Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Order Granting Approval of Proposed Rule Change and Amendment Nos. 1, 2, and 3 Thereto, and Notice of Filing and Order Granting Accelerated Approval of Amendment No. 4 to the Proposed Rule Change, to Adopt NASD Rule 2441 to Require Disclosure and Consent When Trading on a Net Basis With Customers, 38950-38953 [E6-10718]

Download as PDF 38950 Federal Register / Vol. 71, No. 131 / Monday, July 10, 2006 / Notices approach to revenue sharing and determined that the approach reflected in the proposed rule was feasible and appropriate, given the costs involved and competitive concerns. 2. Statutory Basis Nasdaq believes that the proposed rule change is consistent with the provisions of Section 15A of the Act,8 in general, and with Sections 15A(b)(5) 9 and (b)(6) of the Act,10 in particular, in that it provides for the equitable allocation of reasonable dues, fees and other charges among members and issuers and other persons using any facility or system which the NASD operates or controls; and in that it is designed to facilitate transactions in securities, to promote just and equitable principles of trade, to enhance competition, and to protect investors and the public interest. B. Self-Regulatory Organization’s Statement on Burden on Competition Nasdaq does not believe that the proposed rule change will result in any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act, 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. sroberts on PROD1PC70 with NOTICES III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action Because the foregoing proposed rule change does not: (i) Significantly affect the protection of investors or the public interest; (ii) impose any significant burden on competition; and (iii) become operative for 30 days from the date on which it was filed, or such shorter time as the Commission may designate if consistent with the protection of investors and the public interest, the proposed rule change has become effective pursuant to Section 19(b)(3)(A) of the Act 11 and Rule 10b–4(f)(6) thereunder.12 At any time within 60 days of the filing of such proposed rule change, the Commission may summarily abrogate such rule change if it appears to the Commission that such action is necessary or appropriate in the public interest, for the protection of investors, Electronic Comments • Use the Commission’s Internet comment form (http://www.sec.gov/ rules/sro.shtml); or • Send an e-mail to rulecomments@sec.gov. Please include File Number SR–NASD–2006–077 on the subject line. Paper Comments • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, Station Place, 100 F Street, NE., Washington, DC 20549–1090. All submissions should refer to File Number SR–NASD–2006–077. 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 (http://www.sec.gov/ rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the CFR 240.19b–4(f)(6)(iii). purposes only of waiving the 30-day operative delay of this proposal, the Commission has considered the proposed rule’s impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f). U.S.C. 78o–3. 9 15 U.S.C. 78o–3(b)(5) 10 15 U.S.C. 78o–3(b)(6). 11 15 U.S.C. 78s(b)(3)(A). 12 17 CFR 240.19b–4(f)(6). 17:10 Jul 07, 2006 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: 13 17 8 15 VerDate Aug<31>2005 or otherwise in furtherance of the purposes of the Act. Nasdaq has requested that the Commission waive the 30-day operative delay contained in Rule 19b–4(f)(6)(iii) under the Act 13 based upon a representation that the proposal will allow Nasdaq to implement more competitive pricing for transactions reported to the trade reporting service of the Nasdaq Market Center, and in that it is intended as a response to a similar program instituted by a competitor on an immediately effective basis. In light of the foregoing, the Commission believes such waiver is consistent with the protection of investors and the public interest. Accordingly, the Commission designates the proposal to be effective and operative upon filing with the Commission.14 14 For Jkt 208001 PO 00000 Frm 00109 Fmt 4703 Sfmt 4703 Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission’s Public Reference Room. Copies of such filing also will be available for inspection and copying at the principal office of the NASD. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–NASD–2006–077 and should be submitted on or before July 31, 2006. For the Commission, by the Division of Market Regulation, pursuant to delegated authority.15 Nancy M. Morris, Secretary. [FR Doc. E6–10713 Filed 7–7–06; 8:45 am] BILLING CODE 8010–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–54088; File No. SR–NASD– 2004–135] Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Order Granting Approval of Proposed Rule Change and Amendment Nos. 1, 2, and 3 Thereto, and Notice of Filing and Order Granting Accelerated Approval of Amendment No. 4 to the Proposed Rule Change, to Adopt NASD Rule 2441 to Require Disclosure and Consent When Trading on a Net Basis With Customers June 30, 2006 I. Introduction On September 1, 2004, the National Association of Securities Dealers, Inc. (‘‘NASD’’) filed with the Securities and Exchange Commission (‘‘SEC’’ or ‘‘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 require disclosure and consent when trading on a net basis with customers. NASD amended the proposed rule change on February 16, 2005,3 February 25, 2005,4 and March 21, 2005.5 The 15 17 CFR 200.30–3(a)(12). U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 3 See Amendment No. 1. 