Document ID: SEC-2009-1313-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Financial Industry Regulatory, Inc.; Order Approving Proposed Rule Change as Modified by Amendment No. 1 Thereto Amending Rule 2320 Regarding Best Execution and Interpositioning
Posted Date: 2009-09-15T04:00Z

[Federal Register: September 15, 2009 (Volume 74, Number 177)]
[Notices]               
[Page 47302-47303]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr15se09-143]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-60635; File No. SR-FINRA-2007-024]

 
Self-Regulatory Organizations; Financial Industry Regulatory, 
Inc.; Order Approving Proposed Rule Change as Modified by Amendment No. 
1 Thereto Amending Rule 2320 Regarding Best Execution and 
Interpositioning

September 8, 2009.
    On November 27, 2007, the Financial Industry Regulatory Authority, 
Inc. (``FINRA'') filed with the Securities and Exchange Commission 
(``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 amend NASD Rule 2320, Best Execution and 
Interpositioning. On April 13, 2009, FINRA filed Amendment No. 1 to the 
proposed rule change. The proposed rule change was published for 
comment in the Federal Register on April 24, 2009.\3\ The Commission 
received no comments regarding the proposal. This order approves the 
proposed rule change, as modified by Amendment No. 1.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 59788 (April 17, 
2009), 74 FR 18777 (``Notice'').
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    In its filing, FINRA proposed to amend NASD Rule 2320, which 
governs members' obligations regarding best execution and 
interpositioning.\4\ Rule 2320(a) provides that, in any transaction for 
or with a customer or a customer of another broker-dealer, a member 
must use ``reasonable diligence to ascertain the best market for the 
subject security,'' so that the resulting price to the customer is ``as 
favorable as possible under prevailing market conditions.'' \5\ A 
number of factors will be considered in determining whether the member 
exercised reasonable diligence, including the character of the market 
for the security, the size and type of the transaction, and the terms 
and conditions of the order that resulted in the transaction.\6\
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    \4\ NASD Rule 2320 paragraph (a) governs best execution and 
paragraph (b) governs interpositioning.
    \5\ See NASD Rule 2320(a).
    \6\ Id.
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    Currently, Rule 2320(b) prohibits a member from interposing a third 
party between the member and the best available market for a security, 
unless the member ``can demonstrate that to his knowledge at the time 
of the transaction the total cost or proceeds of the transaction * * * 
was better than the prevailing inter-dealer market for the security.'' 
\7\ In addition, a member's obligations to its customer ``are generally 
not fulfilled'' under the current Rule when interposing a third party, 
unless the member can show that the interpositioning ``reduced the 
costs of the transactions to the customer.'' \8\
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    \7\ See NASD Rule 2320(b).
    \8\ Id.
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    With this rule change, FINRA proposed to apply the standards 
governing best execution, which are set forth in Rule 2320(a), to 
interpositioning. As such, a member interposing a third party will have 
to use ``reasonable diligence to ascertain the best market for the 
subject security,'' so that the resulting price to the customer is ``as 
favorable as possible under prevailing market conditions.'' \9\ FINRA 
also proposed to make conforming amendments to other NASD and FINRA 
rules to reflect the re-designation of Rule 2320.
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    \9\ See NASD Rule 2320(a).
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    The Commission has carefully reviewed the proposed rule change and 
finds that the proposed rule change is consistent with the requirements 
of the Act and the rules and regulations thereunder applicable to a 
registered securities association \10\ and, in particular, Section 
15A(b)(6) of the Act,\11\ which requires 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.
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    \10\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \11\ 15 U.S.C. 78o-3(b)(6).
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    In stating that interpositioning generally does not fulfill a 
member's obligation to its customer unless that interpositioning 
``reduced the costs of the transactions to the customer,'' the current 
rule contains a presumption against interpositioning.\12\ FINRA stated 
in its filing that the presumption is overbroad and may not accurately 
reflect the realities of the current market. The Commission understands

[[Page 47303]]

FINRA's argument that the rule, as currently written, may be overbroad. 
There have been a number of changes in the markets since the time the 
rule was adopted by the NASD in 1968. However, the Commission believes 
that there continue to be opportunities for unscrupulous participants 
in the marketplace to interposition third parties in a securities 
transaction between themselves and their customers to the disadvantage 
of those customers.\13\ The Commission expects FINRA, when it finds 
evidence of interpositioning by members that was detrimental to the 
customer, to charge member firms or associated persons, as appropriate, 
with violations of its rules.
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    \12\ See, e.g., In re Thomson & McKinnon, Securities Exchange 
Act Release No. 8310 (May 8, 1968). In that proceeding, an NASD 
member firm interposed broker-dealers between itself and the best 
available market, and the added transaction cost was borne by its 
customers. The Commission found that, ``[i]n view of the obligation 
of a broker to obtain the most favorable price for his customer, 
where he interposes another broker-dealer between himself and a 
third broker-dealer, he prima facie has not met that obligation and 
he has the burden of showing that the customer's total cost or 
proceeds of the transaction is the most favorable obtainable under 
the circumstances.''
    \13\ See, e.g., In re Andrew P. Gonchar and Polyvious T. 
Polyviou, Securities Exchange Act Release No. 34-60506 (August 14, 
2009).
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    The Commission notes that its approval of this rule change is not 
an indication that interpositioning is no longer an issue. Rather, it 
is meant to reflect changes in the market place that have occurred 
since 1968 when the rule was adopted.\14\ The Commission notes that, 
even with this rule change, the cost to the customer under the proposed 
rule will ``remain a crucial factor in determining whether a member has 
fulfilled its best execution obligations under Rule 2320,'' including 
transactions involving interposed third parties.\15\ The Commission 
also notes that interpositioning ``that is unnecessary or violates a 
member's general best execution obligations--either because of 
unnecessary costs to the customer or improperly delayed executions--
would still be prohibited.'' \16\ In this respect, the Commission takes 
comfort from FINRA's representations that interpositioning that harms a 
customer violates NASD Rule 2440 and FINRA Rule 2010.\17\
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    \14\ See Notice, supra note 3, at 18778.
    \15\ Id. at 18778.
    \16\ Id. at 18779.
    In addition to the proposed rule language, other FINRA and NASD 
rules would continue to govern the handling of customer orders. In 
particular, FINRA Rule 2010 requires that members observe high 
standards of commercial honor and just and equitable principles of 
trade, and NASD Rule 2440 requires that members charge fair prices 
and commissions in their dealings with customers.
    \17\ Id. at 18778 n.4.
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    The proposed rule will thus continue to prohibit interpositioning 
that adversely affects the customer, and the cost to the customer will 
remain a central part of that determination. The Commission expects 
FINRA to diligently pursue such conduct by members.\18\
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    \18\ See In re Andrew P. Gonchar and Polyvious T. Polyviou, 
supra note 13.
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    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (SR-FINRA-2007-024), as modified by 
Amendment No. 1, be, and it hereby is, approved.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\19\
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    \19\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-22109 Filed 9-14-09; 8:45 am]

BILLING CODE 8010-01-P