Self-Regulatory Organizations; Notice of Filing of Proposed Rule Change by the National Association of Securities Dealers, Inc. To Adopt an Additional Mark-Up Policy for Transactions in Debt Securities Except Municipal Securities, 12764-12769 [E5-1104]
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Federal Register / Vol. 70, No. 49 / Tuesday, March 15, 2005 / Notices
securities association.8 In particular, the
Commission believes that the proposed
rule change is consistent with Section
15A(b)(6) of the Act,9 which requires,
among other things, that NASD’s 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. The
Commission believes that a random
selection function incorporated into the
NASD Dispute Resolution arbitration
forum provides a fair and equitable
system for parties to select arbitrators.
It is therefore ordered, pursuant to
Section 19(b)(2) of the Act,10 that the
proposed rule change (SR–NASD–2004–
164), as amended, is approved.
For the Commission, by the Division of
Market Regulation, pursuant to delegated
authority.11
Jill M. Petersen,
Assistant Secretary.
[FR Doc. E5–1103 Filed 3–14–05; 8:45 am]
BILLING CODE 8010–01–P
[Release No. 34–51338; File No. SR–NASD–
2003–141]
Self-Regulatory Organizations; Notice
of Filing of Proposed Rule Change by
the National Association of Securities
Dealers, Inc. To Adopt an Additional
Mark-Up Policy for Transactions in
Debt Securities Except Municipal
Securities
March 9, 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
September 17, 2003, 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.3 On June 29, 2004,
8 In approving this proposed rule change, the
Commission notes that it has considered the
proposed rule’s impact on efficiency, competition,
and capital formation. 15 U.S.C. 78(c)(f).
9 15 U.S.C. 78o–3(b)(6).
10 15 U.S.C. 78s(b)(2).
11 17 CFR 200.30–3(a)(12).
1 15 U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
3 Commission staff made certain changes to the
description of the proposed rule change with the
consent of NASD, to enhance clarity and accuracy.
Telephone conversation between Sharon K.
Zackula, Associate General Counsel, Office of
General Counsel, Regulatory Policy and Oversight,
NASD, Richard Strasser, Attorney-Fellow, and
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I. Self-Regulatory Organization’s
Statement of the Terms of Substance of
the Proposed Rule Change
NASD is proposing to adopt a second
interpretation, proposed IM–2440–2, to
Rule 2440 to provide additional markup guidance for transactions in debt
securities except municipal securities.
Below is the text of the proposed rule
change. Proposed new language is in
italics. Text in bold would appear in
italics in the Rule as published in the
NASD Manual.
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IM–2440–1. Mark-Up Policy
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IM–2440–2. Additional Mark-Up Policy
for Transactions in Debt Securities,
Except Municipal Securities 1
SECURITIES AND EXCHANGE
COMMISSION
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NASD filed Amendment No. 1 to the
proposed rule change.4 On February 17,
2005, NASD filed Amendment No. 2 to
the proposed rule change.5 The
Commission is publishing this notice to
solicit comments on the proposed rule
change, as amended, from interested
persons.
1The Interpretation does not apply to
transactions in municipal securities.
Single terms in parentheses within
sentences, such as the terms ‘‘(sales)’’
and ‘‘(to)’’ in the phrase,
‘‘contemporaneous dealer purchases
(sales) in the security in question from
(to) institutional accounts,’’ refer to
scenarios where a member is charging a
customer a mark-down.
IM–2440–1 applies to debt securities
transactions, and this IM–2440–2
supplements the guidance provided in
IM–2440–1.
A dealer that is acting in a principal
capacity in a transaction with a
customer and is charging a mark-up or
mark-down must mark-up or markdown the transaction from the
prevailing market price. Presumptively
for purposes of this IM–2440–2, the
prevailing market price for a debt
security is established by referring to the
dealer’s contemporaneous cost as
incurred, or contemporaneous proceeds
as obtained, consistent with NASD
pricing rules. (See, e.g., Rule 2320).
When the dealer is selling the
security to a customer, countervailing
Andrew Shipe, Special Counsel, Division of Market
Regulation, Commission, March 3, 2005.
4 See letter from Barbara Z. Sweeney, Senior Vice
President and Corporate Secretary, NASD, to
Katherine England, Assistant Director, Division of
Market Regulation, Commission, dated June 29,
2004.
5 See Form 19b–4, filed February 17, 2005.
Amendment No. 2 replaced the previous filings in
their entirety.
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evidence of the prevailing market price
may be considered only where the
dealer made no contemporaneous
purchases in the security or can show
that in the particular circumstances the
dealer’s contemporaneous cost is not
indicative of the prevailing market
price. When the dealer is buying the
security from a customer, countervailing
evidence of the prevailing market price
may be considered only where the
dealer made no contemporaneous
sales in the security or can show that
in the particular circumstances the
dealer’s contemporaneous proceeds
are not indicative of the prevailing
market price.
A dealer that effects a transaction in
debt securities with a customer and
identifies the prevailing market price
using a measure other than the dealer’s
own contemporaneous cost or proceeds
must be prepared to provide evidence
that is sufficient to overcome the
presumption that the dealer’s
contemporaneous cost or proceeds
provide the best measure of the
prevailing market price. A dealer may
be able to show that its
contemporaneous cost or proceeds are
not indicative of prevailing market
price, and thus overcome the
presumption, in instances where (i)
interest rates or the credit quality of the
security changed significantly after the
dealer’s contemporaneous trades, or (ii)
the dealer’s contemporaneous trade was
with an institutional account with
which the dealer regularly effects
transactions in the same or a ‘‘similar’’
security, as defined below, and in the
case of a sale to such account, was
executed at a price higher than the then
prevailing market price, or, in the case
of a purchase from such account, was
executed at a price lower than the then
prevailing market price, and the
execution price was away from the
prevailing market price because of the
size and risk of the transaction (a
‘‘Specified Institutional Trade’’). In the
case of a Specified Institutional Trade,
when a dealer seeks to overcome the
presumption that the dealer’s
contemporaneous cost or proceeds
provide the best measure of the
prevailing market price, the dealer must
provide evidence of the then prevailing
market price by referring exclusively to
inter-dealer trades in the same security
executed contemporaneously with the
dealer’s Specified Institutional Trade.
In instances other than those
pertaining to a Specified Institutional
Trade, where the dealer has presented
evidence that is sufficient to overcome
the presumption that the dealer’s
contemporaneous cost or proceeds
provide the best measure of the
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Federal Register / Vol. 70, No. 49 / Tuesday, March 15, 2005 / Notices
prevailing market price, or where
interest rates or the credit quality of the
security changed significantly after the
dealer’s contemporaneous trades, the
most important or first pricing factor
that should be taken into consideration
in establishing prevailing market price
for a mark-up or a mark-down is prices
of any contemporaneous inter-dealer
transactions in the security in question.
In the absence of inter-dealer
transactions, the second factor that
should be taken into consideration in
establishing the prevailing market prices
for mark-ups (mark-downs) to
customers is prices of contemporaneous
dealer purchases (sales) in the security
in question from (to) institutional
accounts with which any dealer
regularly effects transactions in the
same security. For actively traded
securities, contemporaneous bid (offer)
quotations for the security in question
made through an inter-dealer
mechanism, through which transactions
generally occur at the displayed
quotations, may be used in the absence
of inter-dealer or institutional
transactions (described in the preceding
sentence) in determining prevailing
market price for customer mark-ups
(mark-downs).
In the event that, in particular
circumstances, the above factors are not
available, other factors that may be
taken into consideration for the purpose
of establishing the price from which a
customer mark-up (mark down) may be
calculated, include but are not limited
to:
• Prices of contemporaneous interdealer transactions in a ‘‘similar’’
security, as defined below, or prices of
contemporaneous dealer purchase (sale)
transactions in a ‘‘similar’’ security with
institutional accounts with which any
dealer regularly effects transactions in
the ‘‘similar’’ security with respect to
customer mark-ups (mark-downs);
• Yields calculated from prices of
contemporaneous inter-dealer
transactions in ‘‘similar’’ securities;
• Yields calculated from prices of
contemporaneous purchase (sale)
transactions with institutional accounts
with which any dealer regularly effects
transactions in ‘‘similar’’ securities with
respect to customer mark-ups (markdowns); and
• Yields calculated from validated
contemporaneous inter-dealer bid (offer)
quotations in ‘‘similar’’ securities for
customer mark-ups (mark-downs).