4 See Amendment No. 2. 5 See Amendment No. 3. 1 15 E:\FR\FM\10JYN1.SGM 10JYN1 Federal Register / Vol. 71, No. 131 / Monday, July 10, 2006 / Notices proposed rule change, as modified by Amendment Nos. 1, 2, and 3, was published for notice and comment in the Federal Register on April 6, 2005.6 The Commission received three comments on the proposal.7 On September 13, 2005, NASD responded to the comments, and amended the proposed rule change.8 This order provides notice of filing of Amendment No. 4, and approves the proposed rule change as modified by Amendment Nos. 1, 2, 3, and grants accelerated approval to Amendment No. 4. II. Summary of Comments The Commission received a total of three comment letters on the NASD’s proposal to require consent and disclosure when trading with customers on a net basis. One commenter requested clarification with respect to the interplay between the proposal and NASD Rule 4632. The other two comment letters expressed various objections to the proposal. The following summary of comments provides an overview of the commenters’ concerns. • With Respect to Non-Institutional Clients, Requiring Mandatory, Written, Pre-trade Disclosure and Consent on an Order-By-Order Basis is Unnecessarily Burdensome to Broker-Dealers One commenter asserts that the rule as proposed places an unnecessary burden on broker-dealers when trading on a net basis on behalf of noninstitutional clients. The rule requires that, for non-institutional clients, broker-dealers must provide pre-trade disclosure to and obtain consent from the client in writing on an order-byorder basis.9 The commenter stated that ‘‘the actions detailed in this proposed rule change would be confusing to the client, costly to the firm, and impossible to manage and track on an order-byorder basis.’’ 10 The commenter expressed concern that ‘‘[t]he proposed sroberts on PROD1PC70 with NOTICES 6 See Securities Exchange Act Release No. 51457 (March 31, 2005), 70 FR 17489. 7 See April 20, 2005 letter from David Sieradzki, Esquire, Milbank Tweed, to Lourdes Gonzales, Division of Market Regulation, SEC (via e-mail) (‘‘Milbank Letter’’); April 27, 2005 letter from Klindt Ginsberg, Managing Director, The Seidler Companies, Inc. (via e-mail) (‘‘Seidler Letter’’); May 4, 2005 letter from Amal Aly and Ann Vlcek, Vice Presidents and Associate General Counsels, Securities Industry Association (‘‘SIA’’), to Jonathan G. Katz, Secretary, SEC (‘‘SIA Letter’’). 8 See Amendment No 4. 9 This contrasts with the lower burden for institutional clients under the proposed rule, in which broker-dealers may fulfill their disclosure and consent requirements via a one-time ‘‘negative consent’’ letter. See Securities Exchange Act Release No. 51457 (March 31, 2005), 70 FR 17489 (April 6, 2005) (SR–NASD–2004–135). 10 Seidler Letter. VerDate Aug<31>2005 17:10 Jul 07, 2006 Jkt 208001 rule would burden the firm with additional time and money spent on record keeping and auditing practices’’ and hinder a broker-dealer’s ability to obtain best execution of its customers’ orders.11 Similarly, another commenter—while agreeing in principle with disclosure and consent rules— stated that the requirement ‘‘for a knowing, written consent on an orderby-order basis * * * is impractical where most orders are not taken in writing, and there is no opportunity to obtain [such a consent].’’ 12 This commenter proposed modifying the rule to permit the use of negative consent letters (similar to what the rule requires ` vis-a-vis institutional clients) or of obtaining oral consent on an order-byorder basis and to permit such consent to be evidenced on the customer order ticket.13 Moreover, the two commenters opined that the additional burdens placed on broker-dealers by the rule could not be justified by any added benefit to investors.14 One commenter pointed out that, because the advent of decimal pricing in 2000 substantially reduced the practice of net trading generally, the rule would have little practical benefit.15 • With Respect to Institutional Clients, Requiring Disclosure and Consent via Negative-Consent Letters is Unnecessarily Burdensome to BrokerDealers Regarding institutional clients, the commenters similarly objected to the rule’s consent and disclosure requirements via a ‘‘negative consent’’ letter as unnecessarily burdensome. One commenter stated that the rule was wholly unnecessary because ‘‘investors already receive a ‘net’ trading disclosure when an account is opened * * * [and] institutional investors by nature are accredited and sophisticated.’’ 16 Another commenter, citing the 11 Id. Letter at 5. Letter at 2, 5. The letter further recommended that, for firms choosing to obtain oral consent on an order-by-order basis, pre-trade disclosure be required in the form of a one-time comprehensive disclosure statement, and also that, for fiduciaries of non-institutional customers granted trading discretion who on their own qualify as an ‘‘institutional account’’ under the proposed rule, members be permitted to obtain the consent of such fiduciaries in the same manner as permitted for their institutional customers. Id. 14 See, e.g., Seidler Letter (‘‘Having the client sign a disclosure document prior to each and every trade provides no benefit. It will confuse the client and will provide no additional information that is not available elsewhere.’’); SIA Letter at 5 (‘‘[N]o purpose is served by imposing onerous and impractical requirements on customers who do wish to consent to [trading on a net basis].’’). 