Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Notice of Filing of Proposed Rule Change and Amendment No. 1 Thereto To Adopt NASD Rule 2111 To Prohibit Members From Trading Ahead of Customer Market Orders, 9408-9411 [E5-773]
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Federal Register / Vol. 70, No. 37 / Friday, February 25, 2005 / Notices
‘‘non-controversial’’ filings under Rule
19b–4(f)(6) under the Act.14
2. Basis
Nasdaq believes that the proposed
rule change is consistent with the
provisions of Section 15A of the Act,15
in general, and with Section 15A(b)(5)
of the Act,16 in particular, in that the
proposed rule change provides for the
equitable allocation of reasonable dues,
fees, and other charges among members
and issuers and other persons using any
facility or system which the NASD
operates or controls. Nasdaq states that,
although the proposed reduction in
routing fees is applicable only to market
participants with high volumes of
liquidity accessing and liquidity
provision activity, the average cost of
order execution of such market
participants is actually higher than the
average cost of a large number of lower
volume market participants.
Accordingly, Nasdaq believes that the
proposed routing fee change is
consistent with an equitable allocation
of fees. Moreover, as with all of
Nasdaq’s tiered fees, Nasdaq states that
the change takes account of Nasdaq’s
lower per share costs and enhanced
revenue opportunities associated with
higher volumes of liquidity provision
and liquidity accessing. Nasdaq believes
that the proposed changes with respect
to exchange-listed securities will
introduce greater uniformity and clarity
in the fee schedule applicable to such
securities.
B. Self-Regulatory Organization’s
Statement on Burden on Competition
Nasdaq 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
Nasdaq states that written comments
were neither solicited nor received.
III. Date of Effectiveness of the
Proposed Rule Change and Timing for
Commission Action
The forgoing rule change is subject in
part to Section 19(b)(3)(A)(ii) of the
Act 17 and subparagraph (f)(2) of Rule
19b–4 18 thereunder because it
establishes or changes a due, fee, or
other charge imposed by the self14 17
CFR 240.19b–4(f)(6).
U.S.C. 78o–3.
16 15 U.S.C. 78o–3(b)(5).
17 15 U.S.C. 78s(b)(3)(A)(ii).
18 17 CFR 240.19b–4(f)(2).
regulatory organization and in part to
Section 19(b)(3)(A)(iii) of the Act 19 and
subparagraph (f)(3) of Rule 19b–4 20
thereunder because it is concerned with
the administration of a self-regulatory
organization. Accordingly, the proposal
is effective upon Commission receipt of
the filing. At any time within 60 days
of the filing of such proposed rule
change, the Commission may summarily
abrogate such rule change if it appears
to the Commission that such action is
necessary or appropriate in the public
interest, for the protection of investors,
or otherwise in furtherance of the
purposes of the Act.21
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 (https://www.sec.gov/
rules/sro.shtml); or
• Send an e-mail to rulecomments@sec.gov. Please include File
Number SR–NASD–2005–019 on the
subject line.
Paper Comments
• Send paper comments in triplicate
to Jonathan G. Katz, Secretary,
Securities and Exchange Commission,
450 Fifth Street, NW., Washington, DC
20549–0609.
All submissions should refer to File
Number SR–NASD–2005–019. 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 (https://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. Copies of the filing also will be
15 15
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19:31 Feb 24, 2005
19 15
U.S.C. 78s(b)(3)(A)(iii).
CFR 240.19b–4(f)(3).
21 15 U.S.C. 78s(b)(3)(C).
20 17
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available for inspection and copying at
the principal office of the NASD. 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–2005–019 and
should be submitted on or before March
18, 2005.
For the Commission, by the Division of
Market Regulation, pursuant to delegated
authority.22
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5–772 Filed 2–24–05; 8:45 am]
BILLING CODE 8010–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–51230; File No. SR–NASD–
2004–045]
Self-Regulatory Organizations;
National Association of Securities
Dealers, Inc.; Notice of Filing of
Proposed Rule Change and
Amendment No. 1 Thereto To Adopt
NASD Rule 2111 To Prohibit Members
From Trading Ahead of Customer
Market Orders
February 18, 2005.
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 March 12,
2004, the National Association of
Securities Dealers, Inc. (‘‘NASD’’), 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 NASD. On
February 16, 2005, NASD amended the
proposed rule change.3 The Commission
is publishing this notice to solicit
comments on the proposed rule change,
as amended, from interested persons.4
22 17
CFR 200.30–3(a)(12).
U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
3 See Amendment No. 1 to SR–NASD–2004–045
filed on February 16, 2005. Amendment No. 1 made
clarifying changes to the proposed rule text.
4 NASD notes that related to this proposed rule
filing it has also filed SR–NASD–2004–026, a
proposed rule change that would amend NASD
Rule 2320(a), known as the ‘‘Best Execution Rule.’’
