Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Order Approving Proposed Rule Change as Modified by Amendment Nos. 1-5 To Amend NASD Rule 2320(a) Governing Best Execution, 50959-50961 [E6-14196]

Download as PDF Federal Register / Vol. 71, No. 166 / Monday, August 28, 2006 / Notices IV. Solicitation of Comments until no later than 90 days after the approval of this rule filing.12 2. Statutory Basis Nasdaq believes that the proposed rule change is consistent with the provisions of Section 6 of the Act 13 in general and with Section 6(b)(5) of the Act,14 in particular. Section 6(b)(5) requires that Nasdaq’s rules be designed to promote just and equitable principles of trade, to remove impediments to and perfect the mechanism of a free and open market, and to protect investors and the public interest. The proposed rule change will benefit investors, issuers’ counsel, and member firms by providing additional clarity and transparency to Nasdaq’s corporate governance standards and promoting greater uniformity with existing corporate governance standards of the NYSE. The additional clarity, transparency, and greater uniformity will also reduce administrative costs associated with compliance with Nasdaq’s corporate governance standards. 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. mstockstill on PROD1PC61 with NOTICES 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 Nasdaq 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. 12 The transition period does not affect an issuer’s obligation to comply with the requirements related to audit committee composition. 13 15 U.S.C. 78f. 14 15 U.S≤C. 78f(b)(5). VerDate Aug<31>2005 15:09 Aug 25, 2006 Jkt 208001 Interested persons are invited to submit written data, views, and arguments concerning the foregoing, including whether the proposed rule change, as amended, is consistent with the Act. Comments may be submitted by any of the following methods: 50959 For the Commission, by the Division of Market Regulation, pursuant to delegated authority.15 Nancy M. Morris, Secretary. [FR Doc. E6–14194 Filed 8–25–06; 8:45 am] BILLING CODE 8010–01–P SECURITIES AND EXCHANGE COMMISSION 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–NASDAQ–2006–021 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. [Release No. 34–54339; File No. SR–NASD– 2004–026] Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Order Approving Proposed Rule Change as Modified by Amendment Nos. 1–5 To Amend NASD Rule 2320(a) Governing Best Execution August 21, 2006. I. Introduction On February 12, 2004, the National Association of Securities Dealers, Inc. (‘‘NASD’’) filed with the Securities and All submissions should refer to File Exchange Commission (‘‘Commission’’), Number SR–NASDAQ–2006–021. This pursuant to Section 19(b)(1) of the file number should be included on the Securities Exchange Act of 1934 subject line if e-mail is used. To help the (‘‘Act’’) 1 and Rule 19b–4 thereunder,2 a Commission process and review your proposed rule change to amend NASD comments more efficiently, please use Rule 2320(a) (‘‘Best Execution Rule’’). only one method. The Commission will On May 11, 2004, NASD amended the post all comments on the Commission’s proposed rule change.3 On February 14, Internet Web site (https://www.sec.gov/ 2005, NASD amended the proposed rule rules/sro.shtml). Copies of the change a second time.4 The proposed submission, all subsequent rule change, as modified by Amendment Nos. 1 and 2, was published for amendments, all written statements comment in the Federal Register on with respect to the proposed rule February 25, 2005.5 The Commission change that are filed with the received three comment letters on the Commission, and all written proposal.6 On June 22, 2005, NASD communications relating to the filed a response to comments, and proposed rule change between the 7 Commission and any person, other than simultaneously amended the proposal. The Commission received one comment those that may be withheld from the public in accordance with the 15 17 CFR 200.30–3(a)(12). provisions of 5 U.S.C. 552, will be 1 15 U.S.C. 78s(b)(1). available for inspection and copying in 2 17 CFR 240.19b–4. the Commission’s Public Reference 3 See Amendment No. 1. Room. Copies of such filing also will be 4 See Amendment No. 2. 5 See Securities Exchange Act Release No. 51229 available for inspection and copying at (February 18, 2005), 70 FR 9416. The proposed rule the principal office of the Nasdaq. All change was published a second time on October 26, comments received will be posted 2005. See footnote 10 infra. without change; the Commission does 6 See letters from Amal Aly, Vice President(‘‘VP’’) not edit personal identifying and Associate General Counsel (‘‘AGC’’), and Ann Vlcek, VP and AGC, Securities Industry Association information from submissions. You (‘‘SIA’’) dated March 18, 2005 (‘‘SIA Letter’’); Paul should submit only information that A. Merolla, Executive Vice President and General you wish to make available publicly. Counsel, Instinet Group, Inc. (‘‘Instinet’’) dated March 22, 2005 (‘‘Instinet Letter’’); Micah S. Green, All submissions should refer to File President and Michele C. David, VP and AGC, The Number SR–NASDAQ–2006–021 and Bond Market Association (‘‘BMA’’) dated April 5, 2005 (‘‘BMA Letter’’), to Jonathan G. Katz, should be submitted on or before Secretary, Commission. The Commission received September 18, 2006. one additional comment letter after NASD filed its PO 00000 response to comments, and another letter after the proposed rule change was republished on October 26, 2005. See footnotes 8, 10 and 11, infra. 