[Federal Register Volume 69, Number 129 (Wednesday, July 7, 2004)]
[Rules and Regulations]
[Pages 41060-41087]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-15081]



[[Page 41059]]

-----------------------------------------------------------------------

Part III





Securities and Exchange Commission





-----------------------------------------------------------------------



17 CFR Parts 200, 240, and 249



Collection Practices Under Section 31 of the Exchange Act; Final Rule

  Federal Register / Vol. 69, No. 129 / Wednesday, July 7, 2004 / Rules 
and Regulations  

[[Page 41060]]


-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 200, 240, and 249

RIN 3235-AJ02

[Release No. 34-49928; File No. S7-05-04]


Collection Practices Under Section 31 of the Exchange Act

AGENCY: Securities and Exchange Commission.

ACTION: Final rule; request for comments on Paperwork Reduction Act 
burden estimates.

-----------------------------------------------------------------------

SUMMARY: The Securities and Exchange Commission is establishing new 
procedures that govern the calculation, payment, and collection of fees 
and assessments on securities transactions owed by national securities 
exchanges and national securities associations to the Commission 
pursuant to Section 31 of the Securities Exchange Act of 1934. Under 
these new procedures, each exchange or association must provide the 
Commission with data on its securities transactions. The Commission 
will calculate the amount of fees and assessments due based on the 
volume of these transactions and bill the exchange or association that 
amount. The Commission is also adopting a temporary rule that will 
enable it to calculate Section 31 fees and assessments using the new 
procedures for the whole of its fiscal year 2004.

DATES: Effective Date: August 6, 2004, except Sec.  240.31T is 
effective August 6, 2004 to January 1, 2005.
    Compliance Date: The first Form R31 required by Rule 31 (covering 
the month of July 2004) is due by August 13, 2004, the tenth business 
day of August. The Form R31 submissions required by temporary Rule 31T 
(for the months September 2003 to June 2004, inclusive) also are due by 
August 13, 2004.
    Comment Date: Comments regarding the collection of information 
requirements within the meaning of the Paperwork Reduction Act of 1995 
should be received by August 6, 2004.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/final.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number S7-05-04 on the subject line; or
     Use the Federal eRulemaking Portal http://www.regulations.gov. Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609.
    All submissions should refer to File Number S7-05-04. This file 
number should be included on the subject line if e-mail is used. To 
help us process and review your comments more efficiently, please use 
only one method. The Commission will post all comments on the 
Commission's Internet Web site (http://www.sec.gov/rules/final.shtml). 
Comments are also available for public inspection and copying in the 
Commission's Public Reference Room, 450 Fifth Street, NW., Washington, 
DC 20549. All comments received will be posted without change; we do 
not edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: Michael Gaw, Senior Special Counsel, 
202-942-0158, or Christopher Solgan, Attorney, 202-942-7937; Division 
of Market Regulation; Securities and Exchange Commission; 450 5th 
Street, NW.; Washington, DC 20549-1001.

SUPPLEMENTARY INFORMATION:

I. Background

    Beginning with fiscal year 2004 (``FY2004''), the Securities and 
Exchange Commission (``Commission'') is required to prepare financial 
statements audited by an external auditor. This requirement was created 
by the Accountability of Tax Dollars Act of 2002 (``Accountability 
Act'').\1\ In anticipation of its external audit and to further the 
principles of the Accountability Act, the Commission reviewed its 
policies and procedures for collecting, processing, and documenting its 
accounts receivable, including the fees and assessments that national 
securities exchanges and national securities associations 
(collectively, ``self-regulatory organizations'' or ``SROs'') owe the 
Commission pursuant to Section 31 of the Securities Exchange Act of 
1934 (``Exchange Act'').\2\
---------------------------------------------------------------------------

    \1\ Public Law 107-289, 31 U.S.C. 3515. The Accountability Act 
requires each federal executive agency with appropriated budget 
authority of more than $25 million to prepare annual audited 
financial statements.
    \2\ 15 U.S.C. 78ee.
---------------------------------------------------------------------------

    Pursuant to Section 31(b) of the Exchange Act,\3\ a national 
securities exchange must pay the Commission a fee based on the 
aggregate dollar amount of sales of securities transacted on the 
exchange.\4\ Pursuant to Section 31(c),\5\ a national securities 
association must pay the Commission a fee based on the aggregate dollar 
amount of sales of securities transacted by or through any member of 
the association otherwise than on a national securities exchange.\6\ 
Section 31(d)\7\ requires a national securities exchange to pay the 
Commission an assessment \8\ for each ``round turn transaction''\9\ in 
a security future.\10\
---------------------------------------------------------------------------

    \3\ 15 U.S.C. 78ee(b).
    \4\ One exchange--the International Securities Exchange 
(``ISE'')--trades only options. Three exchanges--the New York Stock 
Exchange (``NYSE''), the Chicago Stock Exchange (``CHX''), and the 
National Stock Exchange (``NSX'')--trade only equity securities. 
Five exchanges--the American Stock Exchange (``Amex''), the Boston 
Stock Exchange (``BSX''), the Chicago Board Options Exchange 
(``CBOE''), the Pacific Exchange (``PCX''), and the Philadelphia 
Stock Exchange (``Phlx'')--trade both options and equity securities.
    \5\ 15 U.S.C. 78ee(c).
    \6\ Currently, only one national securities association--the 
National Association of Securities Dealers (``NASD'')--is subject to 
this requirement. The National Futures Authority is also registered 
with the Commission as a national securities association but 
currently is not required to pay fees or assessments under Section 
31.
    \7\ 15 U.S.C. 78ee(d).
    \8\ Paragraphs (b) and (c) of Section 31 require the Commission 
to collect ``fees'' on sales of securities (other than security 
futures and certain other enumerated securities). Paragraph (d) of 
Section 31 requires the Commission to collect ``assessments'' on 
transactions in security futures.
    \9\ A ``round turn transaction'' is one purchase and one sale of 
a contract of sale for future delivery. See 15 U.S.C. 78ee(d); 17 
CFR 240.31(a)(15).
    \10\ Currently, only two national securities exchanges--NQLX and 
OneChicago--trade security futures.
---------------------------------------------------------------------------

    The Commission has not previously defined ``sales of securities'' 
as used in Section 31 or mandated a formal procedure for aggregating 
trading volumes for purposes of determining Section 31 fees. Instead, 
the Commission has allowed the SROs to develop their own procedures. 
However, in view of the requirements of the Accountability Act, the 
Commission seeks to make the Section 31 calculation and collection 
process more transparent, accurate, and reliable. Therefore, in January 
2004, the Commission proposed new Rule 31, Form R31, and temporary Rule 
31T to establish a procedure for the calculation and collection of 
Section 31 fees and assessments.\11\
    One of the most significant features of the Commission's proposed 
procedure is that the calculation of fees and assessments would for the 
first time be performed exclusively by the Commission. The 
centralization of the

[[Page 41061]]

calculation function should provide a clearer basis for the amounts 
collected. Moreover, a single methodology will be used for all SROs, 
thereby making the calculation process more straightforward and easier 
to understand. Finally, the likelihood of errors due to inconsistent 
interpretation of the terms of Section 31 would be reduced.
---------------------------------------------------------------------------

    \11\ See Securities Exchange Act Release No. 49014 (January 20, 
2004), 69 FR 4018 (January 27, 2004) (File No. S7-05-04) 
(``Proposing Release'').
---------------------------------------------------------------------------

    The proposal also sought to codify the SRO procedures that have 
proven effective in generating auditable and dependable results, while 
curbing others that have proven unreliable or are impractical to audit. 
One practice that the Commission believes has proven effective is 
calculating Section 31 fees based on data provided by the exchanges to 
a registered clearing agency that allow securities transactions 
negotiated on the exchange to clear and settle. This is the mechanism 
currently used to calculate Section 31 fees for the national securities 
exchanges that trade options. All options that trade on an exchange are 
cleared and settled by the Options Clearing Corporation (``OCC''), a 
clearing agency registered under Section 17A of the Exchange Act.\12\ 
OCC and the options exchanges have established arrangements whereby OCC 
tabulates the aggregate dollar amount of sales of options that occur on 
the exchanges, based on the data captured by OCC's systems. OCC then 
calculates the Section 31 fees owed by the exchanges for that trading 
volume.\13\
---------------------------------------------------------------------------

    \12\ 15 U.S.C. 78q-1.
    \13\ In addition, OCC clears and settles all transactions in 
security futures occurring on the two national securities exchanges 
that trade security futures. OCC tabulates the total number of round 
turn transactions in security futures and pays the Section 31 
assessments on behalf of these exchanges.
---------------------------------------------------------------------------

    The Commission believes that clearing data provide an accurate 
measure of trading volume because there are strong incentives for all 
market participants to ensure their accuracy. A registered clearing 
agency cannot transfer the correct amount of funds and securities 
between participant accounts to settle transactions without accurate 
data. Accordingly, the market participants involved have a strong 
incentive to detect and correct any errors prior to settlement so as to 
prevent an incorrect amount of funds or securities from being 
transferred. The internal and external audits of registered clearing 
agencies, as well as regulatory reviews performed by the Commission, 
enhance the reliability of clearing data. For all these reasons, the 
Commission believes that, in codifying a procedure for the calculation 
and collection of Section 31 fees, clearing data should be the primary 
source of the trading volumes for both the equities exchanges and the 
options exchanges. Thus, pursuant to the rules adopted by the 
Commission today, clearing data will serve as the primary basis for the 
Commission's calculations of Section 31 fees and assessments. This 
approach follows the arrangements among OCC and the options and 
security futures exchanges, although the Commission rather than OCC 
will perform the actual calculations. In addition, national securities 
exchanges that trade equity securities are henceforth required to 
provide the Commission with clearing data captured by the National 
Securities Clearing Corporation (``NSCC'') as their primary source of 
the sales volume subject to Section 31 fees.
    Comments on the proposal were generally positive. The Securities 
Industry Association (``SIA'') stated that ``the SEC has devised a 
reasonable approach that generally should yield accurate numbers and 
will enable the SEC to verify that correct amounts are being 
collected.''\14\ CHX stated that it ``understands the Commission's 
desire to implement a more defined process for the collection of this 
data and, in general, agrees with the Commission's proposal to use 
clearing data for that purpose.''\15\ NYSE stated that it ``support[s] 
the Commission's desire to make uniform the way in which the collection 
process is conducted among the various [SROs] subject to the Section 31 
fee'' and that it ``believes that the desired approach is 
feasible.''\16\ A joint comment submitted by OCC and five options 
exchanges called the Commission's decision to rely on clearing data 
``well founded.''\17\
---------------------------------------------------------------------------

    \14\ Letter from Ernest A. Pittarelli, Chairman, Securities 
Industry Association Operations Committee, to Jonathan G. Katz, 
Secretary, Commission, dated March 5, 2004 (``SIA Comment'').
    \15\ Letter from David A. Herron, Chief Executive Officer, CHX, 
to Jonathan G. Katz, Secretary, Commission, dated February 26, 2004 
(``CHX Comment'').
    \16\ Letter from Darla C. Stuckey, Corporate Secretary, NYSE, to 
Jonathan G. Katz, Secretary, Commission, dated March 17, 2004 
(``NYSE Comment'').
    \17\ Letter from Amex, CBOE, ISE, OCC, PCX, and Phlx to Jonathan 
G. Katz, Secretary, Commission, dated March 1, 2004 (``OCC 
Comment'').
---------------------------------------------------------------------------

    However, one commenter, BSE, disagreed with the Commission's 
proposal to rely primarily on clearing data to determine the aggregate 
dollar amount of sales of equity securities that are subject to Section 
31 fees.\18\ According to BSE, ``the proposal will require numerous 
exceptions which could likely lead to it becoming unworkable and 
inherently unreliable.'' BSE argued instead that the most appropriate 
source of data is each exchange's trade reporting system. Furthermore, 
BSE claimed that, by allowing one SRO (NASD) to report its sales volume 
based on its trade reporting system,\19\ the Commission was unfairly 
endorsing that SRO's trade reporting system over the systems of other 
SROs.
---------------------------------------------------------------------------

    \18\ See letter from John A. Boese, Vice President, BSE, to 
Jonathan G. Katz, Secretary, Commission, dated March 16, 2004 (``BSE 
Comment'').
    \19\ See infra notes 46-47 and accompanying text.
---------------------------------------------------------------------------

    As discussed above, the Commission believes that clearing data 
provide an accurate measure of trading volume. While the Commission 
acknowledges that certain sales of equity securities subject to Section 
31 fees are not cleared and settled by NSCC, and thus do not appear in 
NSCC's clearing data, their number is not so great as to impair the use 
of clearing data as the Commission's primary source of trading volume. 
In the near term, exchanges that are subject to Section 31 must 
supplement clearing data by providing data captured in their own trade 
reporting systems. In time, NSCC and the equities exchanges may develop 
new means to bring more of these trades into the clearing record. This 
should further simplify Section 31 calculations as well as strengthen 
the risk management function that NSCC performs on behalf of the 
equities exchanges and broker-dealer participants.
    Under the procedure proposed by the Commission and being adopted 
today, NASD is required to tabulate aggregate sales volume based on its 
own trade reporting systems rather than by obtaining clearing data. 
This approach should not be viewed as favoring one SRO's trade 
reporting system over another's. While the Commission believes that 
clearing data is the most accurate record of covered sales when it is 
available, the structure of the over-the-counter (``OTC'') equity 
market--transactions on which NASD is liable for Section 31 fees--makes 
clearing data unavailable for a large volume of sales. Many 
internalized trades in equity securities, for example, are never 
reported to NSCC. Furthermore, the OTC market includes a large number 
of electronic communication networks (``ECNs'') that might not provide 
NSCC with a trade-by-trade record of their activity. ECNs generally 
clear and settle their trades using the facilities of NSCC but are not 
required to provide a trade-by-trade record. Many ECNs report their 
trades to NSCC in their capacity as, or through, ``qualified special

[[Page 41062]]

representatives'' (``QSRs'').\20\ QSRs may net their trades and report 
to NSCC only net changes in positions. Without trade-by-trade data, the 
aggregate dollar amount of sales of securities cannot be determined for 
purposes of Section 31.
---------------------------------------------------------------------------

    \20\ A QSR is a member of NSCC that operates, has an affiliate 
that operates, or clears for a broker-dealer that operates an 
automated execution system where the designated clearing agency 
member is on the contra-side of every transaction. See Form R31 
Instructions; NSCC Rule 39.
---------------------------------------------------------------------------

    Internalized trades and trades reported through a QSR represent a 
substantial number of all sales of securities for which NASD incurs a 
liability to the Commission under Section 31,\21\ and the Commission 
does not believe it would be practical to require NASD to separate 
these trades from other trades for which NSCC can obtain a complete 
trade-by-trade record. Therefore, in a case such as this where there 
are significant gaps in the clearing data, the Commission believes, on 
balance, that the best alternative is to rely on the SRO's trade 
reporting systems for the aggregate sales volume. However, in a case 
where an exchange (such as BSE) that has only a small number of ECNs 
(or only one ECN) that report trades directly to NSCC as a QSR, the 
exchange should obtain the data that it can from NSCC and supplement 
the clearing data by using its trade reporting systems to provide the 
sales volume transacted by the ECNs. The Commission believes that this 
approach will provide the most accurate record of the exchange's 
volume.
---------------------------------------------------------------------------

    \21\ The Commission has been informed that there are in excess 
of 20 ECNs trading in the OTC markets that may account for up to 50% 
of OTC volume.
---------------------------------------------------------------------------

II. Details of New Rule 31 and Form R31

A. Description of Rule

    Except for the modifications discussed below, the Commission is 
adopting new Rule 31 as proposed. Most of the proposed definitions did 
not generate comment.
    Under new Rule 31, ``covered exchanges'' \22\ and ``covered 
associations'' \23\ (collectively, ``covered SROs'' \24\) are required 
to pay Section 31 fees and assessments in the manner set forth in the 
rule. These terms do not impose new liabilities on any entity; in the 
absence of a Commission rule, the same entities would be required by 
the statute to pay Section 31 fees and assessments.
---------------------------------------------------------------------------

    \22\ A ``covered exchange'' is ``any national securities 
exchange on which covered sales or covered round turn transactions 
occur.'' 17 CFR 240.31(a)(5).
    \23\ A ``covered association'' is ``any national securities 
association by or through any member of which covered sales or 
covered round turn transactions occur otherwise than on a national 
securities exchange.'' 17 CFR 240.31(a)(4).
    \24\ See 17 CFR 240.31(a)(8).
---------------------------------------------------------------------------

    Paragraph (b)(1) of new Rule 31 requires a covered SRO to submit to 
the Commission a completed Form R31 within ten business days after the 
end of each month.\25\ A covered exchange must provide on Form R31 the 
aggregate dollar amount of all ``covered sales'' \26\ and the total 
number of ``covered round turn transactions'' \27\ occurring on the 
exchange; a covered association must provide the aggregate dollar 
amount of all covered sales and the total number of covered round turn 
transactions occurring by or through any member of the association 
otherwise than on a national securities exchange.\28\ The Commission 
will calculate the amount of Section 31 fees due from a covered SRO by 
multiplying the aggregate dollar amount of its covered sales by the 
``fee rate,'' \29\ and the amount of Section 31 assessments due from a 
covered SRO by multiplying the total number of covered round turn 
transactions by the ``assessment charge.'' \30\ The fee rate is set by 
the Commission in a procedure set forth in Section 31(j) of the 
Exchange Act; \31\ the assessment charge is set by Section 31(d) of the 
Exchange Act \32\ and cannot be changed by the Commission. Rule 31 does 
not alter the manner in which either the fee rate or the assessment 
charge is determined.
---------------------------------------------------------------------------

    \25\ See 17 CFR 240.31(b)(1).
    \26\ A ``covered sale'' is ``a sale of a security, other than an 
exempt sale or a sale of a security future, occurring on a national 
securities exchange or by or through any member of a national 
securities association otherwise than on a national securities 
exchange.'' 17 CFR 240.31(a)(6). See also infra notes 52-54 and 
accompanying text (discussing ``exempt sales'').
    \27\ A ``covered round turn transaction'' is ``a round turn 
transaction in a security future, other than a round turn 
transaction in a future on a narrow-based security index, occurring 
on a national securities exchange or by or through a member of a 
national securities association otherwise than on a national 
securities exchange.'' 17 CFR 240.31(a)(7).
    \28\ A covered sale occurring by or through a member of an 
association on a national securities exchange would create liability 
under Section 31 for the exchange rather than the association.
    \29\ The ``fee rate'' is the fee rate applicable to covered 
sales under Section 31(b) or (c) of the Exchange Act, 15 U.S.C. 
78ee(b) or (c), as adjusted from time to time by the Commission 
pursuant to Section 31(j), 15 U.S.C. 78ee(j). See 17 CFR 
240.31(a)(12).
    \30\ The ``assessment charge'' is the amount owed by a covered 
SRO for a covered round turn transaction pursuant to Section 31(d) 
of the Exchange Act, 15 U.S.C. 78ee(d). See 17 CFR 240.31(a)(1).
    \31\ 15 U.S.C. 78ee(j).
    \32\ 15 U.S.C. 78ee(d).
---------------------------------------------------------------------------

