[Federal Register Volume 65, Number 230 (Wednesday, November 29, 2000)]
[Notices]
[Pages 71174-71182]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-30452]


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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-43616; File No. SR-NASD-99-65]


Self-Regulatory Organizations; Notice of Filing of Amendment Nos. 
2 and 3 to Proposed Rule Change by the National Association of 
Securities Dealers, Inc. Relating to the Creation of a Corporate Bond 
Trade Reporting and Transaction Dissemination Facility and the 
Elimination of Nasdaq's Fixed Income Pricing System

November 24, 2000.
    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 November 17, 2000 and November 22, 2000, the National Association of 
Securities Dealers, Inc. (``NASD'' or ``Association'') filed with the 
Securities and Exchange Commission (``SEC'' or ``Commission'') 
Amendment Nos. 2 and 3 to the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by the NASD. 
The proposed rule change was published for comment in the Federal 
Register on December 10, 1999.\3\ The Commission is publishing this 
notice to solicit comments on Amendment Nos. 2 and 3 to the proposed 
rule change from interested persons.\4\
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 42201 (Dec. 3, 
1999), 64 FR 69305.
    \4\ The NASD previously submitted Amendment No. 1 to reflect the 
Association's receipt of written comments from the Regional 
Municipal Operations Association. After consultation with the 
Commission staff, the NASD withdrew Amendment No. 1 and has 
incorporated RMOA's comments and the NASD's response in Amendment 
No. 2. As explained in the original proposal, the NASD represents 
that it will file a separate proposal to establish appropriate fees 
and charges for TRACE prior to implementation.
---------------------------------------------------------------------------

    Amendment No. 2 reflects certain changes proposed by the commenters 
in response to the proposed rule change, as originally noticed, or 
changes suggested by the NASD staff after additional review. Amendment 
No. 3 sets forth the statutory basis of the proposed rule change. For 
convenience, the proposed NASD Rules in Amendment No. 2 are referred to 
as the TRACE Rules, in reference to the proposed facility, which is 
currently referred to as the Trade Reporting and Comparison Entry 
Service (TRACE).\5\
---------------------------------------------------------------------------

    \5\ The NASD represents that it will rename TRACE. When a new 
name is selected, the NASD will amend the TRACE Rules prior to 
implementation of the service to reflect that name change.
---------------------------------------------------------------------------

I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The NASD proposes the following amendments to the rule text (as 
originally proposed) in response to comment letters or suggestions by 
the NASD staff after additional review. Proposed additions are 
italicized; proposed deletions are in brackets.
* * * * *

6200. Trade Reporting and Comparison Entry Service (TRACE)

6210. Definitions
    The terms used in this [paragraph] Rule 6200 Series shall have the 
same meaning as those defined in the Association's By-Laws and Rules 
unless otherwise specified.
    (a) The term [``TRACE eligible Security''] ``TRACE-eligible 
security'' shall mean all United States dollar denominated debt 
securities that are registered with the Securities and Exchange 
Commission and issued by United States and/or foreign private 
corporations and that are depository eligible securities as defined in 
Rule 11310(d); all debt securities qualified as PORTAL securities 
pursuant to the Rule 5000 Series; all investment-grade rated debt 
securities that are issued pursuant to Section 4(2) of the Securities 
Act of 1933 and that are depository eligible securities pursuant to 
Rule 11310(d).

[[Page 71175]]

