[Federal Register Volume 63, Number 108 (Friday, June 5, 1998)]
[Notices]
[Pages 30791-30794]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-14921]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-40047; File No. SR-NASD-98-09]


Self-Regulatory Organizations; Notice of Proposed Rule Change and 
Amendment No. 1 by the National Association of Securities Dealers, Inc. 
Relating to Trade Reporting Rules

May 29, 1998.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
``Act''),\1\ notice is hereby given that on February 2, 1998, the 
National Association of Securities Dealers, Inc. (``NASD'' or 
``Association'') through its wholly owned subsidiary, the Nasdaq Stock 
Market, Inc. (``Nasdaq'') filed with the Securities and Exchange 
Commission (``SEC'' or ``Commission'') a proposed rule change. Nasdaq 
filed an amendment to the proposed rule change on May 19, 1998. The 
proposed rule change, as amended, is described in Items I, II, and III 
below, which Items have been prepared by Nasdaq. The Commission is 
publishing this notice to solicit comments on the proposed rule change 
from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    Nasdaq is proposing to amend various trade reporting rules of the 
Association. Specifically the proposal would: (1) Implement a new trade 
report modifier to identify trades effected at a prior reference price; 
(2) eliminate the 10,000 share limitation on individual trades that may 
be ``bunched'' for trade reporting purposes; (3) require electronic 
communications networks (``ECNs'') to be responsible for reporting all 
trades executed within the ECN; and (4) address riskless principal 
trades involving exchange-listed securities traded in the Third Market. 
Below is the text of the proposed rule change. Proposed new language is 
in italics; proposed deletion are in brackets.
* * * * *
4623. Electronic Communications Networks
    (a) No Change.
    (b) An electronic communications network that seeks to utilize the 
Nasdaq-provided means to comply with the electronic communications 
network display alternative shall:
    (1)-(5) No Change.
    (6) report all transactions executed by or through the electronic 
communications network, with the exception of transactions executed 
through an automated execution system operated by Nasdaq (e.g., 
SelectNet).
* * * * *
4632. Transaction Reporting
    (a)(1) through (a)(8) No Change.
    (9) All members shall append a trade report modifier as designated 
by the Association to transaction reports that reflect a price 
different from the current market when the execution is based on a 
prior reference point in time, which shall be accompanied by the prior 
reference time.
    (b) through (f)(1)(C) No Change.
    (D) Orders received or initiated by the reporting member which are 
impractical to report individually and are executed at the same price 
within 60 seconds of execution of the initial transaction; provided 
however, that no individual order of 10,000 shares or more may be 
aggregated in a transaction report and that the aggregated transaction 
report shall be made within 90 seconds of the initial execution 
reported therein. Furthermore, it is not permissible for a member to 
withhold reporting a trade in anticipation of aggregating the 
transaction with other transactions. The limitation on aggregating 
individual orders of 10,000 shares or more for a particular security 
shall not apply on the first day of secondary market trading of an IPO 
for that security.
    Examples: No Changes.
    (2) No Change.
* * * * *
4642. Transaction Reporting
    (a)(1) through (a)(8) No Change.
    (9) All members shall append a trade report modifier as designated 
by the Association to transaction reports that reflect a price 
different from the current market when the execution is based on a 
prior reference point in time, which shall be accompanied by the prior 
reference time.
    (b) through (f)(1)(C) No Change.
    (D) Orders received or initiated by the reporting member which are 
impractical to report individually and are executed at the same price 
within 60 seconds of execution of the initial transaction; provided 
however, that no individual of 10,000 shares or more may be aggregated 
in a transaction report and that the aggregated transaction report 
shall be made within 90 seconds of the initial execution reported 
therein. Furthermore, it is not permissible for a member to withhold 
reporting a trade in anticipation of aggregating the transaction with 
other transactions. The limitation on aggregating individual orders of 
10,000 shares or more for a particular security shall not apply on the 
first day of secondary market trading of an IPO for that security.
    (2) No Change.
* * * * *
4652. Transaction Reporting
    (a)(1) through (a)(7) No Change.
    (8) All members shall append a trade report modifier as designated 
by the Association to transaction reports that reflect a price 
different from the current market when the execution is based on a 
prior reference point in time, which shall be accompanied by the prior 
reference time.
    (b) through (f) No Change.
* * * * *
6420. Transaction Reporting
    (a) through (d)(3)(A) No Change.
    (B) Exception: A ``riskless'' principal transaction in which a 
member [that is not a market maker in the security] after having 
received from a customer an order to buy, purchases the security as 
principal from another member or customer to satisfy the order to buy 
or, after having received from a customer an order to sell, sells the 
security as principal to another member or customer to satisfy the 
order to sell, shall be reported as one transaction in the same manner 
as an agency transaction, excluding the mark-up or mark-down. A 
riskless principal transaction in which a member purchases or sells the 
security on an exchange to satisfy a customer's order will be reported 
by the exchange and the member shall not report.