    As provided in Section 31(e) of the Exchange Act,\33\ Section 31 
fees and assessments are due twice per year, by March 15 and September 
30. These are the two ``due dates'' in Rule 31.\34\ The September 30 
due date covers the period January 1 to August 31 of the same calendar 
year; the March 15 due date covers the period September 1 to December 
31 of the preceding calendar year. These are the two ``billing 
periods'' in Rule 31.\35\ Before each of the due dates, the Commission 
will send a ``Section 31 bill'' to each covered SRO showing the total 
amount due from the covered SRO for the billing period, as calculated 
by the Commission. The amount of a covered SRO's Section 31 bill will 
equal the sum of the covered SRO's monthly liabilities under Section 31 
for each month in the billing period.\36\ A covered SRO is required to 
pay the Commission the full amount stipulated in its Section 31 bill by 
the due date.\37\
---------------------------------------------------------------------------

    \33\ 15 U.S.C. 78ee(e).
    \34\ See 17 CFR 240.31(a)(10).
    \35\ See 17 CFR 240.31(a)(2).
    \36\ See 17 CFR 240.31(a)(17) and (c)(1).
    \37\ See 17 CFR 240.31(c)(3). The covered SRO may pay its 
Section 31 bill directly or through a designated clearing agency 
acting as agent of the covered SRO. See infra Section II(B)(1).
---------------------------------------------------------------------------

    Form R31 requires a covered SRO to report trade data in separate 
parts, depending on how the trades are reported and settled. Part I of 
Form R31 requires a covered exchange to provide the aggregate dollar 
amount of covered sales and the total number of covered round turn 
transactions that: (1) Occurred on the exchange; (2) had a ``charge 
date'' \38\ in the month of the report; and (3) the exchange reported 
to a ``designated clearing agency.'' \39\ Also in Part I, a covered 
exchange that trades ``physical delivery exchange-traded options'' \40\ 
or security futures that are

[[Page 41063]]

settled by physical delivery of the underlying securities must 
separately report the aggregate dollar amount of covered sales that 
resulting from options exercises or matured security futures.\41\
---------------------------------------------------------------------------

    \38\ The ``charge date'' is the date on which a covered sale or 
covered round turn transaction occurs for purposes of determining 
the liability of a covered SRO pursuant to Section 31. The charge 
date is: (i) The settlement date, with respect to any covered sale 
(other than a covered sale resulting from the exercise of an option 
settled by physical delivery or from the maturation of a security 
future settled by physical delivery) or covered round turn 
transaction that a covered SRO is required to report to the 
Commission based on data that the covered SRO receives from a 
designated clearing agency; (ii) the exercise date, with respect to 
a covered sale resulting from the exercise of an option settled by 
physical delivery; (iii) the maturity date, with respect to a 
covered sale resulting from the maturation of a security future 
settled by physical delivery; and (iv) the trade date, with respect 
to all other covered sales and covered round turn transactions. See 
17 CFR 240.31(a)(3); see also infra notes 56-64 and accompanying 
text (discussing revisions made to definition of ``charge date'' in 
final rule).
    \39\ A ``designated clearing agency'' means a clearing agency 
registered under Section 17A of the Exchange Act, 15 U.S.C. 78q-1, 
that clears and settles covered sales or covered round turn 
transactions. See 17 CFR 240.31(a)(9).
    \40\ A ``physical delivery exchange-traded option'' is ``a 
securities option that is listed and registered on a national 
securities exchange and settled by the physical delivery of the 
underlying securities.'' 17 CFR 240.31(a)(16).
    \41\ See infra Section II(B)(3) (revising the Commission's 
proposal relating to covered sales resulting from exercises of 
physical delivery exchange-traded options and from matured security 
futures).
---------------------------------------------------------------------------

    Rule 31 requires a covered SRO to provide in Part I of Form R31 
only the data supplied to it by a designated clearing agency.\42\ A 
designated clearing agency, upon request, must provide the data in its 
possession needed by the covered SRO to complete Part I.\43\ Under Rule 
31, two entities currently meet the criteria for being ``designated 
clearing agencies'': OCC, which clears and settles transactions in 
options and security futures, and NSCC, which clears and settles 
transactions in equity securities. A covered SRO that trades both 
options and equities must obtain data from both designated clearing 
agencies and must separately report that data in Part I of Form R31. 
This will allow the Commission to distinguish the covered SRO's covered 
sale volume in equities from its covered sale volume in options.
---------------------------------------------------------------------------

    \42\ See 17 CFR 240.31(b)(5).
    \43\ See 17 CFR 240.31(b)(4)(i). See also infra Section II(B)(9) 
(discussing possible liability of a designated clearing agency).
---------------------------------------------------------------------------

    Parts II and III of Form R31 are designed to capture data on 
covered sales that are not reported (or are not reported on a trade-by-
trade basis) to a designated clearing agency. Part II requires a 
covered exchange to report the aggregate dollar amount of covered sales 
that: (1) Occurred on the exchange; (2) had a charge date in the month 
of the report; (3) the exchange did not report to a designated clearing 
agency; and (4) the exchange captured in a ``trade reporting system.'' 
\44\ The covered exchange is required to separate its Part II covered 
sales into those that were reported to a designated clearing agency by 
a QSR and those that were ``ex-clearing transactions.'' \45\ Thus, a 
covered exchange that permits its members to report exchange trades to 
NSCC through a QSR would include such trades in Part II of Form R31 
rather than Part I. Although these trades are reported to NSCC for 
settlement, they must be included in Part II rather than Part I because 
they were not reported to a designated clearing agency by the covered 
exchange itself, as Part I requires.
---------------------------------------------------------------------------

    \44\ A ``trade reporting system'' is ``an automated facility 
operated by a covered SRO used to collect or compare trade data.'' 
17 CFR 240.31(a)(18).
    \45\ An ``ex-clearing transaction'' is a securities transaction 
that is not reported to a designated clearing agency and clears and 
settles otherwise than through a designated clearing agency. See 
Form R31 Instructions. A cash, next day, or seller's option trade 
that is reported to NSCC should be reported in Part I; a cash, next 
day, or seller's option trade that is not reported to NSCC should be 
reported in Part II (assuming this trade were captured in a trade 
reporting system). See infra Section II(B)(7).
---------------------------------------------------------------------------

    In addition, Part II requires a covered association to provide the 
aggregate dollar amount of covered sales that: (1) Occurred by or 
through a member of the association otherwise than on a national 
securities exchange; (2) had a charge date in the month of the report; 
and (3) the association captured in a trade reporting system.\46\ Thus, 
even if the covered association reports some of its covered sales to a 
designated clearing agency, the association should not report any of 
these covered sales in Part I. Instead, the association should rely on 
its trade reporting systems to provide data in Part II on all covered 
sales captured by those systems.\47\
---------------------------------------------------------------------------

    \46\ In paragraphs (b)(3)(ii) and (iii) of proposed Rule 31, the 
Commission inadvertently used the term ``trade comparison system'' 
to describe the facility in which a covered association captures 
trade data. In Rule 31 as adopted, the Commission has corrected this 
to the defined term ``trade reporting system.''
    \47\ Currently, there is one covered association, NASD. It 
operates two trade reporting systems within the meaning of Rule 31, 
the Automated Confirmation Transaction Service (``ACT'') and the 
Trade Reporting and Confirmation Service (``TRACS''). TRACS is the 
trade reporting system for the Alternative Display Facility 
(``ADF''), a pilot system that NASD operates for members that choose 
to quote or effect trades in Nasdaq securities otherwise than 
through Nasdaq's SuperMontage system or on an exchange. See 
Securities Exchange Act Release No. 46249 (July 24, 2002), 67 FR 
49821 (July 21, 2002) (approving ADF pilot). ACT is the trade 
reporting system for all other OTC equity trades that must be trade-
reported pursuant to NASD rules.
---------------------------------------------------------------------------

    Part III of Form R31 requires a covered exchange to report the 
aggregate dollar amount of covered sales that: (1) Occurred on the 
exchange; (2) had a charge date in the month of the report; and (3) the 
exchange neither captured in a trade reporting system nor reported to a 
designated clearing agency. Part III also requires a covered 
association to report the aggregate dollar amount of covered sales 
that: (1) Occurred by or through a member of the association otherwise 
than on a national securities exchange; (2) had a charge date in the 
month of the report; and (3) the association did not capture in a trade 
reporting system. The Commission anticipates that there will be very 
few if any Part III covered sales reported by the covered exchanges, 
because all trading activity should be captured by the exchanges' trade 
reporting systems. In the OTC market, however, various covered sales 
currently are not captured in an NASD trade reporting system. 
Therefore, NASD must report the following in Part III:
     Any covered sales in odd lots (i.e., less than 100 shares) 
that are not captured in a trade reporting system (and thus not 
reported in Part II); \48\
---------------------------------------------------------------------------

    \48\ See NASD Rules 4632(e)(2), 6130(a), and 6420(e)(2).
---------------------------------------------------------------------------

     Covered sales resulting from the exercise of options 
settled by physical delivery and not listed or traded on a national 
securities exchange;\49\ and
---------------------------------------------------------------------------

    \49\ See NASD Rules 4632(e)(6), 4642(e)(5), and 6420(e)(8) 
(providing that ``purchases or sales of securities effected upon the 
exercise of an option pursuant to the terms thereof or the exercise 
of any other right to acquire securities at a pre-established 
consideration unrelated to the current market'' need not be reported 
to ACT).
---------------------------------------------------------------------------

     Covered sales where the buyer and seller have agreed to 
trade at a price substantially unrelated to the current market for the 
security.\50\
---------------------------------------------------------------------------

    \50\ See NASD Rules 4632(e)(5), 4642(e)(4), 6420(e)(5), and 
6920(e)(2) (providing that transactions at a price unrelated to the 
current market--for example, to make a gift--need not be reported to 
ACT). A gift of a security without consideration is not a ``sale'' 
for purpose of Sections 31(c) of the Exchange Act, 15 U.S.C. 
78ee(c), and is not subject to Section 31 fees. However, if 
consideration is given for the securities, even if that 
consideration is not at the current market price, the transaction is 
a covered sale, provided the securities in question are registered 
on a national securities exchange. See 15 U.S.C. 78ee(c).
---------------------------------------------------------------------------

    Currently, these trades are not captured in any trade reporting 
system. NASD employs a paper-based reporting system to obtain the trade 
volume for these sales and to calculate the Section 31 fees due on such 
volume.
    Not every sale of a security is subject to Section 31 fees, and not 
every transaction in a security future is subject to Section 31 
assessments. The statute itself exempts certain sales of securities and 
round turn transactions in security futures, and the Commission has 
exempted others pursuant to the authority granted by Section 31(f) of 
the Exchange Act.\51\ As discussed below, paragraph (a)(11) of Rule 31 
sets forth a comprehensive list of all sales of securities (other than 
security futures) that are exempt from Section 31 fees (``exempt 
sales'').
---------------------------------------------------------------------------

    \51\ 15 U.S.C. 78ee(f).
---------------------------------------------------------------------------

    Paragraphs (a)(11)(i) to (v) restate exemptions set forth in 
paragraphs (a) to (e) of former Rule 31-1. Paragraph (a)(11)(vi), which 
exempts any sale of an option on a security index, combines an 
exemption granted by statute (for a sale of an option on a non-
``narrow-based security index'' \52\) with an exemption that the 
Commission has previously granted by rule (for a sale of an option

[[Page 41064]]

on a narrow-based security index).\53\ The net result is that the sale 
of an option on any security index--be it narrow-based or non-narrow-
based--is exempt from Section 31 fees. Paragraph (a)(11)(vi) of new 
Rule 31 clarifies this point. Paragraph (a)(11)(vii) of new Rule 31 
incorporates language from the statute that specifically exempts sales 
of bonds, debentures, and other evidences of indebtedness. Paragraph 
(a)(11)(viii) creates a new exemption for ``registered riskless 
principal sales.'' \54\
---------------------------------------------------------------------------

    \52\ A ``narrow-based security index'' has the same meaning as 
in Section 3(a)(55)(B) and (C) of the Exchange Act, 15 U.S.C. 
78c(a)(55)(B) and (C). See 17 CFR 240.31(a)(13).
    \53\ See Securities Exchange Act Release No. 45371 (January 31, 
2002), 67 FR 5199 (February 5, 2002).
    \54\ See infra Section II(B)(8).
---------------------------------------------------------------------------

    Section 31 applies only to sales of securities, not to purchases of 
securities; a covered SRO incurs liability to the Commission under 
Section 31 for only one side (the sell side) of the transaction. Thus, 
all of the exemptions listed in paragraph (a)(11) of new Rule 31 are 
only for certain sales of securities because Section 31 does not impose 
fees on purchases of securities.
    Currently, one type of security futures transaction is exempt from 
assessments under Section 31: a round turn transaction in a future on a 
narrow-based security index.\55\ This exemption is incorporated 
directly into the definition of ``covered round turn transaction'' in 
paragraph (a)(7) of new Rule 31.
---------------------------------------------------------------------------

    \55\ See former Rule 31-1(g) under the Exchange Act, 17 CFR 
240.31-1(g).
---------------------------------------------------------------------------

    The Commission adopted the definitions in Rule 31 as proposed, with 
the following exceptions:
    Billing Period. The Commission is making a minor revision to the 
definition of ``billing period,'' by changing the words ``to the close 
of'' to ``through'' in two places. Thus, the two billing periods under 
Rule 31 are ``January 1 through August 31'' and ``September 1 through 
December 31.'' The Commission believes that the final definition 
preserves the intended meaning but with greater economy of words.
    Charge Date. One commenter stated: ``In light of the totality of 
the burden and duplicity of effort which would result from the proposed 
rules, [the commenter] does not believe that the issue of charge dates 
adds significantly to the endeavor.'' \56\ Two other commenters asked 
for clarification as to whether the equities exchanges should use the 
trade date or the settlement date as the charge date for covered sales 
under Rule 31.\57\ One of these commenters noted that some SROs have 
traditionally used the trade date and may be reluctant to change.\58\
---------------------------------------------------------------------------

    \56\ BSE Comment.
    \57\ See letter from Donald F. Donahue, President, National 
Securities Clearing Corporation, Inc., to Jonathan G. Katz, 
Secretary, Commission, dated May 12, 2004 (``NSCC Comment''); NYSE 
Comment.
    \58\ See NYSE Comment.
---------------------------------------------------------------------------

    The Commission believes that the concept of a ``charge date''--
clearly defined and consistently applied across markets--is necessary 
for establishing an accurate and reliable system for calculating and 
collecting Section 31 fees and assessments. Section 31 establishes two 
billing periods over the course of the year (January 1 through August 
31 and September 1 through December 31). Any system for calculating 
fees and assessments must, among other things, specify whether a trade 
that is negotiated at the end of August but not settled until the 
beginning of September ``occurs'' in August or September for purposes 
of Section 31. Covered SROs also must determine whether a trade 
``occurs'' before or after a fee rate change, so that the appropriate 
aggregate dollar amounts of securities sales are multiplied by the 
correct fee rate. Under existing arrangements for the collection and 
payment of Section 31 fees, covered SROs make these determinations, 
albeit implicitly.\59\ New Rule 31 codifies and makes explicit the 
charge date concept.\60\
---------------------------------------------------------------------------

    \59\ As a general matter, NASD and the equities exchanges 
currently use the trade date as the basis for Section 31 
calculations, while OCC, the options exchanges, and the security 
futures exchanges use the settlement date. However, for sales of 
securities resulting from the maturation of security futures or the 
exercise of physical delivery exchange-traded options, OCC bases its 
Section 31 calculations on the date of maturation or exercise.
    \60\ Rule 31 requires covered SROs to submit Form R31 on a 
monthly basis, so there will be 11 additional occasions (other than 
the August/September transition and any transitions caused by fee 
rate changes) when a discrepancy might arise as to when a sale 
``occurred.''
---------------------------------------------------------------------------

    However, the Commission believes that certain changes to the 
definition of ``charge date'' are appropriate. As discussed below,\61\ 
the OCC Comment is prompting the Commission to revise the manner in 
which covered sales resulting from options exercises and matured 
security futures are being treated under Rule 31. The Commission 
believes that, in light of this revision, it would be helpful to 
clarify the definition of ``charge date'' to specify when covered sales 
resulting from options exercises or matured security futures ``occur'' 
for purposes of Section 31. The proposed definition was as follows:
---------------------------------------------------------------------------

    \61\ See infra Section II(B)(3).

    Charge date means the date on which a covered sale or covered 
round turn transaction occurs for purposes of determining the 
liability of a covered SRO pursuant to section 31 of the Act. The 
charge date is the settlement date with respect to a covered sale or 
a covered round turn transaction that a covered exchange reports to 
a designated clearing agency. The charge date is the trade date with 
respect to a covered sale occurring on a covered exchange that the 
exchange does not report to a designated clearing agency, and with 
respect to any covered sale occurring otherwise than on a national 
---------------------------------------------------------------------------
securities exchange.

    The Commission is adopting the first sentence of the definition as 
proposed and replacing the remaining sentences as follows:

    The charge date is: (i) The settlement date, with respect to any 
covered sale (other than a covered sale resulting from the exercise 
of an option settled by physical delivery or from the maturation of 
a security future settled by physical delivery) or covered round 
turn transaction that a covered SRO is required to report to the 
Commission based on data that the covered SRO receives from a 
designated clearing agency; (ii) The exercise date, with respect to 
a covered sale resulting from the exercise of an option settled by 
physical delivery; (iii) The maturity date, with respect to a 
covered sale resulting from the maturation of a security future 
settled by physical delivery; and (iv) The trade date, with respect 
to all other covered sales and covered round turn transactions.