7 See Amendment No. 3. Frm 00078 Fmt 4703 Sfmt 4703 E:\FR\FM\28AUN1.SGM 28AUN1 50960 Federal Register / Vol. 71, No. 166 / Monday, August 28, 2006 / Notices letter regarding NASD’s response.8 On September 22, 2005, NASD filed an amendment to modify the purpose section of the proposal, clarifying the scope of a member’s duty to provide best execution.9 The proposed rule change, as modified by Amendment Nos. 3 and 4, was published for comment in the Federal Register on October 26, 2005.10 The Commission received one additional comment letter on the proposed rule change after it was published for the second time.11 On May 17, 2006, NASD filed Amendment No. 5.12 This order approves the proposed rule change, as modified by Amendment Nos. 1–5.13 II. Summary of Comments mstockstill on PROD1PC61 with NOTICES The Commission received a total of five comment letters from three commenters on the proposed rule change.14 The SIA notes that NASD made several positive changes to the proposed rule in Amendment No. 2.15 However, the SIA, the BMA and Instinet all take issue with NASD requiring a member to provide best execution to the customer of another broker-dealer. The commenters assert that the recipient broker-dealer does not have a relationship with the customer and thus should not be subject to the rule, or if subject to the rule, the SIA suggests that, if the recipient broker-dealer complies with the terms and conditions of the order, as communicated by the originating broker-dealer, the recipient broker-dealer should have fulfilled its best execution obligation under the rule.16 The BMA, while objecting to this requirement, also believes that the Best Execution Rule should not apply to the 8 See letter from Marjorie Gross, Senior Vice President and Regulatory Counsel, BMA, to Jonathan G. Katz, Secretary, Commission, dated September 7, 2005 (‘‘BMA Letter 2’’). 9 See Amendment No. 4. 10 See Securities Exchange Act Release No. 52637 (October 19, 2005), 70 FR 61861. 11 See letter from Michele C. David, VP and AGC, BMA, to Jonathan G. Katz, Secretary, Commission, dated November 16, 2005 (‘‘BMA Letter 3’’). 12 Amendment No. 5 is a technical amendment. With Amendment No. 5, NASD took the substance of Amendment Nos. 3 and 4 and placed that information in IM–2320. 13 In August 2005, the Commission approved two related proposed rule changes: SR–NASD–2004– 045, which prohibits members from trading ahead of customer market orders in certain circumstances, and SR–NASD–2004–089, which provides additional limit order protection by requiring members to provide price improvement under certain circumstances. See Securities Exchange Act Release Nos. 52226 (August 9, 2005), 70 FR 48219 (August 16, 2005), and 52210 (August 4, 2005), 70 FR 46897 (August 11, 2005). 14 See footnotes 6, 8 and 11, supra. 15 See SIA Letter at 2. 16 Id. VerDate Aug<31>2005 15:09 Aug 25, 2006 Jkt 208001 bond market.17 According to the BMA, the rule would cause problems in the bond market because of the way the market operates.18 In addition, the BMA believes that the wording of the rule demonstrates that it was not intended to apply to the bond market.19 After the Commission’s receipt of Amendment No. 3, the BMA submitted a second comment letter that reiterates its concerns with the proposal, and states its belief that Amendment No. 3 does not adequately address the BMA’s concerns.20 Instinet raises two additional points. First, Instinet argues that use of the term ‘‘market center’’ creates a competitive disadvantage because the rule would not apply to market centers operated by NASD and other self-regulatory organizations (‘‘SROs’’).21 Instinet asks that NASD either exclude memberoperated electronic communications networks (‘‘ECNs’’) or alternative trading systems (‘‘ATSs’’) that interact with orders on a fully automated basis from the rule, or apply the same obligations to the Nasdaq Market Center and the BRUT facility. Second, Instinet asks that implementation of the proposed rule change be delayed pending Commission action on Regulation NMS, including interpretive guidance with respect to the obligations of market centers under the trade through proposal.22 III. NASD Response to Comments In response to the comments, NASD filed Amendment Nos. 3 and 4 to the proposed rule change.23 In Amendment No. 3, NASD states that the failure to apply the Best Execution Rule to recipient broker-dealers is contrary to the interests of the investing public as well as the general intent of the Best Execution Rule itself. As amended, the rule requires a member to use reasonable diligence to ascertain the best market for the particular security and to buy or sell in that market so that the price to the customer is as favorable as possible under the prevailing market conditions. The rule contains five factors that NASD will consider in determining if the broker-dealer used reasonable diligence to ascertain the 17 See BMA Letter at 2, 5. at 1. 