Document ID: SEC-2011-1730-0001
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 70195-70198]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-29112]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-65692; File No. SR-FINRA-2011-063]

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

November 4, 2011.
    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 October 28, 2011, 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, 
II, and III 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 (i) Rules 5320 and 7440 to require that 
members report to the Order Audit Trail System (``OATS'') information 
barriers put into place by the member in reliance on Supplementary 
Material .02 to Rule 5320; (ii) Rule 7440 to require that members 
report customer instructions regarding the display of a customer's 
limit order in any OATS-eligible security; and (iii) Rule 7450 to 
codify the specific time OATS reports must be transmitted to FINRA.
    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, Proposed Rule Change

1. Purpose
    FINRA is proposing two changes to the order recording requirements 
in Rule 7440 of the OATS rules to reflect two recent amendments to 
other FINRA rules. First, the proposed rule change requires members 
relying on the ``No-Knowledge Exception'' in Supplementary Material .02 
to Rule 5320 (Prohibition Against Trading Ahead of Customer Orders) to 
report information to OATS regarding the information barriers adopted 
by the member in reliance on the exception. The proposed rule change 
also adds this requirement into Supplementary Material .02 of Rule 
5320. Second, the proposed rule change extends the existing requirement 
to reflect on OATS reports a customer's instruction regarding display 
of the customer's limit orders. The requirement currently applies only 
to limit orders involving NMS stocks; the proposed rule change extends 
the requirement to all OATS-eligible securities.
    FINRA is also proposing amendments to Rule 7450 to codify the 
specific time by which OATS reports must be transmitted to FINRA.
(1) Customer Order Protection
    First, FINRA is proposing to require members to identify on OATS 
reports information barriers that the member has in place in reliance 
on the No-Knowledge Exception in Supplementary Material .02 to Rule 
5320.
    On February 11, 2011, the SEC approved FINRA's proposed rule change 
to consolidate NASD Rule 2111 and IM-2110-2 into new FINRA Rule 
5320.\3\ Under Rule 5320, a member that accepts and holds an order in 
an equity security from its own customer, or a customer of another 
broker-dealer, without immediately executing the order is prohibited 
from trading that security on the same side of the market for its own 
proprietary account at a price that would satisfy the customer order 
unless the member immediately thereafter executes the customer order up 
to the size and at the same, or better, price at which the member 
traded for its proprietary account. The No-Knowledge Exception in 
Supplementary Material .02 to Rule 5320 provides that if a firm 
implements and uses an effective system of internal controls--such as 
appropriate information barriers--that operate to prevent one trading 
unit from obtaining knowledge of customer orders held by a separate 
trading unit, those other trading units may trade in a proprietary 
capacity at prices that would satisfy the customer orders held by the 
separate, walled-off trading unit.\4\
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    \3\ See Securities Exchange Act Release No. 63895 (February 11, 
2011), 76 FR 9386 (February 17, 2011).
    \4\ The Commission notes that the No-Knowledge Exception in 
Supplementary Material .02 to FINRA Rule 5320 contains different 
procedures for OTC equity securities.
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    When FINRA originally proposed Rule 5320, members claiming the No-
Knowledge Exception would have been required to assign and use a unique 
market participant identifier (``MPID'') for any walled-off market-
making desk.\5\ In response to commenters' concerns with the proposed 
MPID requirement, FINRA amended the proposal to delete the unique MPID 
requirement, but stated that it intended to examine alternative means 
of achieving the same regulatory objective of being able to

[[Page 70196]]

