Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Order Approving Proposed Rule Change and Amendment No. 1 Thereto, and Notice of Filing and Order Granting Accelerated Approval to Amendment No. 2 to the Proposed Rule Change, To Adopt NASD Rule 2111 to Prohibit Members From Trading Ahead of Customer Market Orders, 48219-48222 [E5-4412]

Download as PDF Federal Register / Vol. 70, No. 157 / Tuesday, August 16, 2005 / Notices prohibiting sharing information about prior negotiated municipal securities business as well as current and planned solicitations between the dealer, its MFPs and any affiliated PAC is unrealistic because much of the information is public. MSRB Response. The MSRB has revised the language relating to the municipal securities business information barrier to suggest that dealers prohibit the dealer and its MFPs from directly providing or coordinating information about prior negotiated municipal securities business as well as current and planned solicitations to any affiliated PAC. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action Within 35 days of the date of publication of this notice in the Federal Register or within such longer period (i) as the Commission may designate up to 90 days of such date if it finds such longer period to be appropriate and publishes its reasons for so finding or (ii) as to which the self-regulatory organization consents, the Commission will: A. By order approve such proposed rule change, or B. Institute proceedings to determine whether the proposed rule change should be disapproved. IV. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change is consistent with the Act. Comments may be submitted by any of the following methods: Electronic Comments • Use the Commission’s Internet comment form (https://www.sec.gov/ rules/sro.shtml); or • Send an e-mail to rulecomments@sec.gov. Please include File Number SR–MSRB–2005–12 on the subject line. Paper Comments • Send paper comments in triplicate to Jonathan G. Katz, Secretary, Securities and Exchange Commission, Station Place, 100 F Street, NE., Washington, DC 20549–9303. All submissions should refer to File Number SR–MSRB–2005–12. 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 VerDate jul<14>2003 18:02 Aug 15, 2005 Jkt 205001 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 MSRB’s offices. 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–MSRB– 2005–12 and should be submitted on or before September 6, 2005. For the Commission, by the Division of Market Regulation, pursuant to delegated authority.24 Margaret H. McFarland, Deputy Secretary. [FR Doc. E5–4425 Filed 8–15–05; 8:45 am] BILLING CODE 8010–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–52226; File No. SR–NASD– 2004–045] Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Order Approving Proposed Rule Change and Amendment No. 1 Thereto, and Notice of Filing and Order Granting Accelerated Approval to Amendment No. 2 to the Proposed Rule Change, To Adopt NASD Rule 2111 to Prohibit Members From Trading Ahead of Customer Market Orders August 9, 2005. I. Introduction On March 12, 2004, the National Association of Securities Dealers, Inc. (‘‘NASD’’) filed with the Securities and Exchange Commission (‘‘Commission’’), pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (‘‘Act’’) 1 and Rule 19b–4 thereunder,2 a proposed rule change to adopt NASD Rule 2111 (‘‘Manning for Market PO 00000 24 17 CFR 200.30–3(a)(12). U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 1 15 Frm 00121 Fmt 4703 Sfmt 4703 48219 Orders’’). The proposal prohibits members from trading for their own account at prices that would satisfy a customer market order, unless the member immediately thereafter executes the customer market order. On February 16, 2005, NASD amended the proposed rule change.3 The proposed rule change, as modified by Amendment No. 1, was published for comment in the Federal Register on February 25, 2005.4 The Commission received one comment letter on the proposal.5 On August 3, 2005, NASD filed an amendment which incorporated its response to comments.6 This order approves the proposed rule change, as modified by Amendment No. 1, and provides notice of filing and grants accelerated approval of Amendment No. 2.7 II. Summary of Comments The Commission received one comment letter on the proposed rule change.8 The commenter stated that it generally supported the concept of market order protection but cited a number of concerns with the proposal. The following is a summary of the concerns raised by the commenter. • The Rule Should Permit Additional Flexibility With Respect to the Requirement that Members Cross Standing Customer Market Orders The commenter stated that certain member firms’ systems are not able to execute agency crosses if the order resides with the market maker, but the systems are able to proprietarily buy from the market seller and allocate to the market buyer at the same price (i.e. effect a riskless principal transaction).9 Thus, the commenter recommended that the proposed rule change be amended to allow a member that holds a customer market order that has not been immediately executed ‘‘to execute such order in any reasonable manner that meets the pricing requirements of the 3 See Amendment No. 1. Securities Exchange Act Release No. 51230 (February 18, 2005), 70 FR 9408. 