Document ID: SEC-2005-0121-0001
Agency: sec
Document Type: Notice
Title: Self-regulatory organizations; proposed rule changes: National Stock Exchange
Posted Date: 2005-10-18T04:00Z

[Federal Register: October 18, 2005 (Volume 70, Number 200)]
[Notices]               
[Page 60594-60596]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr18oc05-134]                         

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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-52576; File No. SR-NSX-2005-06]

 
Self-Regulatory Organizations; National Stock Exchange; Notice of 
Filing of Proposed Rule Change, and Amendment Nos. 1 and 2 Thereto, To 
Amend the Exchange's Customer Priority Rule To Require Designated 
Dealers To Implement and Maintain Automated Compliance Systems

October 7, 2005.
    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 July 19, 2005, the National Stock Exchange SM (``NSX'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``Commission'') the proposed rule change as described in Items I, II, 
and III below, which Items have been prepared by the NSX. On October 5, 
2005, the Exchange filed Amendment No. 1 to the proposed rule change. 
On October 7, 2005, the Exchange filed Amendment No. 2 to the proposed 
rule change. Amendment Nos. 1 and 2 are incorporated into this notice. 
The Commission is publishing this notice to solicit comments on the 
proposed rule change, as amended, from interested persons.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------

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

    The Exchange proposes to amend the text of Exchange Rule 12.6 
(``Customer Priority Rule'') to require the Exchange's Designated 
Dealers to implement and maintain automated systems reasonably designed 
to ensure compliance with the Customer Priority Rule. The text of the 
proposed rule change is set forth below. Proposed new language is in 
italics.
* * * * *

Rules of National Stock Exchange

* * * * *

Chapter XII Trading Practice Rules

* * * * *
    Rule 12.6. Customer Priority
    (a)-(c) No change to text
    (d) (Reserved).
    (e) Designated Dealers executing customer orders on the Exchange 
are required to implement and maintain automated systems reasonably 
designed to ensure compliance with this Rule. The Exchange will allow 
any Designated Dealer to comply manually with the

[[Page 60595]]

provisions of this Rule for a reasonably limited duration in the event 
that such Designated Dealer's automated systems become inoperative as a 
result of any act, condition or cause beyond the reasonable control of 
the Designated Dealer, including, but not limited to, an act of God, 
fire, flood, extraordinary weather conditions, war, insurrection, riot, 
strike, accident, action of government, communications or power 
failure, or any equipment or software malfunction. Designated Dealers 
shall not otherwise disable or disengage their automated systems. 
Designated Dealers shall promptly notify the Exchange of any changes in 
the operating status of their automated systems.

Interpretations and Policies

    .01 If a Designated Dealer holds for execution on the Exchange a 
customer buy order and a customer sell order that can be crossed, the 
Designated Dealer's automated system shall systemically cross them 
without interpositioning itself as a dealer.
    .02 No change to text
    .03 A member or any associated person of a member responsible for 
entering orders for its own account or any account in which it is 
directly or indirectly interested shall be presumed to have knowledge 
of a particular unexecuted customer order. Such presumption can be 
rebutted by adequate evidence which effectively demonstrates, to the 
Exchange's satisfaction, that the member has implemented a reasonable 
system of internal policies and procedures and has an adequate system 
of internal controls to prevent the misuse of information about 
customer orders by those responsible for entering such proprietary 
orders.
* * * * *

 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 Exchange included statements 
concerning the purpose of, and basis for, the proposal and discussed 
any comments it received on the proposed rule change, as amended. The 
text of these statements may be examined at the places specified in 
Item IV below. The Exchange 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
    The Customer Priority Rule provides, in pertinent part, that no 
member of the Exchange shall: (i) Personally buy or initiate the 
purchase of any security traded on the Exchange for its own account or 
for any account in which it or any associated person of the member is 
directly or indirectly interested while such member holds or has 
knowledge that any person associated with it holds an unexecuted market 
or limit price order to buy such security in the unit of trading for a 
customer, or (ii) sell or initiate the sale of any such security for 
any such account while it personally holds or has knowledge that any 
person associated with it holds an unexecuted market or limit price 
order to sell such security in the unit of trading for a customer.
    On May 19, 2005, the Exchange consented to the entry of an order by 
the Commission instituting administrative and cease-and-desist 
proceedings pursuant to Sections 19(b) and 21C of the Act.\3\ The 
Settlement Order found, among other things, that the Exchange failed to 
enforce compliance by its members with the Customer Priority Rule. As 
part of its undertakings in the Settlement Order, the Exchange agreed 
to propose rule changes requiring Designated Dealers to implement 
systems enhancements to comply with the Customer Priority Rule.
---------------------------------------------------------------------------

    \3\ See Exchange Act Release No. 51714 (May 19, 2005) 
(``Settlement Order'').
---------------------------------------------------------------------------

