Document ID: SEC-2010-1304-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Proposed Rule Changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2010-08-25T04:00Z

[Federal Register: August 25, 2010 (Volume 75, Number 164)]
[Notices]               
[Page 52380-52382]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr25au10-118]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-62739; File No. SR-FINRA-2010-044]

 
Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Proposed Rule Change Relating to 
the Expansion of the Order Audit Trail System to All NMS Stocks

August 18, 2010.
    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 August 6, 2010, the Financial Industry Regulatory Authority, Inc. 
(``FINRA'') filed with the Securities and Exchange Commission (``SEC'' 
or ``Commission'') the proposed rule change as described in Items I and 
II below, which Items have been prepared by FINRA. 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).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA is proposing to amend the Order Audit Trail System (``OATS'') 
rules to extend the recording and reporting requirements to all NMS 
stocks, as that term is defined in Rule 600(b)(47) of Regulation 
NMS,\3\ and to exclude certain firms that became FINRA members pursuant 
to NASD IM-1013-1 or NASD IM-1013-2 and the rules of the NYSE and that 
have limited trading activities.
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    \3\ 17 CFR 242.600(b)(47).
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    The text of the proposed rule change is available on FINRA's Web 
site at http://www.finra.org, at the principal office of FINRA, at the 
Commission's Web site at http://www.sec.gov, and at the Commission's 
Public Reference Room.

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

    In its filing with the Commission, FINRA 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. FINRA 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
    FINRA Rules 7410 through 7470 (the ``OATS Rules'') impose 
obligations on FINRA members to record in electronic form and report to 
FINRA on a daily basis certain information with respect to orders 
originated, received, transmitted, modified, canceled, or executed by 
members relating to OTC equity securities and equity securities listed 
and traded on The Nasdaq Stock Market, Inc. (``Nasdaq'').\4\ OATS 
captures this order information and integrates it with quote and 
transaction information to create a time-sequenced record of orders, 
quotes, and transactions. This information is then used by FINRA staff 
to conduct surveillance and investigations of member firms for 
violations of FINRA rules and Federal securities laws.
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    \4\ As amended by SR-FINRA-2010-003, FINRA Rule 7410 defines an 
``OTC equity security'' for purposes of the OATS Rules as an equity 
security that is not an NMS stock, except that the term does not 
include restricted equity securities and direct participation 
programs, as those terms are defined in FINRA Rule 6420. See 
Securities Exchange Act Release No. 61979 (April 23, 2010), 75 FR 
23316 (May 3, 2010) (Order Approving File No. SR-FINRA-2010-003).
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    To enhance the effectiveness of OATS as a regulatory tool, FINRA is 
proposing to amend the OATS Rules to extend the recording and reporting 
requirements to all NMS stocks, as that term is defined in Rule 
600(b)(47) of Regulation NMS.\5\ The proposed rule change would thus 
effectively extend the OATS recording and reporting requirements to NMS 
stocks listed on markets other than

[[Page 52381]]