    (b) The term ``Trade Reporting And Comparison Entry Service'' or 
``TRACE'' shall mean the automated system owned and operated by the the 
NASD [The Nasdaq Stock Market, Inc.] that, among other things, 
accommodates reporting[, comparison,] and dissemination of transaction 
reports where applicable in TRACE-eligible securities [Securities] and 
which may submit ``locked-in'' trades to National Securities Clearing 
Corporation for clearance and settlement and provide participants with 
monitoring and risk management capabilities to facilitate a ``locked-
in'' trading environment.
    (c) The term ``reportable TRACE transaction'' shall mean [all] any 
transaction[s] in a TRACE-eligible security [Eligible Security as 
required by this rule].
    (d) The term ``time of execution'' for a transaction in a TRACE-
eligible security shall be the time when the parties agree to all of 
the terms of the transaction [are agreed to which] that are 
insufficient to calculate the dollar price of the trade. The time of 
execution for transactions involving TRACE-eligible securities that are 
trading ``when issued'' on a yield basis shall be when the yield for 
the transaction has been agreed to by the parties.
    (e) The term [``Parties to the Transaction''] ``parties to the 
transaction'' shall mean the executing broker/dealer, introducing 
broker/dealer, and clearing brokers, if any.
    (f) The term ``TRACE Participant'' shall mean any NASD member [in 
good standing] that uses the TRACE system.
    [(g) The term ``TRACE Reporting Party'' shall mean a member of the 
Association that is registered as a TRACE participant with the 
Association and obligated to report a TRACE transaction pursuant to 
TRACE system rules and who is member of a registered clearing agency 
for clearing or comparison purposes or has a clearing arrangement with 
such a member.]
    [(h) The term ``TRACE Non-Reporting Party'' shall mean a member of 
the Association that is registered as a TRACE participant with the 
Association who is not obligated to report under TRACE system rules for 
a particular transaction to which it is a party and who is member of a 
registered clearing agency for clearing or comparison purposes or has a 
clearing arrangement with such a member. It shall also mean any 
customer who is not a member of the Association.]
    [(i) The term ``Clearing Broker/Dealer'' or ``Clearing Broker'' 
shall mean the member firm that has been identified in the TRACE system 
as principal for clearing and settling a trade, whether for its own 
account or for a correspondent firm.]
    [(j) The term ``Correspondent Executing Broker/Dealer'' or 
``Correspondent Executing Broker'' shall mean the member firm that has 
been identified in the TRACE system as having a correspondent 
relationship with a clearing firm whereby it executes trades and the 
clearing function is the responsibility of the clearing firm.]
    [(k)(g) The term [``Introducing Broker/Dealer'' or ``introducing 
broker''] ``Introducing Broker'' shall mean the member firm that has 
been identified in the TRACE system as a party to the transaction, but 
does not execute or clear trades.
    [(l) The term ``Browse'' shall mean the functions of TRACE that 
permit a Participant to review (or query) for trades in the system 
identifying the Participant as a party to the transaction, subject to 
the specific uses contained in the TRACE Users Guide.]
    [(m) The term ``Gross Dollar Thresholds'' in the risk management 
application of TRACE shall mean the daily dollar amounts for purchases 
and sales that a clearing broker establishes in the TRACE system for 
each correspondent executing broker that may be raised or lowered on an 
inter-day or intra-day basis. If the value of a correspondent's trades 
equals or exceeds the gross dollar thresholds, the system will alert 
the clearing broker.]
    [(n) The term ``Pre-alert'' shall mean the alert notifying the 
correspondent executing broker and the clearing broker that the 
correspondent executing broker has equaled or exceeded 70% of the 
purchase or sale gross dollar limits established by the clearing 
broker. The Association reserves the right to modify the percentage of 
the pre-alert as necessary and upon prior notification to the TRACE 
Participants.]
    [(o) The term ``Single Trade Limit'' shall mean the dollar amount 
established by the Clearing Broker for a single trade that enables a 
TRACE clearing firm to review the trade before it is obligated to clear 
the trade. When a correspondent executing broker negotiates a trade 
that equals or exceeds the Single Trade Limit, its clearing broker 
shall have a period of thirty (30) minutes to review and agree to 
decline to act as principal for clearing that trade. If a Clearing 
Broker fails to set a single trade limit the TRACE system will 
automatically set a default single trade limit of $0 for the 
Correspondent Broker. The Association reserves the right to modify the 
minimum/maximum dollar amount of the Single Trade Limit as well as the 
time frame for clearing broker review as necessary and upon prior 
notification to the TRACE Participants.]
    [(p)] (h) [For purposes of these rules, the] The term ``Investment 
Grade'' shall mean any TRACE-eligible security rated by a nationally 
recognized statistical rating organization in one of its four highest 
generic rating categories.
    [(q)] (i) [For purposes of these rules, the] The term ``Non-
Investment Grade'' shall mean any TRACE-eligible security that is 
unrated, non-rated, split-rated (where one rating falls below 
investment grade), or does not meet the definition of [investment 
grade] Investment Grade in paragraph [(p)] (h)[,] above.

6220. Participation in TRACE

(a) Mandatory Member Participation [for Clearing Agency Members]
    (1) Pursuant to Article VII, Section 1(a)(vi) and (vii) of the By-
Laws, participation in TRACE is mandatory for all brokers/dealers that 
are members of a clearing agency registered with the Commission 
pursuant to Section 17A of the Act, and for all brokers that have a 
clearing arrangement with such a broker. Such participation shall 
include the reconciliation of all over the counter clearing agency 
eligible transactions involving TRACE securities.] Member participation 
in TRACE for trade reporting purposes is mandatory. Such mandatory 
participation obligates members to submit transaction reports in TRACE-
eligible securities in conformity with the Rule 6200 Series.
    (2) Participation in TRACE shall be conditioned upon the TRACE 
Participant's initial and continuing compliance with the following 
requirements:
    (A) execution of, and continuing compliance with, a TRACE 
Participant Application Agreement and all applicable rules and 
operating procedures of the Association and the Commission; and
    [(B) membership in, or maintenance of, an effective clearing 
arrangement with a member of a clearing agency registered pursuant to 
the Act;]
    [(C)] (B) maintenance of the physical security of the equipment 
located on the premises of the TRACE Participant to prevent 
unauthorized entry of information into TRACE.[; and]
    [(D) acceptance and settlement of each trade that TRACE identifies 
has having been effected by such TRACE Participant, or if settlement is 
to be made through a clearing member, guarantee the acceptance and 
settlement of each TRACE identified trade by the clearing member on the 
regularly scheduled settlement date.]

[[Page 71176]]