5 See letter from Amal Aly, Vice President and Associate General Counsel, and Ann Vlcek, Vice President and Associate General Counsel, Securities Industry Association (‘‘SIA’’) to Jonathan G. Katz, Secretary, Commission, dated March 18, 2005 (‘‘SIA Letter’’). 6 See Amendment No. 2 modified the proposed rule text to state that a member could satisfy the proposal’s crossing requirement by contemporaneously buying from the seller and selling to the buyer at the same price. 7 The Commission recently approved a related proposal, SR–NASD–2004–089, that requires members to provide price improvement to customer limit orders under certain circumstances. See Securities Exchange Act Release No. 52210 (August 4, 2005). 8 See footnote 5, supra. 9 See SIA Letter at 2. 4 See E:\FR\FM\16AUN1.SGM 16AUN1 48220 Federal Register / Vol. 70, No. 157 / Tuesday, August 16, 2005 / Notices rule, and is consistent with the terms of the order.’’ 10 The commenter pointed out that proposed NASD Rule 2111(c) allows a member that has not immediately executed a customer order, and holds multiple orders on both sides of the market that have not been executed, to cross or otherwise execute the order in a manner that is reasonable, and is consistent with the objectives of NASD Rule 2111(c) as well as with the terms and conditions of the order.11 However, when a member does not hold multiple orders on both sides of the market, proposed NASD Rule 2111(c) requires that the member cross the order with any market order, marketable limit order, or non-marketable limit order priced better than the best bid or offer.12 Second, the commenter expressed concern that flickering quotes would create significant compliance and technological challenges for member firms because the rule requires member firms to cross marketable limit orders even if such limit orders were marketable only for a brief period of time.13 The commenter suggested that the proposed rule change should recognize some small period of time in which a given quote would not subject a marketable limit order to the rule’s protections.14 • Certain Order Types Should be Excluded from the Rule The commenter stated that NASD should specifically exclude certain types of market orders from the rule’s protection.15 Specifically, the commenter said that orders that are (i) entered on a ‘‘not held’’ basis; (ii) executed on an agency basis where the customer specifically asks that the order be executed on an agency basis; and (iii) for accounts where the member is bound by another regulation limiting or prohibiting principal transactions, should be excluded from the protections of the rule.16 The commenter stated that ‘‘not held’’ orders should be exempted from the proposed rule change because a member is granted discretion in executing ‘‘not held’’ orders and requiring that a member execute such orders fully and promptly would not be consistent with the terms of the order.17 • The Rule Should Only Apply to Orders Executed on Nasdaq or in the Over-the-Counter Market The commenter suggested that the proposed rule change should only apply 10 Id. to orders executed on Nasdaq or in the over-the-counter (‘‘OTC’’) market because the New York Stock Exchange already has a similar rule.18 The commenter said that limiting the application of the proposed rule change would further recent industry efforts to discourage duplicative regulation.19 • The Proposed Rule Change Should Allow Firms to More Fully Utilize Information Barriers to Segregate NonMarket Making Desks From Other Customer Order Flows The commenter stated that the proposed rule change should allow firms to more fully utilize information barriers to segregate non-market making desks from other customer order flows.20 The commenter believes that where members are able to implement effective internal controls, such as information barriers, which operate ‘‘to prevent non-market making desks from obtaining knowledge of customer market orders held at the market making desk, those other non-market making desks * * * [should be able to] continue to trade in a principal capacity at prices that are the same as or inferior to the customer market orders held at market making desk.’’ 21 Therefore, the commenter urged that in order for there to be consistent treatment of both market orders under NASD Rule 2111 and limit orders under IM–2110–2 (‘‘Manning’’), NASD should recognize the use of information barriers under the proposed rule change.22 III. NASD Response to Comments In response to the comments, the NASD amended the filing.23 In response to the commenter’s statement that some of its members’ systems are not able to execute agency crosses when the order resides with the market maker, and thus so long as a customer’s market order is executed at the proper price, the rule should not mandate the manner in which the order is executed, NASD amended the proposal’s rule text. Specifically, Amendment No. 2 addresses the concern by allowing members to execute such orders on a riskless principal basis. As amended, the rule states that ‘‘a member can satisfy the crossing requirement by contemporaneously buying from the seller and selling to the buyer at the same price.’’ Regarding the commenter’s concern that the proposal would require a 11 Id. 12 Id. 18 NYSE 13 Id. 19 See 14 Id. 20 Id. 15 Id. 21 Id. 16 Id. 22 Id. at 2–3. 17 Id. at 2. VerDate jul<14>2003 23 See 18:02 Aug 15, 2005 Jkt 205001 PO 00000 Rule 92. SIA Letter. footnote 6, supra. Frm 00122 Fmt 4703 Sfmt 4703 member to cross a marketable limit order even if that limit order were marketable only for a brief period of time due to flickering quotes, NASD responded that because the proposal would require the matching of both marketable and non-marketable limit orders that would meet the requirements of the pending market order, the changing marketability or non-marketability of a particular limit order as a result of flickering quotes is not an issue. The NASD recognized that flickering quotes may increase the difficulty in determining the appropriate price of a market order, but such quotes would not dictate whether a particular marketable or nonmarketable limit order should be crossed pursuant to the proposed rule. In response to the commenter’s suggestion that certain order types should be excluded from the rule’s protection, NASD clarified how NASD Rule 2111 would apply to the order types mentioned. First, regarding ‘‘not held’’ orders, NASD stated that for orders for which a customer has granted the member discretion with respect to time or price, those orders would not be considered market orders for the purposes of the rule. Second, regarding orders where the customer specifically asks that the order be handled on an agency basis, the NASD stated that, with regard to those orders where no other regulation limits or prohibits a principal transaction, the rule would apply. Third, with respect to orders for accounts where the member is bound by another regulation limiting or prohibiting principal transactions with customer orders, NASD noted that, consistent with prior interpretations of Manning, the obligation to execute a trade with a customer following a separate proprietary trade on the same side of the market does not apply if the orders subject to the restrictions are sent to another broker-dealer for execution; the obligations under NASD Rule 2111 apply, however, if such orders are not routed elsewhere for execution. NASD reiterated that these interpretations do not change a member’s best execution obligations under NASD Rule 2320. Concerning the commenter’s argument that the proposal should apply only to orders executed on Nasdaq or in the OTC market, NASD stated that the proposal is based on a member’s obligations relating to just and equitable principles of trade with respect to the treatment of customer market orders, and therefore NASD believes that the proposed rule should apply to customer market orders regardless of where the orders are ultimately executed. E:\FR\FM\16AUN1.SGM 16AUN1 Federal Register / Vol. 70, No. 157 / Tuesday, August 16, 2005 / Notices In response to the commenter’s suggestion that the proposal should allow firms to more fully utilize information barriers to segregate nonmarket making desks from other customer order flows, NASD stated that it has issued guidance in connection with Manning concerning the extent to which a trading desk other than the firm’s market-making desk could trade for its own account while the marketmaking desk held protected customer limit orders on its books.24 NASD states that the same guidance would apply for the instant proposal. IV. Discussion and Commission Findings The Commission has reviewed carefully the proposed rule change, the comment letter, and NASD’s response, and finds that the proposed rule change, as amended, is consistent with the requirements of the Act and rules and regulations thereunder applicable to a national securities association25 and, in particular, the requirements of section 15A(b)(6) of the Act,26 which requires, among other things, that the rules of a national securities association 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 the proposal is reasonably designed to ensure that customer market orders are executed quickly and fairly. Indeed, paragraph (a) of the rule requires a member to ‘‘make every effort to execute a customer market order that it receives fully and promptly.’’ Regarding the commenter’s concerns that so long as a customer’s market orders are executed at the proper price under the rule, the proposed rule change should not mandate that the orders be crossed, the NASD amended NASD Rule 2111(c) to allow for members to execute a customer order as a riskless principal to satisfy the crossing requirement. Regarding the commenter’s concern that under the rule a firm must cross a marketable limit order even if the order were only marketable for a brief period of time, the NASD recognized that flickering quotes may increase the difficulty in determining the appropriate price of a market order, but such quotes would not dictate whether a particular marketable 24 See Notice to Members 95–43 (June 1995) and Notice to Members 03–74 (November 2003). 25 In approving this proposed rule change, the Commission has considered the proposed rule’s impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f). 