[Federal Register Volume 69, Number 184 (Thursday, September 23, 2004)]
[Notices]
[Pages 57113-57116]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-21371]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-50409; File No. SR-NASD-2004-137]


Self-Regulatory Organizations; Notice of Filing and Order 
Granting Accelerated Approval of Proposed Rule Change by National 
Association of Securities Dealers, Inc. Relating to Amendments to the 
OATS Rules To Require That ECNs Capture Routed Order Identifier 
Information

September 17, 2004.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on September 13, 2004, the National Association of Securities Dealers, 
Inc. (``NASD'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I and II below, which Items have been prepared by NASD. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons. For the reasons discussed 
below, the Commission is granting accelerated approval of the proposed 
rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NASD is proposing to amend NASD Rule 6954 to require that 
electronic communications networks (``ECNs'') that electronically 
receive routed orders capture and report the transmitting member's 
unique identifier (routed order identifier) to NASD's Order Audit Trail 
System (``OATS''). Below is the text of the proposed rule change. 
Proposed new language is in italics; proposed deletions are in 
brackets.
* * * * *

NASD Systems and Programs

6950. Order Audit Trail System
6951 through 6953 No. Change.
6954. Recording of Order Information
    (a) and (b) No Change.
    (c) Order Transmittal.
    Order information required to be recorded under this Rule when an 
order is transmitted included the following.
    (1) and (2) No Change.
    (3) When a member electronically transmits an order for execution 
on an Electronic Communications Network:
    (A) No Change.
    (B) the receiving Reporting Member operating the Electronic 
Communications Network shall record:
    (i) the fact that the order was received by an Electronic 
Communications Network,
    (ii) the order identifier assigned to the order by the member that 
transmits the order,
    (iii) [(ii)] the market participant symbol assigned by the 
Association to the transmitting Reporting Member, and
    (iv) [(iii)] other information items in Rule 6954(b) that apply 
with respect to such order, which must include information items (1), 
(2), (3), (6), (7), (8), (10), (11), (12), (13), (15), and (16).
    (4) through (6) No Change.
    (d) No Change.
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, NASD included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed

[[Page 57114]]

rule change. The text of these statements may be examined at the places 
specified in Item III below. NASD has prepared summaries, set forth in 
Sections A, B, and C below, of the most significant aspects of such 
statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose

Background

    On March 6, 1998, the SEC approved NASD Rules 6950 through 6957 
(``OATS Rules'').\3\ OATS provides a substantially enhanced body of 
information regarding orders and transactions that the NASD believes 
improves its ability to conduct surveillance and investigations of 
member firms for potential violations of NASD rules and the federal 
securities laws. In addition, OATS is intended to fulfill one of the 
undertakings contained in the order issued by the SEC relating to the 
settlement of an enforcement action against the NASD for failure to 
adequately enforce its rules.\4\ Pursuant to the SEC Order, OATS is 
required, at a minimum, to: (1) Provide an accurate, time-sequenced 
record of orders and transactions, beginning with the receipt of an 
order at the first point of contact between the broker/dealer and the 
customer or counterparty and further documenting the life of the order 
through the process of execution; and (2) provide for market-wide 
synchronization of clocks used in connection with the recording of 
market events.\5\
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    \3\ See Securities Exchange Act Release No. 39729 (March 6, 
1998), 63 FR 12559 (March 13, 1998).
    \4\ See In the Matter of National Association of Securities 
Dealers, Inc., Exchange Act Release No. 37538 (August 8, 1996); 
Administrative Proceeding File No. 3-9056 (``SEC Order'').
    \5\ Id.
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    Since the implementation of OATS, NASD represents that its staff 
has been closely reviewing OATS activities with the goal of identifying 
ways in which to improve OATS and enhance the effectiveness of OATS as 
a regulatory tool. In this regard, NASD identified several changes to 
OATS that it believed would enhance NASD's automated surveillance for 
compliance with trading and market making rules such as the NASD's 
Limit Order Protection Interpretation, the SEC's Order Handling Rules 
and a member firm's best execution obligations. NASD proposed these 
changes in SR-NASD-00-23, which remains pending at the SEC.\6\
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    \6\ See Securities Exchange Act Release No. 43344 (September 26, 
2000), 65 FR 59038 (October 3, 2000). As currently proposed, SR-
NASD-00-23 generally would: (1) Provide that the time of order 
origination and receipt for an electronic order is the time the 
order is captured by a member's electronic order-routing or 
execution system; for a manual order that is fewer than 10,000 
shares, the time of order origination and receipt is the time the 
order is received by the member's trading desk or trading department 
for execution or routing purposes; and for a manual order that is 
10,000 shares or greater, the time of order origination and receipt 
is the time the order is received by the member from the customer; 
(2) exclude certain members from the definition of ``Reporting 
Member'' for those orders that meet specified conditions and are 
recorded and reported to the OATS by another member; (3) require any 
receiving reporting member, including ECNs, that receive, 
electronically or manually, routed orders, to capture and report a 
routed order identifier; and (4) permit NASD to grant exemptive 
relief from the OATS reporting requirements for manual orders to 
members that meet specified criteria.
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    Pursuant to discussions with SEC staff, NASD now is proposing 
separately a portion of one of the proposed changes in SR-NASD-00-23, 
specifically the proposed change to require ECNs that electronically 
receive routed orders to capture and report a routed order identifier. 
SR-NASD-00-23, in part, proposes to require that any receiving 
reporting member, including ECNs, that receive routed orders, 
electronically or manually, capture and report a routed order 
identifier.\7\ This rule filing is intended to withdraw the portion of 
that proposal in SR-NASD-00-23 that would require ECNs to capture and 
report a routed order identifier for electronic orders and is proposing 
it herein. SR-NASD-00-23 would continue to propose that any receiving 
reporting member, including ECNs, capture and report a routed order 
identifier for manual orders that it receives.
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    \7\ Currently, a routed order identifier is only required to be 
captured for routed orders received electronically by Reporting 
Members that are not ECNs.
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Description of Proposal