See Securities Exchange Act Release No. 51229
(February 18, 2005) (SR–NASD–2004–026). NASD
has also filed SR–NASD–2004–089, a proposed rule
change that would provide price improvement to
customer limit orders under certain circumstances.
See Securities Exchange Act Release No. 51231
(February 18, 2005) (SR–NASD–2004–089).
1 15
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Federal Register / Vol. 70, No. 37 / Friday, February 25, 2005 / Notices
received by the member or become
marketable at a later time. Such limit
orders shall be treated as market orders
for purposes of this rule, however, these
NASD is proposing to prohibit
orders must continue to be executed at
members from trading ahead of a
their limit price or better. If a customer
customer market order under the
limit order is not marketable when
circumstances described herein. Below
received, the limit order must be
is the text of the proposed rule change.
provided the full protections of IM–
Proposed new language is in italics.
2110–2 or Rule 6440(f)(2), as applicable.
2111. Trading Ahead of Customer
In addition, if the limit order was
Market Orders
marketable when received and then
becomes non-marketable, once the limit
(a) A member must make every effort
to execute a customer market order that order becomes non-marketable, it must
be provided the full protections of IM–
it receives fully and promptly.
2110–2 or Rule 6440(f)(2), as applicable.
(b) A member that accepts and holds
(f) The obligations under this rule
a market order of its own customer or
shall not apply to a member’s
a customer of another broker-dealer in
proprietary trade if such proprietary
a Nasdaq or exchange-listed security
without immediately executing the order trade is for the purposes of facilitating
the execution, on a riskless principal
is prohibited from trading that security
basis, of another order from a customer
on the same side of the market for its
(whether its own customer or the
own account, unless it immediately
thereafter executes the customer market customer of another member) (the
‘‘facilitated order’’), provided that all of
order up to the size and at the same
the following requirements are satisfied:
price at which it traded for its own
(1) The handling and execution of the
account or at a better price.
facilitated order must satisfy the
(c) A member that is holding a
customer market order that has not been definition of a ‘‘riskless’’ principal
transaction, as that term is defined in
immediately executed must make every
NASD Rules 4632(d)(3)(B),
effort to cross such order with any
market order, marketable limit order, or 4642(d)(3)(B), 4652(d)(3)(B),
non-marketable limit order priced better 4632A(e)(1)(C) or 6420(d)(3)(B);
(2) A member that relies on this
than the best bid or offer, received by
exclusion to the rule must give the
the member on the other side of the
facilitated order the same per-share
market up to the size of such order at
price at which the member accumulated
a price that is no less than the best bid
or sold shares to satisfy the facilitated
and no greater than the best offer at the
order, exclusive of any markup or
time that the subsequent market order,
markdown, commission equivalent or
marketable limit order or nonmarketable limit order is received by the other fee;
(3) A member must submit,
member and that is consistent with the
contemporaneously with the execution
terms of the orders. In the event that a
of the facilitated order, a report as
member is holding multiple orders on
defined in NASD Rules 4632(d)(3)(B)(ii),
both sides of the market that have not
4642(d)(3)(B)(ii), 4652(d)(3)(B)(ii),
been executed, the member must make
every effort to cross or otherwise execute 6420(d)(3)(B)(ii) and 4632A(e)(1)(C)(ii),
or a substantially similar report to
such orders in a manner that is
another trade reporting system; and
reasonable, and is consistent with the
(4) Members must have written
objectives of this rule and with the terms
policies and procedures to assure that
of the orders. The member must have a
written methodology in place governing riskless principal transactions relied
upon for this exclusion comply with
the execution and priority of all such
applicable NASD rules. At a minimum
pending orders and must ensure that
these policies and procedures must
such methodology is consistently
require that the customer order was
applied.
received prior to the offsetting
(d) A member may negotiate specific
transactions, and that the offsetting
terms and conditions applicable to the
transactions are allocated to a riskless
acceptance of a market order only with
respect to market orders that are: (1) for principal or customer account in a
consistent manner and within 60
customer accounts that meet the
seconds of execution. Members must
definition of an ‘‘institutional account’’
have supervisory systems in place that
as that term is defined in Rule
3110(c)(4), or (2) 10,000 shares or more, produce records that enable the member
and NASD to reconstruct accurately,
unless such orders are less than
readily, and in a time-sequenced
$100,000 in value.
manner all orders on which a member
(e) This rule applies to limit orders
relies in claiming this exception.
that are marketable at the time they are
I. Self-Regulatory Organization’s
Statement of the Terms of the Substance
of the Proposed Rule Change
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9409
(g) Nothing in this rule changes the
application of Rule 2320 with respect to
a member’s obligations to customer
orders.