    [(3) Participation in TRACE as a Clearing Broker shall be 
conditioned upon the Clearing Broker's initial and continuing 
compliance with the following requirements:]
    [(A) execution of, and continuing compliance with, a TRACE 
Participant Application Agreement and all applicable rules and 
operating procedures of the Association and the Commission;]
    [(B) membership in a clearing agency registered pursuant to the 
Act;]
    [(C) maintenance of the physical security of the equipment located 
on the premises of the TRACE Clearing Broker to prevent the 
unauthorized entry of information into TRACE; and]
    [(D) acceptance and settlement of each trade that TRACE identifies 
as having been effected by itself or any of its correspondents on the 
regularly scheduled settlement date.]
    [(4)] (3) Each TRACE Participant shall be obligated to inform the 
Association of non-compliance with, or changes to, any of the 
participation requirements set forth above.
(b) Participant Obligations in TRACE
(1) Access to TRACE
    Upon execution and receipt by the Association of the TRACE 
Participant Application Agreement, a TRACE Participant may commence 
input and validation of trade information in TRACE-eligible securities. 
TRACE Participants may access the service via an NASD-approved facility 
during the hours of operation.
(2) Clearing Obligations
    If at any time a TRACE Participant fails to maintain a clearing 
arrangement, it shall be removed from the TRACE system until such time 
as a clearing arrangement is reestablished and notice of such 
arrangement is provided to the Association. If, however, the 
Association finds that the TRACE Participant's failure to maintain a 
clearing arrangement is voluntary, the withdrawal will be considered 
voluntary and unexcused. This section shall not apply to TRACE 
Participants whose trading activity obviates the need for maintaining a 
clearing relationship.
[(3) Clearing Broker Obligations]
    [(A) Clearing brokers may cease to act as principal for a 
correspondent executing broker at any time provided that notification 
has been given to, received and acknowledged by the TRACE Operations 
Center and affirmative action has been completed by the Center to 
remove the correspondent broker from TRACE. The clearing broker's 
obligation to accept and clear trades for its correspondents shall not 
cease prior to the completion of all of the steps detailed in this 
subparagraph (3).]
    [(B) TRACE Clearing brokers shall establish for each correspondent 
executing broker daily Gross Dollar Thresholds and may raise or lower 
the thresholds on an inter-day or intra-day basis. TRACE clearing 
brokers will receive a system alert when a correspondent executing 
broker equals or exceeds its gross dollar thresholds and will also 
receive a system pre-alert when a correspondent executing broker equals 
or exceeds 70% of the daily thresholds.]
    [(C) For trades effected by a correspondent executing broker that 
equal or exceed the correspondent's Single Trade Limit set by the 
clearing broker in TRACE, clearing brokers have 30 minutes from the 
time of trade report input to TRACE to review the trade and accept or 
decline to act as principal to the trade. If the clearing broker does 
not make an affirmative acceptance or declination of the trade report 
within 30 minutes, the trade report will be subject to normal TRACE 
processing and the clearing broker will be obligated to act as 
principal for the trade.]

6230. Transaction Reporting

(a) When and How Transactions Are Reported
    (1)(A) [All NASD members] Members that are required to report 
transaction information pursuant to paragraph (b) below shall, within 1 
hour after trade execution, transmit through TRACE during system hours, 
or if TRACE is unavailable due to system or transmission failure, by 
telephone to the TRACE Operations Center, reports of transactions in 
TRACE-eligible securities [Securities] executed between 8:00 a.m. and 
6:30 p.m. Eastern Time [or shall utilize the Browse function in TRACE 
to accept or decline trades within 30 minutes after execution according 
to paragraph (b) of this rule]. Transactions not reported within 1 hour 
after execution shall be designated as late; provided, however, that if 
[unless] inadequate time remains prior to system close to allow a 
timely report[. In this situation], the member may report [must be 
made] the transaction the next day at system open as designated ``as/
of.''
    (B) Members have an ongoing obligation to report transaction 
information promptly, accurately, and completely. The member may employ 
an agent for the purpose of submitting transaction information; 
however, the primary responsibility for the timely, accurate, and 
complete reporting of TRACE information remains the nondelegable duty 
of the member obligated to report the transaction.
(2) Transaction Reporting Between 6:30 p.m. and 8:00 a.m. Eastern Time
    (A) Reports of transactions in TRACE-eligible securities 
[Securities] executed after 6:30 p.m. Eastern Time and before 12:00 
a.m. Eastern Time shall be reported on the next day and be designed 
``as/of.''[.] Such trade reports will not be included in daily market 
aggregates and will be disseminated beginning at 8:00 a.m. Eastern Time 
on the day of receipt.
    (B) Report of transaction in TRACE-eligible securities [Securities] 
executed after 12:00 a.m. Eastern Time and before 8:00 a.m. Eastern 
Time shall be reported that same day beginning at 8:00 a.m. Eastern 
Time[.] within the maximum time frame mandated. Such trade reports will 
be included in that day's market aggregates and disseminated upon 
receipt.
    [A pattern or practice of late reporting without exceptional 
circumstances may be considered inconsistent with high standards of 
commercial honor and just and equitable principles of trade, in 
violation of Rule 2110.]
(b) Which Party Reports Transaction
    [Both parties executing a transaction shall, subject to the input 
requirements below, either input trade reports into the TRACE system or 
utilize the Browse feature to accept or decline a trade within the 
applicable time frames as specified in paragraph (a)(1) of this Rule.] 
Trade data input obligations are as follows:
    (1) [in] In transactions between two [TRACE Participants] members, 
the member representing the sell side shall submit a trade report to 
TRACE;
    (2) [in] In transactions [between] involving a[n NASD] member and a 
non-member including a customer, the [NASD] member shall [be required 
to] submit a trade report to TRACE.
(c) Trade Information To Be Reported
    Each TRACE trade report shall contain the following information:
    (1) CUSIP number or NASD symbol;
    (2) Number of bonds as required by paragraph (d) below;
    (3) Price of the transaction as required by paragraph (d) below;
    (4) A symbol indicating whether the transaction is a buy, sell or 
cross;
    (5) Date of Trade Execution (as/of trades only);
    (6) Contra-party's identifier;
    (7) Capacity--Principal or Agent (with riskless principal reported 
as principal) as required by paragraph (d) below;

[[Page 71177]]