[[Page 30792]]

    Examples: No Change.
    (e) No Change.
* * * * *
6620. Transaction Reporting
    (a)(1) through (a)(5) No Change.
    (6) All members shall append a trade report modifier as designated 
by the Association to transaction reports that reflect a price 
different from the current market when the execution is based on a 
prior reference point in time, which shall be accompanied by the prior 
reference time.
    (b) through (3) 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, Nasdaq 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. Nasdaq 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
    I. New modifier for trades based on prior reference price. Nasdaq 
recommends the implementation of a trade report modifier for firms to 
append to certain trade reports to more accurately identify 
transactions that are at a price based on a prior reference point in 
time. The modifier would apply to trade reports in Nasdaq securities 
(both Nasdaq National Market and SmallCap) as well as non-Nasdaq OTC 
Equity Securities (e.g., OTC Bulletin Board and Pink Sheets). It would 
not, however, apply to exchange-listed securities traded in the Third 
Market.
    Recently, there have been situations where members execute certain 
transactions that, although reported timely, actually relate to an 
obligation to trade that arose at an earlier point in the day or that 
refer to a prior reference price. These situations include obligations 
to trade arising from a preferenced SelectNet order that was not 
executed timely, orders that are owned the opening or closing price 
(``market on open'' or ``market on close'') but that are not executed 
within 90 seconds of the open or close, respectively, and orders that 
may have been lost or misplaced. In effect, these trades are late 
executions, not late reports of executions.
    After earlier discussions with SEC staff it was agreed that the 
.SLD modifier could be used to refer to these ``out of sequence'' trade 
reports on an interim basis, but that Nasdaq should develop a separate 
identifier to accurately reflect these types of trades.\2\ A separate 
identifier would provide better information to market participants and 
the public as to what these trades actually represent. Because it would 
be used to indicate that the price is based on an earlier reference 
point, the modifier would identify trades whose pries may bear no 
relationship to the current market.
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    \2\ See Letter from Robert L.D. Colby, Deputy Director, Division 
of Market Regulation, SEC, to Richard G. Ketchum, Vice President, 
NASD, dated August 11, 1997.
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    Accordingly, Nasdaq is proposing a rule change to implement a new 
trade report modifier (``.P'' for discussion purposes). This modifier 
must be appended to trade reports that reflect a price that is 
different from the current market because the execution is based on a 
prior reference point in time. This would be coupled with a requirement 
to input the prior reference time. Until a separate time filed in ACT 
can be established, Nasdaq staff envision that members can use the 
execution time field to insert the prior reference time for these 
trades.
    In proposing the rule change, Nasdaq intends that the following be 
made clear:
    <bullet> Such modifier does not apply to ``stopped'' stock 
situations.
    <bullet> By using the modifier, a member is not absolved of its 
obligation to provide best execution, in terms of both price and timely 
execution.
    <bullet> The modifier would not be required to be used if the 
report was made within 90 seconds of the prior reference time.
    The following are some specific examples of when the .P modifier 
would be used:
    1. A member receives a preferenced SelectNet order at the member's 
quote (``liability order'') at 11:00. The member fails to execute the 
trade. Thirty minutes later, at 11:30, this is brought to the attention 
of the receiving member, who agrees that the trade should have taken 
place at that time at the price existing then. The receiving member 
then executes a trade at that price. The member appends .P to the trade 
report and inputs the time ``11:00.''
    2. A member receives a large number of customer orders prior to the 
open, to be executed at the opening print. Once that price can be 
identified, the member's system begins executing each trade at that 
price. Amy such trade that is executed at the opening but due to heavy 
volume is not printed until after 9:31:30 should be identified with the 
.SLD identifier. If, however, at 9:45 the member discovers that a 
customer's order that should have been executed at the open has not yet 
been executed, it would be appropriate to execute that customer's order 
and append the .P modifier with the time ``9:30.'' This tells market 
participants that the execution price represents a price that relates 
to an earlier point in time (in this case, the open), and thus may not 
bear any relation to the current market, which may have moved in the 
interim.
    The text of the proposed rule changes to implement the new modifier 
is contained in NASD Rules 4632(a)(9), 4642(a)(9), 4652(a)(8), and 
6620(a)(6).
    II. Eliminating the 10,000 share limitation on aggregating trades 
in Nasdaq securities that may be bunched for trade reporting. Nasdaq is 
proposing to eliminate the 10,000 share limitations on the maximum 
number of shares in an individual trade that can be aggregated for 
purposes of reporting a ``bunched'' trade in Nasdaq securities, but 
only in the context of IPOs.
    Rules governing the reporting of transactions in Nasdaq securities 
(both National Market and SmallCap) currently permit the aggregation of 
transactions into a ``bunched'' trade report in a variety of 
situations. Most notably, there is a provision whereby a firm may 
aggregate transactions at the same price that would be impractical to 
report individually, provided that no individual order of 10,000 shares 
or more may be aggregated. Such reports are appealed with a ``.B'' 
modifier by the reporting firm and are disseminated to the Nasdaq tape 
and vendors. This rule was originally adopted in 1982 with a limitation 
of 5,000 shares.\3\ It was subsequently increased to 10,000 shares in 
1984, but has remained at that level ever since.\4\
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    \3\ See Exchange Act Release No. 18602 (March 26, 1982), 47 FR 
14642 (April 5, 1982) (notice of filing and order granting 
accelerated approval of File No SR-NASD-82-4).
    \4\ See Exchange Act Release No. 21202 (August 3, 1984), 49 FR 
31971 (August 9, 1984) (order approving File No. SR-NASD-84-12).
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    Nasdaq believes that it would be appropriate to remove the 10,000 
share limitation for bunching on the first day of secondary market 
trading following an IPO. Bunching would remain optional. This would 
facilitate more efficient and timely reporting of large numbers of 
trades in the IPO aftermarket. Nasdaq does not believe