Nasdaq (e.g., NYSE, NYSE Amex, and NYSE Arca). By including order 
information for both OTC equity securities and all NMS stocks in OATS, 
FINRA would receive a substantial portion of order information for all 
U.S. equity securities, which would significantly enhance the scope of 
the order audit trail in the U.S. equity markets. In connection with 
the expansion of the OATS requirements, FINRA is also proposing to 
create an exclusion from the definition of ``Reporting Member'' in 
FINRA Rule 7410 to exclude certain firms that became FINRA members 
pursuant to NASD IM-1013-1 or NASD IM-1013-2 and the rules of the NYSE 
and that have limited trading activities.
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    \5\ Rule 600(b)(47) of Regulation NMS defines ``NMS stock'' as 
``any NMS security other than an option.'' 17 CFR 242.600(b)(47). An 
``NMS security'' is defined as ``any security or class of securities 
for which transaction reports are collected, processed, and made 
available pursuant to an effective transaction reporting plan, or an 
effective national market system plan for reporting transactions in 
listed options.'' 17 CFR 242.600(b)(46).
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    Although FINRA members generally are required to report trades to 
FINRA for all over-the-counter transactions in all NMS stocks \6\ (in 
addition to OTC equity securities \7\), the OATS Rules do not currently 
require members to report order information to FINRA for NMS stocks 
listed on markets other than Nasdaq. As a result, FINRA is unable to 
recreate, on an automated basis, a complete order and transaction audit 
trail for all over-the-counter transactions in NMS stocks. Expansion of 
the OATS requirements to include all NMS stocks would enhance FINRA's 
ability to review and examine for member compliance with certain 
trading rules, including, but not limited to, NASD Rule 2320 (Best 
Execution and Interpositioning) and NASD IM-2110-2 (Limit Order 
Protection) [sic].
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    \6\ FINRA Rule 6110.
    \7\ See FINRA Rule 6400 Series.
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    By capturing OATS information for all NMS stocks, FINRA will also 
be able to expand its existing surveillance patterns to conduct more 
comprehensive cross-market surveillance, which also is in furtherance 
of NYSE's recent outsourcing of surveillance and other regulatory 
functions to FINRA.\8\ Specifically, to have comprehensive surveillance 
patterns that monitor trading in Nasdaq and NYSE-listed securities 
across all markets in a consistent manner, it is necessary for FINRA to 
have the same complement of order, trade, and quote information for 
these securities. Without OATS information for NYSE-listed securities, 
FINRA has a less robust data set upon which to monitor activity in 
NYSE-listed securities and would be forced to continue to have multiple 
patterns, some less optimal, to surveil for the same activity.
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    \8\ See ``FINRA and NYSE Euronext Complete Agreement for FINRA 
to Perform NYSE Regulation's Market Oversight Functions,'' FINRA 
News Release (June 14, 2010), available at http://www.finra.org/
Newsroom/NewsReleases/2010/P121622. However, certain gaps will 
continue to exist (e.g., information relating to orders from non-
FINRA member broker-dealers).
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    FINRA notes that the Commission has recently published a proposed 
rule that, if adopted, would ultimately result in a consolidated audit 
trail for the U.S. securities markets.\9\ FINRA believes that the 
proposed rule change is necessary notwithstanding the Commission's rule 
proposal concerning a consolidated audit trail. The consolidated audit 
trail, as proposed by the Commission, is still in its proposal stage 
and may be several years away from providing a means by which self-
regulatory organizations and the Commission can use the data to surveil 
the equity markets.\10\ In the interim, FINRA believes that extending 
the OATS recording and reporting requirements to NMS stocks listed on 
markets other than Nasdaq will greatly enhance its audit trail and its 
ability to identify illicit trading activity in a more effective and 
efficient manner.
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    \9\ See Securities Exchange Act Release No. 62174 (May 26, 
2010), 75 FR 32556 (June 8, 2010).
    \10\ The Commission has proposed that national securities 
exchanges and national securities associations would begin 
submitting data to the central repository required by the proposed 
rule within one year after effectiveness of the NMS plan and that 
members would begin submitting data one year later. See supra note 
9.
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    Moreover, because Reporting Members \11\ already are reporting 
order information to OATS regarding Nasdaq and OTC equity securities, 
they should have the technological framework in place to report 
information regarding orders in the remaining NMS stocks as well. In 
addition, those FINRA members that are also member organizations of the 
NYSE already are recording order information under the NYSE's Order 
Tracking System (``OTS'') rules that are substantially similar to the 
information required by the OATS Rules.\12\ FINRA believes that 
extending the OATS Rules to NMS stocks listed on markets other than 
Nasdaq can be accomplished in a comparatively short timeframe and can 
provide FINRA with order data for these securities much sooner than the 
consolidated audit trail proposed by the Commission.
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    \11\ See FINRA Rule 7410(o).
    \12\ See NYSE Rules 132B, 132C.
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    Expanding the categories of securities to which the OATS Rules 
apply to include securities listed on the NYSE or other national 
securities exchanges, such as those listed on NYSE Amex, would have the 
ancillary effect of extending the OATS recording and reporting 
requirements to certain members that became members of FINRA pursuant 
to NASD IM-1013-1 or IM-1013-2 \13\ and the rules of the NYSE.\14\ 
These members generally conduct their trading activities on the floor 
of an exchange, which is overseen by the relevant exchange. FINRA 
believes it is appropriate to exclude these firms from the OATS 
recording and reporting requirements. Consequently, FINRA is proposing 
to amend the definition of ``Reporting Member'' in FINRA Rule 7410 so 
that a member will not be considered a ``Reporting Member'' with 
respect to an order if: (i) The firm was approved as a FINRA member 
pursuant to NASD IM-1013-1 or NASD IM-1013-2; (ii) the firm operates 
consistent with NASD IM-1013-1 or NASD IM-1013-2, including limiting 
its business operations to ``permitted floor activities,'' as that term 
is defined in NASD IM-1013-1 and NASD IM-1013-2; and (iii) the order 
was received by the firm through systems operated and regulated by the 
NYSE or NYSE Amex.
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    \13\ NASD IM-1013-1 and NASD IM-1013-2 establish a waive-in 
membership application process for certain firms to become FINRA 
members that were members of the NYSE or NYSE Alternext (n/k/a NYSE 
Amex) but were not members of the National Association of Securities 
Dealers, Inc. See Securities Exchange Act Release No. 58707 (October 
1, 2008), 73 FR 59001 (October 8, 2008); Securities Exchange Act 
Release No. 56653 (October 12, 2007), 72 FR 59127 (October 18, 
2007).
    \14\ See NYSE Rule 2.
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    FINRA will announce the effective date of the proposed rule change 
in a Regulatory Notice to be published no later than 60 days following 
Commission approval. The effective date will be no later than 180 days 
following publication of the Regulatory Notice announcing Commission 
approval.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act,\15\ which requires, among 
other things, that FINRA rules must 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. The proposed rule change is consistent with the Act 
because it will enhance FINRA's ability to conduct surveillance and 
investigations of member firms for violations of FINRA's rules and 
Federal securities laws.
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    \15\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    FINRA does not believe that the proposed rule change will result in 
any

