[Federal Register Volume 68, Number 22 (Monday, February 3, 2003)]
[Notices]
[Pages 5319-5322]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-2485]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47259; File No. SR-NASD-2001-47]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Approving Proposed Rule Change and Notice of 
Filing and Order Granting Accelerated Approval of Amendment No. 1 
Thereto Relating to Audit Trail and Trading Halt Requirements for 
Alternative Trading Systems That Trade Security Futures

January 27, 2003.

I. Introduction

    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 July 30, 2001, the National Association of Securities Dealers, Inc. 
(``NASD'' or ``Association''), through its subsidiary, NASD Regulation, 
Inc. (``NASD Regulation''), filed with the Securities and Exchange 
Commission (``SEC'' or ``Commission'') the proposed rule change 
relating to audit trail and trading halt requirements for Alternative 
Trading Systems (``ATSs'') that trade security futures.\3\ By letter 
dated August 14, 2002, the Association filed

[[Page 5320]]

Amendment No. 1 to the proposed rule change.\4\ The Commission received 
one comment letter.\5\ The Commission approves the proposed rule 
change, as amended, and publishes this notice to solicit comments on 
Amendment No. 1. The Commission also approves Amendment No. 1 on an 
accelerated basis.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Release No. 44623 (July 30, 2001), 
66 FR 41076 (August 6, 2001).
    \4\ See letter from Gary Goldsholle, Associate General Counsel, 
NASD, to Katherine A. England, Assistant Director, Division of 
Market Regulation, Commission, dated August 13, 2002 (``Amendment 
No. 1''). In Amendment No. 1, the NASD responded to a comment letter 
from Island, added proposed NASD rule 3115(a)(15) to indicate that 
the ATS audit trail for security futures trading would include ``an 
account identifier that relates the order back to the account 
owner(s),'' and amended NASD rule 3340(b)(2) to increase the 
percentage of the market capitalization of underlying securities 
that trigger a trading halt in a narrow-based security index from 
30% to 50%.
    \5\ See letter from Chris Concannon, Vice-President, Island, to 
Jonathan Katz, Secretary, Commission, dated August 20, 2001 
(``Island Comment Letter'').
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II. Description of the Proposed Rule Change

    NASD Regulation proposes to add NASD rule 3115 to establish record-
keeping requirements for ATSs that trade security futures \6\ and to 
amend NASD rule 3340 to prohibit members and associated persons from 
publishing a quotation for a security future when there is a regulatory 
trade halt in effect for the underlying security.
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    \6\ Section 3(a)(55) of the Act defines a ``security future'' as 
a contract of sale for future delivery of a single security or of a 
narrow-based security index. Security futures are defined as 
``securities'' under the Act, thus making the federal securities 
laws generally applicable to them.
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    Specifically, NASD Regulation proposes to establish audit trail 
requirements relating to ATSs for the trading of futures on single 
securities and narrow-based security indices consistent with the 
Commodity Futures Modernization Act of 2000 (``CFMA'').\7\ Under 
section 6(h)(5) of the Act,\8\ as added by the CFMA, a person \9\ other 
than a national securities association or national securities exchange 
member may not maintain or provide a marketplace or facilities for 
bringing together purchasers and sellers of security future products 
unless it is a member of a national securities association or national 
securities exchange that has: (1) Procedures for coordinated 
surveillance, (2) rules to require an audit trail necessary or 
appropriate to facilitate coordinated surveillance, and (3) rules to 
require such person to coordinate trading halts with markets trading 
the securities underlying the security futures products and other 
markets trading related securities. The NASD, as a national securities 
association, proposes to meet these CFMA requirements to prepare for 
the trading of security futures by ATSs.
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    \7\ The CFMA was signed into law on December 21, 2000. Pub. L. 
No. 106-554, 114 Stat. 2763 (2000).
    \8\ See 15 U.S.C. 78f(h)(5).
    \9\ The term ``person'' means a natural person, company, 
government, or political subdivision, agency or instrumentality of a 
government. See 15 U.S.C. 78c(a).
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a. Requirements for Alternative Trading Systems

    With respect to audit trails necessary to facilitate coordinated 
surveillance, the proposed rule change would require ATSs to record and 
report audit trail information on a T+1 basis in such form as the NASD 
requires. The NASD has based the required elements of the audit trail 
rule on Regulation ATS rule 302, the Commission's recordkeeping rule 
for ATSs.\10\ The form of the reports will be designed to facilitate 
the NASD's sharing the reports with members of the Intermarket 
Surveillance Group, an organization whose purpose is to coordinate 
surveillance among financial markets. The proposed rule change would 
require that ATSs preserve such records in accordance with rule 17a-
4(b) under the Act,\11\ which requires preservation of records for at 
least three years, the first two years in an easily accessible place.
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    \10\ 17 CFR 242.302(c).
    \11\ 17 CFR 240.17a-4(b).
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b. Trading Halts