15 SIA Letter at 4. 16 Seidler Letter. PO 00000 12 SIA 13 SIA Frm 00110 Fmt 4703 Sfmt 4703 38951 declining practice of net trading since decimalization, argued that ‘‘the costs and burden of sending, receiving and tracking negative consent letters are excessive in light of the fact that institutional customers would receive the requisite level of protection, if not greater, by providing verbal consent on an order-by-order basis.’’ 17 This commenter therefore suggested modifying the proposed rule to allow the use of negative consent letters or of obtaining oral consent on an order-byorder basis and to permit the consent to be evidenced on the customer order ticket.18 • Member Firms and Other Registered Broker-Dealers Should Be Explicitly Exempt from the Proposed Rule One commenter requested that the NASD clarify the proposed rule change to ‘‘confirm that member firms and other registered broker-dealers are exempt from the requirements of the Proposed Rule, as they are neither institutional nor non-institutional customers.’’ 19 • The Proposed Rule Should Be Clarified With Respect to Net Orders Routed Between Broker-Dealers The commenter further requested that the NASD clarify the proposed rule change to ‘‘confirm [that] an executing broker-dealer handling an order marked ‘net’ routed to it from an originating broker-dealer has no consent and disclosure obligation to the customer of the originating broker-dealer for whom it is handling the order.’’ 20 • The Proposed Rule Potentially Conflicts With Rule 4632(d)(3)(A) Regarding Reporting Trades Exclusive of Any Mark-Up, Mark-Down, or Service Charge One commenter noted a potential conflict between the proposed rule and Rule 4632(d)(3)(A), which states that trades must be reported exclusive of any mark-up, mark-down, or service charge.21 III. The NASD’s Response to Comments NASD responded to the comments in Amendment No. 4. Regarding the commenters’ assertion that the proposed disclosure and consent requirements were unnecessary for institutional customers, NASD amended the proposed rule change to allow members the option of obtaining consent from institutional customers orally, on an order-by-order basis. However, NASD does not believe a one-time disclosure 17 SIA Letter at 4. at 2, 4. 19 Id. at 2. 20 SIA Letter at 2. 21 Milbank Letter. 18 Id. E:\FR\FM\10JYN1.SGM 10JYN1 sroberts on PROD1PC70 with NOTICES 38952 Federal Register / Vol. 71, No. 131 / Monday, July 10, 2006 / Notices would be appropriate under such circumstances, thus, NASD proposes that members that choose to obtain oral consent on an order-by-order basis must also explain the terms and conditions for handling the order to the institutional customer before each transaction, and provide the institutional customer with ‘‘a meaningful opportunity to object to the execution of the transaction on a net basis.’’ Additionally, members must document the customer’s understanding of the terms and conditions of the order and the customer’s consent on an orderby-order basis. Regarding the comments relating to net transactions with non-institutional customers, NASD states it ‘‘recognizes the burdens that result from having to obtain written consent on an order-byorder basis’’ but believes the written disclosure and consent requirements are important to ensure that information regarding members’ methods of compensation on transactions is provided to non-institutional customers, and that such customers agree to the methods of compensation. NASD does not believe that the market information available to customers will assist customers to determine whether a member is trading net or to understand the ramifications for the customer of trading net. Ultimately, NASD believes that benefits of requiring member disclosure and consent outweigh the related burdens to members. NASD amended the proposal to allow a member, absent instructions to the contrary, to look to the institutional or non-institutional status of the fiduciary, rather than the underlying account, when deciding which method of disclosure and consent is allowable under the proposal. NASD clarified that the scope of the proposal does not include orders received from member firms and other registered broker-dealers. As such, the proposal would not apply to orders received from members and other registered broker-dealers, nor would a receiving broker-dealer handling an order marked ‘‘net’’ routed to it from an originating broker-dealer have consent and disclosure obligations to the customer of the originating brokerdealer.22 In both scenarios, the originating broker-dealer would be responsible for adhering to the requirements. Finally, with regard to the possible inconsistency between net trading and NASD Rule 4632(d)(3)(A), NASD explained that the trade reporting requirements for net trades ‘‘are not 22 Id. at 10–11. VerDate Aug<31>2005 17:10 Jul 07, 2006 Jkt 208001 germane to this proposed rule change’’ and that no changes to those requirements are needed.23 IV. Discussion and Commission Findings The Commission has reviewed carefully the proposed rule change, the comment letters, and the NASD’s response to the comments, and finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities association.24 