    Under the proposed definition, the charge date of covered sales 
resulting from options exercises or matured security futures would have 
been the trade date. But because the physical delivery of equity 
securities underlying an option or security future is not effected by a 
trade on a public market, the Commission believes that it would be more 
appropriate to employ the terms ``exercise date'' and ``maturity 
date,'' which are more specific to the type of transaction being 
undertaken. Trade date, exercise date, and maturity date are 
substantively similar in that, on these dates, instructions to effect a 
sale of securities are issued. They contrast with the settlement date, 
which is the date on which the movement of funds and securities between 
the accounts of the trade counterparties has been completed.
    Rules 31 and 31T and Form R31 require covered exchanges to obtain 
from one or more designated clearing agencies a tabulation of the 
aggregate dollar amount of their covered sales and to report that data 
to the Commission in Part I of Form R31. For covered sales of options 
and equity securities that a covered exchange reports to a designated 
clearing agency, the Commission believes that the settlement date is 
the most practical charge date. A designated clearing agency knows the 
settlement date for every trade that it clears and settles. The 
Commission has determined to use the settlement date rather than the 
trade date as the charge

[[Page 41065]]

date in these cases because it would be more burdensome for a 
designated clearing agency to track the trade date than the settlement 
date. This approach codifies the existing methods used by OCC to 
calculate Section 31 fees for the options exchanges and Section 31 
assessments for the security futures exchanges. The Commission believes 
that the settlement date also should be used as the charge date for all 
covered sales that a covered exchange reports to NSCC.
    For covered sales resulting from the exercise of an option settled 
by physical delivery or from the maturation of a security future 
settled by physical delivery,\62\ the charge date is the exercise date 
or the maturity date, respectively. The Commission is employing 
exercise date and maturity dates as charge dates under these 
circumstances because OCC already tabulates these sales based on 
exercise date and maturity date, and codifying this approach will place 
the least amount of burden on the designated clearing agencies and 
covered SROs, while satisfying the Commission's need to obtain accurate 
data on covered exchanges' trading volume.
---------------------------------------------------------------------------

    \62\ There must be physical delivery of the underlying 
securities for there to be a covered sale. The cash settlement of a 
derivative product does not result in a covered sale.
---------------------------------------------------------------------------

    For all covered sales reported in Part II of Form R31, the charge 
date is the trade date. The Commission believes that it would be 
impractical for covered SROs to use the settlement date for such sales. 
Part II is designed to capture covered sales the records of which 
cannot be obtained, or cannot be obtained on a trade-by-trade basis, 
from a designated clearing agency. Instead, information on these 
covered sales will be obtained from a covered SRO's trade reporting 
system. For these trades, the Commission believes that the only 
practical choice for a charge date is the trade date. Part III data 
also will use the trade date for the charge date, with one exception: 
The charge date for covered sales resulting from the exercise of OTC 
options that settle by physical delivery will be the exercise date.\63\
---------------------------------------------------------------------------

    \63\ Currently, Section 31 fees on these covered sales are paid 
by NASD and NASD collects data on these transactions from its 
members using a paper-based reporting system.
---------------------------------------------------------------------------

    By taking the approach of having different charge dates in 
different circumstances, a different fee could arise from essentially 
the same trade depending on whether it occurred on an exchange or OTC. 
Under Rule 31, a covered association will use the trade date as the 
charge date for all of its covered sales, while a covered exchange will 
use the settlement date for any covered sale that it reports to NSCC. 
The Commission notes that the potential for a different fee rate 
applying will arise only the few days before a fee rate change goes 
into effect. Moreover, the Commission believes that applying different 
charge dates to different covered SROs in these limited circumstances 
will create no significant arbitrage opportunities that might affect 
order-routing practices.\64\
---------------------------------------------------------------------------

    \64\ The following example will demonstrate the effect of a 
different charge date applying during a transitional period created 
by a fee rate change. Assume that equity security XYZ is traded on 
covered exchange E and OTC through members of covered association A, 
and that a fee rate increase becomes effective on April 1. 
Therefore, for the last three business days of March, a different 
fee rate will apply based on whether XYZ is traded OTC through 
members of association A (which will use the lower fee rate) or on 
exchange E (where the trades will not ``occur'' until they are 
settled in April, thus making them subject to the higher fee rate). 
However, the size of the difference is likely to be very small. For 
example, on April 1, 2003, the Commission implemented the largest 
increase in the fee rate since Congress amended Section 31 to allow 
fee rate changes. The Commission increased the fee rate from $25.20 
per million of sales transacted to $46.80 per million, an increase 
of $21.60 per million. For a covered sale having the principal 
amount of $25,000, this fee rate differential would result in an 
extra charge to B of only $0.54 ($21.60/$1 million x $25,000). This 
example also assumes that exchange E reports its covered sales to 
NSCC for clearance and settlement, broker B is a member of both E 
and A, and both E and A pass Section 31 fees to their members.
---------------------------------------------------------------------------

    Fee Rate. The Commission made minor, non-substantive changes to the 
definition of ``fee rate.'' The Commission made this revision to 
harmonize the manner in which sections of the Exchange Act are cited 
throughout Rule 31.

B. Issues Raised by Commenters

    The Commission received nine comments on the proposal.\65\ Many of 
these comments discussed specific issues relating to the proposed 
rules. The Commission's responses to these comments appear below.
---------------------------------------------------------------------------

    \65\ See e-mail from Thomas J. Westergard to [email protected] dated February 23, 2004; letter from William 
O'Brien, Chief Operating Officer, Brut LLC, to Commission, dated 
March 8, 2004 (``Brut Comment''); letter from Kathleen O'Mara, 
Associate General Counsel, NASD, to Jonathan G. Katz, Secretary, 
Commission, dated April 30, 2004 (``NASD Comment''); BSE Comment; 
CHX Comment; OCC Comment; NSCC Comment; NYSE Comment; SIA Comment.
---------------------------------------------------------------------------

1. Section 31 Payments Made by Agent
    The Commission proposed to require every covered SRO to pay its 
Section 31 fees or assessments directly to the Commission rather than 
through an agent, but requested comment on whether designated clearing 
agencies should be permitted to make payments on behalf of covered 
SROs.\66\ Three comments disagreed with this proposal.\67\ One comment, 
submitted jointly by OCC and five exchanges for which OCC clears and 
settles options transactions, stated that OCC presently calculates and 
pays Section 31 fees to the Commission on behalf of the options 
exchanges \68\ and urged the Commission to continue to allow this 
arrangement.\69\ After carefully considering the comments submitted, 
the Commission believes it is reasonable to continue the current 
practice of allowing a designated clearing agency to pay Section 31 
fees and assessments on behalf of one or more covered exchanges. 
Therefore, the Commission has added the phrase ``directly or through a 
designated clearing agency acting as agent'' to paragraph (c)(3) of 
Rule 31 to specify that the payment need not be made directly by the 
covered SRO. However, ultimate responsibility for making the payment 
remains with the covered SRO. If the Commission does not receive the 
total amount stipulated in a covered exchange's Section 31 bill by the 
due date, the covered exchange--not the designated clearing agency--
will be in violation of Rule 31 (or temporary Rule 31T).\70\
---------------------------------------------------------------------------

    \66\ See Proposing Release, 69 FR at 4026.
    \67\ See BSE Comment; NSCC Comment; OCC Comment.
    \68\ OCC also calculates and pays Section 31 assessments to the 
Commission on behalf of the two security futures exchanges, although 
these exchanges were not signatories to the OCC Comment. In 
addition, since the Commission proposed Rule 31, a sixth national 
securities exchange--BSE--has started to trade options through its 
facility, the Boston Options Exchange. OCC clears and settles 
options transactions negotiated on BSE. BSE, like the security 
futures exchanges, was not a signatory to the OCC Comment.
    \69\ The BSE Comment agreed with the position taken by OCC and 
the other five options exchanges. In its comment, NSCC stated 
generally that it agreed with the view that designated clearing 
agencies should be able to submit payment on behalf of covered SROs 
but that it had not yet determined ``if this is a service it could 
reasonably provide to a covered SRO.''
    \70\ The Commission expects that a designated clearing agency 
will clearly indicate the amount that it is paying on behalf of each 
covered exchange for which it is acting as agent. If a covered 
exchange has requested a designated clearing agency to pay some or 
all of its Section 31 fees and assessments on its behalf, the 
Commission also expects that the covered exchange will indicate the 
total amount that it owes, the amount that it is submitting to the 
Commission directly, and the amount to be expected from a designated 
clearing agency.
---------------------------------------------------------------------------

2. Timeframe for Submission of Form R31
    Paragraph (b)(1) of Rule 31 requires every covered SRO to submit a 
completed Form R31 to the Commission within ten business days after the 
end

[[Page 41066]]

of the month.\71\ One commenter, NASD, recommended instead that covered 
SROs be allowed 12 business days.\72\ In its comment, NASD stated that 
it currently allows its members to submit trade data for odd-lot 
transactions and exercises of OTC options by the tenth calendar day of 
each month, and thus that it might not have sufficient time to compile 
this information for reporting in Part III of Form R31.
---------------------------------------------------------------------------

    \71\ 17 CFR 240.31(b)(1).
    \72\ See NASD Comment.
---------------------------------------------------------------------------

    The Commission is adopting this provision as proposed, with only a 
minor technical change.\73\ The Commission believes that a maximum of 
ten business days is necessitated by external requirements to which the 
Commission is subject. First, as the Commission has previously noted, 
Section 31 requires each covered SRO to make a payment no later than 30 
days after the close of the January-through-August billing period (on 
September 30).\74\ To allow sufficient time for the Commission to 
prepare and send the Section 31 bills before September 30, and for the 
covered SROs to pay the bills, the Commission believes it must receive 
the data on the Form R31 submissions no later than the middle of the 
month. Second, in addition to the obligation to prepare audited 
financial statements annually, the Commission is required to submit 
unaudited financial statements to the Office of Management and Budget 
(``OMB'') within 21 days after the end of each quarter. For the 
Commission to meet this requirement, it must determine and book its 
accounts receivable within this very short time frame. Thus, the 
Commission believes that ten business days strikes an appropriate 
balance between allowing the covered SROs sufficient time to tabulate 
and submit their trade data and the Commission's need to meet external 
deadlines set by the Exchange Act and the accounting requirements to 
which the Commission is subject.
---------------------------------------------------------------------------

    \73\ The Commission added the words ``a completed'' between the 
words ``submit'' and ``Form R31'' in paragraph (b)(1) to emphasize 
that only a submission that includes all relevant data and that has 
been properly executed complies with the filing requirements of new 
Rules 31 and 31T.
    \74\ See Proposing Release, 69 FR at 4022, n.37. The other 
billing period allows for two and a half months between the close of 
the period (December 31) and the due date for payment (March 15).
---------------------------------------------------------------------------

    The Commission does not believe that the NASD Comment raises any 
issue that precludes adopting the ten-business-day requirement. The 
Commission notes that paragraph (b)(1) of Rule 31 allows covered SROs 
ten business days in which to submit a completed Form R31, while NASD's 
rules require members to submit their Part III trade data within ten 
calendar days. Because of weekends, NASD always will have at least two 
business days from when the member data is due and when the aggregate 
data that is self-reported by the members must be provided on Form R31. 
Moreover, if NASD finds that two business days is not sufficient time, 
NASD might wish to consider reducing the time frame within which its 
members must self-report their trade data or to examine ways to 
systematize the submission of this data and thereby reduce the time 
that it spends processing the paper forms.\75\
---------------------------------------------------------------------------

    \75\ In addition, one commenter stated that ten business days 
would be enough time under the proposal, but that ``[t]he real 
burden would be the daily reconciliation required between the 
information reported back to the exchanges by NSCC and the 
exchange's own trade reporting systems.'' BSE Comment. This comment 
is addressed in Section VII(D)(1)(b), infra.
---------------------------------------------------------------------------

3. Settlement by Physical Delivery
    Options are settled by one of two methods: Cash settlement or 
physical delivery of the underlying securities. In the former case, the 
option is settled by payment of the difference between the strike price 
of the option and the market price of the underlying security or 
security index. Because there is no sale of securities upon exercise of 
a cash-settled option, no SRO incurs a Section 31 liability upon 
settlement. With physical delivery, on the other hand, one party must 
sell to the other party (at the strike price) the underlying securities 
to fulfill the option contract. Such sale would create Section 31 
liability for the covered exchange on which the related option had been 
traded.
    Presently, Section 31 fees for sales of securities resulting from 
the exercise of physical delivery exchange-traded options are paid to 
the Commission by OCC on behalf of the options exchanges. When OCC 
receives notice that an option held in the account of one of its 
participants is being exercised, OCC instructs NSCC to move funds and 
securities between NSCC participant accounts to effect the exercise. 
OCC also calculates the Section 31 fees on such covered sales and 
includes these fees as part of its aggregate Section 31 payment to the 
Commission.\76\ OCC currently does not assign the sales of securities 
resulting from such exercises to a particular SRO.
---------------------------------------------------------------------------

    \76\ For example, assume that X is long 10 put options and Y is 
short 10 put options, and that X and Y hold accounts at OCC and 
NSCC. The security underlying the options is ABC, the strike price 
is $20, and the options are settled through physical delivery. X 
elects to exercise the put options and the exercise is assigned to 
Y. Y now must buy from X 1000 shares of ABC (10 puts x 100 shares 
underlying each put) for a price of $20,000 ($20/share x 1000 
shares). OCC instructs NSCC to move $20,000 from Y's NSCC account to 
X's NSCC account and to move 1000 shares of ABC from X's NSCC 
account to Y's NSCC account. OCC also deducts a fee from X's OCC 
account in the amount of $20,000 times the Section 31 fee rate in 
effect when the exercise occurs.
---------------------------------------------------------------------------

    As stated in the Proposing Release, the Commission believes that it 
is not appropriate for these fees to be combined in a single payment 
that obscures the SRO on whose behalf the payment is being made.\77\ 
Each covered SRO is individually liable for Section 31 fees and 
assessments; therefore, the Commission should be able to match each 
Section 31 payment with the specific covered SRO that had the legal 
duty to make it. Because OCC had informed the Commission that it would 
be extremely costly and difficult for it to configure its systems to 
trace the exchanges on which physical delivery exchange-traded options 
are originally sold,\78\ the Commission proposed instead to deem the 
exercise sales as occurring OTC for purposes of Section 31 and to 
assign them to the covered association by or through the members of 
which the sales of the underlying securities were effected.\79\ The 
Commission acknowledged in the Proposing Release that this arrangement 
would represent a departure from current practices. Nevertheless, the 
Commission believed this was the least burdensome means of 
accomplishing the necessary goal of assigning these exercises to a 
specific covered SRO.
---------------------------------------------------------------------------

    \77\ See Proposing Release, 69 FR at 4022.
    \78\ OCC stated that this is because the exercise of an option 
takes place through instructions communicated by the holder of the 
option to OCC, rather than by instructions given to an exchange. See 
OCC Comment.
    \79\ See paragraph (b)(3)(i) of proposed Rule 31.
---------------------------------------------------------------------------

    Two comments disagreed with this approach,\80\ arguing that the 
proposal would be unduly burdensome for NASD (the covered association 
that would have been assigned Section 31 liability for these covered 
sales), OCC, and the options exchanges. Nevertheless, OCC and the 
options exchanges recognized the Commission's concern to assign every 
covered sale to a specific covered SRO and recommended a method of 
assigning covered sales resulting from options exercises. While the OCC 
Comment states that it is still impractical to trace options back to 
the exchange on which they were traded, it suggests that a reasonable 
proxy would be the exchange's pro rata share of the dollar volume from 
the previous month of all options settled by physical delivery.
---------------------------------------------------------------------------

    \80\ See NASD Comment; OCC Comment.
---------------------------------------------------------------------------

    The Commission agrees with this suggestion and is incorporating it 
into

[[Page 41067]]

the final rule by adding new paragraph (b)(4)(ii) to Rule 31. This 
paragraph explains the manner in which a designated clearing agency 
must conduct this pro rata attribution.\81\ The Commission also has 
added new text to paragraph (b)(2)(ii) of Rule 31 to recognize that a 
covered exchange, rather than a covered association, must report in 
Part I of its Form R31 the aggregate dollar amount of covered sales 
resulting from the exercise of physical delivery exchange-traded 
options, as reflected in the data provided by a designated clearing 
agency that clears and settles options or security futures. Proposed 
paragraph (b)(3)(i), which would have required a covered association to 
report the aggregate dollar amount of covered sales resulting from the 
exercise of physical delivery exchange-traded options, has been 
deleted.\82\ Corresponding changes have been made to Form R31.
---------------------------------------------------------------------------

    \81\ The following example will illuminate how new paragraph 
(b)(4)(ii) of Rule 31 will operate. Assume that OCC is required by 
Rules 31 and 31T to provide exchange E with clearing data to 
complete its Form R31 for September 2003. Assume also that exchange 
E in August 2003 accounted for 10% of the aggregate dollar amount of 
covered sales of options that settled by physical delivery. For 
September 2003, OCC should allocate to exchange E 10% of the 
aggregate dollar amount of covered sales resulting from the exercise 
of physical delivery exchange-traded options and having a charge 
date in September 2003. For purposes of the pro rata allocation, 
exchange E's volume of cash-settled options is irrelevant. A cash-
settled option cannot lead to a covered sale of the underlying 
securities, so the volume of cash-settled options should not be 
included in the proxy for exercise volume.
    \82\ The remaining portions of paragraphs (b) and (c) have been 
renumbered accordingly.
---------------------------------------------------------------------------

    In light of the OCC Comment, the Commission believes it would be 
appropriate to treat covered sales resulting from the maturation of 
security futures settled by physical delivery in the same manner 
because the means by which the underlying securities are transferred is 
substantially similar. A security future is a standardized contract 
between two parties to trade a security at a specific future date. If 
the security future is settled by physical delivery, one party upon 
maturation of the security future is required to sell to the other 
party the underlying securities at a predetermined price, which could 
result in a covered sale. As with physical delivery exchange-traded 
options, OCC currently pays Section 31 fees on behalf of covered 
exchanges that trade security futures but does not identify the amount 
being paid on behalf of each exchange. The Commission believes that a 
reasonable proxy for the actual dollar amount of sales of securities 
resulting from the maturation of security futures would be a covered 
exchange's pro rata share of the volume of all security futures settled 
by physical delivery and traded on all covered exchanges in the 
previous month. This approach is reflected in paragraphs (b)(2)(ii) and 
(b)(4)(ii) of Rule 31, as adopted.
4. Brut Comment
    One commenter, Brut, is an ECN that currently reports trades to the 
consolidated tape through BSE. However, BSE generally does not report 
Brut's trades to NSCC for clearance and settlement. Instead, Brut 
reports its trades to NSCC either directly, in its capacity as a QSR, 
or indirectly, through the facilities of a second SRO (generally 
NASD).\83\ Brut urged the Commission to provide guidance that would 
prevent it from being double-billed for transactions reported in this 
manner.\84\
---------------------------------------------------------------------------