19 Id. at 2. 20 See BMA Letter 2. The Commission notes that the BMA reasserts the concerns it raises in BMA Letters 1 and 2 in BMA Letter 3, and further states that the proposed rule change is deficient because it does not specifically address how certain provisions of the proposal pertain to the bond market. BMA Letter 3 at 1–2. 21 See Instinet Letter at 2 and 3. 22 Id. at 3. 23 See footnotes 7 and 9, supra. 18 Id. PO 00000 Frm 00079 Fmt 4703 Sfmt 4703 best market for the security. Whether the broker-dealer used reasonable diligence is factored into the determination of whether the brokerdealer has met its best execution obligation. NASD amended the proposed rule change to replace the term ‘‘market center’’ with the term ‘‘market,’’ which is a broader term. According to NASD, this change was made to address the BMA’s concern that the term ‘‘market center’’ is not relevant in the bond market, as well as Instinet’s concern with respect to the proposed rule creating a competitive disadvantage. As amended, the Best Execution Rule will apply to all trading venues. In response to the BMA’s assertion that the proposed rule should not apply to the bond market, NASD stated the rule has ‘‘never been limited to equity securities.’’ NASD cites to Rule 0116, which enumerates the NASD rules that apply to government and other exempt securities.24 The BMA argues that the bond market is not subject to the same requirements as the equities markets, e.g. a firm quote requirement, pre-trade quote transparency, a uniform, regulated inter-dealer market and an inter-dealer linkage.25 NASD acknowledges the differences in market structure and regulations between the equities markets and the bond markets and notes that, at the time NASD adopted the Best Execution Rule, the equities markets operated in a framework similar to the current framework for bond trading. Furthermore, NASD stated that the term ‘‘quotation’’ refers to either dollar (or other currency) pricing or yield pricing, for purposes of debt, and that accessibility of quotations is a factor in determining if the member used reasonable diligence. If quotations are readily available for a particular debt security, NASD will factor this into its assessment of whether the member complied with its obligations under the rule. In response to BMA Letter 2, NASD clarified the scope of the proposed rule change by stating that a member’s duty to provide best execution to customer orders received from other broker-dealers arises when an order is routed to the member for the 24 See Securities Exchange Act Release No. 44631 (July 31, 2001), 66 FR 41283 (August 7, 2001)(SR– NASD–2000–38)(order approving NASD Rule 0116)(’’Exempted Securities Order’’). See also, Securities Exchange Act Release No. 37588 (August 20, 1996), 61 FR 44100 (August 27, 1996)(order approving NASD’s proposal implementing the expanded sales practice authority granted to NASD pursuant to the Government Securities Act Amendments of 1993 and listing the NASD rules that would apply to exempted securities. Among the rules was the Best Execution Rule. 25 See BMA Letter at 4. E:\FR\FM\28AUN1.SGM 28AUN1 Federal Register / Vol. 71, No. 166 / Monday, August 28, 2006 / Notices purpose of order handling and execution.26 Amendment No. 5 is purely a technical amendment, as its substance was published for notice and comment in Amendment Nos. 3 and 4. With Amendment No. 5, NASD took the substance of Amendment Nos. 3 and 4 and placed that information in IM–2320. mstockstill on PROD1PC61 with NOTICES IV. Discussion and Commission Findings The Commission has reviewed carefully the proposed rule change, the comment letters, and NASD’s response to the comments, and believes that NASD has responded appropriately to the concerns raised by the commenters. The Commission 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, and, in particular, with Section 15A(b)(6) of the Act, 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.27 Regarding the commenters’ assertion that a recipient broker-dealer’s compliance with the terms and conditions of the order, as communicated by the originating broker-dealer, solely, should constitute satisfaction of the duty of best execution with regard to routed orders, the Commission believes that such compliance should be considered a significant factor in determining if the recipient broker-dealer has met its duty of best execution, but should not be the sole factor to consider. In Amendment Nos. 3 and 4, NASD addressed the concerns raised by commenters. In response to issues raised by the BMA, NASD changed the terminology of the proposed rule change, replacing ‘‘market center’’ with ‘‘market’’ and stating that it will interpret the term broadly. Additionally, the Commission notes that the Best Execution Rule currently applies to the bond markets.28 NASD indicated in its amendment how it intends to apply the factors in the rule that provide evidence of reasonable diligence in the context of the bond market, and how it will interpret price 26 See footnote 9, supra. U.S.C. 78o-3(b)(6). 