Specifically, the Commission finds that the proposed rule change is consistent with the provisions of Section 15A(b)(6) of the Act, which requires, among other things, that NASD’s rules be designed to prevent fraudulent and manipulative acts and practices, promote just and equitable principles of trade, and, in general, protect investors and the public interest. The Commission believes that the proposed rule change should promote investor protection by codifying the requirement that members provide disclosure and obtain customer consent when trading on a net basis. The consent provided by noninstitutional investors must evidence the customer’s understanding of the terms and conditions of the order. The Commission also believes that the benefit to investors of requiring certain disclosures and obtaining customer consent when trading on a net basis outweighs the additional responsibilities placed on brokerdealers. The Commission understands the commenters’ assertion that the proposed rule change’s disclosure and consent requirements were unnecessary for institutional customers, and is satisfied that NASD’s modification of the proposal to require that members that choose to obtain oral consent on an order-by-order basis also explain the terms and conditions for handling the order to the institutional customer before each transaction and provide the institutional customer with an opportunity to object to the execution of the transaction on a net basis in a meaningful way to be a reasonable resolution of the issue. The Commission also believes it is reasonable and not unduly burdensome to require members to document a customer’s understanding of the terms and conditions of the order and the at 19. 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). PO 00000 customer’s consent on an order-by-order basis. The Commission believes that the modifications to the proposed rule change that NASD made in response to issues raised by the commenters are reasonable and designed to ease the burdens placed on members without sacrificing the benefits to investors contemplated by the proposal. For example, the Commission believes that (i) absent instructions to the contrary, it is reasonable for a member to look to the institutional or non-institutional status of the fiduciary, rather than the underlying account, when deciding which method of disclosure and consent is consistent with the rule, and (ii) NASD’s decision to allow members the option of obtaining consent from institutional customers orally on an order-by-order basis, but not allowing a one-time disclosure under such circumstances, is consistent with investor protection and the public interest. Additionally, the Commission is satisfied that the clarifications NASD offered in response to the comments should provide sufficient guidance to allow members to satisfy the requirements of the rule. Finally, the Commission agrees with NASD that the trade reporting requirements for net trades contained in NASD Rule 4632(d)(3)(A) are not implicated in this proposed rule change. The Commission finds good cause for approving Amendment No. 4 on an accelerated basis. Amendment No. 4 modifies the proposal in response to issues raised by the commenters. Because Amendment No. 4 raises no novel issues, and provides improvements to the proposed rule change in direct response to issues raised by the commenters, the Commission finds good cause for approving Amendment No. 4 before the 30th day since its publication in the Federal Register. V. Conclusion It is therefore ordered, pursuant to Section 19(b)(2) of the Act 25, that the proposed rule change (SR–NASD–2004– 135), as modified by Amendment Nos. 1, 2, 3 be, and it hereby is, approved, and Amendment No. 4 is approved on an accelerated basis. 23 Id. 24 In Frm 00111 Fmt 4703 Sfmt 4703 25 15 26 17 E:\FR\FM\10JYN1.SGM U.S.C. 78s(b)(2). CFR 200.30–3(a)(12). 10JYN1 Federal Register / Vol. 71, No. 131 / Monday, July 10, 2006 / Notices For the Commission, by the Division of Market Regulation, pursuant to delegated authority.26 Nancy M. Morris, Secretary. [FR Doc. E6–10718 Filed 7–7–06; 8:45 am] BILLING CODE 8010–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–54086; File No. SR–NYSE– 2006–24] Self-Regulatory Organizations; New York Stock Exchange LLC; Order Approving Proposed Rule Change To Lower the Minimum Display Size Requirement for Specialists To Maintain Undisplayed Reserve Interest at the Exchange Best Bid or Offer in the NYSE Hybrid Market June 30, 2006. On April 7, 2006, the New York Stock Exchange LLC (‘‘NYSE’’ or ‘‘Exchange’’) 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 amend Exchange Rule 104(d)(i) to provide that specialists shall have the ability to maintain undisplayed reserve interest on behalf of the dealer account at the Exchange best bid or offer (‘‘BBO’’), provided at least 1,000 shares of dealer interest is displayed at that price, on the same side of the market as the reserve interest. This proposed rule change would lower the specialist’s minimum display size requirement from at least 2,000 shares to at least 1,000 shares at the Exchange BBO and would conform the minimum display requirements for reserve interest for specialists and floor brokers.3 In addition, the Exchange proposes to make a conforming change to Exchange Rule 104(d)(ii) to require that after an execution at the Exchange BBO that does not exhaust the specialist’s interest, the specialist’s displayed interest would be automatically replenished from its reserve interest, if any, so that at least a minimum of 1,000 shares is displayed (or whatever amount remains if the reserve interest is less than 1,000 shares). The proposed rule change was published for comment in the Federal Register on May 16, 2006.4 sroberts on PROD1PC70 with NOTICES 1 15 U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 3 NYSE permits floor brokers to maintain undisplayed reserve interest at the Exchange BBO, provided floor brokers display at least 1,000 shares. See NYSE Rule 70.20(c)(ii). 