The relative weight one may attribute
to these other factors depends on the
facts and circumstances surrounding
the comparison transaction, such as its
size, whether the dealer in the
comparison transaction was on the
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same side of the market as the dealer is
in the subject transaction, the timeliness
of the information, and, with respect to
the final factor listed above, the relative
spread of the quotations in the similar
security to the quotations in the subject
security.
Finally, if information concerning the
prevailing market price of the subject
security cannot be obtained by applying
any of the above factors, NASD or its
members may consider as a factor in
assessing the prevailing market price of
a debt security the prices or yields
derived from economic models (e.g.,
discounted cash flow models) that take
into account measures such as credit
quality, interest rates, industry sector,
time to maturity, call provisions and
any other embedded options, coupon
rate, and face value; and consider all
applicable pricing terms and
conventions (e.g., coupon frequency and
accrual methods). Such models
currently may be in use by bond dealers
or may be specifically developed by
regulators for surveillance purposes.
Because the ultimate evidentiary issue
is the prevailing market price, isolated
transactions or isolated quotations
generally will have little or no weight or
relevance in establishing prevailing
market price. For example, in
considering yields of ‘‘similar’’
securities, except in extraordinary
circumstances, members may not rely
exclusively on isolated transactions or a
limited number of transactions that are
not fairly representative of the yields of
transactions in ‘‘similar’’ securities
taken as a whole.
A ‘‘similar’’ security should be
sufficiently similar to the subject
security that it would serve as a
reasonable alternative investment to the
investor. At a minimum, the security or
securities should be sufficiently similar
that a market yield for the subject
security can be fairly estimated from the
yields of the ‘‘similar’’ security or
securities. Where a security has several
components, appropriate consideration
may also be given to the prices or yields
of the various components of the
security.
The degree to which a security is
‘‘similar,’’ as that term is used in this
Interpretation, to the subject security
may be determined by factors that
include but are not limited to the
following;
(a) Credit quality considerations, such
as whether the security is issued by the
same or similar entity, bears the same
or similar credit rating, or is supported
by a similarly strong guarantee or
collateral as the subject security (to the
extent securities of other issuers are
designated as ‘‘similar’’ securities,
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significant recent information of either
issuer that is not yet incorporated in
credit ratings should be considered (e.g.,
changes to ratings outlooks));
(b) The extent to which the spread
(i.e., the spread over U.S. Treasury
securities of a similar duration) at which
the ‘‘similar’’ security trades is
comparable to the spread at which the
subject security trades;
(c) General structural characteristics
and provisions of the issue, such as
coupon, maturity, duration, complexity
or uniqueness of the structure,
callability, the likelihood that the
security will be called, tendered or
exchanged, and other embedded
options, as compared with the
characteristics of the subject security;
and
(d) Technical factors such as the size
of the issue, the float and recent
turnover of the issue, and legal
restrictions on transferability as
compared with the subject security.
When a debt security’s value and
pricing is based substantially on, and is
highly dependent on, the particular
circumstances of the issuer, including
creditworthiness and the ability and
willingness of the issuer to meet the
specific obligations of the security, in
most cases other securities will not be
sufficiently similar, and therefore, other
securities may not be used to establish
the prevailing market price.
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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
Introduction
Under NASD Rule 2440, ‘‘Fair Prices
and Commissions,’’ a member is
required to sell securities to a customer
at a fair price.6 When a member acts in
6 NASD Rule 2440 specifically provides that a
member is required to sell a security at a fair price
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Federal Register / Vol. 70, No. 49 / Tuesday, March 15, 2005 / Notices
a principal capacity and sells a security
to a customer, a dealer generally ‘‘marks
up’’ the security, increasing the total
price the customer pays. Conversely,
when buying a security from a
customer, a dealer that is a principal
generally ‘‘marks down’’ the security,
reducing the total proceeds the
customer receives. IM–2440, ‘‘Mark-Up
Policy,’’ provides additional guidance
on mark-ups and fair pricing of
securities transactions with customers.7
Both Rule 2440 and IM–2440 apply to
transactions in debt securities and IM–
2440 provides that mark-ups for
transactions in common stock are
customarily higher than those for bond
transactions of the same size.8
Under Rule 2440 and IM–2440, when
a customer buys a security from a
dealer, the customer’s total purchase
price, and the mark-up included in the
price, must be fair and reasonable.
Similarly, when a customer sells a
security to a dealer, the customer’s total
proceeds from the sale, which were
reduced by the mark-down, and the
mark-down, must be fair and
reasonable. A key step in determining
whether a mark-up (mark-down) is fair
and reasonable is correctly identifying
the prevailing market price of the
security, which is the basis from which
the mark-up (mark-down) is calculated.9
The proposed interpretation, ‘‘IM–
2440–2, Additional Mark-Up Policy For
Transactions in Debt Securities, Except
Municipal Securities’’ (‘‘Proposed
to customers, ‘‘taking into consideration all relevant
circumstances, including market conditions with
respect to such security at the time of the
transaction, the expense involved, and the fact that
he is entitled to a profit * * *.’’ Rule 2320, ‘‘Best
Execution and Interpositioning,’’ also addresses a
member’s obligation in pricing customer
transactions. In any transaction for or with a
customer, NASD Rule 2320 requires a member to
‘‘use reasonable diligence to ascertain the best interdealer market for the subject security and buy and
sell in such market so that the resultant price to the
customer is as favorable as possible under
prevailing market conditions.’’ Together, Rule 2440
and Rule 2320 impose broad responsibilities on
broker-dealers to price customer transactions fairly.
Cf. ‘‘Review of Dealer Pricing Responsibilities,’’
Municipal Securities Rulemaking Board (‘‘MSRB’’)
Notice 2004–3 (January 26, 2004) (discussing MSRB
Rules requiring municipal securities dealers to
‘‘exercise diligence in establishing the market value
of [a] security and the reasonableness of the
compensation received on [a] transaction’’).
7 The terms ‘‘mark-up’’ and ‘‘mark-down’’ are not
found in Rule 2440, but are used in IM–2440.
Statements regarding mark-ups also apply generally
to mark-downs unless mark-downs are discussed
specifically in a separate statement.
8 IM–2440(b)(1).
9 The Commission notes that IM–2440 states: ‘‘It
shall be deemed a violation of Rule 2110 and Rule
2440 for a member to enter into any transaction
with a customer in any security at any price not
reasonably related to the current market price of the
security or to charge a commission which is not
reasonable.’’
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Interpretation’’), provides additional
guidance on mark-ups (mark-downs) in
debt securities transactions, except
municipal securities transactions.10 The
Proposed Interpretation addresses two
fundamental issues in debt securities
transactions: (1) How does a dealer
correctly identify the prevailing market
price of a debt security; and (2) what is
a ‘‘similar’’ security and when may it be
considered in determining the
prevailing market price.
Prevailing Market Price
The Proposed Interpretation provides
that when a dealer calculates a mark-up
(or mark-down), the best measure of the
prevailing market price of the security is
presumptively the dealer’s
contemporaneous cost (proceeds).11
Further, the dealer may look to
countervailing evidence of the
prevailing market price only where the
dealer, when selling a security, made no
contemporaneous purchases in the
security or can show that in the
particular circumstances the dealer’s
contemporaneous cost is not indicative
of the prevailing market price. When
buying a security from a customer, the
dealer may look to countervailing
evidence of the prevailing market price
only where the dealer made no
contemporaneous sales in the security
or can show that in the particular
circumstances the dealer’s
contemporaneous proceeds are not
indicative of the prevailing market
price.