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). 28 See footnote 24, supra, and Exempted Securities Order. 27 15 VerDate Aug<31>2005 15:09 Aug 25, 2006 Jkt 208001 50961 in connection with debt. In Amendment No. 4, NASD made a clear distinction between a member’s duties when acting as provider of liquidity versus acting as an order handler for another brokerdealer. The Commission believes that the revisions clarify how the rule applies in the context of the debt market. Furthermore, the Commission notes that, at the time NASD adopted its Best Execution Rule, the equity markets were subject to a regulatory regime similar to the one under which the bond markets operate today.29 The Commission expects that the NASD will take into account the structure and operation of the debt markets when applying the rule to debt market participants. With regard to the commenters’ claim that the proposal would create an unfair competitive disparity between otherwise similarly situated market centers that execute orders on an electronic agency basis, the Commission notes that electronic communications networks (‘‘ECNs’’) are subject to a different regulatory regime than SROs. ECNs are broker-dealers by definition, and must be members of an SRO; consequently ECNs are subject to SRO rules. Moreover, the Commission believes the proposed rule change, as amended, will not unfairly affect ECN operations. With respect to the commenters’ concern that implementation of this proposal should be delayed until after the Commission has adopted guidance under the trade through proposal of Regulation NMS, the Commission notes that the Commission adopted Regulation NMS subsequent to the commenters filing their comment letters. Finally, the Commission views markup obligations and the duty of best execution as separate and distinct requirements. NASD Rule 2320(f) states that best execution obligations ‘‘do not relate to the reasonableness of commission rates, markups or markdowns which are governed by Rule 2440 and IM–2440.’’ proposed rule change (SR–NASD–2004– 026), as modified by Amendment Nos. 1–5, be, and it hereby is, approved. V. Conclusion It is therefore ordered, pursuant to Section 19(b)(2) of the Act,30 that the NASD proposes to amend NASD Rule 2860 to extend a pilot program increasing certain options position and exercise limits. The text of the proposed rule change is available on NASD’s Web site (https://www.nasd.com), at NASD’s principal office, and at the Commission’s Public Reference Room. 29 As NASD notes, in 1968 when the Best Execution Rule was adopted, the market for equity securities was much different than it is today. For example, there was no consolidated tape and thus no readily available trade or quotation information. Market makers in over-the-counter securities conducted transactions via telephone, after checking prices either in the pink sheets or by information they obtained using the telephone. In addition, there was no requirement to report transactions to NASD within 90 seconds. 30 30 15 U.S.C. 78s(b)(2). PO 00000 Frm 00080 Fmt 4703 Sfmt 4703 For the Commission, by the Division of Market Regulation, pursuant to delegated authority.31 Nancy M. Morris, Secretary. [FR Doc. E6–14196 Filed 8–25–06; 8:45 am] BILLING CODE 8010–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–54334; File No. SR–NASD– 2006–097] Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Notice of Filing and Immediate Effectiveness of Proposed Rule Change To Extend a Pilot Program That Increases Position and Exercise Limits for Certain Equity Options August 18, 2006 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 August 10, 2006, the National Association of Securities Dealers, Inc. (‘‘NASD’’) filed with the Securities and Exchange Commission (‘‘Commission’’) the proposed rule change as described in Items I and II below, which Items have been prepared by NASD. NASD has filed the proposal as a ‘‘noncontroversial’’ rule change pursuant to Section 19(b)(3)(A) of the Act 3 and Rule 19b–4(f)(6) thereunder,4 which renders it effective upon filing with the Commission. 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 31 17 CFR 200.30–3(a)(12). U.S.C. 78s(b)(1). 2 17 CFR 240.19b–4. 3 15 U.S.C. 78s(b)(3)(A). 4 17 CFR 240.19b–4(f)(6). 1 15 E:\FR\FM\28AUN1.SGM 28AUN1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 71, Number 166 (Monday, August 28, 2006)]
[Notices]
[Pages 50959-50961]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E6-14196]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54339; File No. SR-NASD-2004-026]


