Document ID: SEC-2007-1205-0001
Agency: sec
Document Type: Notice
Title: Self-regulatory organizations; proposed rule changes: Financial Industry Regulatory Authority, Inc.
Posted Date: 2007-08-28T04:00Z

[Federal Register: August 28, 2007 (Volume 72, Number 166)]
[Notices]               
[Page 49337-49339]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr28au07-153]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-56297; File No. SR-NASD-2007-041]

 
Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc. (n/k/a Financial Industry Regulatory Authority, Inc.); 
Notice of Filing of Proposed Rule Change To Amend the Minimum Price-
Improvement Standards Set Forth in NASD IM 2110-2, Trading Ahead of 
Customer Limit Order

August 21, 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 June 27, 2007, the National Association of Securities Dealers, Inc. 
(``NASD'') (n/k/a Financial Industry Regulatory Authority, Inc.) 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.\3\ 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.
    \3\ On July 26, 2007, the Commission approved a proposed rule 
change filed by NASD to amend NASD's Certificate of Incorporation to 
reflect its name change to Financial Industry Regulatory Authority 
Inc., or FINRA, in connection with the consolidation of the member 
firm regulatory functions of NASD and NYSE Regulation, Inc. See 
Securities Exchange Act Release No. 56146 (July 26, 2007), 72 FR 
42190 (August 1, 2007) (SR-NASD-2007-053).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    FINRA proposes to amend the minimum price-improvement standards set 
forth in NASD Interpretive Material (``IM'') 2110-2, Trading Ahead of 
Customer Limit Order. 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
    On February 26, 2007, the Commission approved SR-NASD-2005-146,\4\ 
which expanded the scope of IM-2110-2 \5\ to apply to over-the-counter 
(``OTC'') equity securities.\6\ The amendments relating to OTC equity 
securities are scheduled to become effective on November 26, 2007.\7\ 
Among other changes, SR-NASD-2005-146 amended the minimum level of 
price-improvement that a member must provide to trade ahead of an 
unexecuted customer limit order (``price-improvement standards'') as 
follows. For customer limit orders priced greater than or equal to 
$1.00 that are at or inside the best inside market, the minimum amount 
of price improvement required is $0.01. For customer limit orders 
priced less than $1.00 that are at or inside the best inside market, 
the minimum amount of price improvement required is the lesser of $0.01 
or one-half (1/2) of the current inside spread. For customer limit 
orders priced outside the best inside market, the member is required to 
execute the incoming order at a price at or inside the best inside 
market for the security. Lastly, for customer limit orders in 
securities for which there is no published inside market, the minimum 
amount of price improvement required is $0.01.
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    \4\ See Securities Exchange Act Release No. 55351 (February 26, 
2007), 72 FR 9810 (March 5, 2007) (order approving SR-NASD-2005-
146).
    \5\ Currently, IM-2110-2 generally prohibits a member from 
trading for its own account in an exchange-listed security at a 
price that is equal to or better than an unexecuted customer limit 
order in that security, unless the member immediately thereafter 
executes the customer limit order at the price at which it traded 
for its own account or better.
    \6\ See NASD Rule 6610(d) for definition of ``OTC equity 
security.''
    \7\ See Securities Exchange Act Release No. 56103 (July 19, 
2007), 72 FR 40918 (July 25, 2007) (SR-NASD-2007-039).
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    For example, if the best inside market for a security is $10 to 
$10.05 and a member is holding a customer limit order to buy priced at 
$10.01, the member would be permitted to buy at $10.02 or higher, 
without triggering the customer limit order. If the best inside market 
for a security is $.50 to $.51 and the member is holding a customer 
limit order to buy priced at $.50, the member would be permitted to buy 
at $.505 ($.50 + \1/2\ ($.51-$.50)) or higher, without triggering the 
customer limit order.
    FINRA is proposing to revise the minimum price improvement 
standards to address three issues. First, because the minimum price 
improvement standard is determined based on the lesser of a specified 
amount ($.01) or \1/2\ of the inside spread, the specified amount acts 
as an ``upper limit'' on the minimum price improvement requirement. 
FINRA is concerned that the specified amount or upper limits on the 
minimum price improvement requirement (i.e., $.01) is 
disproportionately high for securities trading below $.01 and should 
vary proportionately with the amount of the limit order price. To 
address this inconsistency, FINRA is proposing to add the following 
maximum upper limits for each price level: For customer limit orders 
priced less than $.01 but greater than or equal to $0.001, the minimum 
amount of price improvement required is the lesser of $0.001 or one-
half (\1/2\) of the current inside spread. For customer limit orders 
priced less than $.001 but greater than or equal to $0.0001, the 
minimum amount of price improvement required is the lesser of $0.0001 
or one-half (\1/2\) of the current inside spread. For customer limit 
orders priced less than $.0001 but greater than or equal to $0.00001, 
the minimum amount of price improvement required is the lesser of 
$0.00001 or one-half (\1/2\) of the current inside spread.\8\ Lastly, 
for customer limit orders priced less than $.00001, the minimum amount 
of price improvement required is the lesser of

[[Page 49338]]