    \83\ Brut stated that it often submits trades to ACT at the 
request of clients that utilize the risk-management functionality 
that ACT offers. See Brut Comment.
    \84\ The Commission notes that neither Section 31 of the 
Exchange Act nor any Commission rule imposes fees on Brut or any 
other broker-dealer for covered sales. Section 31 does not give the 
Commission authority to assess fees on any broker-dealer. These fees 
are imposed on Brut by the SRO(s) of which it is a member. See infra 
Section IV.
---------------------------------------------------------------------------

    The Commission does not believe that Brut's comment requires any 
revisions to the proposed rule. Under Rule 31 as proposed and as 
adopted, a covered exchange must report to the Commission on Form R31 
only covered sales that occur on that exchange.\85\ Similarly, a 
covered association must report only covered sales that occur by or 
through any member of the association otherwise than on a national 
securities exchange.\86\ Thus, a covered association may report a 
covered sale in its Form R31 data only if the sale did not occur on a 
national securities exchange, even if an ECN submitted a clearing-only 
report to the covered association for that sale. In cases where an ECN 
reports a covered sale to a covered exchange for purposes of printing 
the sale to the consolidated tape, the Commission, for purposes of 
Section 31, will consider the covered sale to have occurred on the 
covered exchange. Thus, the covered exchange rather than the covered 
association is required to report the covered sale on its Form R31.
---------------------------------------------------------------------------

    \85\ See 17 CFR 240.31(b)(2).
    \86\ See 17 CFR 240.31(b)(3).
---------------------------------------------------------------------------

    Any covered association that receives and forwards clearing-only 
reports to a designated clearing agency for trades that occur on a 
covered exchange should ensure that these trade reports are not 
tabulated as part of the association's covered sales. A covered 
association may need to coordinate with its ECN members to ensure that 
these trades are properly marked so that the association can filter 
them out of the trade data that the covered association tabulates on 
Form R31.
5. Assigning Trades to the Appropriate Covered SRO
    The CHX Comment asked the Commission to address how the new rules 
will treat sales of securities that occur through the Intermarket 
Trading System (``ITS'').\87\ CHX described the following situation: 
SRO A sends an ITS commitment to a member of SRO B to sell a security, 
and the commitment is executed on SRO B. Under existing arrangements, 
SRO A pays the Section 31 fee arising from this trade and passes the 
fee to its member that initiated the trade. According to CHX, the SROs 
have devised this system because SRO B does not have the ability to 
require members of SRO A to reimburse it for the cost of its Section 31 
fees. CHX stated that ``[p]roposed Rule 31 might be read to suggest 
that SRO B should pay the fee on the transaction--because it occurred 
on SRO B--but that outcome is not consistent with current practice.'' 
CHX requested the Commission to provide guidance on both the ITS 
situation and other similar circumstances.
---------------------------------------------------------------------------

    \87\ ITS is a National Market System plan approved by the 
Commission pursuant to Section 11A of the Exchange Act, 15 U.S.C. 
78k-1, and Rule 11Aa3-2 thereunder, 17 CFR 240.11Aa3-2. ITS was 
developed to facilitate intermarket trading in exchange-listed 
equity securities based on the current quotation information 
emanating from the linked markets. Securities eligible for trading 
through ITS include securities listed or traded pursuant to unlisted 
trading privileges on NYSE, Amex, or a regional exchange that 
substantially meets the listing requirements of NYSE or Amex. ITS 
enables a broker-dealer that is physically present in one market 
center to execute orders, as principal or agent, in an ITS security 
at another market center.
---------------------------------------------------------------------------

    One such circumstance was described in a no-action letter sent by 
the Commission's Division of Market Regulation to CHX and NASD in March 
2001.\88\ The no-action letter was precipitated by the following facts. 
Securities that are listed and traded on Nasdaq also may be traded on a 
national securities exchange, such as CHX, pursuant to unlisted trading 
privileges (``UTP'').\89\ CHX specialists can trade

[[Page 41068]]

these securities either on CHX itself or through a Nasdaq execution 
system.\90\ In cases where a CHX specialist sells a Nasdaq security 
through a Nasdaq system, both CHX and NASD were collecting and paying 
the Section 31 fees associated with this trading volume. To avoid the 
double payment, CHX and NASD established an arrangement whereby CHX 
would be the SRO responsible for collecting and paying Section 31 fees 
for these sales. In its March 2001 letter, the Division raised no 
objection to this arrangement.
    After carefully considering the CHX Comment and the situation 
raised in the March 2001 no-action letter, the Commission has 
determined to adopt Rule 31 as proposed. The adoption of Rule 31, 
therefore, rescinds the position taken by Commission staff in the no-
action letter, and covered SROs may need to revisit current 
arrangements they may have for reassigning liability for Section 31 
fees. Section 31(b) of the Exchange Act provides that a national 
securities exchange must pay a fee to the Commission based on the 
aggregate dollar amount of covered sales ``transacted on such national 
securities exchange.'' \91\ In the ITS situation discussed above, the 
sale is not ``transacted'' on CHX because the CHX member has routed the 
order through ITS for execution at another exchange. Similarly, in the 
case of a Nasdaq security sold by CHX members through a Nasdaq system, 
the sale is not ``transacted'' on CHX. Therefore, the Commission 
concludes that CHX does not have Section 31 liability for such covered 
sales.
---------------------------------------------------------------------------

    \88\ See letter from Annette L. Nazareth, Director, Division, 
Commission, to Paul O'Kelly, Executive Vice President, CHX, and 
James Shelton, Associate Director, NASD, dated March 5, 2001.
    \89\ See 15 U.S.C. 78l(f) (setting forth the circumstances in 
which a national securities exchange may trade securities pursuant 
to UTP). See also Securities Exchange Act Release No. 45081 
(November 19, 2001), 66 FR 59273 (November 27, 2001) (extending UTP 
eligibility to all Nasdaq securities).
    \90\ At the time of the no-action letter, the relevant Nasdaq 
execution system was SelectNet. However, Nasdaq has since replaced 
SelectNet with SuperMontage. See Securities Exchange Act Release No. 
43863 (January 19, 2001), 66 FR 8020 (January 26, 2001) (approving 
SuperMontage).
    \91\ 15 U.S.C. 78ee(b).
---------------------------------------------------------------------------

    Besides adhering to the terms of the governing statute, this 
approach should simplify the tabulation of the covered sales occurring 
at each SRO and thereby facilitate the creation of auditable records of 
the fees calculated and collected by the Commission. The Commission 
believes that it would be needlessly complicated to devise special 
provisions on Form R31 for a covered exchange to record covered sales 
that in fact occurred in another market. Great care would have to be 
taken to ensure not only that these ``away transactions'' were properly 
tabulated and recorded on the Form R31 of the covered exchange that 
routed them away, but also that they were not recorded as part of the 
covered sales of the covered SRO where the orders were executed. The 
Commission believes it will be simpler and more transparent for each 
covered SRO to report all covered sales that occur on its market.
    The Commission acknowledges that a covered SRO on which a covered 
sale occurs as a result of an incoming ITS order may not be able to 
collect funds to pay the Section 31 fee from one of its own members. 
However, Section 31 does not address the manner or extent to which 
covered SROs may seek to recover the amounts that they pay pursuant to 
Section 31 from their members. Covered SROs may wish to devise new 
arrangements for passing fees between themselves so that the funds are 
collected from the covered SRO that originated the ITS order.\92\ The 
legal duty to pay the Section 31 fee, however, remains with the covered 
SRO on which the sale was in fact transacted.
---------------------------------------------------------------------------

    \92\ Any such arrangement would have to be established pursuant 
to Section 19(b) of the Exchange Act, 15 U.S.C. 78s(b), and Rule 
19b-4 thereunder, 17 CFR 240.19b-4.
---------------------------------------------------------------------------

6. No De Minimis Exemption
    In the Proposing Release, the Commission asked whether it would be 
appropriate for Rule 31 and Form R31 to include a de minimis exemption 
from the obligation to provide the aggregate dollar amount of covered 
sales that are ex-clearing trades.\93\ Under this suggested approach, a 
covered exchange would not be required to tabulate and report the 
aggregate dollar amount of covered sales for Part II of Form R31, if 
the exchange certified that the amount was below a certain threshold. 
The Commission also sought comment on what would be an appropriate 
threshold. In its comment letter, CHX stated that over a 30-day time 
period it averaged five ex-clearing trades per day with an average 
daily value of $16.5 million. CHX urged the Commission to adopt a de 
minimis exemption from Rule 31 for these transactions until such time 
as they could be systematically tabulated by NSCC and thereby included 
in Part I of Form R31.
    The Commission does not believe that commenters have provided 
sufficient rationale to warrant the creation of a de minimis exemption 
for reporting ex-clearing trades. Even though these covered sales 
cannot be included in the Part I data, the Commission believes that 
they can be provided in Part II without undue difficulty. In CHX's 
case, the Commission believes that it would be inappropriate to exempt 
sales representing such a significant dollar amount, and that 
tabulating and reporting such a small number of covered sales should 
not be unduly burdensome.\94\ Furthermore, if the Commission were to 
exempt these sales, the result this fiscal year would \95\ result in 
some amount of foregone fees.\96\
---------------------------------------------------------------------------

    \93\ See Proposing Release, 69 FR at 4025.
    \94\ The Commission notes that, in a previous case where it 
granted an exemption from Section 31, the amounts in question were 
smaller and the costs of tracking the transactions involved much 
greater. See Securities Exchange Act Release No. 45371 (January 31, 
2002), 67 FR 5199 (February 2, 2002). In this matter, the Commission 
exercised its authority under Section 31(f) of the Exchange Act, 15 
U.S.C. 78ee(f), to exempt sales of options on narrow-based security 
indexes from Section 31 fees. In the absence of the exemption, an 
exchange trading such options would have to monitor the value of the 
underlying indexes on almost a moment-by-moment basis and pay 
Section 31 fees on option sales only when an index fell under the 
definition of ``narrow-based.'' The Commission noted that the fees 
paid by exchanges for all sales of options on indexes that were, or 
in the near future might become, narrow-based was below $35,000. The 
Commission concluded that an exemption was warranted ``[i]n light of 
currently low dollar volume of sales of options on narrow-based 
security indexes and the resources that exchanges and associations 
must devote to monitoring the narrow-based status of the underlying 
indexes.'' 67 FR at 5200. However, the Commission noted that, to the 
extent that the dollar volume of sales of options on narrow-based 
security indexes might increase, the Commission might reevaluate 
whether the exemption were warranted. See id.
    \95\ In later years, however, exempting these sales would result 
in a higher fee rate on the remaining non-exempt sales. See 15 
U.S.C. 78ee(j) (requiring the Commission to adjust the fee rate to 
attain the target offsetting collection amount).
    \96\ Currently, the fee rate is $23.40 per million dollars of 
covered sales. See Securities Exchange Act Release No. 49332 
(February 27, 2004), 69 FR 10278 (March 4, 2004) (making mid-year 
adjustment to fee rate). Absent an exemption, CHX would owe the 
Commission $386.10 per day for this $16.5 million of covered sales 
($16.5 million/day x $23.40/million) or approximately $8,494.20 per 
month (assuming 22 business days/month x $386.10/day).
---------------------------------------------------------------------------

7. Cash, Next-Day, and Seller's Option Trades
    Generally, when a trade is forwarded to a registered clearing 
agency for settlement, the clearing agency will settle the trade in 
three business days (i.e., T+3). However, a covered sale might be 
settled other than through the regular T+3 settlement process. For 
example, a covered sale might settle by cash payment on the same day 
(i.e., T+0), next day (i.e., T+1), or seller's option (i.e., the seller 
may choose the date on which it wishes the trade to settle). In its 
comment letter, NSCC stated that it and the covered SROs will have to 
reach a common understanding for the treatment of cash, next-day, and 
seller's option trades for purposes of Rule 31.
    NSCC has records of cash, next-day, and seller's option trades 
occurring on NYSE and Amex since before September 1, 2003. For the 
other covered

[[Page 41069]]

exchanges, NSCC did not begin receiving trade reports of cash, next-
day, and seller's options trades until mid-April 2004. For any month in 
which NSCC has data on covered sales resulting from cash, next-day, and 
seller's option trades, NSCC should provide that data to the respective 
covered exchanges for inclusion in Part I of Form R31. For any covered 
sales resulting from cash, next-day, or sellers option trades that a 
covered exchange did not report to NSCC, the covered exchange should 
treat these as ex-clearing transactions and report them in Part II 
(assuming that such trades were captured in the exchange's trade 
reporting system).
8. Transactions With Multiple Parties
    Several commenters asked whether certain transactions involving 
multiple parties would be treated as a single covered sale under Rule 
31.\97\ Some of the transactions mentioned by the commenters involve 
only a single trade on a securities market, coupled with a prior 
arrangement between one of the trade counterparties and a third party 
to shift the settlement obligations for the trade to the third 
party.\98\ To that extent, the Commission believes that these 
transactions include only one covered sale under Rule 31. However, one 
type of multi-party transaction--a so-called ``riskless principal'' 
transaction--may result in either one covered sale or two, depending on 
the circumstances. In a ``riskless principal'' transaction, a broker-
dealer receives an order from a customer to buy (sell) a security, 
purchases (sells) the security as principal from (to) a third party, 
and immediately sells (buys) the security to (from) the customer at the 
same price. The broker-dealer's position can be considered riskless to 
the extent that the two transactions offset each other and the broker-
dealer incurs no net liability to its principal account. Nevertheless, 
a riskless-principal transaction differs from the other multi-party 
transactions mentioned by the commenters in that two separate 
executions occur on an exchange or an OTC market.
---------------------------------------------------------------------------

    \97\ See BSE Comment; CHX Comment; NSCC Comment; NYSE Comment.
    \98\ These include ``flips,'' ``step-outs,'' and ``correspondent 
clearing transactions.''
---------------------------------------------------------------------------

    The Commission may relieve an SRO from incurring a Section 31 
liability for a particular type of sale of securities by exercising its 
authority under Section 31(f), which states: ``The Commission, by rule, 
may exempt any sale of securities or any class of sales of securities 
from any fee or assessment imposed by [Section 31], if the Commission 
finds that such exemption is consistent with the public interest, the 
equal regulation of markets and brokers and dealers, and the 
development of a national market system.'' \99\ The Commission hereby 
finds that, subject to certain conditions discussed below, an exemption 
from Section 31 fees for the second of two offsetting principal 
transactions meets this standard.
    The Commission is codifying this exemption as part of the 
definition of ``exempt sale'' in paragraph (a)(11) of Rule 31. New 
paragraph (a)(11)(viii) provides that an exempt sale includes a 
``recognized riskless principal sale.'' The Commission has added a new 
paragraph (a)(14) to Rule 31 to define ``recognized riskless principal 
sale'' as a sale of a security where all of the following conditions 
are satisfied:
---------------------------------------------------------------------------

    \99\ 15 U.S.C. 78ee(f).
---------------------------------------------------------------------------

     A broker-dealer receives from a customer an order to buy 
(sell) a security;
     The broker-dealer engages in two contemporaneous 
offsetting transactions as principal, one in which the broker-dealer 
buys (sells) the security from (to) a third party and the other in 
which the broker-dealer sells (buys) the security to (from) the 
customer; and
     The Commission, pursuant to Section 19(b)(2) of the 
Exchange Act,\100\ has approved a rule change submitted by the covered 
SRO on which the second of the two contemporaneous offsetting 
transactions occurs that permits that transaction to be reported as 
riskless.
---------------------------------------------------------------------------

    \100\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

    These requirements are designed to ensure that the two transactions 
in which the broker-dealer acts as principal are the economic 
equivalent of a single agency transaction or, in other words, that the 
combined transaction is indeed riskless for the broker-dealer. The 
Commission believes that the term ``recognized riskless principal 
sale'' is appropriate because a sale of securities occurring on a 
covered SRO will qualify for the Section 31 exemption only if, among 
other things, such sale can be recognized in the covered SRO's audit 
trail as having a second, offsetting transaction. The rule filing 
process affords the Commission the opportunity to assure that the 
covered SRO's trade reporting rules and audit trail systems are 
sufficiently robust to allow riskless principal transactions to be 
recognized as such.
    The Commission previously has approved rule changes relating to 
riskless principal transactions for one covered SRO, NASD. In 1981, the 
Commission approved an NASD rule change requiring a non-market-maker 
member to report two offsetting transactions in which the member acts 
as principal as a single agency trade.\101\ In 1999, the Commission 
approved a second NASD rule change that extended this trade reporting 
convention to all NASD members, including market makers.\102\ In the 
latter case, the Commission stated that ``[r]educing the number of 
transactions required to be reported should result in a corresponding 
reduction in transaction fees.'' \103\ That outcome was reached by 
treating the two offsetting principal transactions as a single agency 
transaction, resulting in a single covered sale. The Commission 
believes that it now would be appropriate to exercise its authority 
under Section 31(f) of the Exchange Act to formally exempt the second 
of the two offsetting transactions. The codified exemption makes clear 
that only sales that meet the enumerated criteria qualify for the 
exemption.
---------------------------------------------------------------------------

    \101\ See Securities Exchange Act Release No. 17501 (January 29, 
1981), 46 FR 10891 (February 4, 1981).
    \102\ Securities Exchange Act Release No. 41208 (March 24, 
1999), 64 FR 15386 (March 31, 1999) (``Second NASD Riskless 
Principal Order'').
    \103\ Second NASD Riskless Principal Order, 64 FR at 15388.
---------------------------------------------------------------------------

9. Possible Liability of a Designated Clearing Agency
    Paragraph (b)(4) of proposed Rule 31 stated that ``[a] designated 
clearing agency shall provide a covered SRO, upon request, the data in 
its possession needed by the covered SRO to complete Part I of Form 
R31.'' In the Proposing Release, the Commission stated that, if a 
covered SRO did not submit its Form R31 in a timely manner but the 
delay was caused by a designated clearing agency, the designated 
clearing agency, rather than the covered SRO, would be in violation of 
Rule 31.\104\ In its comment letter, NSCC stated that its ability to 
provide covered SROs with trade data ``will involve dealing on a 
continuous basis with a number of complex definitional and operational 
issues'' and that ``[i]t would be inappropriate for NSCC as an 
intermediary data processing entity to be subject to implied potential 
liability arising out of delays that it might incur in seeking to 
perform the data reporting function [required by Rule 31].'' NSCC, 
taking the view that ``this implied imposition of potential liability * 
* * does not appear in the Proposed Rule itself,'' argued that ``it 
would be appropriate for the Commission to avoid