*
*
*
*
*
II. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
In its filing with the Commission,
NASD 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. NASD 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
Background. NASD Interpretive
Material 2110–2, Trading Ahead of
Customer Limit Order (commonly
referred to as the ‘‘Manning Rule’’)
generally prohibits members from
trading for their own account at prices
that would satisfy a customer’s limit
order, unless the member immediately
thereafter executes the customer limit
order.5 The legal underpinnings for the
Manning Rule are a member’s basic
fiduciary obligations and the
requirement that it must, in the conduct
of its business, ‘‘observe high standards
of commercial honor and just and
equitable principles of trade.’’ 6
NASD believes that the same
principles on which the Manning Rule
is based should apply to the treatment
of customer market orders. As such, on
March 12, 2004, NASD filed the instant
proposed rule change, proposing
amendments to require market order
protection. The proposed rule change
sought to adopt new NASD Rule 2111
that would prohibit a member from
trading ahead of a customer market
order under the circumstances
described therein. NASD proposed
certain changes to proposed NASD Rule
2111 with Amendment No. 1.
Proposal. NASD is proposing that a
member be prohibited from trading for
5 For example, if the member bought 100 shares
at $10 when holding customer limit orders in the
same security to buy at $10 equaling, in aggregate,
1000 shares, the member is required to fill 100
shares of the customer limit orders. NASD Rule
6440(f)(2) imposes similar requirements with
respect to the receipt of customer limit orders in
exchange-listed securities.
6 See NASD Rule 2110.
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its proprietary account on the same side
of the market as a customer market
order, if that customer market order has
not been executed fully and promptly.
Specifically, the proposed rule change
would prohibit a member from trading
for its own account on the same side of
the market as a customer market order
in a Nasdaq or exchange-listed security 7
if the member accepts and holds a
customer market order in that security
without immediately executing the
order, unless such member immediately
thereafter executes the customer market
order up to the size and at the same
price at which it traded for its own
account or a better price.8 Similar to the
application of the Manning Rule,
customer market orders would include
orders received from the member’s own
customers or customer orders of another
broker-dealer. In addition, if a member
is holding a customer market order that
has not been immediately executed,
such member would be required to
make every effort to match the pending
market order against any market orders,
marketable limit orders or nonmarketable limit orders priced better
than the best bid or offer received by the
member on the other side of the market
up to the size of the pending market
order and at a price that is no less than
the best bid and no greater than the best
offer at the time such subsequent market
order, marketable limit order or nonmarketable limit order is received by
such member and is consistent with the
terms of the pending order.
In the event that a member is holding
multiple orders on both sides of the
market that have not been executed, the
member must make every effort to cross
or otherwise execute such orders in a
7 NASD Rule 6440(f)(1) currently prohibits a
member from personally buying (selling) an
exchange-listed security for its own account while
such member holds an unexecuted market order to
buy (sell) such security for a customer. The
proposed rule change would prohibit a broad range
of conduct, including conduct prohibited by NASD
Rule 6440(f)(1) and therefore, NASD staff will
recommend to Nasdaq that it consider deleting
NASD Rule 6440(f)(1), in light of the proposal
described herein.
8 The agency obligation of a broker-dealer with
respect to a customer order is defined by the
customer’s expectation of the treatment of the order.
A customer’s market order generally represents the
expectation that the order will be executed fully
and promptly at the current best bid, for a sell
order, or best offer, for a buy order, regardless of
the impact on market price. In attempting to meet
this expectation, there is some reasonable period of
time in which market orders may queue while the
broker-dealer is executing orders ahead on both
sides of the market. This proposed rule change
represents NASD’s view that, when that reasonable
time period has expired, the member shall not be
permitted to trade that security for its own account
on the same side of the market as its customer
market order without giving the customer market
order an execution at that same price or better.
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manner that is reasonable and is
consistent with the objectives of the
proposed rule change and with the
terms of the orders. The member also
must have a written methodology in
place governing the execution priority
of all such pending orders and must
ensure that such methodology is
consistently applied.
For example, assume the inside
market for security ABCD is 10 to 10.05
and Firm A receives a market order to
buy 1,000 shares of ABCD from
Customer C1, which Firm A has not
immediately executed. If Firm A buys
1,000 shares of ABCD at 10 from Firm
B (or from any other source), Firm A
would be required to sell 1,000 shares
of ABCD to C1 at 10 or better. Similarly,
if Firm A bought shares for its own
account below the best bid of 10, it
would be required to sell stock to C1 at
that same price below the bid or better.
If a member does not execute an order
fully and promptly, but has not bought
or sold securities for its own account on
the same side of the market as the
customer order or has not received a
market order, marketable limit order or
non-marketable limit order priced better
than the best bid or offer from another
customer on the contra-side of the
market, the proposed rule change would
not impose any specific obligations on
the member above and beyond the
member’s current obligations to market
orders, such as a member’s best
execution requirements under NASD
Rule 2320.9
The proposed rule change also would
incorporate several of the same types of
exclusions that apply to the Manning
Rule. First, the proposed rule change
would permit members to negotiate
specific terms and conditions applicable
to the acceptance of a market order with
respect to a market order for customer
accounts that meet the definition of an
‘‘institutional account’’ as that term is
defined in NASD Rule 3110(c)(4) or a
market order that is for 10,000 shares or
more, unless such order is less than
$100,000 in value.