    (8) Time of trade execution;
    (9) Reporting side executing broker as ``give up'' (if any);
    (10) Contra side [introducing broker] Introducing Broker in case of 
``give up'' trade;
    (11) Stated commission;
    (12) Such trade modifiers as required by either: (a) the TRACE 
[System] Rules; and/or (b) the TRACE Users Guide[.]; and
    (13) Yield as required by SEC Rule 10b-10.
(d) Procedures for Reporting Price, Capacity, Volume
    (1) For agency and principal transactions, report the price, 
including the mark-up, mark-down or commission (commission entered 
separately). Do not include accrued interest.
    (2) For agency and principal transactions, report the actual number 
of bonds traded. Baby bonds (those with a face value of less than 
$1,000) should be reported expressed as a decimal.
    (3) For in-house [In house] cross transactions, report [should be 
reported] as follows: Agency cross--report once as an agency trade; 
Principal cross--report twice, once as an individual principal buy and 
once as an individual principal sell.
(e) Transactions Not Required To Be Reported
    The following types of transactions shall not be required to be 
reported:
    (1) Transactions [which] that are part of a primary distribution by 
an issuer;
    (2) Transactions made in reliance on Section 4(2) of the Securities 
Act of 1933;
    (3) Transactions in listed securities that are both executed on, 
and reported to, a national securities exchange;
    (4) Transactions where the buyer and the seller have agreed to 
trade at a price substantially unrelated to the current market for the 
TRACE-eligible security (e.g., to allow the seller to make a gift).

(f) Compliance With Reporting Obligations

    A pattern or practice of late reporting without exceptional 
circumstances may be considered conduct inconsistent with high 
standards of commercial honor and just and equitable principles of 
trade, in violation of Rule 2110.

Rule 6231. Reporting of Transaction Information Sent to Clearing Agency

(a) When and How Transactions Are Reported
    Each NASD member shall submit to TRACE the same transaction 
information (for transactions in TRACE-eligible securities) that the 
member supplies to its registered clearing agency for clearance and 
settlement. Such information shall be submitted to TRACE by the time 
the member transmits the information to its registered clearing agency.

(b)[(b)]

    (1) In transactions between two members, both the member 
representing the sell side and the member representing the buy side 
shall submit the transaction information specified in Paragraph (a) 
above to TRACE.
    (2) In transactions involving a member and a non-member, including 
a customer, the member shall submit the transaction information 
specified in paragraph (a) above to TRACE.

[6240. TRACE Processing]

    [Locked-in trades may be determined in the TRACE system by matching 
the trade information submitted by the reporting parties through one of 
the following methods:]
[(a) Trade by Trade Match]
    [Both parties to the trade submit transaction data and the TRACE 
system performs an on-line match;]
[(b) Trade Acceptance]
    [The TRACE reporting party enters its version of the trade into the 
system and the TRACE non-reporting contra party reviews the trade 
report and accepts or declines the trade. An acceptance results in a 
locked-in trade; a declined trade report is purged from the TRACE 
system at the end of trade date processing;]
[(c) Post Trade Date Processing]
    [T+N entries may be submitted during system hours each business 
day. At the end of daily matching, all declined trade entries will be 
purged from the TRACE system. TRACE will not purge any open trade 
(i.e., unmatched or unaccepted) at the end of its entry day, but will 
carry-over such trades to the next business day for continued 
comparison and reconciliation. TRACE will automatically lock in and 
submit to NSCC as such any carried-over T to T+21 (calendar day) trade 
if it remains open as of 2:30 p.m. on the next business day. TRACE will 
not automatically lock in T+22 (calendar day) or older open ``as-of'' 
trades that were carried-over from the previous business day; these 
will be purged by TRACE at the end of the carry-over day if they remain 
open. Members may re-submit these T+22 or older ``as-of'' trades as a 
comparison-only entry into TRACE on the next business day for continued 
comparison and reconciliation for up to one calendar year.]

[6250. TRACE Risk Management Functions]

    [The TRACE system will provide the following risk management 
capabilities to clearing brokers:]
[(a) Trade File Scan]
    [Clearing brokers will be able to scan the trading activities of 
their correspondent executing brokers through the TRACE system.]
[(b) Gross Dollar Threshold]
    [Clearing brokers will be able to establish, on an inter-day or 
intra-day basis, gross dollar thresholds for purchases and sales for 
their correspondent executing brokers, and the TRACE system will alert 
the clearing broker and its correspondent if the correspondent's 
trading activity equals or exceeds either threshold.]
[(c) Gross Dollar Threshold Pre-Alert]
    [In addition to the gross dollar threshold alert, the TRACE system 
will also alert the clearing broker and its correspondent when the 
correspondent's trading activity equals or exceeds 70% of either gross 
dollar threshold.]
[(d) On-line Review]
    [Clearing brokers that access TRACE through a computer interface 
will be able to receive intra-day activity of their correspondents as 
it is reported.]
[(e) Single Trade Limit]
    [Clearing brokers will have 30 minutes from trade report input to 
TRACE to review any single trade executed by their correspondent 
executing brokers that equals or exceeds an amount set by the clearing 
broker for that correspondent in order to decide to act as principal. 
If, however, the clearing broker does not affirmatively accept or 
decline the trade, at the end of 30 minutes, the system will subject 
the trade to normal TRACE processing and the clearing broker will be 
obligated to act as principal to clear the trade.]
[(f) Super Cap]
    [The Super Cap will be set as an amount to be determined by the 
Clearing Broker, but in no event less than the gross dollar threshold. 
When a correspondent's Super Cap is reached, notice will be furnished 
to TRACE participants, and no trade in excess of an amount set by the 
clearing broker for that correspondent will be accepted for TRACE 
processing unless the clearing broker accepts the trade within 30 
minutes of execution.]

[[Page 71178]]

[6260. Obligation to Honor Trades]

    [If a TRACE Participant is reported by TRACE as a party to a trade 
that has been treated as locked-in and sent to NSCC, notwithstanding 
any other agreement to the contrary, that party shall be obligated to 
act as a principal to the trade and shall honor such trade on the 
scheduled settlement date.]