[[Page 41070]]

the implication of such liability'' in the final rule.
---------------------------------------------------------------------------

    \104\ See Proposing Release, 69 FR at 4024.
---------------------------------------------------------------------------

    The Commission does not believe that the NSCC Comment warrants a 
revision of paragraph (b)(4), and the Commission is adopting it as 
proposed (although it has been renumbered as paragraph (b)(4)(i)). With 
this provision, the Commission is imposing specific responsibilities on 
designated clearing agencies, including NSCC. A designated clearing 
agency's failure to perform those responsibilities would be a violation 
of Rule 31. To that extent, the Commission disagrees with NSCC's view 
that the liability of a designated clearing agency is only ``implied'' 
by Rule 31. However, the Commission recognizes that a designated 
clearing agency's ability to carry out its responsibilities under Rule 
31 is dependent on its receiving timely, complete, and accurate data 
from the covered exchanges for which it clears and settles 
transactions. Before assigning liability to any party for a potential 
violation of Rule 31, the Commission would examine the facts and 
circumstances of each situation to ascertain the cause of the potential 
violation and the party or parties responsible. The Commission notes, 
furthermore, that a designated clearing agency is responsible only for 
tabulating and reporting data ``in its possession.'' \105\ If a covered 
exchange never reports a covered sale to a designated clearing agency, 
or does not report the covered sale such that it can be recognized as 
such by the systems of its designated clearing agency, the designated 
clearing agency will not be in violation of Rule 31 because that 
covered sale was not included in the covered exchange's Part I data.
---------------------------------------------------------------------------

    \105\ 17 CFR 240.31(b)(4)(i).
---------------------------------------------------------------------------

10. Netting by QSRs
    In the Proposing Release, the Commission stated that QSRs might be 
engaged in the practice of netting trades before reporting them to 
NSCC, instead of reporting to NSCC on a trade-by-trade basis. 
Therefore, the Commission proposed to rely on data generated by a 
covered exchange's trade reporting system rather than by NSCC to obtain 
the aggregate dollar amount of covered sales reported by QSRs.\106\ One 
commenter, NSCC, stated that this approach ``impli[es] that the SEC 
does not have any concerns about QSRs netting trades.'' \107\ 
Furthermore, NSCC recommended that the Commission state in the Rule 31 
adopting release that ``QSR trades should come to NSCC non-netted.'' 
NSCC noted, however, that its current rules do not prohibit a QSR from 
summarizing and netting its trades before reporting them to NSCC.
---------------------------------------------------------------------------

    \106\ See Proposing Release, 69 FR at 4023.
    \107\ NSCC Comment.
---------------------------------------------------------------------------

    By adopting a new procedure for the calculation and collection of 
fees pursuant to Section 31 of the Exchange Act, including covered 
sales reported to NSCC through QSRs, the Commission is expressing no 
opinion on the operational practices of QSRs, including any potential 
netting. New Rules 31 and 31T and Form R31 are designed to obtain 
aggregate trading volume for covered sales from the best currently 
available sources. Nothing in this adopting release should be construed 
as prohibiting NSCC from proposing rule changes that it deems necessary 
and appropriate to improve the clearance and settlement system, 
including the manner in which QSRs report trades to NSCC.
11. Creations and Redemptions of ETFs
    The NSCC Comment also asked whether creations and redemptions of 
shares of exchange-traded funds (``ETFs'') would be covered sales under 
Rule 31. ETF shares are securities issued by an open-end investment 
company (i.e., a mutual fund) that can be traded on an exchange. A 
mutual fund that issues such shares generally will do so only in 
aggregations of a specified number (``creation units''), and purchasers 
of creation units can separate the units into individual shares that 
can be traded on an exchange. An authorized participant may deposit a 
basket of the fund's component securities (and, in some cases, cash) 
into the fund and receive creation units in return. ETF shares can be 
redeemed by aggregating them into creation units, presenting them to 
the fund, and receiving a basket of component securities (and, in some 
cases, cash) in return.
    The Commission believes that the creation of ETF shares falls 
within paragraph (a)(11)(i) of Rule 31, which provides that the term 
``exempt sale'' includes any sale of securities offered pursuant to an 
effective registration statement under the Securities Act of 1933. In 
addition, the Commission believes that the delivery of creation units 
to the fund falls within paragraph (a)(11)(iv) of Rule 31. The 
Commission views the redemption of creation units as transactions 
similar to those covered by that paragraph, such as sales upon 
conversion of convertible securities. Therefore, neither creations nor 
redemptions of ETF shares are covered sales under Rule 31.

III. Temporary Rule 31T

    Beginning in FY2004, the Commission is required to prepare an 
annual financial statement that will be audited by the Government 
Accounting Office (``GAO''). To satisfy applicable auditing standards, 
the Commission must be able to document the sources of its accounts 
receivable, including Section 31 fees and assessments, for its entire 
fiscal year. Rule 31 enables the Commission to obtain from the covered 
SROs aggregate data on all covered sales occurring in the U.S. 
markets--but will not become effective until July 2004. As the 
Commission noted in the Proposing Release, the purpose of temporary 
Rule 31T is to allow the Commission to obtain similar data for the 
months of FY2004 prior to the effective date of Rule 31 so that it can 
calculate, using the new procedure set forth in Rule 31, the fees and 
assessments due from covered SROs for all of its FY2004.\108\ The 
Commission originally hoped that proposed temporary Rule 31T could be 
adopted before the Section 31 payment on March 15, 2004. However, 
because the Commission is adopting these final rules after the March 15 
due date, and covered SROs already have made that payment using their 
existing methods, the Commission has revised temporary Rule 31T to 
carry out the original intent of the rule.
---------------------------------------------------------------------------

    \108\ See 69 FR at 4025.
---------------------------------------------------------------------------

    New paragraph (a)(1)(ii) of temporary Rule 31T defines the ``FY2004 
prepayment amount'' as the total dollar amount of fees and assessments 
already paid by a covered SRO pursuant to the March 15, 2004, due 
date.\109\ New paragraph (b) of temporary Rule 31T requires each 
covered SRO, by August 13, 2004, to file with the Commission a 
completed Form R31 for each of the months September through December 
2003. The Form R31 submissions for these months will enable the 
Commission to calculate the amounts payable for this billing period 
using the new procedure. New paragraph (a)(1)(iii) of temporary Rule 
31T defines the ``FY2004 recalculated amount'' as the total dollar 
amount of fees or assessments owed by a covered SRO for the September-
through-December 2003 billing period, as calculated by the Commission 
based on the data submitted by each covered SRO in its Form R31 
submissions for those four months.\110\
---------------------------------------------------------------------------

    \109\ 17 CFR 240.30T(a)(1)(ii).
    \110\ 17 CFR 240.30T(a)(1)(iii).
---------------------------------------------------------------------------

    For each covered SRO, the Commission will subtract the FY2004 
prepayment amount from the FY2004 recalculated amount; the result is 
the

[[Page 41071]]

``FY2004 adjustment amount.'' \111\ If a covered SRO's FY2004 
adjustment amount is a positive number, the Commission will send the 
covered SRO a Section 31 bill for the months September to December 
2003, and the covered SRO must include the FY2004 adjustment amount 
with the payment for its next Section 31 bill (due by September 30, 
2004).\112\ If the covered SRO's FY2004 adjustment amount is a negative 
number, the Commission will credit the adjustment amount to the covered 
SRO's next Section 31 bill.\113\
---------------------------------------------------------------------------

    \111\ 17 CFR 240.30T(a)(1)(i).
    \112\ See 17 CFR 240.30T(c).
    \113\ See 17 CFR 240.30T(d).
---------------------------------------------------------------------------

    Temporary Rule 31T also requires each covered SRO to file with the 
Commission, by August 13, 2004, a completed Form R31 for each of the 
months January 2004 to July 2004, inclusive.\114\ Taken together, new 
Rules 31 and 31T will give the Commission a complete set of data from 
which to prepare the Section 31 bills for the present billing period 
(January through August 2004). Thereafter, temporary Rule 31T will no 
longer be necessary, and covered SROs will be subject to the ongoing 
obligation to file a completed Form R31 on a monthly basis pursuant to 
paragraph (b)(1) of Rule 31. Temporary Rule 31T expires on January 1, 
2005.\115\
---------------------------------------------------------------------------

    \114\ See 17 CFR 240.30T(b).
    \115\ See 17 CFR 240.30T(f).
---------------------------------------------------------------------------

    Four comments expressed concern with applying the new procedure to 
recalculate Section 31 fees and assessments for the months September to 
December 2003.\116\ One commenter argued that ``the benefits of 
retroactive implementation do not outweigh the costs of work necessary 
to recertify the September through December 2003 submission.'' \117\ 
Two of these comments stated that trade data in the possession of NSCC 
for these months would likely be inaccurate because NSCC's systems were 
not properly configured to capture the correct data.\118\ These 
comments also questioned how the adjustment payments required by 
temporary Rule 31T would correspond with the payments already made 
pursuant to the exchanges' existing rules. NYSE noted, for example, 
that it would be forced to make a retroactive adjustment to its Rule 
440H, which governs the manner in which NYSE passes Section 31 fees to 
its members. Similarly, CHX argued that ``[i]f there are differences 
between the NSCC reports and the data used by CHX in its billing, the 
CHX will be required to reconcile the two sets of data, on a trade-by-
trade basis.''
---------------------------------------------------------------------------

    \116\ See CHX Comment; NASD Comment; NSCC Comment; NYSE Comment.
    \117\ NASD Comment.
    \118\ See CHX Comment; NYSE Comment.
---------------------------------------------------------------------------

    After carefully considering these comments, the Commission 
continues to believe that it is necessary to adopt a temporary Rule 31T 
that requires covered SROs to provide Form R31 submissions for every 
month from September 2003 to the present. Despite the costs associated 
with temporary Rule 31T, the Commission believes that obtaining this 
historical trade data is necessary for the Commission to carry out its 
obligations under the Accountability Act.\119\ Furthermore, although 
there may be some discrepancy between the amounts that covered SROs 
must pay the Commission pursuant to temporary Rule 31T and the amounts 
that covered SROs already have collected from their members pursuant to 
their rules, the Commission does not believe this justifies delaying 
the implementation of a more accurate and reliable system.
---------------------------------------------------------------------------

    \119\ See infra Section VIII.
---------------------------------------------------------------------------

    Historical data are available for the options and security futures 
exchanges because OCC's systems are already configured to capture this 
data \120\ and Rule 31 does not require a fundamental revision of the 
methods by which options and security futures exchanges pay their 
Section 31 fees or assessments. With the equities exchanges, however, 
the Commission understands that trade data going back to September 1, 
2003, may not have been reported to NSCC in a form that can immediately 
be tabulated under the procedure created by new Rule 31. Nevertheless, 
the Commission believes that NSCC, with the assistance of the 
exchanges, can sift the data to produce an accurate record of each 
exchange's covered sales in equities since September 1, 2003. In that 
regard, the Commission anticipates that the following issues will need 
to be addressed:
---------------------------------------------------------------------------

    \120\ Currently, all transactions in options or security futures 
that occur on a national securities exchange are cleared and settled 
by OCC. OCC already has in place procedures to filter out exempt 
transactions listed in former Rule 31-1 under the Exchange Act, 17 
CFR 240.31-1. Therefore, the Commission believes that OCC should, 
with only minor system modifications, be able to tabulate the trade 
data required by the covered SROs for Part I of Form R31.
---------------------------------------------------------------------------

     Debt securities. Sales of debt securities are exempt from 
Section 31 fees.\121\ NSCC clears and settles trades in debt as well as 
equity securities. Any covered exchange that trades debt securities 
should provide NSCC with the CUSIP numbers for such securities so that 
NSCC can filter such trades from its clearing data going back to 
September 1, 2003.
---------------------------------------------------------------------------

    \121\ See 15 U.S.C. 78ee(b) and (c); 17 CFR 240.31(a)(11)(vii).
---------------------------------------------------------------------------

     Reversals. A reversal occurs when a trade is reported 
incorrectly to a designated clearing agency and the covered SRO on 
which the trade occurred sends a second record to inform the clearing 
agency to negate the first record.\122\ Although NSCC's reporting 
system allows a reversal to be marked as such, a covered SRO could 
choose instead to effect the reversal by reporting a second trade that 
nets out the first.\123\ Although no NSCC rule prohibits this practice, 
it would cause two covered sales to appear in NSCC's record when in 
fact there was no covered sale. Any covered exchange that engaged in 
this practice during the period September to December 2003 should 
coordinate with NSCC to ensure that these reverse trades are not 
counted as covered sales.
---------------------------------------------------------------------------

    \122\ If the terms of the trade were adjusted, the covered SRO 
would send a third record to the clearing agency with the correct 
trade data. If the trade were merely canceled, no third record would 
be sent.
    \123\ For example, assume A sells to B 100 shares of XYZ stock 
and this trade was reported to NSCC in error. A covered exchange 
could obtain the same effect as a reversal message by reporting a 
second trade in which B sells to A 100 shares of XYZ stock.
---------------------------------------------------------------------------

     Creations and redemptions of ETFs. As noted above, neither 
the creation nor the redemption of ETF shares results in any covered 
sale under Section 31 of the Exchange Act.\124\ Therefore, NSCC should 
not tabulate as part of a covered exchange's Part I data any securities 
transactions that resulted from the creation or redemption of ETF 
shares.
---------------------------------------------------------------------------

    \124\ See supra Section II(B)(11).
---------------------------------------------------------------------------

     Trades cleared through but not executed on a covered SRO. 
In some cases, a covered exchange will report a covered sale to NSCC on 
behalf of one of its members even though the sale was executed on 
another covered SRO. No liability for a covered sale should result for 
the covered exchange that sent the report.\125\ The Commission expects 
NSCC and any covered exchange \126\ that engages in this practice to 
devise a means by which to remove clearing-only reports from the 
exchange's Part I data.
---------------------------------------------------------------------------

    \125\ See supra Section II(B)(4).
    \126\ A covered association also could send clearing-only 
reports to NSCC, but the procedure created by Rule 31 does not rely 
on clearing data for covered associations. Therefore, Rule 31 does 
not require NSCC to segregate a covered association's clearing-only 
reports for trades that were in fact executed on another SRO from 
the trades that did occur by or through the association's members 
otherwise than on an exchange.
---------------------------------------------------------------------------

     Cash, next-day, and seller's option trades. As noted 
above, during the period covered by temporary Rule 31T, some covered 
sales of equity securities resulting from cash, next-day, and

[[Page 41072]]

seller's option trades were reported to NSCC while others were 
not.\127\ NSCC should tabulate what data it has on these trades and 
provide them to the respective covered SRO for inclusion in Part I of 
Form R31. For any such covered sales that a covered exchange did not 
report to NSCC, the covered exchange should treat these as ex-clearing 
transactions and report them in Part II (assuming that such trades were 
captured in the exchange's trade reporting system).
---------------------------------------------------------------------------

    \127\ See supra Section II(B)(7).
---------------------------------------------------------------------------

     ``Riskless principal'' trades. To date, no covered 
exchange has received the Commission's approval of a rule change 
relating to riskless principal transactions. Therefore, for all trade 
data from September 1, 2003, to the present, NSCC should not exclude 
any covered sales on the grounds that they are ``riskless principal'' 
transactions.
     Step-outs, universal flips, and correspondent clearing 
transactions. As noted above, the Commission believes that each of 
these transactions would constitute only a single covered sale.\128\
---------------------------------------------------------------------------

    \128\ See supra Section II(B)(8).
---------------------------------------------------------------------------

    In their comment letters, CHX and NYSE suggested that adjustments 
required by temporary Rule 31T could require a covered exchange 
retroactively to amend its rules that pass Section 31 fees on to member 
firms. The Commission notes that neither Section 31 of the Exchange Act 
nor the rules adopted by the Commission thereunder address the manner 
or extent to which covered SROs may seek to recover the costs of their 
Section 31 obligations from their members. While the Commission has 
approved SRO rules establishing fees to be paid by SRO members to 
reimburse the covered SROs for Section 31 fees paid to the Commission, 
an SRO's Section 31 obligations are independent of any such 
reimbursement. The rules adopted by the Commission today establish a 
procedure for the amount of an SRO's Section 31 fees to be calculated; 
they do not affect an SRO's obligation to pay fees or assessments to 
the Commission.
    The Commission also acknowledges that the application of temporary 
Rule 31T, particularly the assigning of charge dates, might result in a 
slight discrepancy with respect to the transactions included in the 
billing period. Under the existing arrangements for the calculation and 
payment of Section 31 fees, covered exchanges that trade equity 
securities often use the trade date as the basis for assigning the 
period to which a sale belongs. Thus, fees on sales that occurred on a 
covered exchange between August 27 and August 29, 2003--the last three 
business days of August 2003--likely were deemed by the exchanges to 
have occurred in August 2003, and fees for such sales were included in 
the covered exchange's Section 31 payment made on September 30, 2003. 
For most covered sales in equity securities, however, the charge date 
is now the settlement date. Thus, when the covered exchange submits 
Form R31 for September 2003 pursuant to temporary Rule 31T, most of its 
covered sales having a trade date on August 27, 28, or 29 will settle 
T+3 in September 2003. Thus, the terms of the new rule could 
inadvertently impose a second fee on trades during this three-day 
period. To prevent this outcome, the Commission has adopted paragraph 
(e) of temporary Rule 31T, which provides that ``[a]ny covered exchange 
that as of August 2003 was reporting its Section 31 volume to the 
Commission based on trade date shall not include in its aggregate 
dollar value of covered sales for its September 2003 Form R31 any 
covered sale that had a trade date prior to September 1, 2003.''