Second, the proposal would provide
an exception for member proprietary
trades that are part of an execution, on
a riskless principal basis, of another
order from a customer (whether its own
customer or the customer of another
member) (the ‘‘facilitated order’’). This
exclusion would apply only if the
following requirements are met: (1) The
handling and execution of the facilitated
order must satisfy the definition of a
9 See NASD Rule 2320(a) (the ‘‘Best Execution
Rule’’). NASD has proposed changes to the Best
Execution Rule in SR–NASD–2004–026 (February
12, 2004), See footnote 4, supra.
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‘‘riskless’’ principal transaction, as that
term is defined in NASD Rules; (2) the
member must give the facilitated order
the same per-share price at which the
member accumulated or sold shares to
satisfy the facilitated order, exclusive of
any markup or markdown, commission
equivalent or other fee; (3) a member
must submit, contemporaneously with
the execution of the facilitated order, a
report as defined in NASD Rules
4632(d)(3)(B)(ii), 4642(d)(3)(B)(ii),
4652(d)(3)(B)(ii), 6420(d)(3)(B)(ii) or
4632A(e)(1)(C)(ii), or a substantially
similar report; and (4) members must
have written policies and procedures to
assure that riskless principal
transactions relied upon for this
exclusion comply with applicable
NASD rules.10
For example, assume that the inside
market for security ABCD is 10 to 10.05
and Firm A receives a market order to
buy 1,000 shares of ABCD from
Customer C1 and immediately
thereafter, receives a market order to
buy 500 shares of ABCD from Customer
C2. Firm A has not immediately
executed the orders from C1 and C2. If
Firm A purchases 1,000 shares at 10 to
fill C1’s order on a riskless principal
basis and otherwise meets the
requirements of the riskless principal
exception to the proposed rule change,
the riskless principal trade would not
trigger an execution of C2’s order under
the proposed rule change. Under the
same facts noted above, alternatively if
Firm A were to execute C2’s order for
500 shares on a riskless principal basis
prior to executing C1’s order, the
riskless principal trade would not
trigger the execution (or partial
execution) of C1’s order.11
10 With respect to requirement (4), the member’s
policies and procedures, at a minimum, must
require that the customer order was received prior
to the offsetting transactions, and that the offsetting
transactions are allocated to a riskless principal or
customer account in a consistent manner and
within 60 seconds of execution. Members must
have supervisory systems in place that produce
records that enable the member and NASD to
reconstruct accurately, readily, and in a timesequenced manner, all orders on which a member
relies in claiming this exemption.
11 Except as specifically provided in the proposed
rule change, NASD has not mandated any particular
order handling and execution priority procedures
among market orders. Thus, a member may choose
any reasonable methodology for the way in which
it executes multiple orders that it holds, but the
member must ensure that such methodology is
applied consistently. For example, a member could
use a first in first out (FIFO) methodology or some
other objective methodology or formula. It would be
inappropriate, however, for a member’s
methodology to give priority, for example, to orders
of certain ‘‘preferred accounts’’ or preference
institutional orders over retail orders. To the extent
a member elects a specific methodology, the
member must document that methodology and have
written supervisory procedures and systems in
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The proposed rule change also applies
to limit orders that are marketable at the
time they are received by the member or
that become marketable at a later time.
Such limit orders would be treated as
market orders for purposes of the
proposed rule change; however, these
orders must continue to be executed at
their limit price or better. If a customer
limit order is not marketable when
received, the limit order must be
provided the full protections of IM–
2110–2 for Nasdaq securities of
NASDRule 6440(f)(2) for exchangelisted securities. In addition, if the limit
order was marketable when received
and then becomes non-marketable, once
the limit order becomes non-marketable,
it must be provided the full protections
of IM–2110–2 or NASD Rule 6440(f)(2).
The proposed rule change applies to
NASD members irrespective of upon
which market they trade. If a member
were to execute a proprietary trade on
an exchange while holding a customer
market order on the same side of the
market that the member has not fully
and promptly executed, then the
member would be deemed to have
violated the proposed rule change
unless (1) the member immediately
provides an execution to that market
order at a price equal to or better than
the proprietary trade; or (2) the
member’s proprietary trade was in
accordance with a functional role,
recognized within the rules of that
exchange, of acting as a liquidity
provider, such as acting in the role of a
specialist or some other substantially
similar capacity.
NASD is emphasizing that nothing in
the proposed rule change modifies the
application of NASD Rule 2320 with
respect to a member’s obligations to
customer orders. For example, to the
extent a member does not execute a
market order fully and promptly,
compliance with the proposed rule
change would not safeguard the member
from potential liability due to noncompliance with its best execution
responsibilities.