The presumption that
contemporaneous cost is the best
evidence of prevailing market price is
found in many cases and NASD
decisions, and its specific applicability
to debt securities transactions was
10 MSRB Rule G–30, ‘‘Prices and Commissions,’’
applies to transactions in municipal securities, and
requires that a municipal securities dealer engaging
in a transaction as a principal with a customer must
buy or sell securities at an aggregate price that is
‘‘fair and reasonable.’’
11 Of course, if a dealer violates NASD Rule 2320,
the dealer’s contemporaneous cost (proceeds) in
such transactions would not be a reliable indicator
of the prevailing market price for the purpose of
determining a mark-up or mark-down. If a dealer
violates Rule 2320 because the dealer fails to
exercise diligence, fails to negotiate at arms length
in the market, or engages in fraudulent transactions,
including those entered into in collusion with other
dealers or brokers, including inter-dealer brokers,
the price that the dealer obtains is not a price
reflecting market forces, and, therefore, is not a
valid indicator of the prevailing market price and
should not be used to calculate a mark-up (markdown). In addition, if a dealer that is not a party
to a transaction engages in conduct to improperly
influence the pricing of such transaction, the dealer
could not properly use the execution price as the
basis from which to compute a mark-up (markdown) because the execution price does not
represent the prevailing market price of the
security.
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addressed by the SEC as early as 1992
in F.B. Horner & Associates, Inc., 50
S.E.C. 1063 (1992), aff’d, 994 F.2d 61
(2d Cir. 1993) (‘‘F.B. Horner’’), a debt
mark-up case. In F.B. Horner, the SEC
stated: ‘‘We have consistently held that
where, as in the present case, a dealer
is not a market maker, the best evidence
of the current market, absent
countervailing evidence, is the dealer’s
contemporaneous cost.’’ F.B. Horner, 50
S.E.C. at 1065–66.12 The basis for the
standard was also restated. ‘‘That
standard, which has received judicial
approval, reflects the fact that the prices
paid for a security by a dealer in
transactions closely related in time to
his retail sales are normally a highly
reliable indication of the prevailing
market.’’ F.B. Horner, 50 S.E.C. at 1066
(citations omitted).
The Proposed Interpretation
recognizes that in some circumstances a
dealer may seek to overcome the
presumption that the dealer’s own
contemporaneous cost (proceeds) are
the prevailing market price of the
subject security for determining a markup (mark-down), and sets forth a
process for identifying a value other
than the dealer’s own contemporaneous
cost (proceeds).
Cases Where the Presumption May Be
Overcome
A dealer may seek to overcome the
presumption that its contemporaneous
cost or proceeds are not indicative of the
prevailing market price in either of two
instances: (1) Where the dealer’s
contemporaneous trade was with an
institutional account with which the
dealer regularly effects transactions in
the same or a similar security under
certain conditions, or (2) where interest
rates or the credit quality of the security
changed significantly after the dealer’s
contemporaneous trades.
Specified Institutional Trades
In instances when the dealer
establishes that the dealer’s
contemporaneous trade was a
‘‘Specified Institutional Trade,’’ to
overcome the presumption that the
dealer’s contemporaneous cost (or
proceeds) is the best measure of the
prevailing market price, the dealer must
provide evidence of the then prevailing
market price in the subject security by
referring exclusively to inter-dealer
trades in the same security executed
12 The term ‘‘market maker’’ is defined in Section
3(a)(38) of the Act [15 U.S.C. 78c(a)(38)] and a
dealer in debt securities must meet the legal
requirements of Section 3(a)(38) to be considered a
market maker.
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contemporaneously with the dealer’s
Specified Institutional Trade.13
Transactions Other Than Specified
Institutional Trades.
In instances other than those
pertaining to a Specified Institutional
Trade, where the dealer has presented
evidence that is sufficient to overcome
the presumption that the dealer’s
contemporaneous cost (proceeds)
provide the best measure of the
prevailing market price, or where
interest rates or credit quality of the
security changed significantly, the
dealer must follow a process for
determining prevailing market price,
considering certain factors in the
appropriate order, as set forth in the
Proposed Interpretation. Initially, a
dealer must look to three factors or
measures in the order they are presented
(the ‘‘Hierarchy’’) to determine
prevailing market price. The most
important and first factor in the
Hierarchy is the pricing of any
contemporaneous inter-dealer
transactions in the same security. The
second most important factor in the
Hierarchy recognizes the role of certain
large institutions in the fixed income
securities markets. In the absence of
inter-dealer transactions, the second
factor a dealer must consider is the
prices of contemporaneous dealer
purchases in the security in question
from institutional accounts with which
any dealer regularly effects transactions
in the same security.14 If
contemporaneous inter-dealer trades or
dealer-institutional trades in the same
security are not available, a dealer must
look to the third factor in the Hierarchy,
which may be applied only to actively
traded securities. For actively traded
securities, a dealer is required to look to
contemporaneous bid (offer) quotations
for the security in question for proof of
13 A ‘‘Specified Institutional Trade’’ is defined as
a dealer’s contemporaneous trade with an
institutional account with which the dealer
regularly effects transactions in the same or a
‘‘similar’’ security, as defined below, and in the
case of a sale to such an account, the trade was
executed at a price higher than the then prevailing
market price, and in the case of a purchase from
such an account, the trade was executed at a price
lower than the then prevailing market price, and the
execution price was away from the prevailing
market price because of the size and risk of the
transaction.
14 Contemporaneous dealer sales with such
institutional accounts would be used to calculate a
mark-down. If a dealer has overcome the
presumption by establishing that interest rates or
the credit quality of the security changed
significantly after the dealer’s trade, any interdealer or dealer-institutional trades in the same
security that occurred prior to the event would not
be valid measures of the prevailing market price as
such transactions would be subject to the same
imperfection.
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the prevailing market price if such
quotations are made through an interdealer mechanism through which
transactions generally occur at the
displayed quotations.15
Additional Factors That May Be
Considered in Cases Other Than
Specified Institutional Trades
If none of the three factors in the
Hierarchy is available, the dealer then
may take into consideration the nonexclusive list of four factors in the
Proposed Interpretation in trying to
establish prevailing market price using
a measure other than the dealer’s
contemporaneous cost (proceeds). In
contrast to the Hierarchy of three factors
discussed above, a dealer is not required
to consider the four factors below in a
particular order. The four factors reflect
the particular nature of the debt markets
and the trading and valuation of debt
securities. They are:
• Prices of contemporaneous interdealer transactions in a ‘‘similar’’
security, as defined below, or prices of
contemporaneous dealer purchase (sale)
transactions in a ‘‘similar’’ security with
institutional accounts with which any
dealer regularly effects transactions in
the ‘‘similar’’ security with respect to
customer mark-ups (mark-downs);
• Yields calculated from prices of
contemporaneous inter-dealer
transactions in ‘‘similar’’ securities;
• Yields calculated from prices of
contemporaneous purchase (sale)
transactions with institutional accounts
with which any dealer regularly effects
transactions in ‘‘similar’’ securities with
respect to customer mark-ups (markdowns); and
• Yields calculated from validated
contemporaneous inter-dealer bid (offer)
quotations in ‘‘similar’’ securities for
customer mark-ups (mark-downs).
When applying one or more of the
four factors, a dealer must consider that
the ultimate evidentiary issue is
whether the prevailing market price of
the security will be correctly identified.
As stated in the Proposed Interpretation,
the relative weight one may attribute to
these other factors depends on the facts
and circumstances surrounding the
comparison transaction, such as its size,
whether the dealer in the comparison
transaction was on the same side of the
market as the dealer is in the subject
transaction, the timeliness of the
15 A dealer also is subject to the process of
establishing prevailing market price, including the
analysis under the Hierarchy and the other factors
discussed below, where the dealer has not engaged
in trading in the subject security for an extended
period and therefore can evidence that it has no
contemporaneous cost (proceeds) to refer to as a
basis for computing a mark-up (mark-down).