26 15 U.S.C. 78o–3(b)(6). VerDate jul<14>2003 18:02 Aug 15, 2005 Jkt 205001 or non-marketable limit order should be crossed pursuant to the proposed rule. The Commission believes that the proposed rule change reasonably addresses the manner in which member firms need to execute customer market orders under various market conditions. The requirements of the rule are only triggered if the member fails to execute a market order fully and promptly. The Commission agrees with the NASD’s analysis with respect to whether certain types of market orders should be excluded from the rule. The Commission believes that the proposed rule change allows sufficient flexibility to accommodate those order types by, for example, not considering a ‘‘not held’’ order to be a ‘‘market’’ order for purposes of the proposed rule change. Concerning the commenter’s argument that the rule should only apply to orders executed on Nasdaq or in the OTC market, the Commission agrees with NASD that applying the proposed rule change to NASD members executing customer market orders across all equities markets will help better assure that customer orders receive the protections of the rule, regardless of where the orders ultimately are executed. The commenter did not state that the NASD rule is inconsistent with the NYSE’s rule. In response to the commenter’s assertion that the proposed rule change should permit firms to more fully utilize information barriers to segregate nonmarket making desks from other customer order flows, the Commission believes the NASD’s position—that its existing Manning guidance with respect to information barriers will apply to the proposed rule change—adequately addresses the commenter’s concern. The Commission finds good cause to approve Amendment No. 2 before the 30th day after the date of publication of notice of filing in the Federal Register. NASD filed Amendment No. 2 in response to comments it received after the publication of the notice of filing of the proposed rule change.27 Because Amendment No. 2 is responsive to the commenter’s concerns and explains how the rule applies, the Commission finds good cause for accelerating approval of Amendment No. 2. V. Solicitation of Comments Interested persons are invited to submit written data, views, and arguments concerning Amendment No. 2, including whether Amendment No. 2 is consistent with the Act. Comments may be submitted by any of the following methods: PO 00000 27 See footnote 6, supra. Frm 00123 Fmt 4703 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, 100 F Street, NE., Washington, DC 20549–9303. 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 the 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 September 6, 2005. VI. Conclusion It is therfore ordered, pursuant to section 19(b)(2) of the Act,28 that the proposed rule change (SR–NASD–2004– 045), as modified by Amendment No. 1 thereto, be, and it hereby is, approved and that Amendment No. 2 be, and hereby is, approved on an accelerated basis. 28 15 Sfmt 4703 48221 E:\FR\FM\16AUN1.SGM U.S.C. 78s(b)(2). 16AUN1 48222 Federal Register / Vol. 70, No. 157 / Tuesday, August 16, 2005 / Notices For the Commission, by the Division of Market Regulation, pursuant to delegated authority.29 Margaret H. McFarland, Deputy Secretary. [FR Doc. E5–4412 Filed 8–15–05; 8:45 am] The text of the proposed rule change is available from the Exchange’s Web site (https://www.pacificex.com), at the principal office of the Exchange, and at the Commission’s Public Reference Room. BILLING CODE 8010–01–P 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 proposed rule change. The text of these statements may be examined at the places specified in Item III below. The Exchange has prepared summaries, set forth in Sections A, B, and C below, of the most significant aspects of such statements. SECURITIES AND EXCHANGE COMMISSION [Release No. 34–52221; File No. SR–PCX– 2005–74] Self-Regulatory Organizations; Pacific Exchange, Inc.; Notice of Filing and Order Granting Accelerated Approval of Proposed Rule Change and Amendment No. 1 Thereto To Trade Shares of Certain Vanguard International Equity Index Funds Pursuant to Unlisted Trading Privileges August 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 June 22, 2005, the Pacific Exchange, Inc. (‘‘PCX’’ or ‘‘Exchange’’), through its wholly owned subsidiary PCX Equities, Inc. (‘‘PCXE’’ or ‘‘Corporation’’), filed with the Securities and Exchange Commission (‘‘Commission’’) the proposed rule change as described in Items I and II below, which Items have been substantially prepared by the Exchange. PCX amended the proposed rule change on July 28, 2005.3 The Commission is publishing this notice and order to solicit comments on the proposal, as amended, from interested persons and to approve the proposal, as amended, on an accelerated basis. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change The Exchange, through its wholly owned subsidiary PCXE, proposes to trade shares of the following exchange traded funds (‘‘ETFs’’) based on three Vanguard International Equity Indices pursuant to unlisted trading privileges (‘‘UTP’’) based on PCXE Rule 5.5(j)(3): • Morgan Stanley Capital International Inc. (‘‘MSCI’’) Europe Index (ticker symbol: VGK) • MSCI Pacific Index (ticker symbol: VPL); and • MSCI Emerging Markets Select Index (ticker symbol: VWO). 