Finally, in recognition that the
proposed rule change may alter the way
that many members handle customer
orders, NASD believes it is important to
provide members with adequate time to
develop and implement systems to
comply with the proposed rule change.
place to ensure that the methodology it has chosen
is consistent with the duty of best execution.
Further, simply because a member employs a
methodology for execution of orders and that
methodology is followed in a particular
circumstance does not automatically mean that any
or all customer orders executed pursuant to such a
methodology have received best execution under
NASD Rule 2320.
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Therefore, should the Commission
approve the proposed rule change
NASD is proposing an implementation
date of 90 days after the issuance of a
Notice to Members announcing SEC
approval of the proposed rule change.
2. Statutory Basis
NASD believes that the proposed rule
change is consistent with the provisions
of Section 15A of the Act,12 in general,
and with Section 15A(b)(6) of the Act,13
in particular, which requires that NASD
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. NASD
believes that the proposed rule change
will improve the treatment of market
orders and enhance the integrity of the
market.
B. Self-Regulatory Organization’s
Statement on Burden on Competition
NASD 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, as amended.
C. Self-Regulatory Organization’s
Statement on Comments on the
Proposed Rule Change Received From
Members, Participants, or Others
Written comments were neither
solicited or 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, as amended, is consistent with
the Act. Comments may be submitted by
any of the following methods:
PO 00000
12 15
13 15
U.S.C. 78o–3.
U.S.C. 78o–3(b)(6).
Frm 00145
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9411
Electronic Comments
• Use the Commission’s Internet
comment form (https://www.sec.gov/
rules/sro.shtml); or
• Send an e-mail to rulecomments@sec.gov. Please include File
Number SR–NASD–2004–045 on the
subject line.
Paper Comments
• Send paper comments in triplicate
to Jonathan G. Katz, Secretary,
Securities and Exchange Commission,
450 Fifth Street, NW., Washington, DC
20549–0609.
All submissions should refer to File
Number SR–NASD–2004–045. 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 (https://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. Copies of such filing also will be
available for inspection and copying at
the principal office of the NASD. 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–2004–045 and
should be submitted on or before March
18, 2005.
For the Commission, by the Division of
Market Regulation, pursuant to delegated
authority.14
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5–773 Filed 2–24–05; 8:45 am]
BILLING CODE 8010–01–P
14 17
E:\FR\FM\25FEN1.SGM
CFR 200.30–3(a)(12).
25FEN1
]]>Agencies
[Federal Register Volume 70, Number 37 (Friday, February 25, 2005)]
[Notices]
[Pages 9408-9411]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E5-773]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-51230; File No. SR-NASD-2004-045]
Self-Regulatory Organizations; National Association of Securities
Dealers, Inc.; Notice of Filing of Proposed Rule Change and Amendment
No. 1 Thereto To Adopt NASD Rule 2111 To Prohibit Members From Trading
Ahead of Customer Market Orders
February 18, 2005.
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 March 12, 2004, the National Association of Securities Dealers, Inc.
(``NASD''), 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 NASD. On February
16, 2005, NASD amended the proposed rule change.\3\ The Commission is
publishing this notice to solicit comments on the proposed rule change,
as amended, from interested persons.\4\
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Amendment No. 1 to SR-NASD-2004-045 filed on February
16, 2005. Amendment No. 1 made clarifying changes to the proposed
rule text.
\4\ NASD notes that related to this proposed rule filing it has
also filed SR-NASD-2004-026, a proposed rule change that would amend
NASD Rule 2320(a), known as the ``Best Execution Rule.'' See
Securities Exchange Act Release No. 51229 (February 18, 2005) (SR-
NASD-2004-026). NASD has also filed SR-NASD-2004-089, a proposed
rule change that would provide price improvement to customer limit
orders under certain circumstances. See Securities Exchange Act
Release No. 51231 (February 18, 2005) (SR-NASD-2004-089).
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[[Page 9409]]
I. Self-Regulatory Organization's Statement of the Terms of the
Substance of the Proposed Rule Change
NASD is proposing to prohibit members from trading ahead of a
customer market order under the circumstances described herein. Below
is the text of the proposed rule change. Proposed new language is in
italics.
2111. Trading Ahead of Customer Market Orders
(a) A member must make every effort to execute a customer market
order that it receives fully and promptly.
(b) A member that accepts and holds a market order of its own
customer or a customer of another broker-dealer in a Nasdaq or
exchange-listed security without immediately executing the order is
prohibited from trading that security on the same side of the market
for its own account, unless it immediately thereafter executes the
customer market order up to the size and at the same price at which it
traded for its own account or at a better price.