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12767
information, and, with respect to the
final factor, the relative spread of the
quotations in the ‘‘similar’’ security to
the quotations in the subject security.
Finally, if information concerning the
prevailing market price of the subject
security cannot be obtained by applying
any of the above factors, a member may
consider as a factor in determining the
prevailing market price the prices or
yields derived from economic models
that take into account measures such as
credit quality, interest rates, industry
sector, time to maturity, call provisions
and any other embedded options,
coupon rate, and face value; and
consider all applicable pricing terms
and conventions (e.g., coupon frequency
and accrual methods). However, dealers
may not use any economic model to
establish the prevailing market price for
mark-up (mark-down) purposes, except
in limited instances where none of the
three factors in the Hierarchy apply, the
subject security is infrequently traded,
and the security is of such low credit
quality (e.g., a distressed debt security)
that a dealer cannot identify a ‘‘similar’’
security.16
The final principle in the Proposed
Interpretation regarding prevailing
market price addresses the use of
pricing information from isolated
transactions or quotations. The
Proposed Interpretation provides that
‘‘isolated transactions or isolated
quotations generally will have little or
no weight or relevance in establishing
prevailing market price. For example, in
considering yields of ‘similar’ securities,
except in extraordinary circumstances,
members may not rely exclusively on
isolated transactions or a limited
number of transactions that are not
fairly representative of the yields of
transactions in ‘similar’ securities taken
as a whole.’’
‘‘Similar’’ Securities
The definition of ‘‘similar’’ security,
and the uses and limitations of
‘‘similar’’ securities are the second part
of the Proposed Interpretation. Several
of the factors referenced above to which
16 When a dealer seeks to identify prevailing
market price using information other than the
dealer’s contemporaneous cost or contemporaneous
proceeds, the dealer must be prepared to provide
evidence that will establish the dealer’s basis for
not using contemporaneous cost (proceeds), and
information about the other values reviewed (e.g.,
the specific prices and/or yields of securities that
were identified as similar securities) in order to
determine the prevailing market price of the subject
security. If a firm relies upon pricing information
from a model the firm uses or has developed, the
firm must be able to provide information that was
used on the day of the transaction to develop the
pricing information (i.e., the data that was input,
and the data that the model generated and the firm
used to arrive at prevailing market price).
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Federal Register / Vol. 70, No. 49 / Tuesday, March 15, 2005 / Notices
a dealer may refer when determining the
prevailing market price as a value that
is other than the dealer’s
contemporaneous cost (proceeds)
require a dealer to identify one or more
‘‘similar’’ securities.
The Proposed Interpretation provides
that a ‘‘similar’’ security should be
sufficiently similar to the subject
security that it would serve as a
reasonable alternative investment. In
addition, at a minimum, a dealer must
be able to fairly estimate the market
yield for the subject security from the
yields of ‘‘similar’’ securities. Finally, to
aid members in identifying ‘‘similar’’
securities when appropriate, the
Proposed Interpretation sets forth a list
of non-exclusive factors to determine
the similarity between the subject
security and one or more other
securities. The non-exclusive list of
factors that can be used to assess
similarity includes the following:
(a) Credit quality considerations, such
as whether the security is issued by the
same or similar entity, bears the same or
similar credit rating, or is supported by
a similarly strong guarantee or collateral
as the subject security (to the extent that
securities of other issuers are designated
as ‘‘similar’’ securities, significant
recent information of either issuer that
is not yet incorporated in credit ratings
should be considered (e.g., changes in
ratings outlooks));
(b) The extent to which the spread
(i.e., the spread over U.S. Treasury
securities of a similar duration) at which
the ‘‘similar’’ security trades is
comparable to the spread at which the
subject security trades;
(c) General structural characteristics
of the issue, such as coupon, maturity,
duration, complexity or uniqueness of
the structure, callability, the likelihood
that the security will be called, tendered
or exchanged, and other embedded
options, as compared with the
characteristics of the subject security;
and
(d) Technical factors, such as the size
of the issue, the float and recent
turnover of the issue, and legal
restrictions on transferability as
compared with the subject security.
The provisions regarding ‘‘similar’’
securities, if adopted, would affirm
explicitly, for the first time, that it may
be appropriate under specified
circumstances to refer to ‘‘similar’’
securities to determine prevailing
market price.17
17 The Proposed Interpretation also states that, for
certain securities, there are no ‘‘similar’’ securities.
Specifically, when a debt security’s value and
pricing is based substantially, and is highly
dependent, on the particular circumstances of the
issuer, including creditworthiness and the ability
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Jkt 205001
If the proposal were approved, NASD
would announce the effective date of
the proposed rule change in a Notice to
Members to be published no later than
60 days following Commission
approval. The effective date will be 30
days following publication of the Notice
to Members announcing Commission
approval.
2. Statutory Basis
NASD believes that the proposed rule
change is consistent with Section
15A(b)(6) of the Act,18 which requires,
among other things, that NASD 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. NASD
believes that clarifying the standard for
correctly identifying the prevailing
market price of a debt security for
purposes of calculating a mark-up
(mark-down), clarifying the additional
obligations of a member when it seeks
to use a measure other than the
member’s own contemporaneous cost
(proceeds) as the prevailing market
price, and confirming that similar
securities may be used in certain
instances to determine the prevailing
market price are measures designed to
prevent fraudulent practices, promote
just and equitable principles of trade,
and protect investors and the public
interest.
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 nor received.
and willingness of the issuer to make interest
payments and otherwise meet the specific
obligations of the security, in most cases other
securities will not be sufficiently ‘‘similar,’’ and
therefore, may not be used to establish prevailing
market price of the subject security. As noted above,
NASD may consider a dealer’s pricing information
obtained from an economic model to establish
prevailing market price, when ‘‘similar’’ securities
do not exist and facts and circumstances have
combined to create a price information void in the
subject security. In addition, as provided in the
Proposed Interpretation, NASD also may look to
economic models other than the dealer’s to make
determinations as to the prevailing market price of
a security.
18 15 U.S.C. 78o–3(b)(6).
PO 00000
Frm 00124
Fmt 4703
Sfmt 4703
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 rulecomments@sec.gov. Please include File
Number SR–NASD–2003–141 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–2003–141. 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 NASD. All
E:\FR\FM\15MRN1.SGM
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Federal Register / Vol. 70, No. 49 / Tuesday, March 15, 2005 / Notices
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–2003–141 and
should be submitted on or before April
5, 2005.
For the Commission, by the Division of
Market Regulation, pursuant to delegated
authority.19
Jill M. Peterson,
Assistant Secretary.
[FR Doc. E5–1104 Filed 3–14–05; 8:45 am]
BILLING CODE 8010–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–51329; File No. SR-NYSE–
2004–71]
Self-Regulatory Organizations; Notice
of Filing of Proposed Rule Change and
Amendment No. 1 Thereto by the New
York Stock Exchange, Inc. To Amend
NYSE Rule 104 Regarding the
Requirement That Specialists Obtain
Floor Official Approval for
Destabilizing Dealer Account
Transactions in ETFs
March 8, 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 December
15, 2004, the New York Stock Exchange,
Inc. (‘‘NYSE’’ or ‘‘Exchange’’) filed with
the Securities and Exchange
Commission (‘‘Commission’’) the
proposed rule change as described in
Items I, II, and III below, which Items
have been prepared by the NYSE. On
February 28, 2005, the NYSE submitted
Amendment No. 1 to the proposed rule
change.3 The Commission is publishing
this notice to solicit comments on the
proposed rule change, as amended, from
interested persons.
I. Self-Regulatory Organization’s
Statement of the Terms of Substance of
the Proposed Rule Change
The Exchange is proposing to amend
NYSE Rule 104 (Dealings by Specialists)
to remove the requirement that
specialists obtain Floor Official
approval for destabilizing dealer
account transactions in investment
company units and Trust Issued
19 17
CFR 200.30–3(a)(12).