IV. Reconciliation of Fees Paid to Funds Collected by Covered SROs

    Various commenters argued that the Commission's proposal would 
create difficulties in reconciling the amount that a covered SRO would 
owe the Commission with the amount collected by covered SROs from their 
members.\129\ One commenter discussed various sources of the 
reconciliation problem and stated that ``the Commission should be 
involved in developing a uniform process for allocating transaction 
fees beyond SROs.'' \130\ A second commenter ``strongly urge[d] the 
Commission to work hand-in-hand with NASD and representatives from the 
industry to address th[e] issue'' of reconciling these amounts.\131\ A 
third commenter stated that avoiding a mismatch between what is billed 
by the Commission and what it collects from its member firms would 
necessitate an amendment to the exchange rule that passes the fee to 
its members.\132\
---------------------------------------------------------------------------

    \129\ See NASD Comment; NYSE Comment; SIA Comment.
    \130\ See SIA Comment.
    \131\ See NASD Comment.
    \132\ See NYSE Comment.
---------------------------------------------------------------------------

    Section 31 of the Exchange Act places obligations only on national 
securities exchanges, national securities associations, and the 
Commission. National securities exchanges and national securities 
associations must pay certain fees \133\ and assessments \134\ to the 
Commission. The Commission is required by Section 31 to collect such 
fees and assessments.\135\ Section 31, however, does not address the 
manner or extent to which covered SROs may seek to recover the costs of 
their Section 31 obligations from their members. Nor does Section 31 
address the manner or extent to which members of covered SROs may seek 
to pass any such charges on to their customers. In practice, the 
covered SROs obtain the funds for these fees and assessments by 
assessing charges on their members, and the members in turn pass these 
charges to their customers. It is customary for a customer who sells a 
security to see an ``SEC Fee'' on his or her trade confirmation. 
Furthermore, the broker-dealer typically rounds up the amount of the 
customer's charges to the next whole cent. The accumulation of extra 
fractional cent amounts often results in broker-dealers having ``over-
collected'' for the fees assessed by their SROs for Section 31 
purposes.\136\
---------------------------------------------------------------------------

    \133\ See 15 U.S.C. 78ee(b) and (c).
    \134\ See 15 U.S.C. 78ee(d).
    \135\ See 15 U.S.C. 78ee(a).
    \136\ The SIA Comment discussed three additional reasons for the 
collection discrepancies: (1) Double-counting of OTC odd-lot 
transactions; (2) orders executed partly on an exchange but partly 
OTC but confirmed to the customer at a single average price; and (3) 
the several layers of billing on ECNs and other mechanisms designed 
to provide trading anonymity that are difficult to reconcile.
---------------------------------------------------------------------------

    The Commission is concerned about the manner in which SROs label 
the fees that they pass to their members and the manner in which 
members label the fees passed to their customers. These are not 
``Section 31 Fees'' or ``SEC Fees.'' Section 31 places no obligation on 
members of covered SROs or their customers, and it is misleading to 
suggest that a customer or an SRO member incurs an obligation to the 
Commission under Section 31. Accordingly, the Commission believes that 
covered SROs and their members should take prompt action to correct any 
such misperceptions.

V. Delegation of Authority

    Under new Rule 31 and temporary Rule 31T, the Commission will 
calculate the Section 31 fees and assessments due from covered SROs and 
issue bills to the covered SROs for those amounts. The Commission is 
amending its rules of organization and program management to delegate 
authority to the Director of the Division of Market Regulation, in 
consultation with the Executive Director and the Chief Economist, to 
make these calculations and to issue Section 31 bills pursuant to new 
Rule 31 and temporary Rule 31T.\137\ This amendment is a ``rule[] of 
agency organization, procedure, or practice''

[[Page 41073]]

within the meaning of Section 553(b)(A) of the Administrative Procedure 
Act (``APA'').\138\ Therefore, publication of this proposed rule in the 
Federal Register, opportunity for public comment, and publication of 
the rule prior to its effective date are not required by Section 553 of 
the APA.
---------------------------------------------------------------------------

    \137\ See 17 CFR 200.30-3(a)(82).
    \138\ 5 U.S.C. 553(b)(A).
---------------------------------------------------------------------------

VI. Consideration of the Burden on Competition, and Promotion of 
Efficiency, Competition, and Capital Formation

    Section 3(f) of the Exchange Act \139\ requires the Commission, 
whenever it engages in rulemaking and is required to consider or 
determine whether an action is necessary or appropriate in the public 
interest, to consider whether the action will promote efficiency, 
competition, and capital formation. In addition, Section 23(a)(2) of 
the Exchange Act \140\ requires the Commission, when promulgating rules 
under the Exchange Act, to consider the impact any such rules would 
have on competition. Section 23(a)(2) further provides that the 
Commission may not adopt a rule that would impose a burden on 
competition not necessary or appropriate in furtherance of the purposes 
of the Exchange Act.
---------------------------------------------------------------------------

    \139\ 15 U.S.C. 78c(f).
    \140\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    The duty imposed on covered SROs to pay fees and assessments on 
securities transactions arises from Section 31 of the Exchange Act 
itself; this rulemaking establishes a process for calculating and 
collecting these fees and assessments. The Commission believes that 
this rulemaking will promote efficiency, competition, and capital 
formation by making this process more transparent and reliable. 
Furthermore, the data received on Form R31 should provide the 
Commission with more complete and more precise data on aggregate 
trading volumes that will assist the Commission in setting the 
appropriate fee rate pursuant to Section 31(j) of the Exchange 
Act.\141\
---------------------------------------------------------------------------

    \141\ 15 U.S.C. 78ee(j).
---------------------------------------------------------------------------

    In the Proposing Release, the Commission requested comment on the 
proposal's effect on efficiency, competition, and capital 
formation.\142\ Although no commenter specifically addressed this 
section of the Proposing Release, one commenter stated that it ``does 
not believe that the Commission's proposal is an efficient way of 
achieving their recognizable goal of assuring the accuracy of Section 
31 fees due by each market center.'' \143\ The commenter added that ``a 
much simpler solution'' would be to require covered exchanges to 
document the basis of their Section 31 fees by submitting or making 
available to the Commission their internal trade reporting records.
---------------------------------------------------------------------------

    \142\ See 69 FR at 4026.
    \143\ BSE Comment.
---------------------------------------------------------------------------

    The Commission does not believe that the ``simpler'' solution 
suggested by this commenter would be the more accurate or the more 
efficient solution. As noted above, the Commission believes that 
clearing data captured by the designated clearing agencies provide the 
most accurate basis for the Commission's calculation of Section 31 fees 
and assessments. Moreover, although there will be some initial 
development burdens to adapt to the new rules,\144\ the Commission 
believes that the new procedure for calculating Section 31 fees, 
particularly for the covered exchanges that trade equity securities, 
will eventually yield significant efficiencies. Currently, the manner 
in which Section 31 fees are calculated differs significantly between 
the options and equities exchanges. The options exchanges have 
arrangements with its clearing agency, OCC, whereby OCC calculates the 
aggregate dollar amount of their covered sales and pays the Section 31 
fees on behalf of each options exchange. Under this rulemaking, the 
Commission is leaving this system essentially unchanged, an approach 
strongly endorsed by OCC and five options exchanges. The Commission 
believes that this system has evolved into an efficient means for the 
options exchanges to discharge their responsibilities under Section 
31--as, apparently, do the exchanges themselves.\145\
---------------------------------------------------------------------------

    \144\ See infra Section VII(D)(1).
    \145\ See OCC Comment.
---------------------------------------------------------------------------

    On the equities exchanges, by contrast, there is no central 
mechanism to standardize the data collection and calculation function. 
This rulemaking will require the equities exchanges for the first time 
to utilize such a mechanism to obtain trade data that must be reported 
on new Form R31. This in turn will cause the equities exchanges and 
their principal clearing agency, NSCC, to further standardize the 
manner in which they report transactions, particularly with regard to 
indicating on trade reports whether or not the transaction is a covered 
sale. Such conventions are particularly helpful with regard to 
transactions involving multiple parties \146\ and transactions that are 
reported through more than one SRO.\147\ The Commission believes that, 
as NSCC and the equities exchanges become familiar with new Rules 31 
and 31T and Form R31 and technical issues are resolved, an efficient 
and reliable system for calculating Section 31 fees for the equities 
exchanges--similar to what already exists for the options exchanges--
will emerge.
---------------------------------------------------------------------------

    \146\ See supra Section II(B)(8).
    \147\ See supra Sections II(B)(4) and (5).
---------------------------------------------------------------------------

VII. Paperwork Reduction Act

    Rule 31 and Form R31 contain ``collection of information'' 
requirements within the meaning of the Paperwork Reduction Act of 1995 
(``PRA'').\148\ Accordingly, the Commission submitted them to OMB for 
review in accordance with 44 U.S.C. 3507 and 5 CFR 1320.11. OMB 
approved the new collection of information for Rule 31 and Form 31R and 
assigned OMB Control number 3235-0597. Neither Rule 31's development 
burden nor the burden associated with the temporary Rule 31T, both 
discussed in the Proposing Release and below, was included in OMB's 
approval. The Commission, therefore, is resubmitting the collection of 
information to OMB to account for these burdens. We solicit comment on 
this collection of information below. Compliance with Rules 31 and 31T 
and Form R31 will be mandatory. An agency may not conduct or sponsor, 
and a person is not required to respond to, a collection of information 
unless it displays a valid control number.\149\ Any information filed 
with the Commission will be made publicly available.
---------------------------------------------------------------------------

    \148\ 44 U.S.C. 3501 et seq.
    \149\ See 44 U.S.C. 3512(a).
---------------------------------------------------------------------------

    In the Proposing Release, the Commission solicited comments on the 
collection of information requirements.\150\ NSCC was the only 
commenter to specifically address the Commission's burden estimates 
made in the PRA portion of the Proposing Release. However, some 
commenters expressed concern that compliance with temporary Rule 31T 
would be burdensome.\151\ The Commission is making certain adjustments 
to its initial burden estimate, discussed below, to reflect these 
comments. The Commission's other burden estimates are unchanged.
---------------------------------------------------------------------------

    \150\ See 69 FR at 4028-29.
    \151\ See BSE Comment; CHX Comment; NYSE Comment.
---------------------------------------------------------------------------

A. Summary of Collection of Information

    Rules 31 and 31T and Form R31 require each covered SRO to provide 
the Commission with data on its covered sales and covered round turn 
transactions. Form R31, due on a

[[Page 41074]]

monthly basis, consists of three parts. Part I requires each covered 
exchange to provide the following:
    1. The aggregate dollar amount of covered sales of equity 
securities that: (a) Occurred on the exchange; (b) had a charge date in 
the month of the report; and (c) the exchange reported to a designated 
clearing agency;
    2. The aggregate dollar amount of covered sales of options that: 
(a) Occurred on the exchange; (b) had a charge date in the month of the 
report; and (c) the exchange reported to a designated clearing agency;
    3. The total number of covered round turn transactions that: (a) 
Occurred on the exchange; (b) had a charge date in the month of the 
report; and (c) the exchange reported to a designated clearing agency; 
and 4.The aggregate dollar amount of covered sales of equity securities 
that: (a) occurred on the exchange; (b) had a charge date in the month 
of the report; and (c) resulted from the maturation of a security 
future or the exercise of a physical delivery exchange-traded option.
    Paragraph (b)(4)(i) of Rule 31 requires a designated clearing 
agency to provide a covered SRO, upon request, the data in its 
possession needed by the covered SRO to complete Part I of Form R31. 
Covered associations should not report any data in Part I of Form R31.
    Part II requires each covered exchange to provide the following:
    1. The aggregate dollar amount of covered sales that: (a) Occurred 
on the exchange; (b) had a charge date in the month of the report; (c) 
the covered exchange captured in a trade reporting system; and (d) were 
reported to a designated clearing agency by a QSR; and
    2. The aggregate dollar amount of covered sales that: (a) Occurred 
on the exchange; (b) had a charge date in the month of the report; (c) 
the covered exchange captured in a trade reporting system; and (d) were 
ex-clearing transactions.
    Part II also requires a covered association to provide the 
aggregate dollar amount of any covered sales that: (a) Occurred by or 
through any member of the association otherwise than on a national 
securities exchange; (b) had a charge date in the month of the report; 
and (c) the association captured in a trade reporting system.
    Part III requires a covered exchange to provide the aggregate 
dollar amount of covered sales (other than covered sales resulting from 
the maturation of a security future or the exercise of a physical 
delivery exchange-traded option) that: (a) Occurred on the exchange; 
(b) had a charge date in the month of the report; and (c) the exchange 
neither captured in a trade reporting system nor reported to a 
designated clearing agency. In addition, Part III requires a covered 
association to provide the aggregate dollar amount of covered sales 
that: (a) Occurred by or through a member of the association otherwise 
than on a national securities exchange; (b) had a charge date in the 
month of the report; and (c) the association did not capture in a trade 
reporting system.
    For any month in which the Commission is required to adjust the 
Section 31 fee rate, a covered SRO would have to separate the data on 
its aggregate dollar amount of covered sales into two parts. The first 
part would consist of the aggregate dollar amount of covered sales 
having a charge date in that month before the date of the fee rate 
adjustment; the second part would consist of the aggregate dollar 
amount of covered sales having a charge date on or after the date of 
the fee rate adjustment. The Commission does not have authority under 
Section 31 of the Exchange Act to adjust the assessment charge. 
Therefore, respondents will never need to provide the total numbers of 
covered round turn transactions before and after any adjustment. 
Respondents should provide the total number of covered round turn 
transactions in a single entry on Form R31.

B. Use of Information

    The Commission will use the information obtained on Form R31 to 
calculate the fees and assessments owed by each covered SRO to the 
Commission pursuant to Section 31 of the Exchange Act. Although such 
fees and assessments are due only twice a year (by March 15 and 
September 30), the Commission will use this data to calculate and 
record a receivable on its financial statement every month.

C. Respondents

    There are currently 12 covered SROs that are subject to the 
collection of information requirements of this rulemaking. In addition, 
there are currently two entities--NSCC and OCC--that are designated 
clearing agencies required by paragraph (b)(4)(i) of Rule 31 to provide 
data to the covered SROs. Therefore, there are 14 respondents in total.

D. Total Annual Reporting and Recordkeeping Burden

1. Development Burden for System Modifications
    Pursuant to this rulemaking, each covered SRO has a duty to provide 
on Form R31 the aggregate dollar amount of its covered sales and the 
total number of its covered round turn transactions having a charge 
date in the month of the report. To comply with this collection of 
information requirement, the covered SROs will incur one-time burdens 
to develop new systems and procedures to record and tabulate the 
necessary trade data. The two designated clearing agencies also will 
incur burdens in configuring their systems to enable them to meet their 
obligations under Rule 31.
a. Options and Security Futures
    Currently, the options exchanges and security futures exchanges 
have arrangements with OCC whereby OCC calculates, collects, and pays 
all Section 31 fees and assessments on behalf of the exchanges. OCC 
already has procedures, therefore, to prevent exempt sales from being 
included in the calculation of Section 31 fees. For reasons discussed 
above, the Commission has determined to continue to allow these 
arrangements. OCC currently makes payments to the Commission in one 
lump-sum on behalf of the exchanges without stipulating the amount 
being paid on behalf of each exchange. However, under Rule 31, OCC must 
stipulate the amount paid on behalf of each exchange. Furthermore, OCC 
must provide to each covered exchange for which it clears and settles 
transactions monthly data on the exchange's aggregate dollar amount of 
covered sales and the total number of covered round turn transactions 
cleared and settled by OCC on behalf of the exchange. OCC, therefore, 
must develop procedures to allocate each covered sale or covered round 
turn transaction to a specific exchange. The Commission initially 
estimated this development time to be 180 staff hours.\152\ Although no 
commenter specifically addressed whether this estimate was accurate, 
the OCC Comment stated that ``OCC will be ready to provide the 
Commission with information specifying the amount that it is paying on 
behalf of each exchange by the time that the Commission finalizes its 
Section 31 fee collection rules.''
---------------------------------------------------------------------------

    \152\ See Proposing Release, 69 FR at 4027.
---------------------------------------------------------------------------

    As noted above, the Commission has revised its original proposal 
relating to covered sales resulting from exercises of physical delivery 
exchange-traded

[[Page 41075]]

options.\153\ Under the final rule, the duty to pay fees for such 
covered sales will remain with the covered exchanges that trade the 
overlying derivative products. However, to allocate the volume for 
these covered sales among the covered exchanges, OCC must devise a new 
procedure for making the pro rata allocations. Paragraph (b)(4)(ii) of 
Rule 31 governs this procedure. The Commission estimates that this 
procedure will take 20 OCC staff hours to develop. The Commission's 
total estimate of the initial development burdens of OCC is 200 staff 
hours (180 + 20).
---------------------------------------------------------------------------

    \153\ See supra Section II(B)(3).
---------------------------------------------------------------------------

    Because all covered sales in options and covered round turn 
transactions in security futures are cleared and settled by OCC, and 
the designated clearing agencies will bear the primary burden for 
making systems changes to accommodate Rule 31, the Commission believes 
that the initial development burden on the options and security futures 
exchanges themselves will be minimal. The Commission estimates that the 
total initial burden on these exchanges will be 10 staff hours per 
exchange for a total of 80 staff hours (8 exchanges x 10 hours/
exchange).\154\ Thus, the Commission concludes that OCC, the options 
exchanges, and the security futures exchanges together will incur 
burdens for initial development of new systems and processes of 280 
staff hours (200 + 80).
---------------------------------------------------------------------------

    \154\ The Commission originally estimated that this burden would 
be 70 staff hours (7 exchanges x 10 hours/exchange). See Proposing 
Release, 69 FR at 4027. However, since the Commission issued the 
Proposing Release, a sixth national securities exchange--BSE--began 
trading options. As with the other options exchanges, OCC 
calculates, collects, and pays all of the Section 31 fees on BSE's 
behalf. Therefore, the Commission is increasing this burden estimate 
to reflect the addition of BSE.
---------------------------------------------------------------------------

b. Exchange-Traded Equity Securities
    NSCC does not currently perform any functions with respect to 
Section 31 of the Exchange Act. Therefore, NSCC is likely to incur more 
initial development burdens than OCC. To provide the data required by 
the new rules, NSCC must configure its systems to accurately tabulate 
the aggregate dollar amount of covered sales forwarded to it by the 
covered exchanges that trade equity securities. Such configuration will 
include, among other things, ensuring that reversals and exempt sales 
are filtered out of the exchanges' Part I data; ensuring that covered 
sales that result in no net change of position in any NSCC account are 
still tabulated; and presenting the data to the covered exchanges in a 
manner that can be easily reported on Form R31.
    The Commission originally estimated that NSCC and the eight 
exchanges that trade equities would collectively incur an aggregate 
burden of 1000 staff hours to develop new systems and processes to 
fulfill their obligations under Rule 31.\155\ In response to that 
estimate, NSCC stated in its comment that ``it would take approximately 
1000 hours, at a total cost of $140,000, to be able to develop the 
systems and procedures needed to fulfill its role under the Proposed 
Rule.'' In view of the NSCC Comment and the likelihood that the 
equities exchanges also will incur some burdens to develop new 
procedures to comply with Rule 31 and Form R31, the Commission now 
estimates that NSCC and the eight equities exchanges together will 
incur a total development burden of 1100 staff hours.
---------------------------------------------------------------------------