[[Page 30793]]

that eliminating the 10,000 share limit will result in any relevant 
loss in either the amount of value of information disseminated to the 
public. Also, as it is today, the individual transaction data will 
continue to be captured for clearing and regulatory purposes.
    Nasdaq notes that there are currently no limits in place with 
respect to bunching on the exchanges. It is Nasdaq's understanding, 
however, that some exchanges, unlike Nasdaq, reprint all the component 
trades to a bunched report later in the day. While these individual 
reports to SIAC, Nasdaq understands that most vendors do not re-
disseminate them to public.\5\
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    \5\ It is believed, however, that the exchange count these re-
printed component trades toward their shares of revenue allocation 
for market data fees.
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    The text of the proposed rule changes to implement the proposed 
bunching provision is contained in rules 4632(f)(1)(D) and 
4642(f)(1)(D).
    III. Requirement that ECNs report on behalf of subscribers. Nasdaq 
is proposing a rule requiring ECNs to report all trades executed within 
the ECN on behalf on its subscribers.
    The reporting of trades involving an ECN is inconsistent today, in 
that not all ECNs assume responsibility for reporting all trades within 
the ECN. Instead, an NASD member may be responsible for reporting some 
trades. For example, in these situations, after an ECN executes a 
trade, it must determine which participant, if any, had the trade 
reporting obligation, and them notify that participant. That 
participant would then put up the trade report.
    Nasdaq believes that it is more effective and timely for ECNs to be 
responsible for centrally reporting every trade that takes place 
through the ECN.\6\ Accordingly, Nasdaq is proposing that it be 
mandated by rule, and that the ECN be held responsible for reporting 
properly and timely. The text of the rule change is contained in 
proposed rule 4623(b)(6).
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    \6\ Should a transaction occur between two ECNs, the ``receiving 
ECN'' would be responsible for reporting the trade.
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    IV. Trade reporting rules for riskless principal trades in the 
Third Market. Nasdaq is proposing changes to the trade reporting rules 
for exchange listed securities traded in the Third Market to ensure 
that all riskless principal trades, including those effected by market 
makers, are reported only once. This was determined to be necessary for 
several reasons, including (1) misinterpretation by some of the rules 
relating to the reporting of Third Market trades of exchange-listed 
securities involving an execution on an exchange; (2) the new SEC Order 
Handling Rules, which require market makers to match certain orders in 
an agency-like fashion as opposed to trading at risk as principal; (3) 
the impact of SEC Transaction Fees (Section 31 Fees); and (4) the 
potential for the erroneous perception that Third Market trade 
reporting may be inflated due to ``double reporting.''
    The rules for reporting trades in the Third Market have long 
existed in their current form. The rules were broadly designed to 
capture all trading activity by broker-dealers, both dealer to dealer 
trades and trades with customers. These rules, and the trade reports 
that result, serve several important purposes. They form the basis for 
public dissemination of ``last sale'' transaction prices to the tape, 
thus providing transparency. Trade reports also are an integral part of 
the audit trail used by the NASD in its regulatory efforts to surveil 
and regulate firms' activities. Given the historical structure of the 
dealer market and the need to provide a comprehensive view of all 
trading, and because market makers were always deemed to be ``at 
risk,'' NASD trade reporting rules always have required the reporting 