U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
3 Amendment No. 1 superseded the originally
filed proposed rule change in its entirety.
1 15
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15:31 Mar 14, 2005
Jkt 205001
Receipts (collectively referred to as
‘‘Exchange Traded Funds’’ or ‘‘ETFs’’).
Below is the text of the proposed rule
change, as amended. Proposed new
language is italicized; proposed
deletions are in [brackets].
Dealings by Specialists
Rule 104
(a) No specialist shall effect on the
Exchange purchases or sales of any
security in which such specialist is
registered, for any account in which he,
his member organization or any other
member, allied member, or approved
person, (unless an exemption with
respect to such approved person is in
effect pursuant to Rule 98) in such
organization or officer or employee
thereof is directly or indirectly
interested, unless such dealings are
reasonably necessary to permit such
specialist to maintain a fair and orderly
market, or to act as an odd-lot dealer in
such security.
(b) No change.
Supplementary Material
Functions of Specialists
.10 Regular specialists.—Any
member who expects to act regularly as
specialist in any listed stock and to
solicit orders therein must be registered
as a regular specialist.
The function of a member acting as
regular specialist on the Floor of the
Exchange includes, in addition to the
effective execution of commission
orders entrusted to him, the
maintenance, in so far as reasonably
practicable, of a fair and orderly market
on the Exchange in the stocks in which
he is so acting. This is more specifically
set forth in the following:
(1)–(6) No change.
(7) The requirement to obtain Floor
Official approval for transactions for a
specialist’s own account contained in
subparagraphs (5)(i)(A), (B) and (6)(i)(A)
above shall not apply to transactions
effected [for the purpose of bringing the
price of] in an investment company unit
(the ‘‘unit’’), as that term is defined in
Section 703.16 of the Listed Company
Manual, or a Trust Issued Receipt (the
‘‘receipt’’) as that term is defined in
Rule 1200 [into parity with the value of
the index on which the unit is based,
with the net asset value of the securities
comprising the unit or the receipt, or
with a futures contract on the value of
the index on which the unit is based].
Nevertheless such transactions must be
effected in a manner that is consistent
with the maintenance of a fair and
orderly market and with the other
requirements of this rule and the
supplementary material herein.
PO 00000
Frm 00125
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12769
No changes to remainder of rule.
II. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
In its filing with the Commission, the
Exchange included statements
concerning the purpose of, and basis for,
the proposed rule change and discussed
any comments it received on the
proposal. The text of these statements
may be examined at the places specified
in Item IV below. The Exchange 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
The Exchange proposes to eliminate
the current restriction on the ability of
specialists to buy ETFs on plus ticks or
sell ETFs on minus ticks without Floor
Official approval for the transactions.
NYSE Rule 104 governs specialists’
dealings in their specialty stocks. In
particular, NYSE Rules 104.10(5) and (6)
describe certain types of transactions
that are not to be effected unless they
are reasonably necessary to render the
specialist’s position adequate to the
needs of the market. The Exchange
states that, in effect, these restrictions
generally require specialists’
transactions for their own accounts to be
‘‘stabilizing’’ (i.e., against the trend of
the market) and prohibit specialists
from making transactions that are
‘‘destabilizing’’ (i.e., with the market
trend by buying on plus ticks and
selling on minus ticks), except with the
approval of a Floor Official.
The Exchange is proposing to remove
these restrictions in connection with
destabilizing transactions in ETFs by
specialists for their own account. These
products are based on a portfolio of
underlying securities and are
derivatively priced based upon the
value of those securities. Therefore,
according to the Exchange, specialists
would be unable to effect ETF
transactions for their own accounts in a
manner that would likely lead the
market price in those securities, even if
the transactions were effected on
destabilizing ticks. The Exchange notes
that the Commission has previously
recognized this aspect of ETFs.4
4 See Securities Exchange Act Release No. 49087
(January 15, 2004), 69 FR 3622 (January 26, 2004)
(‘‘[T]he Commission believes that because ETFs are
priced derivatively, an Exchange specialist would
not be able to manipulate the pricing of an ETF.’’).
E:\FR\FM\15MRN1.SGM
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]]>Agencies
[Federal Register Volume 70, Number 49 (Tuesday, March 15, 2005)]
[Notices]
[Pages 12764-12769]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E5-1104]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-51338; File No. SR-NASD-2003-141]
Self-Regulatory Organizations; Notice of Filing of Proposed Rule
Change by the National Association of Securities Dealers, Inc. To Adopt
an Additional Mark-Up Policy for Transactions in Debt Securities Except
Municipal Securities
March 9, 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 September 17, 2003, 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.\3\
On June 29, 2004, NASD filed Amendment No. 1 to the proposed rule
change.\4\ On February 17, 2005, NASD filed Amendment No. 2 to the
proposed rule change.\5\ The Commission is publishing this notice to
solicit comments on the proposed rule change, as amended, from
interested persons.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ Commission staff made certain changes to the description of
the proposed rule change with the consent of NASD, to enhance
clarity and accuracy. Telephone conversation between Sharon K.
Zackula, Associate General Counsel, Office of General Counsel,
Regulatory Policy and Oversight, NASD, Richard Strasser, Attorney-
Fellow, and Andrew Shipe, Special Counsel, Division of Market
Regulation, Commission, March 3, 2005.
\4\ See letter from Barbara Z. Sweeney, Senior Vice President
and Corporate Secretary, NASD, to Katherine England, Assistant
Director, Division of Market Regulation, Commission, dated June 29,
2004.
\5\ See Form 19b-4, filed February 17, 2005. Amendment No. 2
replaced the previous filings in their entirety.
---------------------------------------------------------------------------
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
NASD is proposing to adopt a second interpretation, proposed IM-
2440-2, to Rule 2440 to provide additional mark-up guidance for
transactions in debt securities except municipal securities. Below is
the text of the proposed rule change. Proposed new language is in
italics. Text in bold would appear in italics in the Rule as published
in the NASD Manual.
* * * * *
IM-2440-1. Mark-Up Policy
* * * * *
IM-2440-2. Additional Mark-Up Policy for Transactions in Debt
Securities, Except Municipal Securities \1\
\1\The Interpretation does not apply to transactions in municipal
securities. Single terms in parentheses within sentences, such as the
terms ``(sales)'' and ``(to)'' in the phrase, ``contemporaneous dealer
purchases (sales) in the security in question from (to) institutional
accounts,'' refer to scenarios where a member is charging a customer a
mark-down.
IM-2440-1 applies to debt securities transactions, and this IM-
2440-2 supplements the guidance provided in IM-2440-1.
A dealer that is acting in a principal capacity in a transaction
with a customer and is charging a mark-up or mark-down must mark-up or
mark-down the transaction from the prevailing market price.
Presumptively for purposes of this IM-2440-2, the prevailing market
price for a debt security is established by referring to the dealer's
contemporaneous cost as incurred, or contemporaneous proceeds as
obtained, consistent with NASD pricing rules. (See, e.g., Rule 2320).
When the dealer is selling the security to a customer,
countervailing evidence of the prevailing market price may be
considered only where the dealer made no contemporaneous purchases in
the security or can show that in the particular circumstances the
dealer's contemporaneous cost is not indicative of the prevailing
market price. When the dealer is buying the security from a customer,
countervailing evidence of the prevailing market price may be
considered only where the dealer made no contemporaneous sales in the
security or can show that in the particular circumstances the dealer's
contemporaneous proceeds are not indicative of the prevailing market
price.