[[Page 52382]]

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

    The proposed rule change was published for comment in Notice to 
Members 04-80 (November 2004).\16\ Eight comments were received in 
response to the Notice.\17\ A copy of the Notice is attached as Exhibit 
2a. Copies of the comment letters received in response to the Notice 
are attached as Exhibit 2b.\18\ Seven commenters were generally opposed 
to the proposed rule change. One commenter generally supported the 
proposal provided firms could report all equity securities in the same 
format and there were no redundant reporting responsibilities.\19\
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    \16\ Three other proposals were discussed in the Notice. The 
first involved expanding the OATS requirements to OTC equity 
securities. The second would require enhanced information, including 
execution data, relating to orders routed to non-members or 
exchanges. The third would require members to record and report to 
OATS proprietary orders generated in the ordinary course of market 
making activities. The proposal regarding OTC equity securities was 
approved by the SEC in 2006 and became effective on February 4, 
2008. See Securities Exchange Act Release No. 54585 (October 10, 
2006), 71 FR 61112 (October 17, 2006); see also Securities Exchange 
Act Release No. 55440 (March 9, 2007), 72 FR 12852 (March 19, 2007); 
Notice to Members 06-70 (December 2006). As part of that proposed 
rule change, FINRA discussed the comments related to the expansion 
of OATS to OTC equity securities. See SR-NASD-2005-101. Neither of 
the other two proposals is part of the current proposed rule change. 
Accordingly, FINRA is not addressing the comments received in 
response to those proposals.
    \17\ Letter from Emily Vitale dated November 24, 2004 
(``Vitale''); Letter from ML Stern & Co., LLC dated January 14, 2005 
(``ML Stern''); Letter from Ameritrade, Inc. dated January 18, 2005 
(``Ameritrade''); Letter from Instinet Group dated January 20, 2005 
(``Instinet''); Letter from Operations Committee of the Securities 
Industry Association dated January 20, 2005 (``SIA''); Letter from 
royalblue Financial Corp. dated January 20, 2005 (``royalblue''); 
Letter from Jed Bandes dated January 20, 2005 (``Bandes''); and 
Letter from The Financial Information Forum dated January 21, 2005 
(``FIF'').
    \18\ The Commission notes that Exhibits 2a and 2b are attached 
to the filing itself and not to this notice.
    \19\ See Ameritrade.
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    One commenter opposed the proposed rule change without additional 
discussion but noted that the system in place for OATS at the time was 
inefficient in several ways.\20\ Two other commenters opposed the OATS 
rules generally, without specifically commenting on any of the 
proposals.\21\ These commenters cited the additional costs and burdens 
to member firms of complying with the OATS requirements.
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    \20\ See ML Stern.
    \21\ See Bandes, Vitale.
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    The predominant concern among the commenters with respect to the 
proposal to extend the OATS Rules to securities traded on markets other 
than Nasdaq regarded the potential regulatory duplication that could 
occur by expanding OATS to include NYSE-listed equity securities \22\ 
because NYSE maintains its own rules regarding the retention and 
reporting of order information in its OTS Rules.\23\ As noted above, 
FINRA now has regulatory responsibility for performing the market 
surveillance and enforcement functions previously conducted by NYSE 
Regulation. It is FINRA's understanding that NYSE will propose to 
retire OTS upon the expansion of OATS to all NMS stocks.
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    \22\ See Ameritrade, FIF, Instinet, SIA, royalblue.
    \23\ See NYSE Rules 132B, 132C.
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III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 45 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 or disapprove 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. 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 No. SR-FINRA-2010-044 on the subject line.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File No. SR-FINRA-2010-044. 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 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 Web site viewing and 
printing in the Commission's Public Reference Room, 100 F Street, NE., 
Washington, DC 20549, on official business days between the hours of 10 
a.m. and 3 p.m. Copies of such filing also will be available for 
inspection and copying at the principal office of FINRA. 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 No. SR-FINRA-2010-044 and should be 
submitted on or before September 15, 2010.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\24\
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    \24\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. 2010-21031 Filed 8-24-10; 8:45 am]
BILLING CODE 8010-01-P