29 17 CFR 200.30–3(a)(12). U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 3 In Amendment No. 1, the Exchange modified the trading hours in which it proposes to trade these exchange traded funds. 1 15 VerDate jul<14>2003 18:02 Aug 15, 2005 Jkt 205001 A. Self-Regulatory Organization’s Statement of the Purpose of, and Statutory Basis for, the Proposed Rule Change 1. Purpose The Exchange proposes to trade, pursuant to UTP, Vanguard Index Participation Equity Receipts, which are securities issued by the three funds (‘‘VIPER Shares’’). The MSCI Europe Index and the MSCI Pacific Index are market-capitalization-weighted indices that are designed to measure developed market equity performance in Europe and the Pacific region, respectively. Each MSCI country index is created separately and then aggregated, without change, into the larger regional index. The MSCI Europe Index is comprised of securities from 16 of 50 countries for which MSCI has indices.4 The MSCI Pacific Index is comprised of securities from 5 of the 50 countries for which MSCI has indices.5 The MSCI Emerging Markets Select Index is comprised of securities from 18 of the 50 countries for which MSCI has indices.6 The Commission previously approved the 4 Currently, the MSCI Europe Index includes Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, and the United Kingdom. 5 Currently, the MSCI Pacific Index includes Australia, Hong Kong, Japan, New Zealand, and Singapore. 6 Currently, the MSCI Emerging Markets Select Index includes Argentina, Brazil, Chile, China, Czech Republic, Hungary, India, Indonesia, Israel, Korea, Mexico, Peru, Philippines, Poland, South Africa, Taiwan, Thailand, and Turkey. This information on countries represented in the indices is current as of February 25, 2005. Telephone conversation between Tania J.C. Blanford, Staff Attorney, PCX, and Natasha Cowen, Attorney, Division of Market Regulation, Commission, on July 13, 2005. PO 00000 Frm 00124 Fmt 4703 Sfmt 4703 original listing and trading of the VGK, VPL, and VWO on the American Stock Exchange (‘‘Amex’’).7 The Exchange deems these VIPER Shares to be equity securities, thus rendering trading in these securities subject to the Exchange’s existing rules governing the trading of equity securities. PCX will trade these ETFs during the hours that the Intraday Indicative Value (‘‘IIV’’) is disseminated.8 The Exchange understands that the listing exchange, Amex, will disseminate the following information for each ETF on a daily basis through the facilities of the Consolidated Tape Association (‘‘CTA’’): Recent net asset value (‘‘NAV’’), shares outstanding, and estimated cash amount and total cash amount per creation unit. In addition, the Exchange understands that Amex will make the following information available on its Web site: Daily trading volume, closing price, NAV, and final dividend amounts to be paid for each VIPER Share. The closing prices of the deposit securities are readily available from, as applicable, the relevant exchanges, automated quotation systems, published or other public sources in the relevant country, or online information services such as Bloomberg or Reuters. The exchange rate information required to convert such information into U.S. dollars is also readily available in newspapers and other publications and from a variety of on-line services. To provide updated information relating to each ETF for use by investors, professionals, and persons wishing to create or redeem the VIPER Shares, Amex disseminates through the facilities of the CTA: (1) continuously throughout the trading day, last sale information for each ETF; and (2) every 15 seconds throughout the trading a day, the estimated IIV of each ETF as calculated by a third party. The IIV may not reflect the value of all securities included in the applicable underlying index. In addition, the IIV does not necessarily reflect the precise composition of each index at a particular point in time. Therefore, the IIV on a per-share basis disseminated during Amex’s regular trading hours should not be viewed as a real-time 7 See Securities Exchange Act Release No. 50189 (August 12, 2004), 69 FR 51723 (August 20, 2004) (SR–Amex–2004–05) (‘‘Original Listing Order’’). 8 The IIV is the estimated net asset value, which is disseminated by Amex every 15 seconds throughout the trading day. The IIV is designed to give investors a sense of the relationship between a basket of securities that are representative of those owned in the ETF and the share price of the ETF on an intraday basis. E:\FR\FM\16AUN1.SGM 16AUN1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 70, Number 157 (Tuesday, August 16, 2005)]
[Notices]
[Pages 48219-48222]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E5-4412]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-52226; File No. SR-NASD-2004-045]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Approving Proposed Rule Change and Amendment No. 1 
Thereto, and Notice of Filing and Order Granting Accelerated Approval 
to Amendment No. 2 to the Proposed Rule Change, To Adopt NASD Rule 2111 
to Prohibit Members From Trading Ahead of Customer Market Orders

