Document ID: SEC-2011-1734-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2011-11-10T05:00Z

[Federal Register Volume 76, Number 218 (Thursday, November 10, 2011)]
[Notices]
[Pages 70190-70192]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-29114]

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

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-65695; File No. SR-FINRA-2011-051]

Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Order Approving Proposed Rule Change To Allow FINRA To 
Grant Exemptions From Certain Equity Trade Reporting Obligations for 
Certain Alternative Trading Systems

November 4, 2011.

I. Introduction

    On September 16, 2011, the Financial Industry Regulatory Authority, 
Inc. (``FINRA'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to adopt new rules that will 
allow FINRA to grant exemptions from certain equity trade reporting 
obligations for alternative trading systems (``ATSs'') meeting 
specified criteria. The proposed rule change was published for comment 
in the Federal Register on September 29, 2011.\3\ The Commission 
received three comment letters on the proposed rule change.\4\ FINRA 
responded to the comments in a letter dated November 4, 2011.\5\ This 
order approves the proposed rule change.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 65388 (September 23, 
2011), 76 FR 60567 (July 26, 2011) (``Notice'').
    \4\ See letter from Suzanne H. Shatto, dated October 20, 2011 
(``Shatto Letter''); letter from Naphtali M. Hamlet, Investor, dated 
October 21, 2011 (``Hamlet Letter''); letter from Daniel Zinn, 
General Counsel, OTC Markets Group Inc., dated October 20, 2011 
(``OTC Markets Letter'').
    \5\ See letter from Lisa C. Horrigan, Associate General Counsel, 
FINRA, to Elizabeth M. Murphy, Secretary, Commission, dated November 
4, 2011 (``FINRA Response'').
---------------------------------------------------------------------------

II. Description of the Proposal

    Proposed FINRA Rules 6183 and 6625 will provide FINRA with new 
authority to exempt a member ATS that meets the specified criteria from 
the trade reporting obligation under the equity trade reporting rules. 
In addition, FINRA will adopt a conforming change to Rule 9610 to 
specify that FINRA has exemptive authority under the new rules.
    As described in the Notice, existing FINRA rules require the 
reporting of over-the-counter (``OTC'') transactions in equity 
securities \6\ by the ``executing party.'' The term ``executing party'' 
is defined as the FINRA member that receives an order for handling or 
execution or is presented an order against its quote, does not 
subsequently re-route the order, and executes the transaction. For a 
trade executed on an ATS, the ATS is the ``executing party'' and thus 
has the trade reporting obligation.\7\
---------------------------------------------------------------------------

    \6\ Specifically, these transactions are: (1) Transactions in 
NMS stocks, as defined in SEC Rule 600(b) of Regulation NMS, 
effected otherwise than on an exchange, which are reported through 
the Alternative Display Facility or a Trade Reporting Facility; and 
(2) transactions in OTC Equity Securities and Restricted Equity 
Securities, as those terms are defined in Rule 6420, which are 
reported through the OTC Reporting Facility. As noted in the 
proposal, the new rules will apply to OTC transactions in equity 
securities only. The rules will not apply to TRACE-eligible 
securities. TRACE-eligible securities are subject to a separate 
reporting structure under FINRA's Rule 6700 Series.
    \7\ See Securities Exchange Act Release No. 58903 (November 5, 
2008), 73 FR 67905 (November 17, 2008) (Order Approving File No. SR-
FINRA-2008-011); and Regulatory Notice 09-08 (January 2009). See 
also, e.g., Trade Reporting Frequently Asked Questions, Sections 307 
and 308, available at http://www.finra.org/Industry/Regulation/Guidance/P038942 Guidance/P038942. As described in the proposal, the term ATS 
includes electronic communications networks.

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

[[Page 70191]]