    The use of a routed order identifier reported through OATS permits 
NASD to track the history of orders routed between firms on an 
automated basis. If the order does not contain a routed order 
identifier, the order cannot be linked on an automated basis to 
subsequent actions, such as further routing or execution by other firms 
or Nasdaq systems. Given the current level of participation of ECNs in 
the trading of Nasdaq securities, NASD represents that the lack of a 
routed order identifier for these electronic orders results in NASD 
staff having to recreate manually the lifecycle history for a 
substantial number of orders. Accordingly, NASD is proposing that ECNs 
that electronically receive routed orders capture and report a routed 
order identifier. To provide members adequate time for any 
technological or system changes required by the proposed rule change, 
NASD is proposing an implementation date for this proposed requirement 
of 90 days following publication of a Notice to Members, which will be 
published no later than 60 days from the date of this approval order.
2. Statutory Basis
    NASD believes that the proposed rule change is consistent with the 
provisions of section 15A(b)(6) of the Act, which requires, among other 
things, that NASD's rules be designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest.\8\ NASD believes that the proposed rule change will 
enhance NASD's ability to conduct surveillance and investigations of 
member firms for violations of NASD's and other applicable rules.
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    \8\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

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

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    Written comments on the proposed rule change were solicited by the 
Commission in response to SR-NASD-00-23, which proposed several changes 
relating to OATS requirements.\9\ The Commission received 13 comment 
letters from 12 commenters in response to the Federal Register 
publication of SR-NASD-00-23.\10\ The proposed rule change described in 
this filing relates to only a portion of one of the four proposals in 
SR-NASD-00-23, specifically, the proposal that would require that ECNs 
that electronically receive routed orders capture and report a routed 
order identifier. The comments on that proposal are summarized below.
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    \9\ See supra note 6.
    \10\ Comment letters were submitted by the following: Krys Boyle 
Freedman & Sawyer, P.C. on behalf of Rocky Mountain Securities & 
Investments, Inc.; Mitchell Securities Corporation of Oregon; Storch 
& Brenner, LLP; A.G. Edwards & Sons, Inc.; Instinet Corporation; 
First Options of Chicago; Morgan Stanley Dean Witter; Securities 
Industry Association, Ad Hoc Committee; Weeden & Co., L.P.; 
Financial Information Forum; Pershing Division of Donaldson, Lufkin 
& Jenrette Securities Corporation; and two letters submitted by 
Wachtel & Co., Inc.

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[[Page 57115]]

    While a number of commenters opposed the proposed requirement in 
SR-NASD-00-23 that members be required to capture and report a routed 
order identifier for orders routed manually, only one commenter, 
Instinet Corporation (``Instinet''), specifically opposed the proposed 
requirement to capture and report a routed order identifier for orders 
routed electronically to ECNs. Among other things, Instinet noted that 
the original OATS proposal expressly excluded ECNs from the routed 
order identifier requirements in acknowledgment of the unique 
characteristics of ECNs and the significant unmerited operation burdens 
such requirements would impose on ECNs. Instinet indicated that to add 
a routed order identifier field would require reconfigurement of 
thousands of customer interfaces and redesign of the framework of the 
existing brokerage mechanisms. Further, requiring ECN customers to 
input a routed order identifier would impede speed, efficiency and 
innovation and is not counterbalanced by any regulatory benefit.
    The use of a routed order identifier reported through OATS permits 
NASD to track the history of orders routed between firms on an 
automated basis. If the order does not contain a routed order 
identifier, the order cannot be linked on an automated basis to 
subsequent actions, such as further routing or execution by other firms 
or Nasdaq systems. As noted in the Purpose section of this filing, 
given the current level of participation of ECNs in the trading of 
Nasdaq securities, the lack of a routed order identifier for these 
electronic orders results in NASD staff having to recreate manually the 
lifecycle history for a substantial number of orders.
    Subsequent to the submission of its comment letter, Instinet 
changed its business model and is no longer operating as an ECN.\11\ 
Accordingly, as a non-ECN broker/dealer, Instinet is required under 
current OATS rules to capture routed order identifier information for 
electronic orders. On July 13, 2004, NASD staff spoke with a 
representative from Instinet, who indicated that the concerns raised in 
its October 25, 2000 letter are no longer an issue for Instinet, given 
its change in business model. In addition, on August 30, 2004, NASD 
staff discussed the proposal with a representative from Inet who 
indicated that the proposed requirement to capture a routed order 
identifier for electronic orders would required technological changes 
to Inet's current systems but would not be overly burdensome if 
adequate time is provided for implementation. Accordingly, NASD 
believes that any burdens that do exist are outweighed by the 
regulatory benefits of capturing the lifecycle of these orders on an 
automated basis and is therefore proposing the rule change described 
herein.
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    \11\ In September 2002, Instinet merged with The Island ECN, 
Inc. (Island ECN). As part of the merger, Instinet's ECN business 
migrated to Inet ATS, Inc. (Inet), which formerly was Island ECN.
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III. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number SR-NASD-2004-137 on the subject line.