A dealer that effects a transaction in debt securities with a
customer and identifies the prevailing market price using a measure
other than the dealer's own contemporaneous cost or proceeds must be
prepared to provide evidence that is sufficient to overcome the
presumption that the dealer's contemporaneous cost or proceeds provide
the best measure of the prevailing market price. A dealer may be able
to show that its contemporaneous cost or proceeds are not indicative of
prevailing market price, and thus overcome the presumption, in
instances where (i) interest rates or the credit quality of the
security changed significantly after the dealer's contemporaneous
trades, or (ii) the dealer's contemporaneous trade was with an
institutional account with which the dealer regularly effects
transactions in the same or a ``similar'' security, as defined below,
and in the case of a sale to such account, was executed at a price
higher than the then prevailing market price, or, in the case of a
purchase from such account, was executed at a price lower than the then
prevailing market price, and the execution price was away from the
prevailing market price because of the size and risk of the transaction
(a ``Specified Institutional Trade''). In the case of a Specified
Institutional Trade, when a dealer seeks to overcome the presumption
that the dealer's contemporaneous cost or proceeds provide the best
measure of the prevailing market price, the dealer must provide
evidence of the then prevailing market price by referring exclusively
to inter-dealer trades in the same security executed contemporaneously
with the dealer's Specified Institutional Trade.
In instances other than those pertaining to a Specified
Institutional Trade, where the dealer has presented evidence that is
sufficient to overcome the presumption that the dealer's
contemporaneous cost or proceeds provide the best measure of the
[[Page 12765]]
prevailing market price, or where interest rates or the credit quality
of the security changed significantly after the dealer's
contemporaneous trades, the most important or first pricing factor that
should be taken into consideration in establishing prevailing market
price for a mark-up or a mark-down is prices of any contemporaneous
inter-dealer transactions in the security in question. In the absence
of inter-dealer transactions, the second factor that should be taken
into consideration in establishing the prevailing market prices for
mark-ups (mark-downs) to customers is prices of contemporaneous dealer
purchases (sales) in the security in question from (to) institutional
accounts with which any dealer regularly effects transactions in the
same security. For actively traded securities, contemporaneous bid
(offer) quotations for the security in question made through an inter-
dealer mechanism, through which transactions generally occur at the
displayed quotations, may be used in the absence of inter-dealer or
institutional transactions (described in the preceding sentence) in
determining prevailing market price for customer mark-ups (mark-downs).
In the event that, in particular circumstances, the above factors
are not available, other factors that may be taken into consideration
for the purpose of establishing the price from which a customer mark-up
(mark down) may be calculated, include but are not limited to:
Prices of contemporaneous inter-dealer transactions in a
``similar'' security, as defined below, or prices of contemporaneous
dealer purchase (sale) transactions in a ``similar'' security with
institutional accounts with which any dealer regularly effects
transactions in the ``similar'' security with respect to customer mark-
ups (mark-downs);
Yields calculated from prices of contemporaneous inter-
dealer transactions in ``similar'' securities;
Yields calculated from prices of contemporaneous purchase
(sale) transactions with institutional accounts with which any dealer
regularly effects transactions in ``similar'' securities with respect
to customer mark-ups (mark-downs); and
Yields calculated from validated contemporaneous inter-
dealer bid (offer) quotations in ``similar'' securities for customer
mark-ups (mark-downs).
The relative weight one may attribute to these other factors
depends on the facts and circumstances surrounding the comparison
transaction, such as its size, whether the dealer in the comparison
transaction was on the same side of the market as the dealer is in the
subject transaction, the timeliness of the information, and, with
respect to the final factor listed above, the relative spread of the
quotations in the similar security to the quotations in the subject
security.
Finally, if information concerning the prevailing market price of
the subject security cannot be obtained by applying any of the above
factors, NASD or its members may consider as a factor in assessing the
prevailing market price of a debt security the prices or yields derived
from economic models (e.g., discounted cash flow models) that take into
account measures such as credit quality, interest rates, industry
sector, time to maturity, call provisions and any other embedded
options, coupon rate, and face value; and consider all applicable
pricing terms and conventions (e.g., coupon frequency and accrual
methods). Such models currently may be in use by bond dealers or may be
specifically developed by regulators for surveillance purposes.
Because the ultimate evidentiary issue is the prevailing market
price, isolated transactions or isolated quotations generally will have
little or no weight or relevance in establishing prevailing market
price. For example, in considering yields of ``similar'' securities,
except in extraordinary circumstances, members may not rely exclusively
on isolated transactions or a limited number of transactions that are
not fairly representative of the yields of transactions in ``similar''
securities taken as a whole.
A ``similar'' security should be sufficiently similar to the
subject security that it would serve as a reasonable alternative
investment to the investor. At a minimum, the security or securities
should be sufficiently similar that a market yield for the subject
security can be fairly estimated from the yields of the ``similar''
security or securities. Where a security has several components,
appropriate consideration may also be given to the prices or yields of
the various components of the security.
The degree to which a security is ``similar,'' as that term is used
in this Interpretation, to the subject security may be determined by
factors that include but are not limited to the following;
(a) Credit quality considerations, such as whether the security is
issued by the same or similar entity, bears the same or similar credit
rating, or is supported by a similarly strong guarantee or collateral
as the subject security (to the extent securities of other issuers are
designated as ``similar'' securities, significant recent information of
either issuer that is not yet incorporated in credit ratings should be
considered (e.g., changes to ratings outlooks));
(b) The extent to which the spread (i.e., the spread over U.S.
Treasury securities of a similar duration) at which the ``similar''
security trades is comparable to the spread at which the subject
security trades;
(c) General structural characteristics and provisions of the issue,
such as coupon, maturity, duration, complexity or uniqueness of the
structure, callability, the likelihood that the security will be
called, tendered or exchanged, and other embedded options, as compared
with the characteristics of the subject security; and
(d) Technical factors such as the size of the issue, the float and
recent turnover of the issue, and legal restrictions on transferability
as compared with the subject security.
When a debt security's value and pricing is based substantially on,
and is highly dependent on, the particular circumstances of the issuer,
including creditworthiness and the ability and willingness of the
issuer to meet the specific obligations of the security, in most cases
other securities will not be sufficiently similar, and therefore, other
securities may not be used to establish the prevailing market price.
* * * * *
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
Introduction
Under NASD Rule 2440, ``Fair Prices and Commissions,'' a member is
required to sell securities to a customer at a fair price.\6\ When a
member acts in
[[Page 12766]]
a principal capacity and sells a security to a customer, a dealer
generally ``marks up'' the security, increasing the total price the
customer pays. Conversely, when buying a security from a customer, a
dealer that is a principal generally ``marks down'' the security,
reducing the total proceeds the customer receives. IM-2440, ``Mark-Up
Policy,'' provides additional guidance on mark-ups and fair pricing of
securities transactions with customers.\7\ Both Rule 2440 and IM-2440
apply to transactions in debt securities and IM-2440 provides that
mark-ups for transactions in common stock are customarily higher than
those for bond transactions of the same size.\8\
---------------------------------------------------------------------------
\6\ NASD Rule 2440 specifically provides that a member is
required to sell a security at a fair price to customers, ``taking
into consideration all relevant circumstances, including market
conditions with respect to such security at the time of the
transaction, the expense involved, and the fact that he is entitled
to a profit * * *.'' Rule 2320, ``Best Execution and
Interpositioning,'' also addresses a member's obligation in pricing
customer transactions. In any transaction for or with a customer,
NASD Rule 2320 requires a member to ``use reasonable diligence to
ascertain the best inter-dealer market for the subject security and
buy and sell in such market so that the resultant price to the
customer is as favorable as possible under prevailing market
conditions.'' Together, Rule 2440 and Rule 2320 impose broad
responsibilities on broker-dealers to price customer transactions
fairly. Cf. ``Review of Dealer Pricing Responsibilities,'' Municipal
Securities Rulemaking Board (``MSRB'') Notice 2004-3 (January 26,
2004) (discussing MSRB Rules requiring municipal securities dealers
to ``exercise diligence in establishing the market value of [a]
security and the reasonableness of the compensation received on [a]
transaction'').
\7\ The terms ``mark-up'' and ``mark-down'' are not found in
Rule 2440, but are used in IM-2440. Statements regarding mark-ups
also apply generally to mark-downs unless mark-downs are discussed
specifically in a separate statement.
\8\ IM-2440(b)(1).