of all principal trades by market makers.
    Non-market makers, however, generally do not report all principal 
trades under current rules, to the extent the trades are defined as 
``riskless,'' that is, they involve a trade with another member, 
usually a market maker, which is used to offset a trade with a 
customer. This ``riskless principal exception'' results in one trade 
report even though the non-market maker firm is involved in two 
separate trades against its principal account.
    Nasdaq sees no significant reason to continue this distinction 
between market makers and non-market makers in the context of exchange-
listed securities, and thus believes it to be appropriate now to extend 
this riskless principal exception where possible to market makers as 
well. This determination was reached given the evolution and growth of 
the Third Market, advances in technology at the firm level, and 
particularly in light of the new SEC Order Handling Rules. IN short, 
this would ensure that only one trade report results for transactions 
that are clearly one trade. As indicated above, current rules mandate 
that market makers report all principal trades, notwithstanding that 
such trades may, in effect, be ``riskless'' to the market maker (i.e., 
although the market maker may execute two offsetting trades against its 
principal account, the economic reality is that these may be viewed as 
one trade without risk to the market maker).
    V. Extending riskless principal treatment to transactions in 
exchange-listed securities in the Third Market. Nasdaq believes that 
the exception applicable to non-market makers (which treats riskless 
principal trades as one trade for reporting purposes) should be 
extended to market makers in exchange-listed stocks. For example, if a 
market maker in an exchange-listed security does not assume a risk 
position on an ITS commitment sent to another market, the market maker 
should not be reprinting it in its own market when it receives 
confirmation of an execution on the commitment. The fact that the firm 
is a market maker is irrelevant. Nasdaq also believes that this 
analysis should apply to transactions that result from orders sent to 
the floor even when sent outside of the ITS linkage (e.g., through a 
floor broker or other automated execution system of the exchange).
    a. Definition of riskless principal. To implement the above 
interpretation, a specific definition of ``riskless principal'' for 
reporting purposes would be necessary. A riskless principal trade 
generally is one that involves a conditional order rather than one 
immediately executable by the firm as principal. Such condition may 
involve a customer order whose execution is dependent upon finding the 
other side, or a transaction dependent upon the execution of a part of 
the order placed with another firm or market. For example, after 
receiving an order to buy 500 shares, a firm sends an order to an 
exchange for 1,000 shares. The 1,000 share order is executed, and the 
member then satisfies the 500 share order. The 1,000 share execution is 
reported by the exchange; the 500 share execution by the firm should 
not be printed again in the Third Market.
    To the extent that the transaction being triggered is greater than 
the first leg, only that portion offset by the first leg is deemed 
riskless; the balance would be ``at risk'' and reported as a separate 
trade. For example, after having received an order for 1,000 shares, 
the firm obtains an execution on an exchange for 500 shares. The 
exchange reports 500 shares; the firm only reports 500 shares in the 
Third Market because the other 500 shares are deemed riskless.
    b. ``Marker'' orders. Nasdaq also considered the extent to which 
the definition would apply in situations where the first leg is really 
just a ``marker'' order. These orders, usually of nominal size, are 
used to trigger obligations to other orders the firm may be holding. 
Marker orders serve as a mechanism to notify the market maker