 Self-Regulatory Organizations; National Association of 
Securities Dealers, Inc.; Order Approving Proposed Rule Change as 
Modified by Amendment Nos. 1-5 To Amend NASD Rule 2320(a) Governing 
Best Execution

August 21, 2006.

I. Introduction

    On February 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 amend NASD Rule 2320(a) 
(``Best Execution Rule''). On May 11, 2004, NASD amended the proposed 
rule change.\3\ On February 14, 2005, NASD amended the proposed rule 
change a second time.\4\ The proposed rule change, as modified by 
Amendment Nos. 1 and 2, was published for comment in the Federal 
Register on February 25, 2005.\5\ The Commission received three comment 
letters on the proposal.\6\ On June 22, 2005, NASD filed a response to 
comments, and simultaneously amended the proposal.\7\ The Commission 
received one comment

[[Page 50960]]

letter regarding NASD's response.\8\ On September 22, 2005, NASD filed 
an amendment to modify the purpose section of the proposal, clarifying 
the scope of a member's duty to provide best execution.\9\ The proposed 
rule change, as modified by Amendment Nos. 3 and 4, was published for 
comment in the Federal Register on October 26, 2005.\10\ The Commission 
received one additional comment letter on the proposed rule change 
after it was published for the second time.\11\ On May 17, 2006, NASD 
filed Amendment No. 5.\12\ This order approves the proposed rule 
change, as modified by Amendment Nos. 1-5.\13\
---------------------------------------------------------------------------