[6261. Compliance with TRACE Rules and Trade Reporting 
Requirements]

    [Failure of an NASD member, or person associated with a member, to 
comply with any of the rules or requirements of TRACE, or failure of a 
member or associated person to comply with any of the transaction 
reporting requirements for TRACE-Eligible Securities may be considered 
conduct inconsistent with high standards of commercial honor and just 
and equitable principals of trade, in violation of Rule 2110.]

[6270] 6240. Audit Trail Requirements

    The data elements specified in Rule [6220(c)] 6230(c) are critical 
to the Association's compilation of a transaction audit trail for 
regulatory purposes. As such, all member firms [utilizing] using the 
TRACE [Service] service have an ongoing obligation to input [6220(c)] 
Rule 6230(c) information accurately and completely.

[6280] 6250. Termination of TRACE Service

    The Association may, upon notice, terminate TRACE service to a 
[Participant] member in the event that a[[n] TRACE Participant] member 
fails to abide by any of the rules or operating procedures of the TRACE 
service or the Association, or fails to honor contractual agreements 
entered into with the Association or its subsidiaries, or fails to pay 
promptly for services rendered by the TRACE [Service] service

[6290] 6260. Dissemination of Corporate Bond Trade Information

    [Trade reports entered into TRACE will be collected, processed and 
disseminated on a real-time basis between 8 a.m. and 6:30 p.m. Eastern 
Time.]
    (a) The Association will disseminate transaction information 
immediately upon receipt of transaction reports between 8 a.m. and 6:30 
p.m. Eastern Time relating to transactions in Investment Grade 
corporate bonds having an initial issuance size of $1 billion or 
greater.
    (b) All trade reports in TRACE-eligible securities approved for 
dissemination and submitted to TRACE prior to 5:15 p.m. Eastern Time 
will be included in the calculation of market aggregates and last sale 
except 1)[.] trades reported on an ``as of'' basis, 2) ``when issued'' 
trades executed on a yield basis, or 3) trades in baby bonds with a par 
value of less than $1,000.

[6291] 6270. Lead Underwriter Information Obligation

    In order to facilitate trade reporting of secondary transactions in 
TRACE-eligible securities, the member that is the lead underwriter of 
any newly[-]issued TRACE-eligible security shall provide to the TRADE 
Operations Center the CUSIP number of any debt issue no later than on 
the effective date of the offering.
* * * * *

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

    In its filing with the Commission, the NASD included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The 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
    In 1998, SEC Chairman Arthur Levitt, in recognition of the relative 
lack of transparency in the corporate debt market, called upon the NASD 
to do the following: (1) Adopt rules requiring NASD members to report 
all transactions in corporate bonds to the NASD and to develop systems 
to receive and distribute transaction prices on an immediate basis; (2) 
create a database of transactions in corporate bonds to enable 
regulators to take a proactive role in supervising the corporate debt 
market; and (3) create a surveillance program, in conjunction with the 
development of a database, to better detect fraud and foster investor 
confidence in the fairness of the corporate debt market. The NASD notes 
that after extensive consultation with industry professionals, it filed 
SR-NASD-99-65. The NASD also states that it consulted extensively with 
industry professionals again before filing Amendment Nos. 2 and 3.
    TRACE has generated significant comment. The NASD has identified 
the following common areas in the comment letters: (a) TRACE ownership, 
operation, and governance; (b) the proposed comparison function; (c) 
collection and dissemination of data; (d) TRACE data; (e) 
implementation schedules; and (f) T + 1 clearance and settlement and 
straight-through-processing (STP) issues. These issues are addressed 
below. In addition, the NASD is proposing to add bond yield as a 
mandatory element of reporting, which is discussed as item (g) below.
a. TRACE Ownership, Operation and Governance
    As noted above, at the request of the SEC, the NASD has proposed to 
create a system for the reporting, dissemination and surveillance of 
fixed income transactions. Many commenters expressed concern about, or 
requested further information regarding, the roles and responsibilities 
of NASD and Nasdaq in this initiative. In response to those concerns, 
the NASD states that it will take the following steps to clarify the 
roles of NASD, NASD Regulation, and Nasdaq:
    (1) The NASD will amend proposed TRACE Rule 6210 to clarify that it 
is the owner and operator of the facility, TRACE, to collect 
information on fixed income transactions and to disseminate such 
information;
    (2) The NASD will file an application with the SEC to become 
registered as a exclusive securities information processor (ESIP) under 
Section 11A of the Act;
    (3) The NASD, with the approval of the NASD Board of Governors, 
will establish a body of rules and policies that will be the bases on 
which NASD staff will administer the reporting and dissemination 
facility and assure compliance with the TRACE Rules;
    (4) NASD Regulation will aid the NASD in establishing appropriate 
regulatory rules and policies and in performing all the regulatory 
functions associated with TRACE; and
    (5) Nasdaq will provide technology and operational support pursuant 
to a contractual arrangement.
    The NASD believes that the structure outlined above is responsive 
to many of the concerns raised by commenters. The NASD, the sole self-
regulatory organization (``SRO'') for the over-the-counter (OTC) 
markets, represents that it will exercise full ownership and 
operational control over the TRACE project, including day-to-day 
administration and the information collection process. The NASD states 
that it will become an ESIP under Section

[[Page 71179]]