$0.000001 or one-half (\1/2\) of the current inside spread.\9\ FINRA 
believes these proposed requirements are better aligned with the value 
of the limit order and continue to require an appropriate amount of 
minimum price improvement over a customer limit order before a member 
can trade for its own account.
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    \8\ The proposed minimum price-improvement provisions in this 
proposed rule change do not supersede, alter or otherwise affect any 
of the minimum pricing increment restrictions under Rule 612 of 
Regulation NMS. Rule 612 of Regulation NMS prohibits market 
participants from displaying, ranking, or accepting bids or offers, 
orders, or indications of interest in any NMS stock priced in an 
increment smaller than $0.01 if the bid or offer, order, or 
indication of interest is priced equal to or greater than $1.00 per 
share. If the bid or offer, order, or indication of interest in any 
NMS stock is priced less than $1.00 per share, the minimum pricing 
increment is $0.0001. See Securities Exchange Act Release No. 51808 
(June 9, 2005), 70 FR 37496 (June 29, 2005) (File No. S7-10-04) 
(Regulation NMS Adopting Release).
    \9\ For customer limit orders in securities for which there is 
no published inside market, the minimum amount of price improvement 
required would default to the same tiered minimum price improvement 
standards described herein. FINRA believes that the minimum price 
improvement requirement of $.01 for customer limit orders in 
securities for which there is no published inside market is 
disproportionately high for lower-priced securities and, therefore, 
the proposed tiered requirements are more appropriate.
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    Second, the current minimum price improvement standard for limit 
orders priced over $1.00 is $.01 and applies uniformly to NMS stocks 
\10\ and OTC equity securities. However, given that subpenny quoting 
and trading is permissible in OTC equity securities priced over $1.00 
(and therefore subpenny spreads are possible), FINRA believes that the 
minimum price improvement standard should be adjusted to also include a 
measure based on the inside spread, consistent with the standards below 
$1.00. Accordingly, FINRA is proposing that for customer limit orders 
in OTC equity securities priced greater than or equal to $1.00, the 
minimum amount of price improvement required is the lesser of $0.01 or 
one-half (\1/2\) of the current inside spread.\11\
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    \10\ See Rule 600(b)(47) of Regulation NMS for definition of 
``NMS stock.'' 17 CFR 242.600(b)(47).
    \11\ Other than the proposed distinction to address permissible 
subpenny quoting and trading in OTC equity securities priced over 
$1.00, the proposed price-improvement standards will apply uniformly 
to NMS stocks and OTC equity securities. See supra note 8.
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    Finally, FINRA is proposing to change the minimum price improvement 
standard for limit orders priced outside the inside market. Although 
typically trades occur at or inside the best inside market, firms may 
trade proprietarily outside the best inside market for a variety of 
reasons, such as where there is little or no depth at the inside market 
or the inside market is manual or not easily accessible. Under the 
current requirements, such trades would trigger all limit orders priced 
outside the inside market, no matter how far outside the inside market 
the limit order is priced. For example, the best inside market for a 
security is $.50 to $.51. The member is displaying a quote to buy at 
$.49 and also is holding a customer limit order to buy priced at $.45. 
The member's quotation is accessed by another broker-dealer and the 
member buys at $.49. Under the current requirements, the member would 
be required to fill the customer's purchase order at $.45 because it 
had not purchased at the inside market of $.50.
    FINRA does not believe this is an appropriate result, and is 
therefore proposing that, where the limit order is priced outside the 
inside market for the security, the minimum amount of price improvement 
required must either meet the same tiered minimum price improvement 
standards set forth above or the member must trade at a price at or 
inside the best inside market for the security. FINRA believes this 
will continue to require an appropriate amount of price improvement for 
a member to trade ahead of a customer limit order, irrespective of 
whether the limit order is priced inside or outside the best inside 
market.
    As noted above, FINRA proposes to implement the proposed rule 
change on the final implementation date of SR-NASD-2005-146, November 
26, 2007.
2. Statutory Basis
    FINRA believes that the proposed rule change is consistent with the 
provisions of section 15A(b)(6) of the Act,\12\ 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 better 
reflects trading in low-priced securities and the application of IM-
2110-2.
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    \12\ 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

    The original filing, SR-NASD-2005-146, which proposed the recently 
approved price-improvement standards, was subject to notice and 
comment.\13\ No comments were received in response to the Federal 
Register publication of that filing. However, following Commission 
approval, several broker-dealers raised concerns regarding the 
application of the amended price-improvement standards, in particular 
for securities trading below $.01 and those trading outside the best 
inside market. One broker-dealer indicated that the inside market may 
not be a good reflection of trading in certain OTC equity securities. 
With respect to these low-priced OTC equity securities, the broker-
dealer indicated that the amended price-improvements standards could 
result in a minimum price improvement that is significantly greater 
than the value of the security. In addition, certain broker-dealers 
indicated that, under the amended minimum price improvement standards, 
firms that trade proprietarily outside the best inside market would 
trigger all customer limit orders outside the best inside market. These 
broker-dealers recommended that FINRA revisit the amended price-
improvement standards to better address trading in low-priced 
securities and trading outside the best inside market.
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    \13\ See Securities Exchange Act Release No. 54705 (November 3, 
2006), 71 FR 65863 (November 9, 2006) (Notice of filing of SR-NASD-
2005-146).
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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-NASD-2007-041 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-NASD-2007-041. This 
file

[[Page 49339]]

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-
NASD-2007-041 and should be submitted on or before September 18, 2007.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\14\
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    \14\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-16955 Filed 8-27-07; 8:45 am]

BILLING CODE 8010-01-P