(c) A member that is holding a customer market order that has not
been immediately executed must make every effort to cross such order
with any market order, marketable limit order, or non-marketable limit
order priced better than the best bid or offer, received by the member
on the other side of the market up to the size of such order at a price
that is no less than the best bid and no greater than the best offer at
the time that the subsequent market order, marketable limit order or
non-marketable limit order is received by the member and that is
consistent with the terms of the orders. In the event that a member is
holding multiple orders on both sides of the market that have not been
executed, the member must make every effort to cross or otherwise
execute such orders in a manner that is reasonable, and is consistent
with the objectives of this rule and with the terms of the orders. The
member must have a written methodology in place governing the execution
and priority of all such pending orders and must ensure that such
methodology is consistently applied.
(d) A member may negotiate specific terms and conditions applicable
to the acceptance of a market order only with respect to market orders
that are: (1) for customer accounts that meet the definition of an
``institutional account'' as that term is defined in Rule 3110(c)(4),
or (2) 10,000 shares or more, unless such orders are less than $100,000
in value.
(e) This rule applies to limit orders that are marketable at the
time they are received by the member or become marketable at a later
time. Such limit orders shall be treated as market orders for purposes
of this rule, however, these orders must continue to be executed at
their limit price or better. If a customer limit order is not
marketable when received, the limit order must be provided the full
protections of IM-2110-2 or Rule 6440(f)(2), as applicable. In
addition, if the limit order was marketable when received and then
becomes non-marketable, once the limit order becomes non-marketable, it
must be provided the full protections of IM-2110-2 or Rule 6440(f)(2),
as applicable.
(f) The obligations under this rule shall not apply to a member's
proprietary trade if such proprietary trade is for the purposes of
facilitating the execution, on a riskless principal basis, of another
order from a customer (whether its own customer or the customer of
another member) (the ``facilitated order''), provided that all of the
following requirements are satisfied:
(1) The handling and execution of the facilitated order must
satisfy the definition of a ``riskless'' principal transaction, as that
term is defined in NASD Rules 4632(d)(3)(B), 4642(d)(3)(B),
4652(d)(3)(B), 4632A(e)(1)(C) or 6420(d)(3)(B);
(2) A member that relies on this exclusion to the rule must give
the facilitated order the same per-share price at which the member
accumulated or sold shares to satisfy the facilitated order, exclusive
of any markup or markdown, commission equivalent or other fee;
(3) A member must submit, contemporaneously with the execution of
the facilitated order, a report as defined in NASD Rules
4632(d)(3)(B)(ii), 4642(d)(3)(B)(ii), 4652(d)(3)(B)(ii),
6420(d)(3)(B)(ii) and 4632A(e)(1)(C)(ii), or a substantially similar
report to another trade reporting system; and
(4) Members must have written policies and procedures to assure
that riskless principal transactions relied upon for this exclusion
comply with applicable NASD rules. At a minimum these policies and
procedures must require that the customer order was received prior to
the offsetting transactions, and that the offsetting transactions are
allocated to a riskless principal or customer account in a consistent
manner and within 60 seconds of execution. Members must have
supervisory systems in place that produce records that enable the
member and NASD to reconstruct accurately, readily, and in a time-
sequenced manner all orders on which a member relies in claiming this
exception.
(g) Nothing in this rule changes the application of Rule 2320 with
respect to a member's obligations to customer orders.
* * * * *
II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
In its filing with the Commission, NASD 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. NASD 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
Background. NASD Interpretive Material 2110-2, Trading Ahead of
Customer Limit Order (commonly referred to as the ``Manning Rule'')
generally prohibits members from trading for their own account at
prices that would satisfy a customer's limit order, unless the member
immediately thereafter executes the customer limit order.\5\ The legal
underpinnings for the Manning Rule are a member's basic fiduciary
obligations and the requirement that it must, in the conduct of its
business, ``observe high standards of commercial honor and just and
equitable principles of trade.'' \6\
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\5\ For example, if the member bought 100 shares at $10 when
holding customer limit orders in the same security to buy at $10
equaling, in aggregate, 1000 shares, the member is required to fill
100 shares of the customer limit orders. NASD Rule 6440(f)(2)
imposes similar requirements with respect to the receipt of customer
limit orders in exchange-listed securities.
\6\ See NASD Rule 2110.
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NASD believes that the same principles on which the Manning Rule is
based should apply to the treatment of customer market orders. As such,
on March 12, 2004, NASD filed the instant proposed rule change,
proposing amendments to require market order protection. The proposed
rule change sought to adopt new NASD Rule 2111 that would prohibit a
member from trading ahead of a customer market order under the
circumstances described therein. NASD proposed certain changes to
proposed NASD Rule 2111 with Amendment No. 1.