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Under Rule 2440 and IM-2440, when a customer buys a security from a
dealer, the customer's total purchase price, and the mark-up included
in the price, must be fair and reasonable. Similarly, when a customer
sells a security to a dealer, the customer's total proceeds from the
sale, which were reduced by the mark-down, and the mark-down, must be
fair and reasonable. A key step in determining whether a mark-up (mark-
down) is fair and reasonable is correctly identifying the prevailing
market price of the security, which is the basis from which the mark-up
(mark-down) is calculated.\9\
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\9\ The Commission notes that IM-2440 states: ``It shall be
deemed a violation of Rule 2110 and Rule 2440 for a member to enter
into any transaction with a customer in any security at any price
not reasonably related to the current market price of the security
or to charge a commission which is not reasonable.''
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The proposed interpretation, ``IM-2440-2, Additional Mark-Up Policy
For Transactions in Debt Securities, Except Municipal Securities''
(``Proposed Interpretation''), provides additional guidance on mark-ups
(mark-downs) in debt securities transactions, except municipal
securities transactions.\10\ The Proposed Interpretation addresses two
fundamental issues in debt securities transactions: (1) How does a
dealer correctly identify the prevailing market price of a debt
security; and (2) what is a ``similar'' security and when may it be
considered in determining the prevailing market price.
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\10\ MSRB Rule G-30, ``Prices and Commissions,'' applies to
transactions in municipal securities, and requires that a municipal
securities dealer engaging in a transaction as a principal with a
customer must buy or sell securities at an aggregate price that is
``fair and reasonable.''
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Prevailing Market Price
The Proposed Interpretation provides that when a dealer calculates
a mark-up (or mark-down), the best measure of the prevailing market
price of the security is presumptively the dealer's contemporaneous
cost (proceeds).\11\ Further, the dealer may look to countervailing
evidence of the prevailing market price only where the dealer, when
selling a security, made no contemporaneous purchases in the security
or can show that in the particular circumstances the dealer's
contemporaneous cost is not indicative of the prevailing market price.
When buying a security from a customer, the dealer may look to
countervailing evidence of the prevailing market price only where the
dealer made no contemporaneous sales in the security or can show that
in the particular circumstances the dealer's contemporaneous proceeds
are not indicative of the prevailing market price.
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\11\ Of course, if a dealer violates NASD Rule 2320, the
dealer's contemporaneous cost (proceeds) in such transactions would
not be a reliable indicator of the prevailing market price for the
purpose of determining a mark-up or mark-down. If a dealer violates
Rule 2320 because the dealer fails to exercise diligence, fails to
negotiate at arms length in the market, or engages in fraudulent
transactions, including those entered into in collusion with other
dealers or brokers, including inter-dealer brokers, the price that
the dealer obtains is not a price reflecting market forces, and,
therefore, is not a valid indicator of the prevailing market price
and should not be used to calculate a mark-up (mark-down). In
addition, if a dealer that is not a party to a transaction engages
in conduct to improperly influence the pricing of such transaction,
the dealer could not properly use the execution price as the basis
from which to compute a mark-up (mark-down) because the execution
price does not represent the prevailing market price of the
security.
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The presumption that contemporaneous cost is the best evidence of
prevailing market price is found in many cases and NASD decisions, and
its specific applicability to debt securities transactions was
addressed by the SEC as early as 1992 in F.B. Horner & Associates,
Inc., 50 S.E.C. 1063 (1992), aff'd, 994 F.2d 61 (2d Cir. 1993) (``F.B.
Horner''), a debt mark-up case. In F.B. Horner, the SEC stated: ``We
have consistently held that where, as in the present case, a dealer is
not a market maker, the best evidence of the current market, absent
countervailing evidence, is the dealer's contemporaneous cost.'' F.B.
Horner, 50 S.E.C. at 1065-66.\12\ The basis for the standard was also
restated. ``That standard, which has received judicial approval,
reflects the fact that the prices paid for a security by a dealer in
transactions closely related in time to his retail sales are normally a
highly reliable indication of the prevailing market.'' F.B. Horner, 50
S.E.C. at 1066 (citations omitted).
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\12\ The term ``market maker'' is defined in Section 3(a)(38) of
the Act [15 U.S.C. 78c(a)(38)] and a dealer in debt securities must
meet the legal requirements of Section 3(a)(38) to be considered a
market maker.
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The Proposed Interpretation recognizes that in some circumstances a
dealer may seek to overcome the presumption that the dealer's own
contemporaneous cost (proceeds) are the prevailing market price of the
subject security for determining a mark-up (mark-down), and sets forth
a process for identifying a value other than the dealer's own
contemporaneous cost (proceeds).
Cases Where the Presumption May Be Overcome
A dealer may seek to overcome the presumption that its
contemporaneous cost or proceeds are not indicative of the prevailing
market price in either of two instances: (1) Where the dealer's
contemporaneous trade was with an institutional account with which the
dealer regularly effects transactions in the same or a similar security
under certain conditions, or (2) where interest rates or the credit
quality of the security changed significantly after the dealer's
contemporaneous trades.
Specified Institutional Trades
In instances when the dealer establishes that the dealer's
contemporaneous trade was a ``Specified Institutional Trade,'' to
overcome the presumption that the dealer's contemporaneous cost (or
proceeds) is the best measure of the prevailing market price, the
dealer must provide evidence of the then prevailing market price in the
subject security by referring exclusively to inter-dealer trades in the
same security executed
[[Page 12767]]
contemporaneously with the dealer's Specified Institutional Trade.\13\
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\13\ A ``Specified Institutional Trade'' is defined as a
dealer's contemporaneous trade with an institutional account with
which the dealer regularly effects transactions in the same or a
``similar'' security, as defined below, and in the case of a sale to
such an account, the trade was executed at a price higher than the
then prevailing market price, and in the case of a purchase from
such an account, the trade was executed at a price lower than the
then prevailing market price, and the execution price was away from
the prevailing market price because of the size and risk of the
transaction.
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Transactions Other Than Specified Institutional Trades.
In instances other than those pertaining to a Specified
Institutional Trade, where the dealer has presented evidence that is
sufficient to overcome the presumption that the dealer's
contemporaneous cost (proceeds) provide the best measure of the
prevailing market price, or where interest rates or credit quality of
the security changed significantly, the dealer must follow a process
for determining prevailing market price, considering certain factors in
the appropriate order, as set forth in the Proposed Interpretation.
Initially, a dealer must look to three factors or measures in the order
they are presented (the ``Hierarchy'') to determine prevailing market
price. The most important and first factor in the Hierarchy is the
pricing of any contemporaneous inter-dealer transactions in the same
security. The second most important factor in the Hierarchy recognizes
the role of certain large institutions in the fixed income securities
markets. In the absence of inter-dealer transactions, the second factor
a dealer must consider is the prices of contemporaneous dealer
purchases in the security in question from institutional accounts with
which any dealer regularly effects transactions in the same
security.\14\ If contemporaneous inter-dealer trades or dealer-
institutional trades in the same security are not available, a dealer
must look to the third factor in the Hierarchy, which may be applied
only to actively traded securities. For actively traded securities, a
dealer is required to look to contemporaneous bid (offer) quotations
for the security in question for proof of the prevailing market price
if such quotations are made through an inter-dealer mechanism through
which transactions generally occur at the displayed quotations.\15\
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\14\ Contemporaneous dealer sales with such institutional
accounts would be used to calculate a mark-down. If a dealer has
overcome the presumption by establishing that interest rates or the
credit quality of the security changed significantly after the
dealer's trade, any inter-dealer or dealer-institutional trades in
the same security that occurred prior to the event would not be
valid measures of the prevailing market price as such transactions
would be subject to the same imperfection.
\15\ A dealer also is subject to the process of establishing
prevailing market price, including the analysis under the Hierarchy
and the other factors discussed below, where the dealer has not
engaged in trading in the subject security for an extended period
and therefore can evidence that it has no contemporaneous cost
(proceeds) to refer to as a basis for computing a mark-up (mark-
down).