11A of the Act, providing appropriate regulatory oversight by the SEC 
of the NASD's operations, administration, and fees. The NASD also 
represents that it will be able to employ Nasdaq as its vendor of 
information processing services. The NASD believes that this will allow 
it to take advantage of Nasdaq's prior experience, yet exercise 
appropriate regulatory and administrative control over the collection 
of the information, the fees charged, the selection of vendors, and 
other important administrative and regulatory matters. The NASD 
believes that this structure parallels the structure used by other 
registered ESIPs under Section 11A, such as the Consolidated Tape 
Association (CTA) and Options Price Reporting Authority (OPRA). For 
example, the NASD represents that CTA, for purposes of Networks A and 
B, and OPRA, for purposes of options information, obtain information 
processing services by agreement with SIAC, and do so without 
decreasing their control or ceding such control to SIAC.
    Although ultimate statutory authority will reside with the NASD 
Board of Governors, to more fully incorporate bond market expertise 
into TRACE operations and decision-making, the NASD proposes to create 
a new committee, the Bond Transaction Reporting Committee (BTRC), to 
advise the NASD Board. BTRC would consist of 8 persons selected by the 
NASD Board. Four of the members will be recommended by the staff of the 
NASD, and the other four members will be recommended by the Bond Market 
Association (TBMA). Selections would not include current staff or 
officers of either the NASD or TBMA. Both the NASD and TBMA would 
commit to having their selections consist of a broad range of bond 
market participants and include public representation. BTRC would 
provide significant input to the NASD Board on issues related to the 
operation of TRACE, including future NASD proposals to phase in 
dissemination and the setting of fees for dissemination of real-time 
TRACE data to the public. In addition, BTRC will be tasked with 
reviewing the effects upon liquidity associated with the dissemination 
of fixed income transaction information. BTRC will make recommendations 
to the NASD Board concerning appropriate time frames for public 
dissemination of smaller, less-actively traded issues.
    The NASD represents that the NASD Board will give significant 
weight to the advice and recommendations of the BTRC. The NASD 
represents, however, that the formation and operation of BTRC shall in 
no way limit or hinder the responsibility and ability of the NASD Board 
to make final decisions, as required in accordance with the statutory 
obligations and responsibility articulated in Section 15A of the Act 
and the NASD By-Laws. In addition, the NASD represents that its staff 
may continue to make independent recommendations or proposals to the 
NASD Board concerning bond market issues.
    In addition to concern expressed by some commenters about the role 
of Nasdaq in the TRACE initiative, other commenters suggested that a 
super-utility, rather than the NASD or Nasdaq, be used to collect fixed 
income transaction information. Others suggested the creation of a new 
SRO or vesting that authority in the NSCC. Since the NASD is the SRO 
charged with regulating the OTC markets and 95% of corporate bond 
transactions occur in the OTC market, the NASD believes that it is the 
SRO most appropriately situated to undertake this regulatory initiative 
and to assure compliance with it. It believes that creating a super-
utility or a new SRO would not be cost-effective, would result in 
regulatory duplication and duplicative fees to the industry, and would 
delay greatly the implementation of reporting and dissemination.
    Finally, one set of commenters, consisting of a data vendor and 
securities exchange, urged the Commission to adopt a de-centralized, 
multiple SRO-collector and disseminator model for fixed income 
transaction reporting. These commenters assert that such a model would 
encourage innovation and competition among organizations for the 
collection, comparison and dissemination of corporate bond trade data. 
While the NASD agrees that competition is an important goal, the NASD 
believes that the Commission and Congress have long recognized that in 
the area of collection, consolidation, and dissemination of market data 
information, other factors, such as equality of access, reasonableness 
of fees, and sufficient system capacity and security, are equally 
important.
b. Trade Comparison
    Some commenters expressed concern that the proposal would mandate 
that all corporate bond trade comparison take place within TRACE. Among 
other things, commenters objected to mandated comparison through TRACE 
because, they argued, it would result in Nasdaq having an exclusive 
franchise over the provision of comparison services for corporate bond 
trades.
    The NASD believes that the proposal to require mandatory comparison 
through TRACE was intended to ensure that the corporate bond trade data 
reported to and disseminated by the NASD was as accurate as possible, 
as evidenced by the acceptance of the trade by both parties. In 
addition to the fact that the NASD, not Nasdaq, will own and control 
TRACE, to further alleviate concerns expressed by the commenters, the 
NASD proposes to delete the TRACE Rules regarding trade comparison. 
(The NASD also proposes to delete the risk management provisions 
contained in the initial proposal.) Although NASD plans to offer 
voluntary comparison services to NASD members, firms will be free to 
select other entities to compare their transactions in TRACE-eligible 
securities. The NASD represents that elimination of mandatory 
comparison through TRACE will provide an opportunity for other entities 
to offer competing value-added comparison services for fixed income 
transactions.
    As a result of Amendment No. 2, both compared and un-compared 
corporate bond trade data will be disseminated by the NASD. The NASD 
represents that it will amend the proposal further to require TRACE 
participants, whether reporting or non-reporting members, to provide to 
the NASD the same data on TRACE-eligible securities transactions that 
is provided to the member's registered clearing agency, within the same 
time frame, and, to the extent possible, in the same format. (Proposed 
TRACE Rule 6231.) This requirement is in addition to a member's 
obligation, if any, to report a fixed income transaction on a real-time 
basis under proposed TRACE Rule 6230. The NASD believes that this will 
improve considerably the quality of the data for surveillance purposes, 
while imposing minimal additional burdens on the firms.
c. Collection and Dissemination of TRACE Data
    The NASD originally proposed a reporting plan that began first with 
high yield and convertible debt securities, followed by an alphabetical 
phase-in of all other TRACE-eligible corporate bonds. The initial time 
frame proposed for reporting trades would be no later than 1 hour after 
trade execution, which subsequently would be reduced to 15 minutes. 
After a brief start-up period during which the NASD would conduct a 
data integrity review, all eligible trade reports received would 
thereafter be disseminated immediately, subject to TRACE's proposed 
limitations on reporting the actual size of large

