Document ID: SEC-2009-0579-0001
Agency: sec
Document Type: Notice
Title: Self-Regulatory Organizations; Financial Industry Regulatory Authority, Inc.; Notice of Filing of Proposed Rule Change and Amendment No. 1 Thereto Relating to Amendments Involving Best Execution and Interpositioning
Posted Date: 2009-04-24T04:00Z

[Federal Register: April 24, 2009 (Volume 74, Number 78)]
[Notices]               
[Page 18777-18779]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr24ap09-110]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-59788; File No. SR-FINRA-2007-024]

 
Self-Regulatory Organizations; Financial Industry Regulatory 
Authority, Inc.; Notice of Filing of Proposed Rule Change and Amendment 
No. 1 Thereto Relating to Amendments Involving Best Execution and 
Interpositioning

April 17, 2009.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934

[[Page 18778]]

(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on November 27, 2007, Financial Industry Regulatory Authority, Inc. 
(``FINRA'') 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 FINRA. On April 13, 
2009, FINRA filed Amendment No. 1 to the proposed rule change. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change, as amended, 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 NASD Rule 2320 to update members' best 
execution obligations involving interpositioning and to amend NASD Rule 
3110(b), NASD IM-2320, and FINRA Rule 6635 to reflect the redesignation 
of certain paragraphs in NASD Rule 2320.
    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 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

    NASD Rule 2320(b) (the ``Interpositioning Rule'') requires that, 
when interposing a third party between a member and the best available 
market for a security, the member must show that the total cost or 
proceeds of the transaction were better than the prevailing inter-
dealer market. Accordingly, it is a violation of the Interpositioning 
Rule if a member interposes a third party and the total cost of the 
transaction is equal to or greater than that of the prevailing inter-
dealer market or the total proceeds of the transaction were equal to or 
less than that of the prevailing inter-dealer market.
    Although unclear from the legislative history of the 
Interpositioning Rule, it appears that the intent of requiring a 
``better than'' standard, rather than an ``equal to'' standard, was to 
deter members from interposing a third party in transactions that 
should be sent directly to a market maker.\3\ Since the adoption of the 
Interpositioning Rule in 1968, there have been substantial changes to 
the ways in which markets function, including technological advances, 
increased market transparency in the equities markets, and the 
development of electronic communication networks and order routing 
services. These changes enable firms, under certain circumstances, to 
use intermediaries and third parties to improve the handling of orders 
with no additional cost to the customer. Firms are now frequently able 
to send an order to a third party with minimal or no delay in the 
execution of the customer's order and with no additional cost to the 
customer. In addition, there are occasions when the use of a third 
party may be necessary to effectuate the execution of an order. For 
example, a firm may need to involve a third party if it receives an 
order for a foreign security that may not trade in the United States 
and the firm lacks the ability to execute the order without involving 
another broker-dealer. The language of the Interpositioning Rule could 
be read to include such circumstances, even if the customer incurs no 
additional cost or the cost is necessary to effectuate the trade. FINRA 
believes that the current language of the Interpositioning Rule does 
not reflect the reality of recent technological advances in order 
handling and that the rule could be read to prohibit conduct that does 
not adversely affect the customer and, in some cases, benefits the 
customer.
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    \3\ In the mid-1980s, as part of extensive amendments to NASD 
rules, several changes to the Interpositioning Rule were proposed 
but never adopted. See NASD Notice to Members 89-20 (February 17, 
1989); NASD Notice to Members 86-9 (February 7, 1986). One of the 
proposed changes, which is similar to the current proposed rule 
change, would have prohibited interpositioning unless a member could 
demonstrate that the price paid or received by the customer was 
``better than or equal to'' the prevailing inter-dealer price. One 
commenter to that proposal, the Securities Industry Association, 
which merged with the Bond Market Association to form the Securities 
Industry and Financial Markets Association, supported the proposal, 
noting that if a member deems it advantageous for legitimate 
business reasons to buy or sell a security from a non-market maker 
and the customer receives a price equal to the inter-dealer price, 
the customer would not be prejudiced.
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    The proposed rule change is intended to address the potential 
overbreadth of the current Interpositioning Rule while making clear 
that interpositioning third parties in a way that results in customer 
harm is still prohibited. The proposed rule change would replace the 
current Interpositioning Rule with a more general statement that the 
factors enumerated in Rule 2320(a) apply to those situations 
contemplated by the Interpositioning Rule (i.e., orders routed to third 
parties between a member and the best available market). Rule 2320(a) 
states that members and persons associated with a member must use 
reasonable diligence to ascertain the best market for a security when 
handling transactions for or with a customer or a customer of another 
broker-dealer. Among the factors to be considered in determining 
whether a member has used reasonable diligence to ascertain the best 
market for a security, are: (1) The character of the market for the 
security, e.g., price, volatility, relative liquidity, and pressure on 
available communications; (2) the size and type of transaction; (3) the 
number of markets checked; (4) accessibility of the quotation; and (5) 
the terms and conditions of the order which result in the transaction, 
as communicated to the member and persons associated with the member. 
In addition, Rule 2320(a) requires members and persons associated with 
a member to buy or sell in the best market ``so that the resultant 
price to the customer is as favorable as possible under prevailing 
market conditions.''
    Rather than focusing exclusively on cost, as the current 
Interpositioning Rule does, the proposed rule change would apply the 
standards in Rule 2320(a) to the execution of all orders, including 
those involving interposed third parties. Thus, although the cost (or, 
as phrased in 2320(a), the resultant price) to a customer would remain 
a crucial factor in determining whether a member has fulfilled its best 
execution obligations under Rule 2320, particularly in the context of 
retail customer order executions, the proposed rule change would allow 
an analysis of a variety of factors, based on the terms of the 
customer's order and instructions, rather than focusing solely on cost 
any time a member interposes a third party between the member and the 
best available market for a security.\4\

[[Page 18779]]

However, 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.
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    \4\ A member's best execution obligations under NASD Rule 2320 
require a member to buy or sell a security in the best market for 
the subject security ``so that the resultant price to the customer 
is as favorable as possible under prevailing market conditions.'' 
However, other FINRA rules also apply when handling customer orders. 
For example, NASD Rule 2440 and FINRA Rule 2010 prohibit members 
from charging customers more than a fair commission or service 
charge, taking into consideration all relevant circumstances. If a 
member interposes a third party that charges a commission or service 
charge, the member must ensure that the total resulting commissions 
or service charges paid by the customer are fair. Consequently, 
unnecessarily interposing a third party in a transaction and passing 
on to a customer a fee charged by that third party would violate 
NASD Rule 2440 and FINRA Rule 2010.
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    The effective date of the proposed rule change will be the date of 
Commission approval. FINRA will announce the approval in a Regulatory 
Notice within 30 days following 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,\5\ 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 the proposed rule change will 
allow for a determination of best execution to be based on all of the 
facts and circumstances surrounding an order rather than a singular 
focus on one aspect of the transaction.
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    \5\ 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.

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-2007-024 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 Number SR-FINRA-2007-024. 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, 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 publicly available. All 
submissions should refer to File Number SR-FINRA-2007-024 and should be 
submitted on or before May 15, 2009.

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\6\
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    \6\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E9-9374 Filed 4-23-09; 8:45 am]

BILLING CODE 8010-01-P