Document ID: SEC-2007-1301-0001
Agency: sec
Document Type: Notice
Title: Self-regulatory organizations; proposed rule changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2007-09-21T04:00Z

[Federal Register: September 21, 2007 (Volume 72, Number 183)]
[Notices]               
[Page 54087-54089]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr21se07-146]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-56439; File No. SR-FINRA-2007-007]

 
Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Proposed Rule Change Relating to 
Exemption From Reporting for TRACE-Eligible Securities Transactions 
Resulting From Exercise or Settlement of Options, Termination or 
Settlement of Credit Default Swaps, Other Types of Swaps, or Similar 
Instruments

September 13, 2007.
    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 10, 2007, the Financial Industry Regulatory Authority, Inc. 
(``FINRA'') (f/k/a National Association of Securities Dealers, Inc. 
(``NASD'')) 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 substantially 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: (1) NASD Rule 6230(e) to exempt from 
reporting to the Trade Reporting and Compliance Engine (``TRACE'') 
transactions in TRACE-eligible securities resulting from the exercise 
or settlement of an option or a similar instrument, or the termination 
or settlement of a credit default swap (``CDS''), other type of swap, 
or a similar instrument (collectively, ``Derivative-Related 
Transactions''); and (2) NASD Rule 6210(c) to conform the definition of 
``reportable TRACE transaction'' to exclude this class and any other 
class of exempted transactions from the defined term. The text of the 
proposed rule change is available on FINRA's Web site (http://www.finra.org
), at FINRA, 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 proposes to amend NASD Rule 6230(e) to exempt transactions in 
TRACE-eligible securities \3\ that are Derivative-Related Transactions 
from the TRACE reporting requirements in NASD Rule 6230, and to make 
conforming amendments to NASD Rule 6210(c). (The TRACE reporting 
requirement does not exist in connection with any cash-settled 
derivative, even if the derivative, such as a CDS, refers to one or 
several securities that are TRACE-eligible securities.) Concurrently, 
FINRA withdraws SR-NASD-2006-103.\4\ In

[[Page 54088]]

