[Federal Register Volume 68, Number 226 (Monday, November 24, 2003)]
[Notices]
[Pages 65978-65980]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-29295]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-48788; File No. SR-NASD-2001-85]


Self-Regulatory Organizations; Order Approving Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval to 
Amendment Nos. 1 and 2 to the Proposed Rule Change by the National 
Association of Securities Dealers, Inc. Relating to Affirmative 
Determination Requirements for Short Sale Orders Received by Members 
From Non-Member Broker-Dealers

November 14, 2003.

I. Introduction

    On November 27, 2001, the National Association of Securities 
Dealers, Inc. (``NASD''), through its wholly owned subsidiary, NASD 
Regulation, Inc., filed with the Securities and Exchange Commission 
(``Commission''), pursuant to section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change to require that before accepting

[[Page 65979]]

a short sale order from a broker-dealer that is not an NASD member 
(``non-member broker-dealer'') a member must make an affirmative 
determination that the member will receive delivery of the security 
from the non-member broker-dealer or that the member can borrow the 
security on behalf of the non-member broker-dealer for delivery by 
settlement date. The proposed rule change was published for comment in 
the Federal Register on January 23, 2002.\3\ The Commission received 
one comment letter on the proposal. On July 18, 2003, the NASD 
submitted Amendment No. 1 to the proposed rule change. On September 15, 
2003, the NASD submitted Amendment No. 2 to the proposed rule change. 
This order approves the proposed rule change, as amended, and solicits 
comments from interested persons on Amendment Nos. 1 and 2.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 45257 (January 9, 
2002), 67 FR 3249.
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II. Description of the Proposal

    NASD Rule 3370(b)(2)(A) provides that no member or person 
associated with a member shall accept a short sale order for any 
customer in any security unless the member or person associated with a 
member makes an affirmative determination that the member will receive 
delivery of the security from the customer or that the member can 
borrow the security on behalf of the customer for delivery by 
settlement date. For purposes of NASD Rule 3370(b)(2), the term 
``customer'' is defined in NASD Rule 0120(g) and excludes a broker or 
dealer.
    As a result, the requirements of NASD Rule 3370(b)(2)(A) generally 
do not apply directly to orders received by a member from another 
broker-dealer (the ``originating broker-dealer''). This does not 
present regulatory concerns where the originating broker-dealer is also 
an NASD member because, as a member, the originating broker-dealer 
would have an independent obligation to comply with the requirements 
under NASD Rule 3370(b)(4)(B) (``Affirmative Determination 
Requirements'') with respect to the order. Non-member broker-dealers, 
however, are not subject to NASD rules and, therefore, are not 
independently required to comply with the NASD's Affirmative 
Determination Requirements. Thus the Affirmative Determination 
Requirements generally do not apply to short sale orders that originate 
with a non-member broker-dealer and are subsequently routed to an NASD 
member.
    To address these concerns, the proposed rule change would amend 
NASD Rule 3370(b)(2)(A) to require that no member or person associated 
with a member shall accept a short sale order for any customer, or any 
non-member broker-dealer in any security unless the member or person 
associated with a member makes an affirmative determination that the 
member will receive delivery of the security from the customer or non-
member broker-dealer, or that the member can borrow the security on 
behalf of the customer or non-member broker-dealer for delivery by 
settlement date. In such instances, members also would be required to 
comply with the corresponding recordkeeping requirements under NASD 
Rule 3370(b)(4)(B).
    While NASD members generally are required to make affirmative 
determinations for both customer and proprietary orders, there are 
limited exceptions for proprietary orders that are bona fide market 
making, bona fide fully hedged or bona fide fully arbitraged 
transactions.\4\ Under the proposed rule change, if a member can 
establish and document that a proprietary order it has received from a 
non-member broker-dealer meets one of these exceptions, it would be in 
compliance with the proposed amendments to the Affirmative 
Determination Requirements.
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    \4\ NASD Rule 3370(b)(2)(B).
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III. Comments and NASD Response