August 9, 2005.

I. Introduction

    On March 12, 2004, the National Association of Securities Dealers, 
Inc. (``NASD'') filed with the Securities and Exchange Commission 
(``Commission''), pursuant to section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change to adopt NASD Rule 2111 (``Manning for Market 
Orders''). The proposal prohibits members from trading for their own 
account at prices that would satisfy a customer market order, unless 
the member immediately thereafter executes the customer market order. 
On February 16, 2005, NASD amended the proposed rule change.\3\ The 
proposed rule change, as modified by Amendment No. 1, was published for 
comment in the Federal Register on February 25, 2005.\4\ The Commission 
received one comment letter on the proposal.\5\ On August 3, 2005, NASD 
filed an amendment which incorporated its response to comments.\6\ This 
order approves the proposed rule change, as modified by Amendment No. 
1, and provides notice of filing and grants accelerated approval of 
Amendment No. 2.\7\
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Amendment No. 1.
    \4\ See Securities Exchange Act Release No. 51230 (February 18, 
2005), 70 FR 9408.
    \5\ See letter from Amal Aly, Vice President and Associate 
General Counsel, and Ann Vlcek, Vice President and Associate General 
Counsel, Securities Industry Association (``SIA'') to Jonathan G. 
Katz, Secretary, Commission, dated March 18, 2005 (``SIA Letter'').
    \6\ See Amendment No. 2 modified the proposed rule text to state 
that a member could satisfy the proposal's crossing requirement by 
contemporaneously buying from the seller and selling to the buyer at 
the same price.
    \7\ The Commission recently approved a related proposal, SR-
NASD-2004-089, that requires members to provide price improvement to 
customer limit orders under certain circumstances. See Securities 
Exchange Act Release No. 52210 (August 4, 2005).
---------------------------------------------------------------------------

II. Summary of Comments

    The Commission received one comment letter on the proposed rule 
change.\8\ The commenter stated that it generally supported the concept 
of market order protection but cited a number of concerns with the 
proposal. The following is a summary of the concerns raised by the 
commenter.
---------------------------------------------------------------------------

    \8\ See footnote 5, supra.
---------------------------------------------------------------------------

     The Rule Should Permit Additional Flexibility With Respect 
to the Requirement that Members Cross Standing Customer Market Orders
    The commenter stated that certain member firms' systems are not 
able to execute agency crosses if the order resides with the market 
maker, but the systems are able to proprietarily buy from the market 
seller and allocate to the market buyer at the same price (i.e. effect 
a riskless principal transaction).\9\ Thus, the commenter recommended 
that the proposed rule change be amended to allow a member that holds a 
customer market order that has not been immediately executed ``to 
execute such order in any reasonable manner that meets the pricing 
requirements of the

[[Page 48220]]

rule, and is consistent with the terms of the order.'' \10\ The 
commenter pointed out that proposed NASD Rule 2111(c) allows a member 
that has not immediately executed a customer order, and holds multiple 
orders on both sides of the market that have not been executed, to 
cross or otherwise execute the order in a manner that is reasonable, 
and is consistent with the objectives of NASD Rule 2111(c) as well as 
with the terms and conditions of the order.\11\ However, when a member 
does not hold multiple orders on both sides of the market, proposed 
NASD Rule 2111(c) requires that the member cross the order with any 
market order, marketable limit order, or non-marketable limit order 
priced better than the best bid or offer.\12\
---------------------------------------------------------------------------

    \9\ See SIA Letter at 2.
    \10\ Id.
    \11\ Id.
    \12\ Id.
---------------------------------------------------------------------------

    Second, the commenter expressed concern that flickering quotes 
would create significant compliance and technological challenges for 
member firms because the rule requires member firms to cross marketable 
limit orders even if such limit orders were marketable only for a brief 
period of time.\13\ The commenter suggested that the proposed rule 
change should recognize some small period of time in which a given 
quote would not subject a marketable limit order to the rule's 
protections.\14\
---------------------------------------------------------------------------

    \13\ Id.
    \14\ Id.
---------------------------------------------------------------------------

     Certain Order Types Should be Excluded from the Rule
    The commenter stated that NASD should specifically exclude certain 
types of market orders from the rule's protection.\15\ Specifically, 
the commenter said that orders that are (i) entered on a ``not held'' 
basis; (ii) executed on an agency basis where the customer specifically 
asks that the order be executed on an agency basis; and (iii) for 
accounts where the member is bound by another regulation limiting or 
prohibiting principal transactions, should be excluded from the 
protections of the rule.\16\ The commenter stated that ``not held'' 
orders should be exempted from the proposed rule change because a 
member is granted discretion in executing ``not held'' orders and 
requiring that a member execute such orders fully and promptly would 
not be consistent with the terms of the order.\17\
---------------------------------------------------------------------------