    In late 2004, the Exchange implemented automated daily surveillance 
for potential violations of the Customer Priority Rule. The Exchange 
believes that requiring Designated Dealers to have automated systems 
reasonably designed to comply with the Customer Priority Rule before 
and during the process of executing a proprietary trade would 
effectively complement the Exchange's post-trade surveillance. 
Accordingly, the Exchange proposes to require its Designated Dealers to 
implement and maintain automated systems reasonably designed to meet 
this goal. Moreover, the Exchange believes that the proposed amendment 
is designed to further ensure that executable public orders on the 
Exchange are protected to the fullest possible extent.
    The Exchange has long recognized the utility of information 
barriers in preventing the misuse of information by an associated or 
affiliated person of a member when such information is acquired or 
generated by another associated or affiliated person of such member 
under an obligation to protect such information. For example, Exchange 
Rule 5.5 provides for the establishment by Designated Dealers of 
procedures reasonably designed to prevent misuse by the firms' 
associated and affiliated persons of the information associated with 
the firms' specialist operations.\4\ While Rule 5.5 by its terms is 
applicable only to Designated Dealers, the Exchange believes that any 
member may establish appropriate functional separation to prevent the 
misuse of information about customer orders by those responsible for 
entering proprietary orders. Members with effective information 
barriers can avoid violations of the Customer Priority Rule because 
such information barriers would prevent the members from having the 
requisite knowledge that they are holding an unexecuted customer order. 
In order to clarify and codify this interpretation, the Exchange is 
proposing to add a new interpretation to the Customer Priority Rule. 
This proposed Interpretation .03 to Rule 12.6 indicates that a member 
or associated persons of a member responsible for entering proprietary 
orders presumptively has knowledge of a particular customer order. Any 
member or associated person of a member can rebut this presumption by 
providing evidence to the Regulatory Services Division of the Exchange 
demonstrating that the member has a system of internal policies and 
procedures and an adequate system of internal controls in place to 
prevent the misuse of information about customer orders by those 
responsible for entering proprietary orders.\5\ The evidence provided 
by the member or the associated person of the member may be subjected 
to further scrutiny, investigation and examination by the Regulatory 
Services Division to

[[Page 60596]]

determine whether the presumption has been adequately rebutted.\6\
---------------------------------------------------------------------------

    \4\ The Exchange's Examination Department regularly examines 
those Designated Dealers that previously obtained Exchange approval 
under Rule 5.5 for the functional separation of such firm's 
specialist operations from the firm's associated and affiliated 
persons. These examinations help ensure the existence of the 
Designated Dealers' compliance and audit procedures reasonably 
designed to maintain functional separation as evidenced by such 
things as separate physical locations and limitations on traders' 
access to information while at the firms.
    \5\ The Exchange believes that this proposal is consistent with 
the way in which other self-regulatory organizations interpret their 
trading ahead rules. See, e.g., Supplementary Material .10 of NYSE 
Rule 92 and NASD Notice to Members 95-43 (interpreting NASD IM-2110-
2).
    \6\ It is important to note that the Exchange only conducts 
routine examinations of its Designated Dealers. Any member that is 
not the subject of a routine examination and that seeks to rely on 
proposed Interpretation .03, when confronted with an inquiry 
concerning its trading practices under the Customer Priority Rule, 
must be prepared to provide evidence to the Exchange of its 
information barrier policies and procedures for review so the 
Exchange can determine whether such evidence rebuts the presumption 
of knowledge of a particular unexecuted customer order.
---------------------------------------------------------------------------

2. Statutory Basis
    The Exchange believes the proposed rule change, as amended, is 
consistent with Section 6(b) of the Act \7\ in general, and furthers 
the objectives of Section 6(b)(5) \8\ in particular, in that it is 
designed to promote just and equitable principles of trade and to 
remove impediments to and perfect the mechanism of a free and open 
market and a national market system and, generally, in that it protects 
investors and the public interest.
---------------------------------------------------------------------------

    \7\ 15 U.S.C. 78f(b).
    \8\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change, as 
amended, will impose any inappropriate burden on competition.

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

    The Exchange has neither solicited nor received written comments on 
the proposed rule change.

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 Exchange consents, the Commission will:
    (a) By order approve such proposed rule change, as amended; or
    (b) institute proceedings to determine whether the proposed rule 
change, as amended, 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, as amended, 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 rule-comments@sec.gov. Please include 

File Number SR-NSX-2005-06 on the subject line.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-9303.
    All submissions should refer to File Number SR-NSX-2005-06. 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 respect to the proposed rule change, as 
amended, that are filed with the Commission, and all written 
communications relating to the proposed rule change, as amended, 
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 also will be available for 
inspection and copying at the principal office of the NSX. 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-NSX-2005-06 and should be 
submitted on or before November 8, 2005.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\9\
---------------------------------------------------------------------------

    \9\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Jill M. Peterson,
Assistant Secretary.
 [FR Doc. E5-5726 Filed 10-17-05; 8:45 am]

BILLING CODE 8010-01-P