[[Page 30794]]

that the market has traded at that price and that the conditional order 
has now become executable in accord with the firm's understanding with 
its customer. Such orders generally are not intended to offset to any 
significant degree other executions by the market maker.
    Under the definition above, these executions would appear to merit 
riskless principal treatment to the extent of the size of the marker 
order. However, given the purpose for which such marker orders are 
used, Nasdaq believe that these should not require the breakup of the 
order into two separate components to distinguish between a risk and 
riskless portion, provided the marker order is no larger than 10% of 
the size of an execution or group of executions that it would trigger. 
It was felt that the nominal size of the marker order did not to any 
material extent change the overall risk profile of the order.
    For example, after receiving an order for 5000 shares, a firm 
places a marker order of 500 shares on an exchange. The marker order, 
which is executed, then triggers the 5000 share order. The firm would 
report the 5000 shares in its entirety. In another example, the marker 
order triggers 10 different orders of 500 shares each for a total of 
5000 shares. Similarly, each of these 500 share executions also are 
reported.
    Another example involves how an order of 2500 shares would be 
reported if 2400 shares were sent to the floor and had been executed. 
The 2400 shares would be reported by the exchange, and thus the 100 
shares would be separately reported as a risk trade by the market 
maker.
    Accordingly, Nasdaq is proposing a rule change and corresponding 
interpretations as described above to ensure that all riskless 
principal trades, including those effected by market makers, are 
reported only once. Specifically, the text of the proposed rule change 
is in the form of amendments to NASD Rule 6420(d)(3)(B).
2. Statutory Basis
    Nasdaq believes that the proposed rule change is consistent with 
the provisions of Section 15A(b)(6) of the Act \7\ in that the proposed 
rule change will result in more accurate, reliable, and informative 
information regarding last sale transaction reports. Section 15A(b)(6) 
requires that the rules of a registered national securities association 
be designed to prevent fraudulent and manipulative acts and practices, 
to promote just and equitable principals of trade, to foster 
cooperation and coordination with persons engaged in regulating, 
clearing, settling, processing information with respect to, and 
facilitating transactions in securities, to remove impediments to and 
perfect the mechanism of a free and open market and a national market 
system, and, in general, to protect investors and the public interest; 
and are not designed to permit unfair discrimination between customers, 
issuers, brokers, or dealers.
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    \7\ 15 U.S.C. 78o-3.
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B. Self-Regulatory Organization's Statement on Burden on Competition

    Nasdaq 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 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 the foregoing, including whether the proposed rule 
change is consistent with the Act. Persons making written submission 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
NASD. All submissions should refer to file number SR-NASD-98-08 and 
should be submitted by June 26, 1998.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\8\
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    \8\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-14921 Filed 6-4-98; 8:45 am]
BILLING CODE 8010-01-M