4 See Securities Exchange Act Release No. 53780 (May 10, 2006), 71 FR 28398. VerDate Aug<31>2005 17:10 Jul 07, 2006 Jkt 208001 The Commission received no comments regarding the proposal. The Commission finds that the proposed rule change is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities exchange, and, in particular, with the requirements of Section 6(b) of the Act.5 Specifically, the Commission finds that the proposed rule change is consistent with Section 6(b)(5) of the Act 6 in that it is designed, among other things, to promote just and equitable principle of trade, to remove impediments to and perfect the mechanism of a free and open market and a national market system, and, in general, to protect investors and the public interest. The Commission previously approved NYSE’s proposal to permit specialists and floor brokers to maintain undisplayed reserve interest at the Exchange BBO, provided that they display a minimum number of shares and yield priority to all displayed interest.7 In the Hybrid Market Order, the Commission found it to be consistent with the requirements of the Act to allow specialists to place reserve interest in the Display Book system because it could increase the liquidity available for execution at the Exchange BBO. The Commission specifically noted that the minimum size requirement and the priority of displayed interest over undisplayed reserve interest should help ensure that market participants continue to have an incentive to display quotes or orders on NYSE. The Commission stated that, taken together, these requirements could promote additional depth at the Exchange BBO, while preserving incentives for investors to display limit orders. Since NYSE’s proposal would retain the requirements that specialists display a minimum amount of size at the BBO in order to maintain undisplayed reserve interest and that undisplayed reserve interest yield priority to displayed interest at that price, the Commission finds that the proposed rule change remains consistent with the requirements of the Act. It is therefore ordered, pursuant to Section 19(b)(2) of the Act,8 that the 5 15 U.S.C. 78f(b). In approving this proposed rule change, the Commission considered the proposed rule’s impact on efficiency, competition, and capital formation. 15 U.S.C. 78c(f). 6 15 U.S.C. 78f(b)(5). 7 See Securities Exchange Act Release No. 53539 (March 22, 2006), 71 FR 16353 (March 31, 2006) (‘‘Hybrid Market Order’’). 8 15 U.S.C. 78s(b)(2). PO 00000 Frm 00112 Fmt 4703 Sfmt 4703 38953 proposed rule change (SR–NYSE–2006– 24) is hereby approved. For the Commission, by the Division of Market Regulation, pursuant to delegated authority.9 Nancy M. Morris, Secretary. [FR Doc. E6–10716 Filed 7–7–06; 8:45 am] BILLING CODE 8010–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–54078; File No. SR–PCX– 2005–54] Self-Regulatory Organizations; NYSE Arca, Inc., Notice of Filing of Proposed Rule Change and Amendment Nos. 1 and 2 Thereto Requiring OTP Holders and OTP Firms To Participate in the Federal Trade Commission’s National Do-Not-Call Registry June 30, 2006. Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 (the ‘‘Act’’) 1 and Rule 19b–4 thereunder,2 notice is hereby given that on May 18, 2006, NYSE Arca, Inc. (‘‘NYSE Arca’’ or ‘‘Exchange’’) 3 filed with the Securities and Exchange Commission (‘‘Commission’’ or ‘‘SEC’’) the proposed rule change as described in Items I, II and III below, which Items have been prepared by the self-regulatory organization. On May 26, 2006, NYSE Arca filed Amendment No. 1 to the proposed rule change.4 On June 21, 2006, NYSE Arca filed Amendment No. 2 to the proposed rule change.5 The Commission is publishing this notice to solicit comments on the proposed rule change from interested persons. I. Self-Regulatory Organization’s Statement of the Terms of Substance of the Proposed Rule Change NYSE Arca proposes to amend NYSE Arca Rule 9.20. The proposed rule change would require OTP Holders and 9 17 CFR 200.30–3(a)(12). U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 3 On March 6, 2006, the Pacific Exchange, Inc. filed a rule proposal, effective upon filing, to amend its rules to reflect these name changes: from Pacific Exchange, Inc. to NYSE Arca, Inc.; from PCX Equities, Inc. to NYSE Arca Equities, Inc.; from PCX Holdings, Inc., to NYSE Arca Holdings, Inc.; and from the Archipelago Exchange, L.L.C. to NYSE Arca, L.L.C. See File No. SR–PCX–2006–24 (March 6, 2006). This proposal has been amended to reflect these name changes. 4 In Amendment No. 1, NYSE Arca partially amended the text of proposed amended NYSE Arca Rule 9.20 and made conforming and technical changes to the original filing. 5 In Amendment No. 2, NYSE Arca made additional changes to the text of proposed amended NYSE Arca Rule 9.20 and to the original filing. 1 15 E:\FR\FM\10JYN1.SGM 10JYN1