determine on an automated basis those customer orders that are received 
from walled-off desks.\6\ The proposed rule change accomplishes the 
objective by adding provisions to the No-Knowledge Exception and to 
Rule 7440 that require firms relying on the exception to identify the 
information barriers to FINRA in their OATS reports.\7\
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    \5\ See Securities Exchange Act Release No. 61168 (December 15, 
2009), 74 FR 68084 (December 22, 2009).
    \6\ See Securities Exchange Act Release No. 63895 (February 11, 
2011), 76 FR 9386 (February 17, 2011).
    \7\ Members are permitted to report this information to OATS on 
a voluntary basis. See OATS Reporting Technical Specifications, at 
iii (ed. May 3, 2011); see also OATS for all NMS Stocks Frequently 
Asked Questions, Question 12, available at www.finra.org/oats. FINRA 
has encouraged members to do so to avoid ``false positive'' results 
that can be caused by automated surveillance patterns aggregating 
trading data without regard to information barriers that firms have 
put in place pursuant to the No-Knowledge Exception. See Regulatory 
Notice 11-24, n.12 (May 2011). The proposed rule change would make 
reporting of the information mandatory for those members relying on 
the No-Knowledge Exception.
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    Through the use of OATS, FINRA will be able to ascertain, on an 
automated basis, those firms claiming the No-Knowledge Exception. This 
will reduce the potential for ``false positive'' alerts by allowing 
FINRA to account for the existence of information barriers when running 
automated surveillance patterns designed to identify inappropriate 
trading ahead of customer orders. FINRA believes that the new 
requirements will substantially reduce the number of ``false 
positives'' that are identified through automated surveillance patterns 
by being able to account for information barriers when trading ahead 
may otherwise be indicated.
(2) Limit Order Display
    Rule 7440(b)(14) requires OATS Reporting Members to identify ``any 
request by a customer that an order not be displayed, or that a block 
size order be displayed, pursuant to Rule 604(b) of SEC Regulation 
NMS.'' \8\ These customer requests are identified in the OATS system 
through a ``Customer Instruction Flag'' that indicates whether the 
customer has requested that the firm handle its limit order in a 
specified way. Because of the reference in Rule 7440(b)(14) to SEC 
Regulation NMS, members are only required to populate the Customer 
Instruction Flag when the order involves a security subject to SEC 
Regulation NMS.
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    \8\ Rule 604 of SEC Regulation NMS generally requires OTC market 
makers in NMS stocks to display customer limit orders that would 
improve the market maker's published bid or offer (either by price 
or size). See 17 CFR 242.604(a)(2). Rule 604(b)(2) of SEC Regulation 
NMS excepts from the display requirement any customer limit order 
that is placed by a customer who expressly requests that the order 
not be displayed. See 17 CFR 242.604(b)(2). Rule 604(b)(4) of SEC 
Regulation NMS excepts from the display requirement any customer 
limit order of block size unless the customer requests that the 
order be displayed. See 17 CFR 242.604(b)(4).
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    On June 22, 2010, the Commission approved Rule 6460,\9\ which 
became effective on May 9, 2011.\10\ Rule 6460 generally requires OTC 
market makers to display a customer limit order in an OTC equity 
security held by the OTC market maker that is at a price that would 
improve the bid or offer of such OTC market maker in such security or 
that would represent more than a de minimis change in relation to the 
size associated with the OTC market maker's bid or offer. Rule 6460(b) 
includes exceptions to the display requirement for OTC equity 
securities that mirror the exceptions in Rule 604(b) of SEC Regulation 
NMS.\11\
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    \9\ See Securities Exchange Act Release No. 62359 (June 22, 
2010), 75 FR 37488 (June 29, 2010).
    \10\ See Regulatory Notice 10-42 (September 2010).
    \11\ See FINRA Rule 6460(b)(2), (b)(4).
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    FINRA is proposing to require that OATS Reporting Members indicate 
on all OATS reports for customer limit orders, including OTC equity 
securities, whether the customer has instructed the member not to 
display the limit order or to display a limit order of block size. As a 
result, OATS Reporting Members would be required to populate the 
Customer Instruction Flag for all limit orders, not just those 
involving NMS stocks. Use of the Customer Instruction Flag for all 
limit orders reported to OATS will notify FINRA that a customer has 
requested display of a limit order that would not otherwise be required 
to be displayed under applicable rules as well as avoid potential 
``false positives'' generated by customer limit orders that are not 
being displayed due to the customer's request.
(3) Order Data Transmission Requirements
    Rule 7450 requires members to report order information recorded 
pursuant to Rule 7440. Paragraph (a) of the rule imposes the general 
requirement that members report applicable order information to FINRA 
that the member is required to record by Rule 7440. Paragraph (b) of 
the rule addresses the form the order data must take and the timing of 
order reports. Paragraph (c) concerns the use of reporting agent 
agreements that a member may use to allow a third party to report 
information to OATS on behalf of the member. The proposed rule change 
amends paragraph (b) of Rule 7450 to codify the specific time OATS 
reports must be transmitted to FINRA, which is the same time that 
currently is required under the OATS Reporting Technical 
Specifications, as described in more detail below.
    Rule 7450(b) provides that, generally, reports should be 
transmitted on the day of the order event unless information is not 
available.\12\ In addition, if the member aggregates information, the 
information must be transmitted ``during such business hours as may be 
prescribed by FINRA.''
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    \12\ FINRA announced that OATS reports would be marked late if 
submitted after 8 a.m. Eastern Time on the calendar day following 
the OATS Business Day on which the order event occurred in the May 
3, 2011 edition of the OATS Reporting Technical Specifications. See 
OATS Reporting Technical Specifications, at 8-1 (ed. May 3, 2011). 
Previously, OATS reports were marked late if received after 5 a.m. 
Eastern Time. See OATS Reporting Technical Specifications, at 8-1 
(ed. November 8, 2010); Letter from Brant Brown, Associate General 
Counsel, FINRA, to Elizabeth Murphy, Secretary, SEC (October 28, 
2010) relating to SR-FINRA-2010-044.
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    The proposed rule change would update the language in the rule, 
which has not been changed substantially since it was adopted in 1998, 
and codify a specific deadline that members must meet. When the rule 
language was adopted, and before OATS reporting was implemented in 
1999, the rule language acknowledged that firms could choose to report 
OATS data to FINRA on a rolling basis throughout the day, or reports 
could be aggregated into one or more transmissions and submitted 
``during such business hours as may be prescribed by [FINRA].'' This 
rule language further reflected the fact that, at the time the rules 
were proposed, issues involving the capacity of OATS and technological 
changes could affect the manner and timing of transmitting order 
information to OATS. In its initial filing with the Commission, FINRA 
noted:

    Based on further development of the Order Audit System and 
determinations relating to system capacity and other factors, NASDR 
will prescribe the hours during which information may be 
transmitted. The prescribed hours likely will extend past the end of 
the trading day. The proposal contemplates that all Order 
information, along with corresponding ACT data that has been 
integrated with such information, will be available to NASDR staff 
at the beginning of the trading day following the day on which the 
information has been transmitted.\13\
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    \13\ See Securities Exchange Act Release No. 38990 (August 28, 
1997), 62 FR 47096, 47103 (September 5, 1997) (Notice of Filing of 
Proposed Rule Change SR-NASD-97-56).

