10b-
10? Are the proposed facilities sufficient for trade reporting and
trade comparison? Is the phase-in schedule appropriate? Is the method
of trade report dissemination appropriate? Should Rule 144A
transactions be treated differently? Is the timetable for operation of
the TRACE system to begin in Spring 2000 appropriate? 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 would refer to File No.
SR-NASD-99-65 and should be submitted by February 8, 2000.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\11\
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\11\ 17 CFR 200.30-3(a)(12).
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Jonathan G. Katz,
Secretary.
[FR Doc. 99-32060 Filed 12-9-99; 8:45 am]
BILLING CODE 8010-01-M