Agencies

[Federal Register Volume 71, Number 131 (Monday, July 10, 2006)]
[Notices]
[Pages 38950-38953]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E6-10718]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54088; File No. SR-NASD-2004-135]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Granting Approval of Proposed Rule Change and 
Amendment Nos. 1, 2, and 3 Thereto, and Notice of Filing and Order 
Granting Accelerated Approval of Amendment No. 4 to the Proposed Rule 
Change, to Adopt NASD Rule 2441 to Require Disclosure and Consent When 
Trading on a Net Basis With Customers

June 30, 2006

I. Introduction

    On September 1, 2004, the National Association of Securities 
Dealers, Inc. (``NASD'') filed with the Securities and Exchange 
Commission (``SEC'' or ``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 require disclosure and consent 
when trading on a net basis with customers. NASD amended the proposed 
rule change on February 16, 2005,\3\ February 25, 2005,\4\ and March 
21, 2005.\5\ The

[[Page 38951]]

proposed rule change, as modified by Amendment Nos. 1, 2, and 3, was 
published for notice and comment in the Federal Register on April 6, 
2005.\6\ The Commission received three comments on the proposal.\7\ On 
September 13, 2005, NASD responded to the comments, and amended the 
proposed rule change.\8\ This order provides notice of filing of 
Amendment No. 4, and approves the proposed rule change as modified by 
Amendment Nos. 1, 2, 3, and grants accelerated approval to Amendment 
No. 4.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Amendment No. 1.
    \4\ See Amendment No. 2.
    \5\ See Amendment No. 3.
    \6\ See Securities Exchange Act Release No. 51457 (March 31, 
2005), 70 FR 17489.
    \7\ See April 20, 2005 letter from David Sieradzki, Esquire, 
Milbank Tweed, to Lourdes Gonzales, Division of Market Regulation, 
SEC (via e-mail) (``Milbank Letter''); April 27, 2005 letter from 
Klindt Ginsberg, Managing Director, The Seidler Companies, Inc. (via 
e-mail) (``Seidler Letter''); May 4, 2005 letter from Amal Aly and 
Ann Vlcek, Vice Presidents and Associate General Counsels, 
Securities Industry Association (``SIA''), to Jonathan G. Katz, 
Secretary, SEC (``SIA Letter'').
    \8\ See Amendment No 4.
---------------------------------------------------------------------------

II. Summary of Comments

    The Commission received a total of three comment letters on the 
NASD's proposal to require consent and disclosure when trading with 
customers on a net basis. One commenter requested clarification with 
respect to the interplay between the proposal and NASD Rule 4632. The 
other two comment letters expressed various objections to the proposal. 
The following summary of comments provides an overview of the 
commenters' concerns.
     With Respect to Non-Institutional Clients, Requiring 
Mandatory, Written, Pre-trade Disclosure and Consent on an Order-By-
Order Basis is Unnecessarily Burdensome to Broker-Dealers
    One commenter asserts that the rule as proposed places an 
unnecessary burden on broker-dealers when trading on a net basis on 
behalf of non-institutional clients. The rule requires that, for non-
institutional clients, broker-dealers must provide pre-trade disclosure 
to and obtain consent from the client in writing on an order-by-order 
basis.\9\ The commenter stated that ``the actions detailed in this 
proposed rule change would be confusing to the client, costly to the 
firm, and impossible to manage and track on an order-by-order basis.'' 
\10\ The commenter expressed concern that ``[t]he proposed rule would 
burden the firm with additional time and money spent on record keeping 
and auditing practices'' and hinder a broker-dealer's ability to obtain 
best execution of its customers' orders.\11\ Similarly, another 
commenter--while agreeing in principle with disclosure and consent 
rules--stated that the requirement ``for a knowing, written consent on 
an order-by-order basis * * * is impractical where most orders are not 
taken in writing, and there is no opportunity to obtain [such a 
consent].'' \12\ This commenter proposed modifying the rule to permit 
the use of negative consent letters (similar to what the rule requires 
vis-[agrave]-vis institutional clients) or of obtaining oral consent on 
an order-by-order basis and to permit such consent to be evidenced on 
the customer order ticket.\13\
---------------------------------------------------------------------------