    FINRA (then NASDR) began testing the capabilities of its systems in 
August 1998 in anticipation of the implementation of Phase One of OATS 
in early 1999.\14\ In the November 30,

[[Page 70197]]

1998 version of the OATS Reporting Technical Specifications, FINRA 
prescribed that, for purposes of OATS reporting, an OATS business day 
would begin after the close of the Nasdaq Stock Market on one market 
day (4:00:01 p.m. Eastern Time) and end with the close of the Nasdaq 
Stock Market on the next market day (4:00:00 p.m. Eastern Time). Orders 
received during an OATS business day would be required to be submitted 
to OATS by 4:00:00 a.m. Eastern Time the following calendar day.\15\ 
This was intended to provide firms with adequate time to aggregate data 
files and transmit them to FINRA before the beginning of the next 
trading day.
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    \14\ See SR-NASD-97-56, Amendment No. 4; NASD Special Notice to 
Members 98-33 (March 1998).
    \15\ See NASD Notice to Members 99-04 (January 1999). FINRA 
extended the time from 4:00 a.m. Eastern Time to 5:00 a.m. Eastern 
Time in 2007 connection with the expansion of OATS to OTC equity 
securities. See August 21, 2007 Addendum to OATS Reporting Technical 
Specifications (ed. August 6, 2007).
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    FINRA is proposing to replace the current rule language regarding 
the timing of OATS transmissions to FINRA with a specific requirement. 
Under the proposed rule, all order events that occur on a particular 
OATS Business Day must be transmitted to FINRA by 8:00 a.m. Eastern 
Time on the calendar day following the end of the OATS Business Day. 
For purposes of the rule, an ``OATS Business Day'' begins at 4:00:01 
p.m. Eastern Time on one market day and ends at 4:00:00 p.m. Eastern 
Time on the next market day.\16\ FINRA is retaining the exception for 
information that is not available by the time the report must be 
transmitted; in such cases, the report must be transmitted on the day 
that the information becomes available.\17\
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    \16\ Thus, for example, assuming no holidays, if an order is 
received at 5:00:00 p.m. Eastern Time on Wednesday, the order event 
occurs on the OATS Business Day ending Thursday at 4:00:00 p.m. 
Eastern Time. Receipt of the order (and any subsequent event(s) 
regarding the order until Thursday at 4:00:00 p.m. Eastern Time) 
must be reported by 8:00:00 a.m. on Friday. Order events occurring 
on market days during regular market hours (i.e., before 4:00:01 
p.m. Eastern Time) are reported by 8:00:00 a.m. Eastern Time on the 
following calendar day.
    \17\ This provision was initially intended to address 
circumstances where complete information is not available at the 
time an order report must be submitted (for example, where an order 
is executed over the course of multiple days, and the total 
execution information is not available on the same day the order is 
received). See Securities Exchange Act Release No. 38990 (August 28, 
1997), 62 FR 47096 (September 5, 1997). The provision was amended in 
2006 to also address circumstances where a firm has traded a 
security that has not been assigned a symbol and can report the 
information only after a symbol has been requested, which must be 
done promptly, and assigned. See Securities Exchange Act Release No. 
54585 (October 10, 2006), 71 FR 61112 (October 17, 2006); Notice to 
Members 06-70 (December 2006).
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    The effective date of the proposed rule change will be no later 
than 120 days after 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,\18\ 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 
enhance FINRA's automated surveillance systems by providing customer 
instruction information relating to limit orders and significantly 
reducing the incidence of ``false positive'' results caused by 
identifying permitted trading activity in automated surveillance 
patterns. By reducing ``false positive'' results, FINRA can focus its 
resources on trading activity that has properly been identified as 
warranting further regulatory scrutiny, thus promoting just and 
equitable principles of trade and protecting investors and the public 
interest. FINRA also believes that codifying the time by which OATS 
reports must be submitted will promote just and equitable principles of 
trade by ensuring that all members are aware of their reporting 
obligations.
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    \18\ 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 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 email to rule-comments@sec.gov. Please include 
File Number SR-FINRA-2011-063 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-2011-063. This 
file number should be included on the subject line if email 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 Number SR-FINRA-2011-063 and should be 
submitted on or before December 1, 2011.

[[Page 70198]]

    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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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2011-29112 Filed 11-9-11; 8:45 am]
BILLING CODE 8011-01-P