[[Page 71180]]

transactions to the public through data vendors.
    Some commenters raised concerns that this plan failed to take into 
account the potential negative impact on liquidity that immediate 
dissemination of bond transaction reports could have on smaller, less-
activity traded issues. Additional concerns were raised regarding 
likely confusion relating to trade reporting obligations in a plan that 
involved multiple phases and categories of fixed income securities. In 
response, the NASD has determined to propose a new phase-in 
methodology. Under this new approach, a member's obligation to report 
and the NASD's initial dissemination of reports in TRACE-eligible 
securities will take place as follows:

Phase I--Three Months in Length

    <bullet> NASD members will be required to report all transactions 
in TRACE-eligible securities within 1 hour of trade execution.
    <bullet> NASD will immediately disseminate transaction reports to 
the public and data vendors of all transactions in publicly offered, 
investment grade corporate bonds having an initial issuance of $1 
billion or greater. If applicable, these reports will be disseminated 
using the large volume trade dissemination cap identifiers (i.e., 
``1MM+'' for high yield securities and ``5MM+'' for investment grade 
corporate bonds) that were proposed in NASD's original TRACE filing.
    <bullet> Transaction reports in the high yield debt securities 
denominated as the ``FIPS 50'' at the time of filing becomes effective 
will also be disseminated--also using the ``1MM+'' large volume trade 
dissemination cap identifiers.
    <bullet> The BTRC will commence its examination of the impact of 
TRACE's transaction dissemination on liquidity. By the end of Phase I 
(three months after the start of TRACE reporting), the BTRC will 
provide its recommendations for appropriate dissemination protocols 
covering those investment grade bonds, starting with the largest 
issuance size, that, when combined together, make up the top 50% (by 
dollar volume) of such bonds.
Phase II--Six Months in Length
    <bullet> NASD members will continue to be required to report all 
transactions in TRACE-eligible securities within 1 hour of trade 
execution.
    <bullet> NASD will disseminate transaction reports to the public 
and data vendors of all transactions in the top 50% (by dollar volume) 
of investment grade bonds consistent with the recommendations of the 
BTRC (subject to the approval of the NASD Board and the SEC.\6\ If 
applicable, these reports will be disseminated, subject to using the 
large-volume trade dissemination cap identifiers (i.e., ``1MM+'' for 
high yield securities and ``5MM+'' for investment grade securities) 
that were proposed in NASD's original TRACE filing.
---------------------------------------------------------------------------

    \6\ Trade reports for Rule 144A securities will not be 
considered as part of the total average daily volume of the TRACE 
system for purposes of Phase II. In addition, the NASD notes that 
the proposed Phase II formula will result in an overlap with Phase I 
securities that may reduce the number of newly disseminated bonds in 
the second phase. The NASD represents that it will ask BTRC to 
review the Phase II dissemination formula in more detail to 
determine if a different approach to expanding the universe of 
disseminated bonds in Phase II is appropriate.
---------------------------------------------------------------------------

    <bullet> Three months after the start of Phase II (six months after 
the start of TRACE reporting), the 1 hour maximum time period to submit 
TRACE trade reports will be reduced to 15 minutes, subject to the 
ability of firms to comply technologically and operationally.
    <bullet> Transaction reports in the ``FIPS 50'' will continue to be 
disseminated--also using the large volume trade dissemination cap 
identifiers (i.e., ``1MM+'').
    <bullet> The BTRC will continue its evaluation of the impact that 
dissemination of transaction information has on liquidity. By the end 
of Phase II (9 months after the start of TRACE reporting), the BTRC 
will provide recommendations for appropriate dissemination protocols 
for all remaining TRACE issues eligible for public dissemination.
    During all phases, the NASD represents that the BTRC continually 
will evaluate industry technological readiness with a view to reducing 
further the post-execution deadlines for submitting trade reports to 
TRACE. The NASD believes that this new approach to collecting and 
disseminating real-time market data draws an appropriate balance 
between the Commission's desire for quick and measurable progress in 
improving transparency in the corporate bond market and industry 
concerns about liquidity. Moreover, the NASD believes that the new 
approach captures more information for regulatory purposes in a shorter 
time frame than under NASD's earlier TRACE transaction reporting plan. 
In turn, the NASD believes that the new approach will allow it to more 
quickly to develop and refine its surveillance plan for the fixed 
income market.
d. TRACE Data
    Many commenters raised concerns that TRACE would grant the NASD 
exclusive control over corporate bond trade data. The NASD, in response 
to concerns raised regarding such exclusive control, intends to 
register as an ESIP under Section 11A of the Act. The NASD states that, 
as explained in the SEC's release entitled Regulation of Market 
Information Fees and Revenues, \7\ in furtherance of national market 
system goals, the SEC recognizes the structure in which one central 
information processor receives and consolidates market ``information 
into a single stream for dissemination to the public.'' \8\ Regarding 
this consolidated data stream, the NASD notes that the SEC stated, 
``the practical effect of comprehensive federal regulation of market 
information is that proprietary interests in this information are 
subordinated to the Exchange Act's objectives for a national market 
system.'' \9\
---------------------------------------------------------------------------

    \7\ Securities Exchange Act Release No. 42208 (Dec. 9, 1999), 64 
FR 70613 (Dec. 17, 1999).
    \8\ 64 FR 70613, 70615.
    \9\ Id.
---------------------------------------------------------------------------