Proposal. NASD is proposing that a member be prohibited from
trading for
[[Page 9410]]
its proprietary account on the same side of the market as a customer
market order, if that customer market order has not been executed fully
and promptly. Specifically, the proposed rule change would prohibit a
member from trading for its own account on the same side of the market
as a customer market order in a Nasdaq or exchange-listed security \7\
if the member accepts and holds a customer market order in that
security without immediately executing the order, unless such member
immediately thereafter executes the customer market order up to the
size and at the same price at which it traded for its own account or a
better price.\8\ Similar to the application of the Manning Rule,
customer market orders would include orders received from the member's
own customers or customer orders of another broker-dealer. In addition,
if a member is holding a customer market order that has not been
immediately executed, such member would be required to make every
effort to match the pending market order against any market orders,
marketable limit orders or non-marketable limit orders priced better
than the best bid or offer received by the member on the other side of
the market up to the size of the pending market order and at a price
that is no less than the best bid and no greater than the best offer at
the time such subsequent market order, marketable limit order or non-
marketable limit order is received by such member and is consistent
with the terms of the pending order.
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\7\ NASD Rule 6440(f)(1) currently prohibits a member from
personally buying (selling) an exchange-listed security for its own
account while such member holds an unexecuted market order to buy
(sell) such security for a customer. The proposed rule change would
prohibit a broad range of conduct, including conduct prohibited by
NASD Rule 6440(f)(1) and therefore, NASD staff will recommend to
Nasdaq that it consider deleting NASD Rule 6440(f)(1), in light of
the proposal described herein.
\8\ The agency obligation of a broker-dealer with respect to a
customer order is defined by the customer's expectation of the
treatment of the order. A customer's market order generally
represents the expectation that the order will be executed fully and
promptly at the current best bid, for a sell order, or best offer,
for a buy order, regardless of the impact on market price. In
attempting to meet this expectation, there is some reasonable period
of time in which market orders may queue while the broker-dealer is
executing orders ahead on both sides of the market. This proposed
rule change represents NASD's view that, when that reasonable time
period has expired, the member shall not be permitted to trade that
security for its own account on the same side of the market as its
customer market order without giving the customer market order an
execution at that same price or better.
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In the event that a member is holding multiple orders on both sides
of the market that have not been executed, the member must make every
effort to cross or otherwise execute such orders in a manner that is
reasonable and is consistent with the objectives of the proposed rule
change and with the terms of the orders. The member also must have a
written methodology in place governing the execution priority of all
such pending orders and must ensure that such methodology is
consistently applied.
For example, assume the inside market for security ABCD is 10 to
10.05 and Firm A receives a market order to buy 1,000 shares of ABCD
from Customer C1, which Firm A has not immediately executed. If Firm A
buys 1,000 shares of ABCD at 10 from Firm B (or from any other source),
Firm A would be required to sell 1,000 shares of ABCD to C1 at 10 or
better. Similarly, if Firm A bought shares for its own account below
the best bid of 10, it would be required to sell stock to C1 at that
same price below the bid or better.
If a member does not execute an order fully and promptly, but has
not bought or sold securities for its own account on the same side of
the market as the customer order or has not received a market order,
marketable limit order or non-marketable limit order priced better than
the best bid or offer from another customer on the contra-side of the
market, the proposed rule change would not impose any specific
obligations on the member above and beyond the member's current
obligations to market orders, such as a member's best execution
requirements under NASD Rule 2320.\9\
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\9\ See NASD Rule 2320(a) (the ``Best Execution Rule''). NASD
has proposed changes to the Best Execution Rule in SR-NASD-2004-026
(February 12, 2004), See footnote 4, supra.
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The proposed rule change also would incorporate several of the same
types of exclusions that apply to the Manning Rule. First, the proposed
rule change would permit members to negotiate specific terms and
conditions applicable to the acceptance of a market order with respect
to a market order for customer accounts that meet the definition of an
``institutional account'' as that term is defined in NASD Rule
3110(c)(4) or a market order that is for 10,000 shares or more, unless
such order is less than $100,000 in value.
Second, the proposal would provide an exception for member
proprietary trades that are part of an execution, on a riskless
principal basis, of another order from a customer (whether its own
customer or the customer of another member) (the ``facilitated
order''). This exclusion would apply only if the following requirements
are met: (1) The handling and execution of the facilitated order must
satisfy the definition of a ``riskless'' principal transaction, as that
term is defined in NASD Rules; (2) the member must give the facilitated
order the same per-share price at which the member accumulated or sold
shares to satisfy the facilitated order, exclusive of any markup or
markdown, commission equivalent or other fee; (3) a member must submit,
contemporaneously with the execution of the facilitated order, a report
as defined in NASD Rules 4632(d)(3)(B)(ii), 4642(d)(3)(B)(ii),
4652(d)(3)(B)(ii), 6420(d)(3)(B)(ii) or 4632A(e)(1)(C)(ii), or a
substantially similar report; and (4) members must have written
policies and procedures to assure that riskless principal transactions
relied upon for this exclusion comply with applicable NASD rules.\10\
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\10\ With respect to requirement (4), the member's policies and
procedures, at a minimum, must require that the customer order was
received prior to the offsetting transactions, and that the
offsetting transactions are allocated to a riskless principal or
customer account in a consistent manner and within 60 seconds of
execution. Members must have supervisory systems in place that
produce records that enable the member and NASD to reconstruct
accurately, readily, and in a time-sequenced manner, all orders on
which a member relies in claiming this exemption.