    \15\ Id.
    \16\ Id. at 2-3.
    \17\ Id. at 2.
---------------------------------------------------------------------------

     The Rule Should Only Apply to Orders Executed on Nasdaq or 
in the Over-the-Counter Market
    The commenter suggested that the proposed rule change should only 
apply to orders executed on Nasdaq or in the over-the-counter (``OTC'') 
market because the New York Stock Exchange already has a similar 
rule.\18\ The commenter said that limiting the application of the 
proposed rule change would further recent industry efforts to 
discourage duplicative regulation.\19\
---------------------------------------------------------------------------

    \18\ NYSE Rule 92.
    \19\ See SIA Letter.
---------------------------------------------------------------------------

     The Proposed Rule Change Should Allow Firms to More Fully 
Utilize Information Barriers to Segregate Non-Market Making Desks From 
Other Customer Order Flows
    The commenter stated that the proposed rule change should allow 
firms to more fully utilize information barriers to segregate non-
market making desks from other customer order flows.\20\ The commenter 
believes that where members are able to implement effective internal 
controls, such as information barriers, which operate ``to prevent non-
market making desks from obtaining knowledge of customer market orders 
held at the market making desk, those other non-market making desks * * 
* [should be able to] continue to trade in a principal capacity at 
prices that are the same as or inferior to the customer market orders 
held at market making desk.'' \21\ Therefore, the commenter urged that 
in order for there to be consistent treatment of both market orders 
under NASD Rule 2111 and limit orders under IM-2110-2 (``Manning''), 
NASD should recognize the use of information barriers under the 
proposed rule change.\22\
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    \20\ Id.
    \21\ Id.
    \22\ Id.
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III. NASD Response to Comments

    In response to the comments, the NASD amended the filing.\23\ In 
response to the commenter's statement that some of its members' systems 
are not able to execute agency crosses when the order resides with the 
market maker, and thus so long as a customer's market order is executed 
at the proper price, the rule should not mandate the manner in which 
the order is executed, NASD amended the proposal's rule text. 
Specifically, Amendment No. 2 addresses the concern by allowing members 
to execute such orders on a riskless principal basis. As amended, the 
rule states that ``a member can satisfy the crossing requirement by 
contemporaneously buying from the seller and selling to the buyer at 
the same price.''
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    \23\ See footnote 6, supra.
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    Regarding the commenter's concern that the proposal would require a 
member to cross a marketable limit order even if that limit order were 
marketable only for a brief period of time due to flickering quotes, 
NASD responded that because the proposal would require the matching of 
both marketable and non-marketable limit orders that would meet the 
requirements of the pending market order, the changing marketability or 
non-marketability of a particular limit order as a result of flickering 
quotes is not an issue. The NASD recognized that flickering quotes may 
increase the difficulty in determining the appropriate price of a 
market order, but such quotes would not dictate whether a particular 
marketable or non-marketable limit order should be crossed pursuant to 
the proposed rule.
    In response to the commenter's suggestion that certain order types 
should be excluded from the rule's protection, NASD clarified how NASD 
Rule 2111 would apply to the order types mentioned. First, regarding 
``not held'' orders, NASD stated that for orders for which a customer 
has granted the member discretion with respect to time or price, those 
orders would not be considered market orders for the purposes of the 
rule. Second, regarding orders where the customer specifically asks 
that the order be handled on an agency basis, the NASD stated that, 
with regard to those orders where no other regulation limits or 
prohibits a principal transaction, the rule would apply. Third, with 
respect to orders for accounts where the member is bound by another 
regulation limiting or prohibiting principal transactions with customer 
orders, NASD noted that, consistent with prior interpretations of 
Manning, the obligation to execute a trade with a customer following a 
separate proprietary trade on the same side of the market does not 
apply if the orders subject to the restrictions are sent to another 
broker-dealer for execution; the obligations under NASD Rule 2111 
apply, however, if such orders are not routed elsewhere for execution. 
NASD reiterated that these interpretations do not change a member's 
best execution obligations under NASD Rule 2320.
    Concerning the commenter's argument that the proposal should apply 
only to orders executed on Nasdaq or in the OTC market, NASD stated 
that the proposal is based on a member's obligations relating to just 
and equitable principles of trade with respect to the treatment of 
customer market orders, and therefore NASD believes that the proposed 
rule should apply to customer market orders regardless of where the 
orders are ultimately executed.