    The NASD represents that the SEC exercises oversight over the 
information consolidator by requiring registration of the consolidator 
as an ESIP under Section 11A of the Act, and regulating the registered 
ESIP's conduct. Under Section 11A, the NASD, as the registered ESIP, 
will be obligated to deliver market information on terms that are fair 
and reasonable, and to meet all other obligations imposed on ESIPs, 
including capacity, redundancy, audit trail, and surveillance 
capabilities. The NASD represents that it will be solely responsible 
for establishing rules and fees related to the sale of real-time data 
dissemination, subject to SEC oversight Nasdaq, which will not be the 
ESIP, will not possess any ownership rights in TRACE data, and will not 
exercise any control over the TRACE project. Nasdaq's role will be that 
of a contractor, providing to the NASD the collection and dissemination 
systems that will enable the NASD to perform its SRO functions.
e. Implementation Schedules
    The NASD states that it has discussed TRACE's implementation with 
various members, vendors, and industry groups to understand the likely 
amount of time necessary to implement the regulatory reporting and 
transparency aspects of TRACE. After discussions with corporate bond 
market participants, the NASD represents that it has determined to 
modify its original filing and seek

[[Page 71181]]

SEC approval to begin phase I of TRACE 180 days following SEC approval 
of the service. The NASD believes that this additional time will allow 
its members to better prepare for the advent of TRACE trade reporting 
as well as give the NASD sufficient time to more fully test TRACE 
technology.
f. T+1 Clearance and Settlement and STP Issues
    Many commenters raised concerns about how TRACE fits into ongoing 
industry initiatives to facilitate a T+1 clearance and settlement cycle 
anticipated in 2004 and later, straight-through processing (STP). The 
NASD believes that TRACE provides significant tools to the fixed income 
industry to assist them in moving to a T+1 settlement cycle. The NASD 
represents that when implemented, TRACE's real-time comparison and 
forwarding features will give market participants a fast, efficient way 
to enter their ``locked-in'' trade reports into the trade processing 
system and allow for faster settlement. The NASD believes that TRACE's 
open system architecture provides multiple ways of entering trade 
reports and also ensures that these powerful tools will be available to 
all firms regardless of size. The NASD represents that it is committed 
to the concept of interoperability between its systems and others 
operated by national and international clearing entities. In the final 
analysis, however, it believes that the pressing need for improved 
transparency in the corporate bond market cannot be subordinated to the 
much more complex and long-term goals of global straight-through 
processing. The NASD represents that it will continue to take action to 
ensure that its systems remain the most flexible and open possible, as 
well as being capable of quickly and efficiently adapting to whatever 
STP standards and protocols are adopted in the future.
g. Addition of a Yield Value to TRACE Trade Reports
    As a result of further internal NASD review regarding the proper 
elements of a fixed income transaction report, the NASD has determined 
to add a yield requirement to TRACE trade reports. The NASD believes 
that the addition of a yield value, determined in conformity with Rule 
10b-10 under the Act, provides a valuable mechanism to match, verify, 
and analyze pricing of corporate bonds. The NASD notes that firms are 
already required to provide this information to customers as part of 
the transaction confirmation process and believes that any additional 
burden on firms to enter such information is more than offset by the 
regulatory value of such information. Specifically, the NASD represents 
that yield information will enable the NASD to identify potentially 
erroneous fixed income transactions on a real time basic, thereby 
promoting the integrity of the transactions reports.
    The NASD's principal goal in developing TRACE is to meet the 
mandate of the SEC to provide greater transparency to investors and to 
enhance the NASD's regulatory oversight of corporate bond trading. The 
NASD believes it has responded in a flexible and proactive manner to 
various industry concerns regarding TRACE.
2. Statutory Basis
    The NASD represents that it 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 the NASD's rules must be 
designed to prevent fraudulent and manipulative acts and practices, to 
promote just and equitable principles of trade, to foster cooperation 
and coordination with persons engaged in regulating, clearing, 
settling, processing information with respect to, and facilitating 
transactions in securities, and, in general, to protect investors and 
the public interest.
    The NASD states that the proposed rule change, if approved, will 
establish rules for the reporting and dissemination of information on 
fixed income transactions that will provide the NASD, as the self-
regulatory organization designed to regulate the over-the-counter 
markets, with heightened capabilities to regulate the fixed income 
markets in order to prevent fraudulent and manipulative acts and 
practices. The NASD also represents that the proposed structure to 
collect the information, with the NASD as the proposed exclusive 
securities information processor under Section 11A of the Act, is 
consistent with other information processing structures that have been 
proposed and approved by the SEC, and will foster cooperation and 
coordination with persons engaged in regulating, clear4ing, settling, 
and processing information with respect to fixed income securities and 
among persons facilitating transactions in fixed income securities. 
Finally, the NASD believes that the proposed rule change, by requiring 
reporting and dissemination of such transaction information, will 
protect investors and the public interest by, among other things, 
increasing transparency in the fixed income market.

(B) Self-Regulatory Organization's Statement on Burden on Competition

    The 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.

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

    Written comments were neither solicited nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate, up to 90 days of such date, if it finds such longer period 
to be appropriate and publishes its reasons for so finding, or (ii) as 
to which the self-regulatory organization consents, the Commission 
will:
    A. By order approve such proposed rule change, or
    B. Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment Nos. 2 and 3, including whether 
Amendment Nos. 2 and 3 are consistent with the Act. Persons making 
written submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, 
DC 20549-0609. Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the NASD. All submissions should refer to Amendment 
Nos. 2 and 3 to file number NASD 99-65 and should be submitted by 
December 20, 2000.

[[Page 71182]]

    For the Commission, by the Division of Market Regulation, pursuant 
to delegated authority.\10\
---------------------------------------------------------------------------

    \10\ 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 00-30452 Filed 11-28-00; 8:45 am]
BILLING CODE 8010-01-M