    \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 Securities Exchange Act Release No. 51229 (February 18, 
2005), 70 FR 9416. The proposed rule change was published a second 
time on October 26, 2005. See footnote 10 infra.
    \6\ See letters from Amal Aly, Vice President(``VP'') and 
Associate General Counsel (``AGC''), and Ann Vlcek, VP and AGC, 
Securities Industry Association (``SIA'') dated March 18, 2005 
(``SIA Letter''); Paul A. Merolla, Executive Vice President and 
General Counsel, Instinet Group, Inc. (``Instinet'') dated March 22, 
2005 (``Instinet Letter''); Micah S. Green, President and Michele C. 
David, VP and AGC, The Bond Market Association (``BMA'') dated April 
5, 2005 (``BMA Letter''), to Jonathan G. Katz, Secretary, 
Commission. The Commission received one additional comment letter 
after NASD filed its response to comments, and another letter after 
the proposed rule change was republished on October 26, 2005. See 
footnotes 8, 10 and 11, infra.
    \7\ See Amendment No. 3.
    \8\ See letter from Marjorie Gross, Senior Vice President and 
Regulatory Counsel, BMA, to Jonathan G. Katz, Secretary, Commission, 
dated September 7, 2005 (``BMA Letter 2'').
    \9\ See Amendment No. 4.
    \10\ See Securities Exchange Act Release No. 52637 (October 19, 
2005), 70 FR 61861.
    \11\ See letter from Michele C. David, VP and AGC, BMA, to 
Jonathan G. Katz, Secretary, Commission, dated November 16, 2005 
(``BMA Letter 3'').
    \12\ Amendment No. 5 is a technical amendment. With Amendment 
No. 5, NASD took the substance of Amendment Nos. 3 and 4 and placed 
that information in IM-2320.
    \13\ In August 2005, the Commission approved two related 
proposed rule changes: SR-NASD-2004-045, which prohibits members 
from trading ahead of customer market orders in certain 
circumstances, and SR-NASD-2004-089, which provides additional limit 
order protection by requiring members to provide price improvement 
under certain circumstances. See Securities Exchange Act Release 
Nos. 52226 (August 9, 2005), 70 FR 48219 (August 16, 2005), and 
52210 (August 4, 2005), 70 FR 46897 (August 11, 2005).
---------------------------------------------------------------------------

II. Summary of Comments

    The Commission received a total of five comment letters from three 
commenters on the proposed rule change.\14\ The SIA notes that NASD 
made several positive changes to the proposed rule in Amendment No. 
2.\15\ However, the SIA, the BMA and Instinet all take issue with NASD 
requiring a member to provide best execution to the customer of another 
broker-dealer. The commenters assert that the recipient broker-dealer 
does not have a relationship with the customer and thus should not be 
subject to the rule, or if subject to the rule, the SIA suggests that, 
if the recipient broker-dealer complies with the terms and conditions 
of the order, as communicated by the originating broker-dealer, the 
recipient broker-dealer should have fulfilled its best execution 
obligation under the rule.\16\
---------------------------------------------------------------------------

    \14\ See footnotes 6, 8 and 11, supra.
    \15\ See SIA Letter at 2.
    \16\ Id.
---------------------------------------------------------------------------

    The BMA, while objecting to this requirement, also believes that 
the Best Execution Rule should not apply to the bond market.\17\ 
According to the BMA, the rule would cause problems in the bond market 
because of the way the market operates.\18\ In addition, the BMA 
believes that the wording of the rule demonstrates that it was not 
intended to apply to the bond market.\19\ After the Commission's 
receipt of Amendment No. 3, the BMA submitted a second comment letter 
that reiterates its concerns with the proposal, and states its belief 
that Amendment No. 3 does not adequately address the BMA's 
concerns.\20\
---------------------------------------------------------------------------

    \17\ See BMA Letter at 2, 5.
    \18\ Id. at 1.
    \19\ Id. at 2.
    \20\ See BMA Letter 2. The Commission notes that the BMA 
reasserts the concerns it raises in BMA Letters 1 and 2 in BMA 
Letter 3, and further states that the proposed rule change is 
deficient because it does not specifically address how certain 
provisions of the proposal pertain to the bond market. BMA Letter 3 
at 1-2.
---------------------------------------------------------------------------