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 SR-NASD-2004-137. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission 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/sro.shtml). Copies of the submission, all subsequent amendments, 
all written statements with respects to the proposed rule change that 
are filed with the Commission, and all written communications relating 
to the proposed rule change between the Commission and any person, 
other than those that may be withheld from the public in accordance 
with the provisions of 5 U.S.C. 552, will be available for inspection 
and copying in the Commission's Public Reference Section, 450 Fifth 
Street, NW., Washington, DC 20549. Copies of such filing also will be 
available for inspection and copying at the principal offices of the 
NASD. All comments received will be posted without change; the 
Commission does not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly. All submissions should refer to File Number SR-
NASD-2004-137 and should be submitted on or before October 14, 2004.

IV. Commission's Findings and Order Granting Accelerated Approval of 
Proposed Rule Change

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder applicable to a national securities association.\12\ In 
particular, the Commission finds that proposed rule change is 
consistent with section 15A(b)(6) of Act, which requires, among other 
things, that NASD's rules be designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest.\13\ Specifically, the Commission believes that the 
proposed rule change should enhance OATS information and improve NASD's 
ability to conduct effective surveillance and timely investigations 
relating to compliance with NASD and other applicable rule in an 
efficient manner.
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    \12\ In approving this proposed rule change, the Commission has 
considered its impact on efficiency, competition and capital 
formation. 15 U.S.C. 78c(f).
    \13\ 15 US.C. 78o-3(b)(6).
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    The Commission notes that Instinet commented on this proposed 
change in response to the notice of SR-NASD-00-23.\14\ At that time, 
Instinet argued that the proposal to require ECNs to capture and report 
a routed order identifier for orders routed electronically to ECNs 
would cause significant unmerited operational burdens to be placed on 
ECNs and that requiring ECN customers to input a routed order 
identifier would impede speed, efficiency, and innovation.
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    \14\ See note 6, supra.
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    Since that time, given recent changes in the Nasdaq market, NASD 
represents that its inability, without a routed order identifier, to 
link an order to an automated basis to subsequent action requires NASD 
staff to recreate manually the lifecycle history for the significant 
number of ECN orders. Consequently, NASD contacted Instinet to discuss 
Instinet's concerns raised by the proposed rule change. According to 
NASD, Instinet explained that as it was no longer operating as an ECN, 
the concerns it expressed previously no longer applied it. NASD next 
spoke with

[[Page 57116]]

representatives of Inet,\15\ about the issues originally raised by 
Instinet. Again according to NASD, while Inet explained that the 
proposed requirements to capture a routed order identifier for 
electronic orders would require the ECN to make technological changes, 
it did not believe these changes would be overly burdensome as long as 
NASD allowed an adequate implementation period. Accordingly, the 
Commission believes that the regulatory benefits to be derived from the 
greater automation provided by the proposed rule change should outweigh 
the burden imposed on ECNs.
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    \15\ See note, 11, supra.
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    Because this proposal was previously noticed for public comment as 
part of NASD-00-23,\16\ and, as described above, NASD has adequately 
responded to comments received on the proposal, the Commission finds 
good cause, pursuant to section 19(b)(2) of the Act,\17\ for approving 
the proposed rule change prior to the thirtieth day after the date of 
publication of notice thereof in the Federal Register. The proposed 
rule change will be become effective 90 days following publication of a 
Notice to Members, which will be published no later than 60 days from 
the date of this approval order.
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    \16\ See note 6, supra.
    \17\ 15 U.S.C. 78s(b)(2).
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V. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\18\ that the proposed rule change (SR-NASD-2004-137) is hereby 
approved on an accelerated basis.
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    \18\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\19\
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    \19\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-21371 Filed 9-22-04; 8:45 am]
BILLING CODE 8010-01-M