    With respect to coordinated trading halts, the proposed rule change 
would amend the NASD's existing rule prohibiting trading during a halt. 
Currently, NASD rule 3340 broadly prohibits broker-dealers and 
associated persons from effecting a ``transaction * * * in any security 
as to which a trading halt is currently in effect.'' The NASD proposes 
to amend this rule by adding a provision that prohibits member firms, 
including ATSs, from effecting any transaction or publishing a priced 
bid and/or unpriced indication of interest for: (a) A future on a 
single stock when the underlying stock is subject to a regulatory 
trading halt; and (b) a future on a narrow based securities index when 
one or more underlying securities that constitute 50 percent or more of 
the market capitalization of the index are subject to a regulatory 
trading halt.\12\ Further, by limiting application of new NASD rule 
3340(b) to regulatory trading halts, the NASD intends to exclude halts 
resulting from events such as an order imbalance or a systems failure.
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    \12\ See Amendment No. 1, supra note 4.
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III. Comments

    The Commission received one comment letter from Island. Island 
recommended that the Commission require the NASD to: (1) More narrowly 
tailor the proposed recordkeeping requirements to be consistent with 
security futures and the regulatory framework governing security 
futures; and (2) conditionally exempt ATSs from certain aspects of the 
trading halt rule. Specifically, Island disputed that NASD rule 3115 
governing recordkeeping requirements should mirror the existing audit 
trail rule in Regulation ATS designed for equity and debt securities. 
Island also noted its belief that the proposed recordkeeping 
requirements in NASD rule 3115 require far greater audit trail 
information than is necessary to perform coordinated surveillance to 
detect manipulation and insider trading as contemplated by the CFMA. In 
addition, Island did not believe it was appropriate to amend NASD rule 
3340 to include ATSs trading security futures because the effective 
date of the rule had been delayed to clarify the NASD's interpretation 
of the rule. Island proposed that the rule be interpreted to exempt 
ATSs that: (1) Do not accept new orders in such security during a 
trading halt; and (2) have procedures in place reasonably designed to 
prevent the execution of orders during a trading halt.
    In Amendment No. 1, the NASD responded to Island's comment letter. 
Specifically, the NASD stated that it reviewed the items required by 
NASD rule 3115 and the information provided by other markets that are 
expected to trade security futures products with respect to coordinated 
surveillance by the Intermarket Surveillance Group, and concluded that 
the NASD rule 3115 requirements are not unnecessarily broad or 
burdensome. Regarding the amendments to NASD rule 3340, the NASD noted 
that the rule has been in effect since October 9, 2001, and thus the 
proposed amendments, which supplement the rule to account for security 
futures, should be approved.

IV. Discussion

    The Commission has reviewed carefully the proposed rule change, the 
comment letter, NASD's response to the comment letter, and the entire 
record herein, and finds that the proposed rule change, as amended, is 
consistent with the Act and the rules and regulations applicable to the 
Association. \13\
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    \13\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78c(f).

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[[Page 5321]]