[[Page 48221]]

    In response to the commenter's suggestion that the proposal should 
allow firms to more fully utilize information barriers to segregate 
non-market making desks from other customer order flows, NASD stated 
that it has issued guidance in connection with Manning concerning the 
extent to which a trading desk other than the firm's market-making desk 
could trade for its own account while the market-making desk held 
protected customer limit orders on its books.\24\ NASD states that the 
same guidance would apply for the instant proposal.
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    \24\ See Notice to Members 95-43 (June 1995) and Notice to 
Members 03-74 (November 2003).
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IV. Discussion and Commission Findings

    The Commission has reviewed carefully the proposed rule change, the 
comment letter, and NASD's response, and finds that the proposed rule 
change, as amended, is consistent with the requirements of the Act and 
rules and regulations thereunder applicable to a national securities 
association\25\ and, in particular, the requirements of section 
15A(b)(6) of the Act,\26\ which requires, among other things, that the 
rules of a national securities association 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 the proposal is 
reasonably designed to ensure that customer market orders are executed 
quickly and fairly. Indeed, paragraph (a) of the rule requires a member 
to ``make every effort to execute a customer market order that it 
receives fully and promptly.''
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    \25\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. 15 U.S.C. 78c(f).
    \26\ 15 U.S.C. 78o-3(b)(6).
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    Regarding the commenter's concerns that so long as a customer's 
market orders are executed at the proper price under the rule, the 
proposed rule change should not mandate that the orders be crossed, the 
NASD amended NASD Rule 2111(c) to allow for members to execute a 
customer order as a riskless principal to satisfy the crossing 
requirement. Regarding the commenter's concern that under the rule a 
firm must cross a marketable limit order even if the order were only 
marketable for a brief period of time, the NASD recognized that 
flickering quotes may increase the difficulty in determining the 
appropriate price of a market order, but such quotes would not dictate 
whether a particular marketable or non-marketable limit order should be 
crossed pursuant to the proposed rule. The Commission believes that the 
proposed rule change reasonably addresses the manner in which member 
firms need to execute customer market orders under various market 
conditions. The requirements of the rule are only triggered if the 
member fails to execute a market order fully and promptly.
    The Commission agrees with the NASD's analysis with respect to 
whether certain types of market orders should be excluded from the 
rule. The Commission believes that the proposed rule change allows 
sufficient flexibility to accommodate those order types by, for 
example, not considering a ``not held'' order to be a ``market'' order 
for purposes of the proposed rule change.
    Concerning the commenter's argument that the rule should only apply 
to orders executed on Nasdaq or in the OTC market, the Commission 
agrees with NASD that applying the proposed rule change to NASD members 
executing customer market orders across all equities markets will help 
better assure that customer orders receive the protections of the rule, 
regardless of where the orders ultimately are executed. The commenter 
did not state that the NASD rule is inconsistent with the NYSE's rule.
    In response to the commenter's assertion that the proposed rule 
change should permit firms to more fully utilize information barriers 
to segregate non-market making desks from other customer order flows, 
the Commission believes the NASD's position--that its existing Manning 
guidance with respect to information barriers will apply to the 
proposed rule change--adequately addresses the commenter's concern.
    The Commission finds good cause to approve Amendment No. 2 before 
the 30th day after the date of publication of notice of filing in the 
Federal Register. NASD filed Amendment No. 2 in response to comments it 
received after the publication of the notice of filing of the proposed 
rule change.\27\ Because Amendment No. 2 is responsive to the 
commenter's concerns and explains how the rule applies, the Commission 
finds good cause for accelerating approval of Amendment No. 2.
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    \27\ See footnote 6, supra.
---------------------------------------------------------------------------

V. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 2, including whether Amendment No. 2 
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, 100 F Street, NE., 
Washington, DC 20549-9303.
    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 the 
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 
September 6, 2005.

VI. Conclusion

    It is therfore ordered, pursuant to section 19(b)(2) of the 
Act,\28\ that the proposed rule change (SR-NASD-2004-045), as modified 
by Amendment No. 1 thereto, be, and it hereby is, approved and that 
Amendment No. 2 be, and hereby is, approved on an accelerated basis.
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    \28\ 15 U.S.C. 78s(b)(2).


[[Page 48222]]


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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\29\
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    \29\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. E5-4412 Filed 8-15-05; 8:45 am]
BILLING CODE 8010-01-P

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