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Additional Factors That May Be Considered in Cases Other Than Specified
Institutional Trades
If none of the three factors in the Hierarchy is available, the
dealer then may take into consideration the non-exclusive list of four
factors in the Proposed Interpretation in trying to establish
prevailing market price using a measure other than the dealer's
contemporaneous cost (proceeds). In contrast to the Hierarchy of three
factors discussed above, a dealer is not required to consider the four
factors below in a particular order. The four factors reflect the
particular nature of the debt markets and the trading and valuation of
debt securities. They are:
Prices of contemporaneous inter-dealer transactions in a
``similar'' security, as defined below, or prices of contemporaneous
dealer purchase (sale) transactions in a ``similar'' security with
institutional accounts with which any dealer regularly effects
transactions in the ``similar'' security with respect to customer mark-
ups (mark-downs);
Yields calculated from prices of contemporaneous inter-
dealer transactions in ``similar'' securities;
Yields calculated from prices of contemporaneous purchase
(sale) transactions with institutional accounts with which any dealer
regularly effects transactions in ``similar'' securities with respect
to customer mark-ups (mark-downs); and
Yields calculated from validated contemporaneous inter-
dealer bid (offer) quotations in ``similar'' securities for customer
mark-ups (mark-downs).
When applying one or more of the four factors, a dealer must
consider that the ultimate evidentiary issue is whether the prevailing
market price of the security will be correctly identified. As stated in
the Proposed Interpretation, the relative weight one may attribute to
these other factors depends on the facts and circumstances surrounding
the comparison transaction, such as its size, whether the dealer in the
comparison transaction was on the same side of the market as the dealer
is in the subject transaction, the timeliness of the information, and,
with respect to the final factor, the relative spread of the quotations
in the ``similar'' security to the quotations in the subject security.
Finally, if information concerning the prevailing market price of
the subject security cannot be obtained by applying any of the above
factors, a member may consider as a factor in determining the
prevailing market price the prices or yields derived from economic
models that take into account measures such as credit quality, interest
rates, industry sector, time to maturity, call provisions and any other
embedded options, coupon rate, and face value; and consider all
applicable pricing terms and conventions (e.g., coupon frequency and
accrual methods). However, dealers may not use any economic model to
establish the prevailing market price for mark-up (mark-down) purposes,
except in limited instances where none of the three factors in the
Hierarchy apply, the subject security is infrequently traded, and the
security is of such low credit quality (e.g., a distressed debt
security) that a dealer cannot identify a ``similar'' security.\16\
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\16\ When a dealer seeks to identify prevailing market price
using information other than the dealer's contemporaneous cost or
contemporaneous proceeds, the dealer must be prepared to provide
evidence that will establish the dealer's basis for not using
contemporaneous cost (proceeds), and information about the other
values reviewed (e.g., the specific prices and/or yields of
securities that were identified as similar securities) in order to
determine the prevailing market price of the subject security. If a
firm relies upon pricing information from a model the firm uses or
has developed, the firm must be able to provide information that was
used on the day of the transaction to develop the pricing
information (i.e., the data that was input, and the data that the
model generated and the firm used to arrive at prevailing market
price).
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The final principle in the Proposed Interpretation regarding
prevailing market price addresses the use of pricing information from
isolated transactions or quotations. The Proposed Interpretation
provides that ``isolated transactions or isolated quotations generally
will have little or no weight or relevance in establishing prevailing
market price. For example, in considering yields of `similar'
securities, except in extraordinary circumstances, members may not rely
exclusively on isolated transactions or a limited number of
transactions that are not fairly representative of the yields of
transactions in `similar' securities taken as a whole.''
``Similar'' Securities
The definition of ``similar'' security, and the uses and
limitations of ``similar'' securities are the second part of the
Proposed Interpretation. Several of the factors referenced above to
which
[[Page 12768]]
a dealer may refer when determining the prevailing market price as a
value that is other than the dealer's contemporaneous cost (proceeds)
require a dealer to identify one or more ``similar'' securities.
The Proposed Interpretation provides that a ``similar'' security
should be sufficiently similar to the subject security that it would
serve as a reasonable alternative investment. In addition, at a
minimum, a dealer must be able to fairly estimate the market yield for
the subject security from the yields of ``similar'' securities.
Finally, to aid members in identifying ``similar'' securities when
appropriate, the Proposed Interpretation sets forth a list of non-
exclusive factors to determine the similarity between the subject
security and one or more other securities. The non-exclusive list of
factors that can be used to assess similarity includes the following:
(a) Credit quality considerations, such as whether the security is
issued by the same or similar entity, bears the same or similar credit
rating, or is supported by a similarly strong guarantee or collateral
as the subject security (to the extent that securities of other issuers
are designated as ``similar'' securities, significant recent
information of either issuer that is not yet incorporated in credit
ratings should be considered (e.g., changes in ratings outlooks));
(b) The extent to which the spread (i.e., the spread over U.S.
Treasury securities of a similar duration) at which the ``similar''
security trades is comparable to the spread at which the subject
security trades;
(c) General structural characteristics of the issue, such as
coupon, maturity, duration, complexity or uniqueness of the structure,
callability, the likelihood that the security will be called, tendered
or exchanged, and other embedded options, as compared with the
characteristics of the subject security; and
(d) Technical factors, such as the size of the issue, the float and
recent turnover of the issue, and legal restrictions on transferability
as compared with the subject security.
The provisions regarding ``similar'' securities, if adopted, would
affirm explicitly, for the first time, that it may be appropriate under
specified circumstances to refer to ``similar'' securities to determine
prevailing market price.\17\
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\17\ The Proposed Interpretation also states that, for certain
securities, there are no ``similar'' securities. Specifically, when
a debt security's value and pricing is based substantially, and is
highly dependent, on the particular circumstances of the issuer,
including creditworthiness and the ability and willingness of the
issuer to make interest payments and otherwise meet the specific
obligations of the security, in most cases other securities will not
be sufficiently ``similar,'' and therefore, may not be used to
establish prevailing market price of the subject security. As noted
above, NASD may consider a dealer's pricing information obtained
from an economic model to establish prevailing market price, when
``similar'' securities do not exist and facts and circumstances have
combined to create a price information void in the subject security.
In addition, as provided in the Proposed Interpretation, NASD also
may look to economic models other than the dealer's to make
determinations as to the prevailing market price of a security.
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If the proposal were approved, NASD would announce the effective
date of the proposed rule change in a Notice to Members to be published
no later than 60 days following Commission approval. The effective date
will be 30 days following publication of the Notice to Members
announcing Commission approval.
2. Statutory Basis
NASD believes that the proposed rule change is consistent with
Section 15A(b)(6) of the Act,\18\ which requires, among other things,
that NASD 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. NASD
believes that clarifying the standard for correctly identifying the
prevailing market price of a debt security for purposes of calculating
a mark-up (mark-down), clarifying the additional obligations of a
member when it seeks to use a measure other than the member's own
contemporaneous cost (proceeds) as the prevailing market price, and
confirming that similar securities may be used in certain instances to
determine the prevailing market price are measures designed to prevent
fraudulent practices, promote just and equitable principles of trade,
and protect investors and the public interest.
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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
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 nor received.
III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action
Within 35 days of the date of publication of this notice in the
Federal Register or within such longer period (i) as the Commission may
designate up to 90 days of such date if it finds such longer period to
be appropriate and publishes its reasons for so finding or (ii) as to
which the self-regulatory organization consents, the Commission will:
(A) By order approve such proposed rule change, or
(B) Institute proceedings to determine whether the proposed rule
change should be disapproved.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change, 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-2003-141 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-2003-141. 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 NASD. All
[[Page 12769]]
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-2003-141 and should be
submitted on or before April 5, 2005.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\19\
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\19\ 17 CFR 200.30-3(a)(12).
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Jill M. Peterson,
Assistant Secretary.
[FR Doc. E5-1104 Filed 3-14-05; 8:45 am]
BILLING CODE 8010-01-P