    Under FINRA's new rules, for an ATS to qualify for an exemption, 
the following conditions must be satisfied:
    First, trades must be between ATS subscribers that are both FINRA 
members. For any trades between non-members or a FINRA member and a 
non-member, the exemption will not apply, and the ATS will have the 
trade reporting obligation under FINRA rules.
    In addition, the ATS must demonstrate that the following criteria 
are met: (1) The member subscribers must be fully disclosed to one 
another at all times on the ATS; (2) although the system brings 
together the orders of buyers and sellers and uses established, non-
discretionary methods under which such orders interact with each other, 
the system does not permit automatic execution. A member subscriber 
must take affirmative steps beyond the submission of an order to agree 
to a trade with another member subscriber; (3) the trade does not pass 
through any ATS account, and the ATS does not in any way hold itself 
out to be a party to the trade; and (4) the ATS does not exchange 
shares or funds on behalf of the member subscribers, take either side 
of the trade for clearing or settlement purposes, including, but not 
limited to, at DTC or otherwise, or in any other way insert itself into 
the trade.
    The ATS and its FINRA member subscribers must also acknowledge and 
agree in writing that the ATS shall not be deemed a party to the trade 
for purposes of trade reporting and that trades shall be reported by 
the subscriber that, as between the two counterparties to the trade, 
would satisfy the definition of ``executing party'' under FINRA trade 
reporting rules. An ATS that is granted an exemption would have to 
obtain such written agreements from all of its FINRA member subscribers 
prior to relying on the exemption. Any ATS granted an exemption under 
the new rules would be required to retain the written agreements and be 
able to produce them to FINRA upon request.
    Finally, the ATS must agree to provide to FINRA on a monthly basis, 
or such other basis as prescribed by FINRA, data relating to the volume 
of trades, by security, executed by the ATS's member subscribers using 
the ATS's system (e.g., number of trades, number of shares traded and 
total settlement value for each security traded). The ATS also must 
acknowledge that failure to report such data to FINRA, in addition to 
constituting a violation of FINRA rules, would result in revocation of 
any exemption granted pursuant to the new rules.
    Where FINRA grants an exemption pursuant to Rules 6183 or 6625, the 
ATS will not be deemed a party to the trade for purposes of FINRA trade 
reporting rules and will not be identified in trade reports submitted 
to FINRA. The ATS will bear no responsibility for reporting such 
transactions. The transaction, however, must be reported to FINRA by 
the member subscriber that, as between the two member subscribers who 
are the counterparties, satisfies the definition of ``executing party'' 
under paragraph (b) of Rules 6282, 6380A, 6380B, or 6622. In addition, 
where an ATS has been granted an exemption under the new rules, the 
member subscribers, as the parties identified in the trade report, will 
be assessed regulatory transaction fees under Section 3 of Schedule A 
to the FINRA By-Laws and the Trading Activity Fee under FINRA By-Laws, 
Schedule A, Sec.  1(b)(2). The ATS would not be assessed such fees.
    Notwithstanding an exemption, any transactions that occur through 
the ATS would be considered volume of the ATS for purposes of, among 
other things, various provisions of Regulation ATS. Such provisions 
include the recordkeeping requirements of Rule 302,\8\ the display 
requirements under Rule 301(b)(3),\9\ the access requirements under 
Rule 301(b)(5),\10\ and the capacity, integrity, and security 
requirements of Rule 301(b)(6).\11\
---------------------------------------------------------------------------

    \8\ 17 CFR 242.302.
    \9\ 17 CFR 242.301(b)(3).
    \10\ 17 CFR 242.301(b)(5).
    \11\ 17 CFR 242.301(b)(6).
---------------------------------------------------------------------------

    The effect of an exemption provided pursuant to FINRA Rules 6183 
and 6625 is illustrated in the following example that was included in 
the Notice: FINRA member BD1 displays a quote through ATS X and member 
BD2 routes an order to BD1 for the price and size of BD1's quote using 
a messaging system provided by ATS X. BD1 does not subsequently re-
route the order and executes the trade. Assuming that ATS X meets all 
of the criteria set forth in the proposed rule and has been granted an 
exemption by FINRA, it will not be deemed a party to the trade for 
trade reporting purposes and should not be identified as such in the 
trade report submitted to FINRA. In this example, BD1 is the 
``executing party'' and has the obligation to report the trade between 
BD1 and BD2.
    FINRA stated that the proposed rule change will be effective on the 
date of Commission approval.

III. Summary of Comment Letters

    Among the three comment letters received, two of the commenters 
expressed concern about dark pools and their potential impact on the 
fairness and transparency of the national market system.\12\ One of 
these commenters suggested that dark pools be prohibited entirely.\13\ 
FINRA responded that these arguments are not germane to the proposal, 
which does not change the level of transparency that currently 
exists.\14\ FINRA stated that all trades executed on an ATS, including 
a dark pool, must be reported to FINRA and are publicly disseminated. 
With respect to any ATS that is granted an exemption under the proposed 
rule change, all of the trades executed on the ATS would continue to be 
reported for public dissemination.
---------------------------------------------------------------------------

    \12\ See Shatto Letter; Hamlet Letter.
    \13\ See Shatto Letter.
    \14\ See FINRA Response at 3.
---------------------------------------------------------------------------

    Another commenter challenged the need for any new rules at all.\15\ 
This commenter asserted that any ATS that meets the criteria set out in 
the proposed rule change would not be an executing party, and 
consequently, would not be subject to any reporting obligation under 
current FINRA rules. On this basis, the commenter concluded that the 
proposal is unnecessary and should not be approved by the Commission, 
because no FINRA exemption is necessary for entities that bear no 
regulatory obligation.
---------------------------------------------------------------------------

    \15\ See OTC Markets Letter at 1-2.
---------------------------------------------------------------------------

    FINRA responded that this commenter's assertion is based on an 
erroneous interpretation of FINRA rules and directly at odds with 
statements made by FINRA in the original filing.\16\ FINRA noted 
previous interpretations and guidance that an ATS is the ``executing 
party'' and has the trade reporting obligation where the transaction is 
executed on the ATS.\17\ FINRA reiterated its belief that an ATS that 
satisfies the criteria set forth in the proposal has a more limited 
involvement in the trade execution than the member subscribers, and 
therefore, the proposed exemption is appropriate in this narrow 
instance.
---------------------------------------------------------------------------