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For example, assume that the inside market for security ABCD is 10
to 10.05 and Firm A receives a market order to buy 1,000 shares of ABCD
from Customer C1 and immediately thereafter, receives a market order to
buy 500 shares of ABCD from Customer C2. Firm A has not immediately
executed the orders from C1 and C2. If Firm A purchases 1,000 shares at
10 to fill C1's order on a riskless principal basis and otherwise meets
the requirements of the riskless principal exception to the proposed
rule change, the riskless principal trade would not trigger an
execution of C2's order under the proposed rule change. Under the same
facts noted above, alternatively if Firm A were to execute C2's order
for 500 shares on a riskless principal basis prior to executing C1's
order, the riskless principal trade would not trigger the execution (or
partial execution) of C1's order.\11\
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\11\ Except as specifically provided in the proposed rule
change, NASD has not mandated any particular order handling and
execution priority procedures among market orders. Thus, a member
may choose any reasonable methodology for the way in which it
executes multiple orders that it holds, but the member must ensure
that such methodology is applied consistently. For example, a member
could use a first in first out (FIFO) methodology or some other
objective methodology or formula. It would be inappropriate,
however, for a member's methodology to give priority, for example,
to orders of certain ``preferred accounts'' or preference
institutional orders over retail orders. To the extent a member
elects a specific methodology, the member must document that
methodology and have written supervisory procedures and systems in
place to ensure that the methodology it has chosen is consistent
with the duty of best execution. Further, simply because a member
employs a methodology for execution of orders and that methodology
is followed in a particular circumstance does not automatically mean
that any or all customer orders executed pursuant to such a
methodology have received best execution under NASD Rule 2320.
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[[Page 9411]]
The proposed rule change also applies to limit orders that are
marketable at the time they are received by the member or that become
marketable at a later time. Such limit orders would be treated as
market orders for purposes of the proposed rule change; however, these
orders must continue to be executed at their limit price or better. If
a customer limit order is not marketable when received, the limit order
must be provided the full protections of IM-2110-2 for Nasdaq
securities of NASDRule 6440(f)(2) for exchange-listed securities. In
addition, if the limit order was marketable when received and then
becomes non-marketable, once the limit order becomes non-marketable, it
must be provided the full protections of IM-2110-2 or NASD Rule
6440(f)(2).
The proposed rule change applies to NASD members irrespective of
upon which market they trade. If a member were to execute a proprietary
trade on an exchange while holding a customer market order on the same
side of the market that the member has not fully and promptly executed,
then the member would be deemed to have violated the proposed rule
change unless (1) the member immediately provides an execution to that
market order at a price equal to or better than the proprietary trade;
or (2) the member's proprietary trade was in accordance with a
functional role, recognized within the rules of that exchange, of
acting as a liquidity provider, such as acting in the role of a
specialist or some other substantially similar capacity.
NASD is emphasizing that nothing in the proposed rule change
modifies the application of NASD Rule 2320 with respect to a member's
obligations to customer orders. For example, to the extent a member
does not execute a market order fully and promptly, compliance with the
proposed rule change would not safeguard the member from potential
liability due to non-compliance with its best execution
responsibilities.
Finally, in recognition that the proposed rule change may alter the
way that many members handle customer orders, NASD believes it is
important to provide members with adequate time to develop and
implement systems to comply with the proposed rule change. Therefore,
should the Commission approve the proposed rule change NASD is
proposing an implementation date of 90 days after the issuance of a
Notice to Members announcing SEC approval of the proposed rule change.
2. Statutory Basis
NASD believes that the proposed rule change is consistent with the
provisions of Section 15A of the Act,\12\ in general, and with Section
15A(b)(6) of the Act,\13\ in particular, which requires that NASD 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. NASD believes that the
proposed rule change will improve the treatment of market orders and
enhance the integrity of the market.
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\12\ 15 U.S.C. 78o-3.
\13\ 15 U.S.C. 78o-3(b)(6).
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B. Self-Regulatory Organization's Statement on Burden on Competition
NASD 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, as amended.
C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others
Written comments were neither solicited or 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, as amended, is consistent with the Act. Comments may be
submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (https://
www.sec.gov/rules/sro.shtml); or
Send an e-mail to rule-comments@sec.gov. Please include
File Number SR-NASD-2004-045 on the subject line.
Paper Comments
Send paper comments in triplicate to Jonathan G. Katz,
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW.,
Washington, DC 20549-0609.
All submissions should refer to File Number SR-NASD-2004-045. 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 (https://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. Copies of such
filing also will be available for inspection and copying at the
principal office of the NASD. 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-2004-045 and should be submitted on or before March
18, 2005.
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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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5-773 Filed 2-24-05; 8:45 am]
BILLING CODE 8010-01-P