    \155\ See Proposing Release, 69 FR at 4027.
---------------------------------------------------------------------------

    Another commenter, BSE, stated that the proposal would require 
``the institution of a new internal process to conduct a daily 
reconciliation of trades reported to the NSCC against those reported 
internally on BSE systems.''\156\ BSE estimated this process to take a 
minimum of two man-hours per day. The Commission notes, however, that 
Rule 31 does not require BSE or any other covered SRO ``to conduct a 
daily reconciliation of trades.'' A covered SRO may wish, but is under 
no obligation, to do so. Therefore, the Commission is not revising its 
estimate in response to the BSE Comment.
---------------------------------------------------------------------------

    \156\ BSE Comment.
---------------------------------------------------------------------------

c. OTC Equity Securities
    NASD is currently the only covered association that will be 
required to report on Form R31 covered sales occurring otherwise than 
on a national securities exchange. Under the current arrangements for 
the payment of Section 31 fees, NASD calculates the aggregate dollar 
amount of sales reported to ACT after filtering out sales that are 
exempt from Section 31 fees. NASD also administers a paper-based system 
whereby NASD members report and pay fees on odd-lot sales as well as 
sales of securities resulting from the exercise of non-exchange-listed 
options, neither of which are reported to ACT. The Commission 
anticipates that these NASD procedures will continue under the 
proposal. In addition, Rule 31 requires NASD to tabulate and report all 
covered sales occurring in the ADF, although TRACS, the trade reporting 
system for the ADF, currently is not configured to provide such data. 
Based on conversations between Commission staff and NASD, the 
Commission preliminarily estimated that the necessary configurations to 
TRACS would require 50 hours of NASD staff time. NASD already has 
established procedures to pass Section 31 fees to its members based on 
their transaction volume (as reflected in ACT) and to collect data and 
fees on sales of certain securities self-reported by its members. The 
Commission preliminarily estimated that only 15 staff hours would be 
needed to adapt these processes to the requirements of this 
rulemaking.\157\ The Commission received no comments on these 
estimates.
---------------------------------------------------------------------------

    \157\ See Proposing Release, 69 FR at 4027.
---------------------------------------------------------------------------

    The Commission is revising one element of its initial burden 
estimates for NASD. The Commission originally proposed that NASD would 
be the covered SRO liable for Section 31 fees on covered sales 
resulting from exercises of physical delivery exchange-traded options. 
The Commission initially estimated that 25 hours of OCC and NASD staff 
would be required to develop a process whereby OCC would convey, and 
NASD would receive and report on its Form R31, data on covered sales 
resulting from exercises of physical delivery exchange-traded options. 
However, for reasons discussed above,\158\ this aspect of the proposal 
has been eliminated. Therefore, the Commission is reducing its estimate 
of NASD's initial development burden by 25 hours. In sum, the 
Commission now estimates that NASD's initial development burden for 
this rulemaking will be 65 staff hours (50 + 15).
---------------------------------------------------------------------------

    \158\ See supra Section II(B)(3).
---------------------------------------------------------------------------

d. Total Initial Development Burden
    The Commission estimates that the 14 respondents subject to the 
collection of information requirements of this rulemaking will incur a 
total one-time development burden of 1445 staff hours (280 hours for 
OCC and the options and security futures exchanges + 1100 for NSCC and 
the equities exchanges + 65 for NASD).
2. Ongoing Compliance Burden
    On an ongoing basis, covered SROs are required to submit to the 
Commission Form R31 within ten business days after the end of every 
month. Rule 31 requires a designated clearing agency to furnish to a 
covered SRO, upon request, the data in its possession needed by the SRO 
to complete Part I of Form R31. Each covered SRO also must submit 
payment for its fees and assessments by March 15 and September 30 of 
each year, although this requirement is established by Section 31 
itself and is merely reiterated in this rulemaking.

[[Page 41076]]

a. Designated Clearing Agencies
    Presently, NSCC clears transactions occurring on eight national 
securities exchanges while OCC also clears transactions occurring on 
eight exchanges.\159\ Equities trading volume is far larger than 
options trading volume. Therefore, the Commission believes that NSCC's 
monthly burden in tabulating the necessary data and providing it to the 
exchanges will be larger than OCC's burden. The NSCC Comment stated 
that NSCC's monthly operating costs following initial development of 
its processing systems would be minimal. Therefore, the Commission 
estimates that NSCC will incur an average monthly burden of 4 staff 
hours to provide the exchanges with the data for Part I of Form R31 
while OCC will incur an average monthly burden of 2 staff hours to 
provide data to the options and securities futures exchanges.
---------------------------------------------------------------------------

    \159\ Currently, three exchanges--CHX, NSX, and NYSE--trade only 
equity securities, which are cleared and settled by NSCC. Three 
exchanges--ISE, NQLX, and OneChicago--trade securities that are 
cleared and settled only by OCC. Five exchanges--Amex, BSE, CBOE, 
PCX, and Phlx--trade both equities and options, thus requiring the 
clearance and settlement services of both NSCC and OCC.
---------------------------------------------------------------------------

    In addition, the Commission anticipates that Rule 31 will impose 
additional financial resource burdens on NSCC. These resources will 
provide, among other things, CPU time, data storage, power, and systems 
maintenance. The Commission estimates that this burden will be $1000 
per month.
b. Covered Exchanges
    The covered exchanges also will incur burdens in fulfilling the 
requirement imposed by paragraph (b)(2) of Rule 31 to complete and 
submit to the Commission proposed Form R31 on a monthly basis. The 
Commission believes that an exchange's burden will be slightly larger 
if it trades both equities and options, since the exchange would have 
to coordinate inputs from both NSCC and OCC. Furthermore, the 
Commission believes that an exchange that trades only options or 
security futures would incur slightly less burden than an exchange that 
trades only equities, because all data on all of its covered sales of 
options should be obtainable from OCC and reported in Part I of Form 
R31. By contrast, a covered exchange that trades equities is more 
likely to have covered sales that must be reported in Parts II or III. 
The Commission preliminarily estimated that the ongoing monthly burden 
for the covered exchanges to complete and submit to the Commission Form 
R31 would be as follows:
     Two exchanges that trade only security futures and one 
exchange that trades only options: 0.5 hours/form.
     Four exchanges that trade only equities: 1.0 hours/form.
     Four exchanges that trade both equities and options: 1.5 
hours/form.
    The Commission is adopting these estimates as proposed, but with a 
minor adjustment due to the fact that since the Proposing Release was 
issued one exchange that previously traded only equities (BSE) now also 
trades options. Thus, the Commission estimates that the covered 
exchanges will incur a total of 12.0 burden hours \160\ to complete the 
Form R31 submissions required in a given month.
---------------------------------------------------------------------------

    \160\ This total of 12.0 burden hours is calculated as follows: 
(3 OCC-only exchanges x 0.5 hour/exchange = 1.5 hours) + (3 NSCC-
only exchanges x 1.0 hour/exchange = 3.0 hours) + (5 dual exchanges 
x 1.5 hours/exchange = 7.5 hours).
---------------------------------------------------------------------------

c. Covered Associations
    The Commission estimates that 2 NASD staff hours will be required 
to produce monthly reports from ACT and TRACS of all covered sales and 
to record those data on Form R31. The Commission estimates that 1 NASD 
staff hour will be required to aggregate and record in Part III of Form 
R31 data on covered sales that are self-reported by NASD members. The 
Commission estimates that the total monthly burden imposed on the NASD 
by proposal will be 3 staff hours (2 + 1). In the Proposing Release, 
the Commission initially estimated that NASD would incur a monthly 
burden of 4 staff hours to comply with Rule 31 and Form R31.\161\ This 
extra hour's difference was caused by the proposal to require NASD to 
record on its Form R31 data on covered sales resulting from exercises 
of physical delivery exchange-traded options. However, since the 
Commission has revised that proposal,\162\ NASD will no longer have 
this responsibility. Therefore, the Commission is lowering its estimate 
of NASD's monthly compliance burden from 4 staff hours to 3.
---------------------------------------------------------------------------

    \161\ See 69 FR at 4028.
    \162\ See supra Section II(B)(3).
---------------------------------------------------------------------------

d. Total Ongoing Monthly Burden
    In summary, the Commission believes that the total burden on the 14 
respondents for completing Form R31 for a single month will be 21.0 
staff hours (6.0 hours for two designated clearing agencies + 12.0 
hours for 11 covered exchanges + 3.0 hours for one covered 
association), or 252 staff hours per year (21.0 hours/month x 12 
months).\163\ This represents a reduction in the Commission's original 
estimate of 270 staff hours for the annual ongoing compliance burdens 
of Rule 31 and Form R31.\164\ The 18-hour difference results from 24 
fewer staff hours per year on the part of OCC and NASD for OCC to 
provide NASD with data on covered sales resulting from the exercise of 
physical delivery exchange-traded options, plus 6 staff hours per year 
due to the fact that BSE now trades both options and securities.
---------------------------------------------------------------------------

    \163\ In addition, the Commission estimates that one designated 
clearing agency, NSCC, will incur additional financial burdens of 
$1000 per month or $12,000 per year.
    \164\ See Proposing Release, 69 FR at 4028.
---------------------------------------------------------------------------

3. Temporary Rule 31T
    Temporary Rule 31T requires every covered SRO--by August 13, 2004--
to submit to the Commission a completed Form R31 for each of the months 
September 2003 to June 2004, inclusive.\165\ This will enable the 
Commission to obtain data on all covered sales and covered round turn 
transactions occurring in its FY2004 and to make any necessary 
adjustments to the amount that a covered SRO paid pursuant to the March 
15, 2004, due date. The Commission notes that the obligation of 
national securities exchanges and national securities associations to 
pay fees and assessments on securities transactions arises directly 
from Section 31 of the Exchange Act and would exist even in the absence 
of this rulemaking.
---------------------------------------------------------------------------

    \165\ The first Form R31 required by Rule 31 also is due by 
August 13, 2004 (the tenth business day of August) and will cover 
the month of July 2004.
---------------------------------------------------------------------------

    The Commission initially estimated that temporary Rule 31T would 
require each covered SRO to provide six Form R31 submissions.\166\ 
However, because Rule 31T is not being adopted until June 2004 and the 
Form 31 submissions required by the rule will not be due until August 
13, Rule 31T will now require covered SROs to provide ten historical 
Form R31 submissions (for September 2003 through June 2004, inclusive). 
In addition, various commenters, although not specifically addressing 
the Commission's hourly burden estimates, stated that compliance with 
temporary Rule 31T would be burdensome.\167\ In light of these comments 
and the expanded period that temporary Rule 31T will cover, the 
Commission is increasing the estimated burden on all respondents for 
temporary Rule 31T from 135 staff hours to 200 staff hours.
---------------------------------------------------------------------------

    \166\ See Proposing Release, 69 FR at 4028.
    \167\ See CHX Comment; NYSE Comment.

---------------------------------------------------------------------------

[[Page 41077]]

4. Total Burdens of Rules 31 and 31T
    In summary, the Commission estimates that the burdens imposed by 
new Rules 31 and 31T together before August 2004 will be 1645 staff 
hours. This figure represents the initial development burdens to be 
incurred by covered SROs and designated clearing agencies to establish 
new systems and procedures to comply with Rules 31 and 31T and to 
provide historical trading data going back to September 1, 2003. The 
Commission estimates that, after August 2004 (the first month that a 
Form R31 is due pursuant to Rule 31), the 14 respondents will incur 
annual burdens of 252 staff hours per year to comply with Rule 31 and 
Form R31.

E. Record Retention Period

    Rule 17a-1 under the Exchange Act \168\ requires national 
securities exchanges, national securities associations, and registered 
clearing agencies to preserve at least one copy of all documents, 
including all correspondence, memoranda, papers, books, notices, 
accounts, and other such records as shall be made or received by it in 
the course of its business as such and in the conduct of its self-
regulatory activity for a period of not less than five years, the first 
two years in an easily accessible place, subject to the destruction and 
disposition provisions of Rule 17a-6 under the Exchange Act.\169\
---------------------------------------------------------------------------

    \168\ 17 CFR 240.17a-1.
    \169\ 17 CFR 240.17a-6.
---------------------------------------------------------------------------

F. Request for Comments

    The Commission requests comment in order to:
     Evaluate whether the proposed collection of information is 
necessary for the proper performance of the functions of the 
Commission, including whether the information has practical utility;
     Evaluate the accuracy of the Commission's estimates of the 
burden of the proposed collection of information;
     Determine whether there are ways to enhance the quality, 
utility, and clarity of the information to be collected; and
     Evaluate whether there are ways to minimize the burden of 
the collection of information on the respondents, including through the 
use of automated collection techniques or other forms of information 
technology.
    Any member of the public may direct to the Commission any comments 
concerning the accuracy of these burden estimates and any suggestions 
for reducing the burdens. Persons who desire to submit comments on the 
collection of information requirements should direct their comments to 
OMB, Attention: Desk Officer for the Securities and Exchange 
Commission, Office of Information and Regulatory Affairs, Washington, 
DC 20503; and send a copy of the comments to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609, with reference to File No. S7-05-04. 
Requests for materials submitted to OMB by the Commission with regard 
to these collections of information should be in writing, refer to File 
No. S7-05-04, and be submitted to the Securities and Exchange 
Commission, Records Management, Office of Filings and Information 
Services, 450 Fifth Street, NW., Washington, DC 20549. Because OMB is 
required to make a decision concerning the collections of information 
between 30 and 60 days after publication, your comments are best 
assured of having their full effect if OMB receives them within 30 days 
of publication of this notice.

VIII. Consideration of Costs and Benefits

    To assist the Commission in its evaluation of the costs and 
benefits that might result from the proposal, commenters were requested 
to provide analysis and data relating to the costs and benefits. The 
Commission preliminarily identified certain costs and benefits 
associated with the new system for calculating and collection Section 
31 fees and assessments in the Proposing Release.\170\ The Commission 
requested comment on its preliminary analysis and asked specifically 
whether, in the commenters' view, the benefits justify the costs. One 
commenter argued that ``the benefits of retroactive implementation [of 
temporary Rule 31T] do not outweigh the costs of the work necessary to 
recertify the September to December 2003 submission'' of trade data 
supporting the Section 31 payment for that period.\171\ However, 
neither this commenter nor any other commenter provided any empirical 
data relating to the costs and benefits of this proposal. After 
carefully considering the comments received, the Commission concludes 
that the benefits of this proposal justify the costs that it will 
impose.
---------------------------------------------------------------------------

    \170\ See 69 FR at 4029-30.
    \171\ NASD Comment.
---------------------------------------------------------------------------

A. Benefits

    A primary benefit of this rulemaking is that the Commission will be 
able to obtain more accurate data on all covered sales and covered 
round turn transactions occurring in the U.S. securities markets. This 
data will facilitate the Commission's compliance with the 
Accountability Act, pursuant to which the Commission must prepare 
annual financial statements that are audited by an external auditor. 
The Commission's obligations under the Accountability Act begin in 
FY2004. To meet these obligations, the Commission must be able to 
demonstrate the accuracy of the payments collected by the Commission, 
including payments made by covered SROs pursuant to Section 31. The 
Commission believes that the trade data provided on Form R31 will yield 
the most accurate bases for their Section 31 payments. The Commission's 
annual audit, as required by the Accountability Act, necessitates that 
the Commission verify the amount of fees and assessments that it 
collects using the most accurate data available.
    A related benefit of this rulemaking is that the means by which the 
Commission derives a large source of its revenue will become more 
transparent and more easily subject to verification. These data are to 
be provided on a simple form. Requiring the covered SROs to report 
their trade data in this manner should improve the ability of an 
auditor or other interested person to understand the sources and 
calculation of Section 31 payments. The Commission believes, and the 
SIA agrees,\172\ that the public interest benefits when the Commission 
can demonstrate that it is properly carrying out the fiscal 
responsibilities assigned to it by Congress.
---------------------------------------------------------------------------

    \172\ See SIA Comment.
---------------------------------------------------------------------------

    Another benefit of this proposal is that the data used by the 
Commission to determine whether a fee rate adjustment is required 
pursuant to Section 31(j) of the Exchange Act \173\ will be more 
precise. Paragraph (j) requires the Commission to make an annual and 
(in some circumstances, a mid-year) adjustment to the fee rate. The 
data received on Form R31 should provide the Commission with more 
complete and more precise data on aggregate trading volumes that will 
assist the Commission in determining the appropriate fee rate.
---------------------------------------------------------------------------

    \173\ 15 U.S.C. 78ee(j).
---------------------------------------------------------------------------

B. Costs

    Rule 31 and Form R31 require covered SROs to provide the 
Commission, on a monthly basis beginning with the month of July 2004, 
data on their covered sales and covered round turn transactions. 
Temporary Rule 31T requires covered SROs to provide the Commission with 
Form R31

[[Page 41078]]

submissions for the months of September 2003 until June 2004, 
inclusive. As discussed above, this rulemaking will cause the covered 
SROs and designated clearing agencies to incur certain paperwork costs 
in tabulating and reporting to the Commission the data required by Form 
R31.\174\ The Commission estimates that the covered SROs and designated 
clearing agencies will incur a burden of 1445 staff hours for initial 
development, 252 staff hours per year to submit Form R31 on a monthly 
basis, and 200 staff hours to comply with temporary Rule 31T. The 
Commission also estimates that one designated clearing agency, NSCC, 
will incur a monthly financial cost of $1000 for systems maintenance to 
comply with Rule 31.
---------------------------------------------------------------------------

    \174\ See supra Section VII.
---------------------------------------------------------------------------

    In addition, the Commission believes that certain covered exchanges 
may incur additional costs to develop new methods for allocating 
Section 31 fees among their members.\175\ NYSE and Amex require their 
members to self-report the aggregate dollar amount of their covered 
sales and the corresponding Section 31 fees due based on that volume. 
The other equities exchanges impose fees on their members based on the 
sales of securities that the exchange reports to the consolidated tape. 
Since the rules adopted here base the calculation of Section 31 fees 
largely on clearing data, either or both of the existing methods for 
allocating Section 31 fees among members of the equities exchanges 
could yield an amount that differs from that calculated by the 
Commission pursuant to Rule 31. A covered exchange that seeks to ensure 
that the amount paid to the Commission is as close as possible to the 
amount collected from its members might wish to develop new procedures 
to subdivide Section 31 fees among its members. Any new rule to 
implement such a procedure would have to be filed as a rule change 
pursuant to Section 19(b) of the Exchange Act.\176\
---------------------------------------------------------------------------

    \175\ See NYSE Comment (stating that NYSE would have to amend 
its Rule 440H).
    \176\ 15 U.S.C. 78s(b).
---------------------------------------------------------------------------

    To assist a covered exchange in dividing the fee equitably among 
its members, the exchange could request that NSCC subdivide the data by 
exchange member so that the exchange can pass to each member its 
accurate pro rata portion of the total exchange fee. While subdividing 
the data in this manner is not required by Rule 31, the Commission 
anticipates that covered exchanges may elect to establish such 
arrangements to collect from their members only the precise amount that 
the Commission bills them under Rule 31.
    The Commission notes that this proposal does not impose new costs 
on covered SROs in the form of higher fees or assessments. The target 
amounts that the Commission should collect under Section 31 are set by 
statute; the rules approved today establish a procedure for the 
Commission to use to calculate the fees and assessments from each 
covered SRO.