    The Commission finds that the proposed rule change, as amended, is 
consistent with section 15A.\14\ Specifically, the Commission finds 
that the proposed rule change is consistent with section 15A(b)(6) of 
the Act which requires, among other things, that the Association's 
rules 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.\15\
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    \14\ 15 U.S.C. 78o-3.
    \15\ 15 U.S.C. 78o-3(b)(6).
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    In addition, the Commission finds that the proposed rule change is 
consistent with section 15A(b)(11),\16\ which requires that the rules 
of a registered national securities association be designed to produce 
fair and informative quotations, prevent fictitious or misleading 
quotations, and to promote orderly procedures for collecting, 
distributing, and publishing quotations.
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    \16\ 15 U.S.C. 78o-3(b)(11).
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    The Commission also believes that proposed rule change, as amended, 
is consistent with subparagraphs (B) and (C) of section 6(h)(5) of the 
Act,\17\ which sets forth the requirements that must be in place before 
ATSs provide a marketplace for trading security futures products. 
Island asserted that NASD rule 3115 requires that ATSs maintain more 
records than this statutory provision requires. In response, the NASD 
stated that the rule was not unnecessarily broad or burdensome. 
Pursuant to section 6(h)(5)(B) of the Act, the NASD, among other 
requirements, must have ``rules to require audit trails necessary or 
appropriate to facilitate the coordinated surveillance required [under 
the Act]'' before an ATS can trade security futures products.\18\ The 
Commission believes that the proposed rule change satisfies this 
requirement and agrees with the NASD that it is not unnecessarily broad 
or burdensome.
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    \17\ 15 U.S.C. 78f(h)(5)(B) and (C).
    \18\ See 15 U.S.C. 78f(h)(5)(B).
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    The Commission also believes that the amendment to NASD rule 3340 
meets the goals of section 6(h)(5)(C) of the Act,\19\ which requires a 
national securities association to adopt rules to require its members 
``to coordinate trading halts with markets trading the securities 
underlying the security future products and other markets trading 
related securities.''\20\ Island suggested that the NASD exempt ATSs 
that: (1) Do not accept new orders in such security during a trading 
halt; and (2) have procedures in place reasonably designed to prevent 
the execution of orders during a trading halt. The Commission, however, 
does not believe that it is necessary for NASD Rule 3340 to provide for 
the suggested exemption in order for the rule to be consistent with the 
Act. The Commission also notes that to satisfy other regulatory 
requirements, some ATSs have been able to block the public 
dissemination of orders for individual securities on their limit order 
books. Accordingly, ATSs appear to have the technological capability to 
restrict the display or publication of orders on their books. Thus, in 
the Commission's view, the NASD's amendments to its trading halt rule 
to cover security futures are not overly burdensome or inappropriate.
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    \19\ See 15 U.S.C. 78f(h)(5)(C).
    \20\ See 15 U.S.C. 78f(h)(5)(c).
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    Finally, the Commission believes that the proposed rule is 
consistent with the goals expressed in section 11A(a)(1)(C) of the 
Act,\21\ which grants the Commission the authority to require rules 
designed to ensure appropriate protection of investors and the 
maintenance of fair and orderly markets to assure: (1) Economically 
efficient execution of securities transactions; (2) fair competition 
among brokers and dealers; (3) the availability to brokers, dealers and 
investors of information with respect to quotations and transactions in 
securities; (4) the practicability of brokers executing investors' 
orders in the best market; and (5) an opportunity for investors' orders 
to be executed without the participation of a dealer.
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    \21\ 15 U.S.C. 78k-1(a)(1)(C).
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V. Commission's Findings and Order Granting Accelerated Approval of 
Proposed Rule Change

    For the reasons discussed below, the Commission finds good cause 
for approving Amendment No. 1 to the proposed rule change prior to the 
30th day after the date of publication of notice thereof in the Federal 
Register.
    In Amendment No. 1, the NASD proposed NASD rule 3115(a)(15) to 
indicate that the ATS audit trail for security futures trading would 
include ``an account identifier that relates the order back to the 
account owner(s),'' and amended NASD rule 3340(b)(2) to increase the 
percentage of the market capitalization of underlying securities 
subject to a trading halt in a narrow-based security index from 30% to 
50%. The NASD amended the rule to include the account identifier 
provision because the account identifier has traditionally been a key 
component of an audit trail. The percentage increase from 30% to 50% in 
the market capitalization of underlying securities that triggers a 
trading halt in futures on a narrow-based security index was also 
proposed to more closely mirror rules approved by the Commission and 
the Commodity Futures Trading Commission (``CFTC'') with respect to 
trading halts in security futures products.\22\ As Amendment No. 1, 
does not raise any novel regulatory issues, the Commission finds that 
granting accelerated approval to Amendment No. 1 is appropriate and 
consistent with section 19(b)(2) of the Act.\23\
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    \22\ See Securities and Exchange Act Release No. 34-45956 (May 
17, 2002 ), 67 FR 36741 (May 24, 2002) (Cash Settlement and 
Regulatory Halt Requirements for Security Futures Products, Joint 
Final Rule of CFTC and the Commission).
    \23\ 15 U.S.C. 78s(b)(2).
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VI. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Amendments No. 1 to NASD-2001-47, including 
whether the proposed amendment 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 Amendment No. 1 to File No. SR-NASD-2001-47 
and should be submitted by February 24, 2003.

VII. Conclusion

    For the foregoing reasons, the Commission finds that the proposal, 
as amended, is consistent with the requirements of the Act and rules 
and regulations hereunder.

[[Page 5322]]

    It is therefore ordered, pursuant to section 19(b)(2) of the Act, 
\24\ that the proposed rule change (SR-NASD-2001-47), as amended, is 
approved.
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    \24\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\25\
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    \25\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. 03-2485 Filed 1-31-03; 8:45 am]
BILLING CODE 8010-01-P