    The Commission received one comment letter from Island ECN, Inc. 
(``Island''). Island's comment letter makes two basic points. First, it 
suggests the Commission should not approve the proposal until the issue 
of the Nasdaq primary market maker (``PMM'') standards exemption is 
addressed. Second, Island argues that the NASD offers no factual basis 
for the proposal. The NASD believes that no changes to the proposal are 
necessary in response to Island's letter.
    Regarding Island's first point, the NASD's response is that Island 
confuses the requirements of the bid test, which addresses the price at 
which a short sale may be made, with the affirmative determination 
requirement, which prevents abusive short selling and ensures that 
short sellers satisfy their settlement obligations. According to the 
NASD, short selling members must comply with both affirmative 
determinations and bid test requirements. According to the NASD, the 
current rule applies only to a member's proprietary orders and customer 
orders, which excludes another broker or dealer by definition.\5\ NASD 
proposes to close this gap.
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    \5\ See NASD Rule 0120(g).
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    Further, NASD has made similar changes NASD Rule 2860 to the option 
position, exercise and reporting requirements.\6\
    NASD's response to Island second point is that NASD has set forth a 
factual basis for approval of the proposal consistent with section 
15A(b)(6) of the Act.\7\ According to NASD, hard evidence of violative 
conduct sought by Island has not been necessary for similar proposed 
rule changes, and, if required, would undermine the ability of self-
regulatory organizations to close gaps in their rules. Moreover, NASD 
represents that it has observed cases of member firms that have not 
complied with short sale requirements for orders received from non-
member broker-dealers. NASD believes that orders from non-member 
broker-dealers have the potential for fails to deliver just as short 
sales by other persons subject to the rule.
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    \6\ Securities Exchange Act Release No. 43718 (December 13, 
2000), 65 FR 80969 (December 22, 2000) (approving SR-NASD-2000-36).
    \7\ 15 U.S.C. 78o-3(b)(6).
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IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment Nos. 1 and 2 to the proposed rule 
change, including whether Amendment Nos. 1 and 2 are 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 No. SR-NASD-2001-85 and should be 
submitted by December 15, 2003.

V. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder

[[Page 65980]]

applicable to a national securities association.\8\ In particular, the 
Commission believes that the proposal, as amended, is consistent with 
the requirements of section 15A(b)(7) of the Act \9\ because it is 
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. The 
Commission believes that the failure to have uniform application of the 
Affirmative Determination Requirements affects the integrity of the 
marketplace by potentially increasing fails to deliver and creates 
regulatory disparity by allowing certain firms to effect short sales 
outside the purview of the NASD's Affirmative Determination 
Requirements.
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    \8\ In approving the proposed rule change, as amended, the 
Commission has considered its impact on efficiency, competition, and 
capital formation. See 15 U.S.C. 78c(f).
    \9\ 15 U.S.C. 78o-3.
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VI. Accelerated Approval of Amendment Nos. 1 and 2

    The Commission finds good cause for approving Amendment Nos. 1 and 
2 to the proposed rule change prior to the thirtieth day after the 
amendments are published for comment in the Federal Register pursuant 
to section 19(b)(2) of the Act.\10\ Amendment No. 1 extends NASD 
members' affirmative determination obligations to orders received from 
non-member broker-dealers. Amendment No. 2 specifies which firms can 
claim an exemption from the affirmative determination requirements. 
These amendments will correct a regulatory disparity that allows 
certain firms to effect short sales outside the purview of the 
Affirmative Determination Requirements. The Commission believes that 
accelerating approval will allow the implementation of this rule 
without unnecessary delay.
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    \10\ 15 U.S.C. 78s(b)(2).
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VII. Conclusion

    For the foregoing reasons, the Commission finds that the proposed 
rule change, as amended, is consistent with the Act and the rules and 
regulations thereunder applicable to a national securities association, 
and, in particular, with section 15A(b)(7) of the Act.\11\
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    \11\ 15 U.S.C. 78o(3).
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    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\12\ that the proposed rule change (SR-NASD-2001-85) is approved, 
and that Amendment Nos. 1 and 2 thereto are approved on an accelerated 
basis.
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    \12\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-29295 Filed 11-21-03; 8:45 am]
BILLING CODE 8010-01-P