IX. Regulatory Flexibility Act

    Pursuant to Section 605(b) of the Regulatory Flexibility Act,\177\ 
the Commission certified that Rules 31 and 31T and Form R31 will not 
have a significant economic impact on a substantial number of small 
businesses. This certification, including the reasons supporting the 
certification, were set forth in the Proposing Release.\178\ The 
Commission solicited comments on the potential impact of Rules 31 and 
31T and Form R31 on small entities in the Proposing Release. 
Specifically, the Commission requested that commenters describe the 
nature of any impact on small businesses and provide empirical data to 
support the extent of the impact. The Commission received no comments 
on this certification and is adopting it as proposed.
---------------------------------------------------------------------------

    \177\ 5 U.S.C. 605(b).
    \178\ See 69 FR at 4030.
---------------------------------------------------------------------------

X. Statutory Authority

    Rules 31 and 31T under the Exchange Act are adopted pursuant to 15 
U.S.C. 78a et seq., particularly Sections 6, 15A, 17A, 19, 23(a), and 
31 of the Exchange Act (15 U.S.C. 78f, 78o-3, 78q-1, 78s, 78w(a), and 
78ee).

List of Subjects

17 CFR Part 200

    Administrative practice and procedure, Authority delegations 
(Government agencies).

17 CFR Parts 240 and 249

    Reporting and recordkeeping requirements, Securities.

Text of Final Rule

0
For the reasons set out in the preamble, the Commission is amending 
Title 17, Chapter II of the Code of Federal Regulations as follows:

PART 200--ORGANIZATION; CONDUCT AND ETHICS; AND INFORMATION AND 
REQUESTS

0
1. The authority citation for part 200 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77s, 77o, 77sss, 78d, 78d-1, 78d-2, 78w, 
78ll(d), 78mm, 79t, 80a-37, 80b-11, and 7202, unless otherwise 
noted.


0
2. Section 200.30-3 is amended by adding new paragraph (a)(82) as 
follows:


Sec.  200.30-3  Delegation of authority to Director of Division of 
Market Regulation.

* * * * *
    (a) * * *
    (82) To calculate the amount of fees and assessments due from 
covered SROs based on the trade data that the covered SROs submit on 
Form R31 (17 CFR 249.11) and to issue Section 31 bills to covered SROs, 
in consultation with the Executive Director and the Chief Economist, 
pursuant to Rules 31 and 31T of this chapter (17 CFR 240.31 and 
240.31T).
* * * * *

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

0
3. The authority citation for part 240 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 
78w, 78x, 78ll, 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-
3, 80b-4, 80b-11, and 7201 et seq.; and 18 U.S.C. 1350, unless 
otherwise noted.
* * * * *

0
4. Section 240.31-1 is removed.

0
5. Section 240.31 is added to read as follows:


Sec.  240.31  Section 31 transaction fees.

    (a) Definitions. For the purpose of this section, the following 
definitions shall apply:
    (1) Assessment charge means the amount owed by a covered SRO for a 
covered round turn transaction pursuant to section 31(d) of the Act (15 
U.S.C. 78ee(d)).
    (2) Billing period means, for a single calendar year:
    (i) January 1 through August 31 (``billing period 1''); or
    (ii) September 1 through December 31 (``billing period 2'').
    (3) Charge date means the date on which a covered sale or covered 
round turn transaction occurs for purposes of determining the liability 
of a covered SRO pursuant to section 31 of the Act (15 U.S.C. 78ee). 
The charge date is:
    (i) The settlement date, with respect to any covered sale (other 
than a covered sale resulting from the exercise of an option settled by 
physical delivery or from the maturation of a security future settled 
by physical delivery) or

[[Page 41079]]

covered round turn transaction that a covered SRO is required to report 
to the Commission based on data that the covered SRO receives from a 
designated clearing agency;
    (ii) The exercise date, with respect to a covered sale resulting 
from the exercise of an option settled by physical delivery;
    (iii) The maturity date, with respect to a covered sale resulting 
from the maturation of a security future settled by physical delivery; 
and
    (iv) The trade date, with respect to all other covered sales and 
covered round turn transactions.
    (4) Covered association means any national securities association 
by or through any member of which covered sales or covered round turn 
transactions occur otherwise than on a national securities exchange.
    (5) Covered exchange means any national securities exchange on 
which covered sales or covered round turn transactions occur.
    (6) Covered sale means a sale of a security, other than an exempt 
sale or a sale of a security future, occurring on a national securities 
exchange or by or through any member of a national securities 
association otherwise than on a national securities exchange.
    (7) Covered round turn transaction means a round turn transaction 
in a security future, other than a round turn transaction in a future 
on a narrow-based security index, occurring on a national securities 
exchange or by or through a member of a national securities association 
otherwise than on a national securities exchange.
    (8) Covered SRO means a covered exchange or covered association.
    (9) Designated clearing agency means a clearing agency registered 
under section 17A of the Act (15 U.S.C. 78q-1) that clears and settles 
covered sales or covered round turn transactions.
    (10) Due date means:
    (i) March 15, with respect to the amounts owed by covered SROs 
under section 31 of the Act (15 U.S.C. 78ee) for covered sales and 
covered round turn transactions having a charge date in billing period 
2; and
    (ii) September 30, with respect to the amounts owed by covered SROs 
under section 31 of the Act (15 U.S.C. 78ee) for covered sales and 
covered round turn transactions having a charge date in billing period 
1.
    (11) Exempt sale means:
    (i) Any sale of a security offered pursuant to an effective 
registration statement under the Securities Act of 1933 (except a sale 
of a put or call option issued by the Options Clearing Corporation) or 
offered in accordance with an exemption from registration afforded by 
section 3(a) or 3(b) of the Securities Act of 1933 (15 U.S.C. 77c(a) or 
77c(b)), or a rule thereunder;
    (ii) Any sale of a security by an issuer not involving any public 
offering within the meaning of section 4(2) of the Securities Act of 
1933 (15 U.S.C. 77d(2));
    (iii) Any sale of a security pursuant to and in consummation of a 
tender or exchange offer;
    (iv) Any sale of a security upon the exercise of a warrant or right 
(except a put or call), or upon the conversion of a convertible 
security;
    (v) Any sale of a security that is executed outside the United 
States and is not reported, or required to be reported, to a 
transaction reporting association as defined in Sec.  240.11Aa3-1 and 
any approved plan filed thereunder;
    (vi) Any sale of an option on a security index (including both a 
narrow-based security index and a non-narrow-based security index);
    (vii) Any sale of a bond, debenture, or other evidence of 
indebtedness; and
    (viii) Any recognized riskless principal sale.
    (12) Fee rate means the fee rate applicable to covered sales under 
section 31(b) or (c) of the Act (15 U.S.C. 78ee(b) or (c)), as adjusted 
from time to time by the Commission pursuant to section 31(j) of the 
Act (15 U.S.C. 78ee(j)).
    (13) Narrow-based security index means the same as in section 
3(a)(55)(B) and (C) of the Act (15 U.S.C. 78c(a)(55)(B) and (C)).
    (14) Recognized riskless principal sale means a sale of a security 
where all of the following conditions are satisfied:
    (i) A broker-dealer receives from a customer an order to buy (sell) 
a security;
    (ii) The broker-dealer engages in two contemporaneous offsetting 
transactions as principal, one in which the broker-dealer buys (sells) 
the security from (to) a third party and the other in which the broker-
dealer sells (buys) the security to (from) the customer; and
    (iii) The Commission, pursuant to section 19(b)(2) of the Act (15 
U.S.C. 78s(b)(2)), has approved a proposed rule change submitted by the 
covered SRO on which the second of the two contemporaneous offsetting 
transactions occurs that permits that transaction to be reported as 
riskless.
    (15) Round turn transaction in a security future means one purchase 
and one sale of a contract of sale for future delivery.
    (16) Physical delivery exchange-traded option means a securities 
option that is listed and registered on a national securities exchange 
and settled by the physical delivery of the underlying securities.
    (17) Section 31 bill means the bill sent by the Commission to a 
covered SRO pursuant to section 31 of the Act (15 U.S.C. 78ee) showing 
the total amount due from the covered SRO for the billing period, as 
calculated by the Commission based on the data submitted by the covered 
SRO in its Form R31 (Sec.  249.11 of this chapter) submissions for the 
months of the billing period.
    (18) Trade reporting system means an automated facility operated by 
a covered SRO used to collect or compare trade data.
    (b) Reporting of covered sales and covered round turn transactions.
    (1) Each covered SRO shall submit a completed Form R31 (Sec.  
249.11 of this chapter) to the Commission within ten business days 
after the end of each month.
    (2) A covered exchange shall provide on Form R31 the following data 
on covered sales and covered round turn transactions occurring on that 
exchange and having a charge date in that month:
    (i) The aggregate dollar amount of covered sales that it reported 
to a designated clearing agency, as reflected in the data provided by 
the designated clearing agency;
    (ii) The aggregate dollar amount of covered sales resulting from 
the exercise of physical delivery exchange-traded options or from 
matured security futures, as reflected in the data provided by a 
designated clearing agency that clears and settles options or security 
futures;
    (iii) The aggregate dollar amount of covered sales that it captured 
in a trade reporting system but did not report to a designated clearing 
agency;
    (iv) The aggregate dollar amount of covered sales that it neither 
captured in a trade reporting system nor reported to a designated 
clearing agency; and
    (v) The total number of covered round turn transactions that it 
reported to a designated clearing agency, as reflected in the data 
provided by the designated clearing agency.
    (3) A covered association shall provide on Form R31 the following 
data on covered sales and covered round turn transactions occurring by 
or through any member of such association otherwise than on a national 
securities exchange and having a charge date in that month:
    (i) The aggregate dollar amount of covered sales that it captured 
in a trade reporting system;
    (ii) The aggregate dollar amount of covered sales that it did not 
capture in a trade reporting system; and

[[Page 41080]]

    (iii) The total number of covered round turn transactions that it 
reported to a designated clearing agency, as reflected in the data 
provided by the designated clearing agency.
    (4) Duties of designated clearing agency.
    (i) A designated clearing agency shall provide a covered SRO, upon 
request, the data in its possession needed by the covered SRO to 
complete Part I of Form R31 (Sec.  249.11 of this chapter).
    (ii) If a covered exchange trades physical delivery exchange-traded 
options or security futures that settle by physical delivery of the 
underlying securities, the designated clearing agency that clears and 
settles such transactions shall provide that covered exchange with the 
data in its possession relating to the covered sales resulting from the 
exercise of such options or from the matured security futures. If, 
during a particular month, the designated clearing agency cannot 
determine the covered exchange on which the options or security futures 
originally were traded, the designated clearing agency shall assign 
covered sales resulting from exercises or maturations as follows. To 
provide Form R31 data to the covered exchange for a particular month, 
the designated clearing agency shall:
    (A) Calculate the aggregate dollar amount of all covered sales in 
the previous calendar month resulting from exercises and maturations, 
respectively, occurring on all covered exchanges for which it clears 
and settles transactions;
    (B) Calculate, for the previous calendar month, the aggregate 
dollar amount of covered sales of physical delivery exchange-traded 
options occurring on each covered exchange for which it clears and 
settles transactions, and the aggregate dollar amount of covered sales 
of physical delivery exchange-traded options occurring on all such 
exchanges collectively;
    (C) Calculate, for the previous calendar month, the total number of 
covered round turn transactions in security futures that settle by 
physical delivery that occurred on each covered exchange for which it 
clears and settles transactions, and the total number of covered round 
turn transactions in security futures that settle by physical delivery 
that occurred on all such exchanges collectively;
    (D) Determine for the previous calendar month each covered 
exchange's percentage of the total dollar volume of physical delivery 
exchange-traded options (``exercise percentage'') and each covered 
exchange's percentage of the total number of covered round turn 
transactions in security futures that settle by physical delivery 
(``maturation percentage''); and
    (E) In the current month, assign to each covered exchange for which 
it clears and settles covered sales the exercise percentage of the 
aggregate dollar amount of covered sales on all covered exchanges 
resulting from the exercise of physical delivery exchange-traded 
options and the maturation percentage of all covered sales on all 
covered exchanges resulting from the maturation of security futures 
that settle by physical delivery.
    (5) A covered SRO shall provide in Part I of Form R31 only the data 
supplied to it by a designated clearing agency.
    (c) Calculation and billing of section 31 fees.
    (1) The amount due from a covered SRO for a billing period, as 
reflected in its Section 31 bill, shall be the sum of the monthly 
amounts due for each month in the billing period.
    (2) The monthly amount due from a covered SRO shall equal:
    (i) The aggregate dollar amount of its covered sales that have a 
charge date in that month, times the fee rate; plus
    (ii) The total number of its covered round turn transactions that 
have a charge date in that month, times the assessment charge.
    (3) By the due date, each covered SRO shall pay the Commission, 
either directly or through a designated clearing agency acting as 
agent, the entire amount due for the billing period, as reflected in 
its Section 31 bill.

0
6. Section 240.31T is added to read as follows:


Sec.  240.31T  Temporary rule regarding fiscal year 2004.

    (a) Definitions.
    (1) For the purpose of this section, the following definitions 
shall apply:
    (i) FY2004 adjustment amount means the FY2004 recalculated amount 
minus the FY2004 prepayment amount.
    (ii) FY2004 prepayment amount means the total dollar amount of fees 
and assessments paid by a covered SRO pursuant to the March 15, 2004, 
due date for covered sales and covered round turn transactions having a 
charge date between September 1, 2003, and December 31, 2003, 
inclusive.
    (iii) FY2004 recalculated amount means the total dollar amount of 
fees and assessments owed by a covered SRO for covered sales and 
covered round turn transactions having a charge date between September 
1, 2003, and December 31, 2003, inclusive, as calculated by the 
Commission based on the data submitted by the covered SRO in its Form 
R31 (Sec.  249.11 of this chapter) submissions for September 2003, 
October 2003, November 2003, and December 2003, and indicated on a 
Section 31 bill for these months.
    (2) Any term used in this section that is defined in Sec.  
240.30(a) of this chapter shall have the same meaning as in Sec.  
240.30(a) of this chapter.
    (b) By August 13, 2004, each covered SRO shall submit to the 
Commission a completed Form R31 for each of the months September 2003 
to June 2004, inclusive.
    (c) If the FY2004 adjustment amount of a covered SRO is a positive 
number, the covered SRO shall include the FY2004 adjustment amount with 
the payment for its next Section 31 bill.
    (d) If the FY2004 adjustment amount is a negative number, the 
Commission shall credit the FY2004 adjustment amount to the covered 
SRO's next Section 31 bill.
    (e) Notwithstanding paragraph (a)(1)(iii) of this section, any 
covered exchange that as of August 2003 was calculating its Section 31 
fees based on the trade date of its covered sales shall not include on 
its September 2003 Form R31 data for any covered sale having a trade 
date before September 1, 2003.
    (f) This temporary section shall expire on January 1, 2005.

PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934

0
7. The authority citation for part 249 continues to read in part as 
follows:

    Authority: 15 U.S.C. 78a et seq. and 7201 et seq.; and 18 U.S.C. 
1350, unless otherwise noted.
* * * * *

0
8. Section 249.11 and Form R31 (referenced in Sec.  249.11) are added 
to read as follows:


Sec.  249.11  Form R31 for reporting covered sales and covered round 
turn transactions under section 31 of the Act.

    This form shall be used by each national securities exchange to 
report to the Commission within ten business days after the end of 
every month the aggregate dollar amount of sales of securities that 
occurred on the exchange, had a charge date in the month of the report, 
and are subject to fees pursuant to section 31(b) of the Act (15 U.S.C. 
78ee) and Sec.  240.31 of this chapter; and the total number of round 
turn transactions in security futures that occurred on the exchange, 
had a charge date in the month of the report, and are subject to 
assessments pursuant to section 31(d) of the Act and Sec.  240.31 of 
this chapter. This form also shall be used by a national securities 
association to report to the Commission within ten

[[Page 41081]]

business days after the end of every month the aggregate dollar amount 
of sales of securities that occurred by or through a member of the 
association otherwise than on a national securities exchange, had a 
charge date in the month of the report, and are subject to fees 
pursuant to section 31(c) of the Act and Sec.  240.31 of this chapter; 
and the total number of round turn transactions in security futures 
that occurred by or through any member of the association otherwise 
than on a national securities exchange, had a charge date in the month 
of the report, and are subject to assessments pursuant to section 31(d) 
of the Act and Sec.  240.31 of this chapter.

    Note: The text of Form R31 does not, and this amendment will 
not, appear in the Code of Federal Regulations.

BILLING CODE 8010-01-P

[[Page 41082]]

[GRAPHIC] [TIFF OMITTED] TR07JY04.009


[[Page 41083]]


[GRAPHIC] [TIFF OMITTED] TR07JY04.010


[[Page 41084]]


[GRAPHIC] [TIFF OMITTED] TR07JY04.011


[[Page 41085]]


[GRAPHIC] [TIFF OMITTED] TR07JY04.012


[[Page 41086]]


[GRAPHIC] [TIFF OMITTED] TR07JY04.013


[[Page 41087]]


[GRAPHIC] [TIFF OMITTED] TR07JY04.014


    By the Commission.

    Dated: June 28, 2004.
Jill M. Peterson,
Assistant Secretary.
[FR Doc. 04-15081 Filed 7-6-04; 8:45 am]
BILLING CODE 8010-01-C