    \9\ This contrasts with the lower burden for institutional 
clients under the proposed rule, in which broker-dealers may fulfill 
their disclosure and consent requirements via a one-time ``negative 
consent'' letter. See Securities Exchange Act Release No. 51457 
(March 31, 2005), 70 FR 17489 (April 6, 2005) (SR-NASD-2004-135).
    \10\ Seidler Letter.
    \11\ Id.
    \12\ SIA Letter at 5.
    \13\ SIA Letter at 2, 5. The letter further recommended that, 
for firms choosing to obtain oral consent on an order-by-order 
basis, pre-trade disclosure be required in the form of a one-time 
comprehensive disclosure statement, and also that, for fiduciaries 
of non-institutional customers granted trading discretion who on 
their own qualify as an ``institutional account'' under the proposed 
rule, members be permitted to obtain the consent of such fiduciaries 
in the same manner as permitted for their institutional customers. 
Id.
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    Moreover, the two commenters opined that the additional burdens 
placed on broker-dealers by the rule could not be justified by any 
added benefit to investors.\14\ One commenter pointed out that, because 
the advent of decimal pricing in 2000 substantially reduced the 
practice of net trading generally, the rule would have little practical 
benefit.\15\
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    \14\ See, e.g., Seidler Letter (``Having the client sign a 
disclosure document prior to each and every trade provides no 
benefit. It will confuse the client and will provide no additional 
information that is not available elsewhere.''); SIA Letter at 5 
(``[N]o purpose is served by imposing onerous and impractical 
requirements on customers who do wish to consent to [trading on a 
net basis].'').
    \15\ SIA Letter at 4.
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     With Respect to Institutional Clients, Requiring 
Disclosure and Consent via Negative-Consent Letters is Unnecessarily 
Burdensome to Broker-Dealers
    Regarding institutional clients, the commenters similarly objected 
to the rule's consent and disclosure requirements via a ``negative 
consent'' letter as unnecessarily burdensome. One commenter stated that 
the rule was wholly unnecessary because ``investors already receive a 
`net' trading disclosure when an account is opened * * * [and] 
institutional investors by nature are accredited and sophisticated.'' 
\16\ Another commenter, citing the declining practice of net trading 
since decimalization, argued that ``the costs and burden of sending, 
receiving and tracking negative consent letters are excessive in light 
of the fact that institutional customers would receive the requisite 
level of protection, if not greater, by providing verbal consent on an 
order-by-order basis.'' \17\ This commenter therefore suggested 
modifying the proposed rule to allow the use of negative consent 
letters or of obtaining oral consent on an order-by-order basis and to 
permit the consent to be evidenced on the customer order ticket.\18\
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    \16\ Seidler Letter.
    \17\ SIA Letter at 4.
    \18\ Id. at 2, 4.
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     Member Firms and Other Registered Broker-Dealers Should Be 
Explicitly Exempt from the Proposed Rule
    One commenter requested that the NASD clarify the proposed rule 
change to ``confirm that member firms and other registered broker-
dealers are exempt from the requirements of the Proposed Rule, as they 
are neither institutional nor non-institutional customers.'' \19\
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    \19\ Id. at 2.
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     The Proposed Rule Should Be Clarified With Respect to Net 
Orders Routed Between Broker-Dealers
    The commenter further requested that the NASD clarify the proposed 
rule change to ``confirm [that] an executing broker-dealer handling an 
order marked `net' routed to it from an originating broker-dealer has 
no consent and disclosure obligation to the customer of the originating 
broker-dealer for whom it is handling the order.'' \20\
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    \20\ SIA Letter at 2.
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     The Proposed Rule Potentially Conflicts With Rule 
4632(d)(3)(A) Regarding Reporting Trades Exclusive of Any Mark-Up, 
Mark-Down, or Service Charge
    One commenter noted a potential conflict between the proposed rule 
and Rule 4632(d)(3)(A), which states that trades must be reported 
exclusive of any mark-up, mark-down, or service charge.\21\
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    \21\ Milbank Letter.
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III. The NASD's Response to Comments

    NASD responded to the comments in Amendment No. 4. Regarding the 
commenters' assertion that the proposed disclosure and consent 
requirements were unnecessary for institutional customers, NASD amended 
the proposed rule change to allow members the option of obtaining 
consent from institutional customers orally, on an order-by-order 
basis. However, NASD does not believe a one-time disclosure

[[Page 38952]]