    \16\ See FINRA Response at 1-2.
    \17\ See note 7 supra.
---------------------------------------------------------------------------

    The commenter further stated that, notwithstanding its opposition, 
were the Commission inclined to approve FINRA's proposal, the proposed 
rules should be modified.\18\ First, the commenter asserted that the 
exemption authority should be expanded to cover TRACE-eligible 
securities, because there is no meaningful basis to distinguish the 
reporting rules and obligations

[[Page 70192]]

associated with this class of securities from those for other 
securities.
---------------------------------------------------------------------------

    \18\ See OTC Markets Letter at 2.
---------------------------------------------------------------------------

    FINRA responded that the comment goes beyond the scope of the 
instant proposal, but that it would consider the comment 
separately.\19\ FINRA stated that if it determines that a similar 
exemption is appropriate for TRACE reporting, FINRA would submit a 
separate rule filing to effect that change.
---------------------------------------------------------------------------

    \19\ See FINRA Response at 2.
---------------------------------------------------------------------------

    In addition, the commenter argued that the criteria for the 
exemption should be clarified in certain respects.\20\ FINRA disagreed 
with the comment and reasserted its belief that the criteria for the 
exemption were sufficiently clear.\21\
---------------------------------------------------------------------------

    \20\ See OTC Markets Letter at 3-6.
    \21\ See FINRA Response at 2.
---------------------------------------------------------------------------

    Finally, the commenter argued that the proposed exemption should be 
automatic, and not subject to FINRA staff discretion.\22\ The commenter 
maintained that FINRA has not explained the ``relevant factors'' that 
FINRA staff would consider, which could lead to inconsistent 
application of the new rules. FINRA responded that it is important for 
its staff to have the opportunity to review an ATS's application for 
exemptive relief and to make a determination whether the ATS meets the 
criteria in the proposed rule before the ATS is able to rely on the 
exemption.\23\ FINRA believes that it is important to know in advance 
which party--the ATS or one of its subscribers--will have the trade 
reporting obligation. FINRA stated that, while it expects to grant an 
exemption to any ATS that can demonstrate that it meets all of the 
criteria set forth in the new rules, FINRA staff should have notice and 
discretion in the event of a disagreement with an ATS about whether it 
qualifies for an exemption under the proposed rule. FINRA plans to post 
on its Web site which ATSs are operating under any exemption granted 
pursuant to the new rules.
---------------------------------------------------------------------------

    \22\ See OTC Markets Letter at 7.
    \23\ See FINRA Response at 2-3.
---------------------------------------------------------------------------

IV. Discussion and Commission's Findings

    The Commission has carefully reviewed the proposed rule change, the 
comments received, and FINRA's response to the comments, and finds that 
the proposed rule change is consistent with the requirements of the Act 
and the rules and regulations thereunder applicable to a national 
securities association.\24\ In particular, the Commission finds that 
the proposed rule change is consistent with the provisions of Section 
15A(b)(6) of the Act,\25\ which requires, among other things, that 
FINRA rules be designed to prevent fraudulent and manipulative acts and 
practices, to promote just and equitable principles of trade, and, in 
general, to protect investors and the public interest.
---------------------------------------------------------------------------

    \24\ In approving this proposed rule change, the Commission has 
considered the rule's impact on efficiency, competition, and capital 
formation. See 15 U.S.C. 78c(f).
    \25\ 15 U.S.C. 78o-3(b)(6).
---------------------------------------------------------------------------

    As described above, the proposal is designed to provide FINRA the 
authority to exempt an ATS from reporting obligations under FINRA's 
equity trade reporting rules where the ATS does not perform all the 
functions normally associated with those of an executing party. Where 
an exemption is granted, the duty to report will fall on one of the 
subscribers that is a counterparty to the trade and that itself 
satisfies the definition of ``executing party.'' The Commission 
believes that the exemption mechanism is reasonably designed to promote 
efficient reporting of OTC transactions in equity securities, and that 
FINRA can--consistent with the Exchange Act--be afforded some 
discretion regarding which of its members should have the duty to 
report a trade when there are multiple members who could potentially 
assume that duty.
    The Commission does not believe that any commenters raised issues 
that would preclude approval of this proposal. The Commission believes 
that the proposal is sufficiently clear, and modifications are not 
necessary to allow the Commission to find it consistent with the Act. 
Furthermore, the comments that raised issues with dark pools go beyond 
the scope of the present proposal. All transactions currently subject 
to reporting will continue to be reported; the new rules merely allow 
FINRA to reassign the duty to report in certain circumstances.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\26\ that the proposed rule change (SR-FINRA-2011-051) be, and it 
hereby is, approved.
---------------------------------------------------------------------------

    \26\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\27\
---------------------------------------------------------------------------

    \27\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2011-29114 Filed 11-9-11; 8:45 am]
BILLING CODE 8011-01-P