    Instinet raises two additional points. First, Instinet argues that 
use of the term ``market center'' creates a competitive disadvantage 
because the rule would not apply to market centers operated by NASD and 
other self-regulatory organizations (``SROs'').\21\ Instinet asks that 
NASD either exclude member-operated electronic communications networks 
(``ECNs'') or alternative trading systems (``ATSs'') that interact with 
orders on a fully automated basis from the rule, or apply the same 
obligations to the Nasdaq Market Center and the BRUT facility. Second, 
Instinet asks that implementation of the proposed rule change be 
delayed pending Commission action on Regulation NMS, including 
interpretive guidance with respect to the obligations of market centers 
under the trade through proposal.\22\
---------------------------------------------------------------------------

    \21\ See Instinet Letter at 2 and 3.
    \22\ Id. at 3.
---------------------------------------------------------------------------

III. NASD Response to Comments

    In response to the comments, NASD filed Amendment Nos. 3 and 4 to 
the proposed rule change.\23\ In Amendment No. 3, NASD states that the 
failure to apply the Best Execution Rule to recipient broker-dealers is 
contrary to the interests of the investing public as well as the 
general intent of the Best Execution Rule itself. As amended, the rule 
requires a member to use reasonable diligence to ascertain the best 
market for the particular security and to buy or sell in that market so 
that the price to the customer is as favorable as possible under the 
prevailing market conditions. The rule contains five factors that NASD 
will consider in determining if the broker-dealer used reasonable 
diligence to ascertain the best market for the security. Whether the 
broker-dealer used reasonable diligence is factored into the 
determination of whether the broker-dealer has met its best execution 
obligation.
---------------------------------------------------------------------------

    \23\ See footnotes 7 and 9, supra.
---------------------------------------------------------------------------

    NASD amended the proposed rule change to replace the term ``market 
center'' with the term ``market,'' which is a broader term. According 
to NASD, this change was made to address the BMA's concern that the 
term ``market center'' is not relevant in the bond market, as well as 
Instinet's concern with respect to the proposed rule creating a 
competitive disadvantage. As amended, the Best Execution Rule will 
apply to all trading venues.
    In response to the BMA's assertion that the proposed rule should 
not apply to the bond market, NASD stated the rule has ``never been 
limited to equity securities.'' NASD cites to Rule 0116, which 
enumerates the NASD rules that apply to government and other exempt 
securities.\24\ The BMA argues that the bond market is not subject to 
the same requirements as the equities markets, e.g. a firm quote 
requirement, pre-trade quote transparency, a uniform, regulated inter-
dealer market and an inter-dealer linkage.\25\ NASD acknowledges the 
differences in market structure and regulations between the equities 
markets and the bond markets and notes that, at the time NASD adopted 
the Best Execution Rule, the equities markets operated in a framework 
similar to the current framework for bond trading. Furthermore, NASD 
stated that the term ``quotation'' refers to either dollar (or other 
currency) pricing or yield pricing, for purposes of debt, and that 
accessibility of quotations is a factor in determining if the member 
used reasonable diligence. If quotations are readily available for a 
particular debt security, NASD will factor this into its assessment of 
whether the member complied with its obligations under the rule. In 
response to BMA Letter 2, NASD clarified the scope of the proposed rule 
change by stating that a member's duty to provide best execution to 
customer orders received from other broker-dealers arises when an order 
is routed to the member for the

[[Page 50961]]

purpose of order handling and execution.\26\
---------------------------------------------------------------------------

    \24\ See Securities Exchange Act Release No. 44631 (July 31, 
2001), 66 FR 41283 (August 7, 2001)(SR-NASD-2000-38)(order approving 
NASD Rule 0116)(''Exempted Securities Order''). See also, Securities 
Exchange Act Release No. 37588 (August 20, 1996), 61 FR 44100 
(August 27, 1996)(order approving NASD's proposal implementing the 
expanded sales practice authority granted to NASD pursuant to the 
Government Securities Act Amendments of 1993 and listing the NASD 
rules that would apply to exempted securities. Among the rules was 
the Best Execution Rule.
    \25\ See BMA Letter at 4.
    \26\ See footnote 9, supra.
---------------------------------------------------------------------------

    Amendment No. 5 is purely a technical amendment, as its substance 
was published for notice and comment in Amendment Nos. 3 and 4. With 
Amendment No. 5, NASD took the substance of Amendment Nos. 3 and 4 and 
placed that information in IM-2320.