would be appropriate under such circumstances, thus, NASD proposes that 
members that choose to obtain oral consent on an order-by-order basis 
must also explain the terms and conditions for handling the order to 
the institutional customer before each transaction, and provide the 
institutional customer with ``a meaningful opportunity to object to the 
execution of the transaction on a net basis.'' Additionally, members 
must document the customer's understanding of the terms and conditions 
of the order and the customer's consent on an order-by-order basis.
    Regarding the comments relating to net transactions with non-
institutional customers, NASD states it ``recognizes the burdens that 
result from having to obtain written consent on an order-by-order 
basis'' but believes the written disclosure and consent requirements 
are important to ensure that information regarding members' methods of 
compensation on transactions is provided to non-institutional 
customers, and that such customers agree to the methods of 
compensation. NASD does not believe that the market information 
available to customers will assist customers to determine whether a 
member is trading net or to understand the ramifications for the 
customer of trading net. Ultimately, NASD believes that benefits of 
requiring member disclosure and consent outweigh the related burdens to 
members.
    NASD amended the proposal to allow a member, absent instructions to 
the contrary, to look to the institutional or non-institutional status 
of the fiduciary, rather than the underlying account, when deciding 
which method of disclosure and consent is allowable under the proposal.
    NASD clarified that the scope of the proposal does not include 
orders received from member firms and other registered broker-dealers. 
As such, the proposal would not apply to orders received from members 
and other registered broker-dealers, nor would a receiving broker-
dealer handling an order marked ``net'' routed to it from an 
originating broker-dealer have consent and disclosure obligations to 
the customer of the originating broker-dealer.\22\ In both scenarios, 
the originating broker-dealer would be responsible for adhering to the 
requirements.
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    \22\ Id. at 10-11.
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    Finally, with regard to the possible inconsistency between net 
trading and NASD Rule 4632(d)(3)(A), NASD explained that the trade 
reporting requirements for net trades ``are not germane to this 
proposed rule change'' and that no changes to those requirements are 
needed.\23\
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    \23\ Id. at 19.
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IV. Discussion and Commission Findings

    The Commission has reviewed carefully the proposed rule change, the 
comment letters, and the NASD's response to the comments, and finds 
that the proposed rule change is consistent with the requirements of 
the Act and the rules and regulations thereunder applicable to a 
national securities association.\24\ Specifically, the Commission finds 
that the proposed rule change is consistent with the provisions of 
Section 15A(b)(6) of the Act, which requires, among other things, that 
NASD's rules be designed to prevent fraudulent and manipulative acts 
and practices, promote just and equitable principles of trade, and, in 
general, protect investors and the public interest. The Commission 
believes that the proposed rule change should promote investor 
protection by codifying the requirement that members provide disclosure 
and obtain customer consent when trading on a net basis. The consent 
provided by non-institutional investors must evidence the customer's 
understanding of the terms and conditions of the order. The Commission 
also believes that the benefit to investors of requiring certain 
disclosures and obtaining customer consent when trading on a net basis 
outweighs the additional responsibilities placed on broker-dealers.
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    \24\ 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).
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    The Commission understands the commenters' assertion that the 
proposed rule change's disclosure and consent requirements were 
unnecessary for institutional customers, and is satisfied that NASD's 
modification of the proposal to require that members that choose to 
obtain oral consent on an order-by-order basis also explain the terms 
and conditions for handling the order to the institutional customer 
before each transaction and provide the institutional customer with an 
opportunity to object to the execution of the transaction on a net 
basis in a meaningful way to be a reasonable resolution of the issue. 
The Commission also believes it is reasonable and not unduly burdensome 
to require members to document a customer's understanding of the terms 
and conditions of the order and the customer's consent on an order-by-
order basis.
    The Commission believes that the modifications to the proposed rule 
change that NASD made in response to issues raised by the commenters 
are reasonable and designed to ease the burdens placed on members 
without sacrificing the benefits to investors contemplated by the 
proposal. For example, the Commission believes that (i) absent 
instructions to the contrary, it is reasonable for a member to look to 
the institutional or non-institutional status of the fiduciary, rather 
than the underlying account, when deciding which method of disclosure 
and consent is consistent with the rule, and (ii) NASD's decision to 
allow members the option of obtaining consent from institutional 
customers orally on an order-by-order basis, but not allowing a one-
time disclosure under such circumstances, is consistent with investor 
protection and the public interest. Additionally, the Commission is 
satisfied that the clarifications NASD offered in response to the 
comments should provide sufficient guidance to allow members to satisfy 
the requirements of the rule. Finally, the Commission agrees with NASD 
that the trade reporting requirements for net trades contained in NASD 
Rule 4632(d)(3)(A) are not implicated in this proposed rule change.
    The Commission finds good cause for approving Amendment No. 4 on an 
accelerated basis. Amendment No. 4 modifies the proposal in response to 
issues raised by the commenters. Because Amendment No. 4 raises no 
novel issues, and provides improvements to the proposed rule change in 
direct response to issues raised by the commenters, the Commission 
finds good cause for approving Amendment No. 4 before the 30th day 
since its publication in the Federal Register.

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the Act 
\25\, that the proposed rule change (SR-NASD-2004-135), as modified by 
Amendment Nos. 1, 2, 3 be, and it hereby is, approved, and Amendment 
No. 4 is approved on an accelerated basis.
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    \25\ 15 U.S.C. 78s(b)(2).
    \26\ 17 CFR 200.30-3(a)(12).


[[Page 38953]]


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    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\26\
Nancy M. Morris,
Secretary.
[FR Doc. E6-10718 Filed 7-7-06; 8:45 am]
BILLING CODE 8010-01-P