addition, if the proposed rule change is approved, FINRA will rescind 
NASD Notice to Members 05-77 (November 2005), in which FINRA clarified 
members' obligations to report Derivative-Related Transactions to 
TRACE.\5\
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    \3\ See NASD Rule 6210 for definition of ``TRACE-eligible 
security.''
    \4\ SR-NASD-2006-103 was filed with the Commission on August 28, 
2006. FINRA proposed NASD IM-6230 to provide exemptive relief from 
certain reporting requirements for transactions executed in 
connection with the termination or settlement of a CDS or a similar 
instrument (``CDS-Related Transactions'') and an amendment to NASD 
Rule 6250 to exempt all Derivative-Related Transactions from 
dissemination. See Securities Exchange Act Release No. 54681 
(November 1, 2006), 71 FR 65555 (November 8, 2006) (notice of filing 
of proposed rule change). Among other things, in SR-NASD-2006-103, 
FINRA stated that the reporting requirement addressed previously in 
NASD Notice to Members 05-77 (November 2005) applies only to those 
derivative instruments that are terminated or settled in whole or in 
part by the purchase or sale of TRACE-eligible securities 
(``physical settlement''), and has no application to derivatives 
that are cash-settled.
    \5\ See NASD Notice to Members 05-77 (November 2005).
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    FINRA believes that Derivative-Related Transactions, although 
technically transactions if they result in a change of beneficial 
ownership of TRACE-eligible securities, should not be reported for 
several reasons.\6\ Such transactions should be exempt from reporting 
because the information regarding price (and yield) being reported does 
not reflect a currently negotiated transaction price. The price of a 
transaction in a TRACE-eligible security executed in such circumstances 
is agreed upon at the time of the execution of a CDS or other 
derivative. In the event of a CDS, for example, the price is usually 
set at par. At the time of an event triggering a termination and 
settlement of a CDS such as a filing of bankruptcy, an issuer's bonds 
are very likely trading below par. Accordingly, the resulting 
Derivative-Related Transaction, if the CDS is physically settled, will 
be at a price that does not reflect current market conditions. FINRA 
recognized this in NASD Notice to Members 05-77, requiring that such 
transactions be reported using the ``special price'' flag or modifier, 
which is appropriately used when a transaction is executed at a price 
based on arm's length negotiation and done for investment, commercial, 
or trading considerations, but does not appear to reflect current 
market pricing. In addition, the pricing and time of the reporting and 
dissemination of certain Derivative-Related Transactions, such as CDS-
related transactions, not only will not aid in price discovery, but 
also may create significant investor confusion. For example, due to the 
basic structure of a CDS, all or many of such Derivative-Related 
Transactions in a single issuer likely would occur, and be reported and 
disseminated during the same period. Thus, a very large number of non-
market-priced transactions in the debt securities of the issuer likely 
would be reported and disseminated and create confusion in the 
marketplace, especially to retail investors who may expect pricing at 
par, and, in most cases, will receive quotes substantially below par. 
Accordingly, as prices from Derivative-Related Transactions do not 
contribute to price discovery, the costs of continuing to require such 
reporting, including potential investor confusion, argue in favor of 
the proposed exemption from TRACE reporting and dissemination.
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    \6\ Transactions that are not reported also are not 
disseminated.
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    Finally, the rationale underlying the proposed exemption from TRACE 
reporting and dissemination--price discovery does not occur and 
investor confusion is likely to occur--has been recognized previously 
by the Commission and FINRA as logical bases for exempting certain 
transactions from trade reporting and dissemination. For example, for 
many years FINRA had a similar trade reporting exemption for certain 
transactions in equity securities, such as transactions occurring as a 
result of the exercise of an over-the-counter (``OTC'') option on an 
equity security.\7\ Transactions from Derivative-Related Transactions 
should be exempt for the same reasons that the Commission approved such 
trade reporting exemptions for transactions that occurred as a result 
of the exercise of the derivative OTC option.
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    \7\ Historically, purchases and sales of equity securities that 
occurred as a result of the exercise of an OTC option were not 
required to be reported to FINRA. In 2006, FINRA amended its rules 
to establish ``Reporting * * * for Purposes of Regulatory 
Transaction Fee Assessment'' for such equity transactions (and 
certain other equity transactions). The rules were changed 
specifically to improve FINRA's program regarding certain fees 
(``Section 31 fees'') payable to the Commission to improve FINRA's 
collection of transaction-based fees; the changes were not made to 
further either the policy to improve market surveillance or to 
facilitate price discovery, which are primary policy objectives of 
trade reporting and dissemination. Due to the nature of such 
reports, they are not disseminated and a member does not pay the 
usual fees--certain system usage fees--charged for trade reporting. 
(Under Section 31 of the Act, FINRA is required to pay transaction 
fees and certain other assessments to the Commission that are 
designed to recover the costs related to the government's 
supervision and regulation of the securities markets and securities 
professionals.) See Section 31 of the Act, 15 U.S.C. 78ee and Rule 
31 thereunder, 17 CFR 240.31; Securities Exchange Act Release No. 
53977 (June 12, 2006), 71 FR 34976 (June 16, 2006) (order approving 
SR-NASD-2006-055, equity trade reporting amendments); NASD Notice to 
Members 06-39 (August 2006).
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    FINRA also proposes to make conforming amendments to NASD Rule 
6210(c), the term ``reportable TRACE transaction.'' The definition 
currently restates a trade reporting exemption in NASD Rule 6230(e) and 
states that these exempt transactions are not reportable TRACE 
transactions. FINRA proposes to substitute a general statement 
regarding exempted transactions for the specific reference, which would 
make ``TRACE reportable transaction'' consistent with proposed NASD 
Rule 6230(e) and eliminate the need to amend NASD Rule 6210(c) each 
time NASD Rule 6230(e) is amended. The amendment would restate 
``Reportable TRACE transaction'' as ``any secondary market transaction 
in a TRACE-eligible security except transactions exempt from reporting 
as specified in NASD Rule 6230(e).''
    FINRA would announce the effective date of the proposed rule change 
in a Regulatory Notice to be published no later than 60 days following 
Commission approval, if the Commission approves the proposal. The 
effective date would be no later than 30 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,\8\ 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. FINRA believes that Derivative-Related Transactions 
should be exempt from TRACE reporting because such information does not 
contribute to price discovery and the reporting and dissemination of 
such information may confuse market participants, particularly retail 
and non-professional investors, and investors and the public interest 
will be protected if the trade report information is not so reported 
and disseminated.
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    \8\ 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 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.\9\
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    \9\ FINRA notes that one written comment letter was received by 
the Commission in response to SR-NASD-2006-103, the proposed rule 
change to provide exemptive relief from certain TRACE reporting 
requirements in NASD Rule 6230 for CDS-related transactions and to 
not disseminate transaction information under NASD Rule 6250 for 
Derivatives-Related Transactions. The commenter requested that FINRA 
consider providing exemptive relief beyond that proposed in SR-NASD-
2006-103, and supported the proposed amendment to Rule 6250 to not 
disseminate Derivative-Related Transactions, except if a member 
would incur additional costs by being required to designate in the 
report that certain transactions should not be disseminated. The 
commenter also stated its opposition generally to any reporting and 
dissemination of Derivative-Related Transactions. See letter to 
Nancy M. Morris, Secretary, Commission, from Mary Kuan, Vice 
President and Assistant General Counsel, Securities Industry and 
Financial Markets Association, dated December 8, 2006.

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[[Page 54089]]

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. 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-FINRA-2007-007 on the subject line.

Paper Comments

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

All submissions should refer to File Number SR-FINRA-2007-007. 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 inspection 
and copying in the Commission's Public Reference Room, 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 Number 
SR-FINRA-2007-007 and should be submitted on or before October 12, 
2007.
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    \10\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\10\
Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-18551 Filed 9-20-07; 8:45 am]

BILLING CODE 8010-01-P