IV. Discussion and Commission Findings

    The Commission has reviewed carefully the proposed rule change, the 
comment letters, and NASD's response to the comments, and believes that 
NASD has responded appropriately to the concerns raised by the 
commenters. The Commission 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, 
and, in particular, with Section 15A(b)(6) of the Act, 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.\27\ Regarding the 
commenters' assertion that a recipient broker-dealer's compliance with 
the terms and conditions of the order, as communicated by the 
originating broker-dealer, solely, should constitute satisfaction of 
the duty of best execution with regard to routed orders, the Commission 
believes that such compliance should be considered a significant factor 
in determining if the recipient broker-dealer has met its duty of best 
execution, but should not be the sole factor to consider. In Amendment 
Nos. 3 and 4, NASD addressed the concerns raised by commenters. In 
response to issues raised by the BMA, NASD changed the terminology of 
the proposed rule change, replacing ``market center'' with ``market'' 
and stating that it will interpret the term broadly. Additionally, the 
Commission notes that the Best Execution Rule currently applies to the 
bond markets.\28\ NASD indicated in its amendment how it intends to 
apply the factors in the rule that provide evidence of reasonable 
diligence in the context of the bond market, and how it will interpret 
price in connection with debt. In Amendment No. 4, NASD made a clear 
distinction between a member's duties when acting as provider of 
liquidity versus acting as an order handler for another broker-dealer. 
The Commission believes that the revisions clarify how the rule applies 
in the context of the debt market. Furthermore, the Commission notes 
that, at the time NASD adopted its Best Execution Rule, the equity 
markets were subject to a regulatory regime similar to the one under 
which the bond markets operate today.\29\ The Commission expects that 
the NASD will take into account the structure and operation of the debt 
markets when applying the rule to debt market participants.
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    \27\ 15 U.S.C. 78o-3(b)(6). 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).
    \28\ See footnote 24, supra, and Exempted Securities Order.
    \29\ As NASD notes, in 1968 when the Best Execution Rule was 
adopted, the market for equity securities was much different than it 
is today. For example, there was no consolidated tape and thus no 
readily available trade or quotation information. Market makers in 
over-the-counter securities conducted transactions via telephone, 
after checking prices either in the pink sheets or by information 
they obtained using the telephone. In addition, there was no 
requirement to report transactions to NASD within 90 seconds.
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    With regard to the commenters' claim that the proposal would create 
an unfair competitive disparity between otherwise similarly situated 
market centers that execute orders on an electronic agency basis, the 
Commission notes that electronic communications networks (``ECNs'') are 
subject to a different regulatory regime than SROs. ECNs are broker-
dealers by definition, and must be members of an SRO; consequently ECNs 
are subject to SRO rules. Moreover, the Commission believes the 
proposed rule change, as amended, will not unfairly affect ECN 
operations.
    With respect to the commenters' concern that implementation of this 
proposal should be delayed until after the Commission has adopted 
guidance under the trade through proposal of Regulation NMS, the 
Commission notes that the Commission adopted Regulation NMS subsequent 
to the commenters filing their comment letters.
    Finally, the Commission views markup obligations and the duty of 
best execution as separate and distinct requirements. NASD Rule 2320(f) 
states that best execution obligations ``do not relate to the 
reasonableness of commission rates, markups or markdowns which are 
governed by Rule 2440 and IM-2440.''

V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\30\ that the proposed rule change (SR-NASD-2004-026), as modified 
by Amendment Nos. 1-5, be, and it hereby is, approved.
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    \30\ 30 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\31\
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    \31\ 17 CFR 200.30-3(a)(12).
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Nancy M. Morris,
Secretary.
 [FR Doc. E6-14196 Filed 8-25-06; 8:45 am]
BILLING CODE 8010-01-P

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