Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Order Approving Proposed Rule Change and Notice of Filing and Order Granting Accelerated Approval to Amendment No. 1 Thereto Relating to Expansion of OATS Reporting Requirements to OTC Equity Securities, 61112-61115 [E6-17167]

Download as PDF 61112 Federal Register / Vol. 71, No. 200 / Tuesday, October 17, 2006 / Notices 2. Statutory Basis Electronic Comments The Exchange believes that the proposed rule change is consistent with Section 6(b) of the Act,4 in general, and furthers the objectives of Sections 6(b)(1) and 6(b)(5) of the Act,5 in particular in that it will enhance the ability of the Exchange to enforce compliance by its members and persons associated with its members with the provisions of the Act, the rules and regulations thereunder, and the rules of the Exchange; and it is designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to foster cooperation and coordination with persons engaged in facilitating transactions in securities, and to remove impediments to and perfect the mechanism of a free and open market and a national market system. • 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–Amex–2006–57 on the subject line. B. Self-Regulatory Organization’s Statement on Burden on Competition The Exchange does not believe that the proposed rule change will result in any burden on competition that is not necessary or appropriate in furtherance of the purposes of the Act. C. Self-Regulatory Organization’s Statement on Comments on the Proposed Rule Change Received From Members, Participants or Others Written comments were neither solicited nor received. III. Date of Effectiveness of the Proposed Rule Change and Timing for Commission Action Within 35 days of the date of publication of this notice in the Federal Register or within such longer period (i) As the Commission may designate up to 90 days of such date if it finds such longer period to be appropriate and publishes its reasons for so finding or (ii) as to which the Exchange 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. bajohnson on PROD1PC69 with NOTICES 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: 4 15 5 15 U.S.C. 78f(b). U.S.C. 78f(b)(1) and (b)(5). VerDate Aug<31>2005 04:06 Oct 18, 2006 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–Amex–2006–57. This file number should be included on the subject line if e-mail is used. To help the Commission process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s Internet Web site (https://www.sec.gov/ rules/sro.shtml). Copies of the submission, all subsequent amendments, all written statements with respect to the proposed rule change that are filed with the Commission, and all written communications relating to the proposed rule change between the Commission and any person, other than those that may be withheld from the public in accordance with the provisions of 5 U.S.C. 552, will be available for inspection and copying in the Commission’s Public Reference Room. Copies of such filing also will be available for inspection and copying at the principal office of the Amex. 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–Amex–2006–57 and should be submitted on or before November 7, 2006. For the Commission, by the Division of Market Regulation, pursuant to delegated authority.6 Jill M. Peterson, Assistant Secretary. [FR Doc. E6–17169 Filed 10–16–06; 8:45 am] BILLING CODE 8011–01–P 6 17 Jkt 211001 PO 00000 CFR 200.30–3(a)(12). Frm 00099 Fmt 4703 Sfmt 4703 SECURITIES AND EXCHANGE COMMISSION [Release No. 34–54585; File No. SR–NASD– 2005–101] Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Order Approving Proposed Rule Change and Notice of Filing and Order Granting Accelerated Approval to Amendment No. 1 Thereto Relating to Expansion of OATS Reporting Requirements to OTC Equity Securities October 10, 2006. I. Introduction On August 25, 2005, 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 the proposed rule change relating to expansion of the Order Audit Trail System (‘‘OATS’’) reporting requirements to OTC equity securities. The proposed rule change was published for comment in the Federal Register on October 18, 2005.3 The Commission received three comment letters on the proposal.4 NASD filed Partial Amendment No. 1 to the proposed rule change on September 21, 2006 (‘‘Amendment No. 1’’).5 This order approves the proposed rule change, grants accelerated approval to Amendment No. 1, and solicits 1 15 U.S.C. 78s(b)(l). CFR 240.19b–4. 3 See Securities Exchange Act Release No. 52581 (October 11, 2006), 70 FR 60592 (the ‘‘Notice’’). 4 Two comment letters were specific to this proposal. See letters to Jonathan G. Katz, Secretary, Commission, from John Polanin Jr., Chair, SIA SelfRegulation and Supervisory Practices Committee, dated December 2, 2005 (‘‘SIA Letter’’) and from Phylis M. Esposito, Executive Vice President, Chief Strategy Officer, Ameritrade, Inc., dated November 8, 2005 (‘‘Ameritrade Letter’’). One comment letter expressed general opposition to OATS. See letter filed via the Commission’s Web Comment Form, from Rich Bertematti, dated September 7, 2006 (‘‘Bertematti Letter’’). In addition, NASD received comment letters about the proposed rule change following publication in NASD’s Notice to Members 04–80 (November 2004). NASD addressed those comment letters in the Notice. 5 In Amendment No. 1, NASD proposes to (1) amend NASD Rule 6955(b)(2) to clarify that members will not be required to comply with OATS reporting obligations with respect to an OTC equity security until a symbol has been assigned to the security; (2) exclude direct participation programs (‘‘DPPs’’) from the proposed definition of ‘‘OTC equity security;’’ (3) extend the implementation period; and (4) make technical changes necessary in light of the commencement of The NASDAQ Stock Market LLC (‘‘Nasdaq’’) as a national securities exchange. NASD also responded to comment letters received. 2 17 E:\FR\FM\17OCN1.SGM 17OCN1 Federal Register / Vol. 71, No. 200 / Tuesday, October 17, 2006 / Notices A. Scope of a Member’s OATS Obligations Relating to OTC Equity Securities comments from interested persons on Amendment No. 1. II. Description of the Proposed Rule Change NASD Rules 6950 through 6957 impose obligations on member firms to record in electronic form and report to NASD on a daily basis certain information with respect to orders originated, received, transmitted, modified, canceled or executed by NASD members relating to equity securities listed and traded on Nasdaq. OATS captures this order information and integrates it with quote and transaction information to create a timesequenced record of orders, quotes and transactions. NASD believes this information is critical to its conducting surveillance and investigations of member firms for violations of NASD rules and Federal securities laws. To enhance the effectiveness of OATS as a regulatory tool, NASD proposes to amend NASD Rules 6951, 6952, and 6955 to require members to record and report to OATS order information relating to OTC equity securities.6 Currently, the OATS requirements do not apply to OTC equity securities and as a result, NASD is unable to recreate, on an automated basis, an order and transaction audit trail for these securities. NASD believes that expanding OATS requirements to these securities would enhance its ability to review and examine for member compliance with certain trading rules, including, but not limited to, NASD’s rules governing best execution and interpositioning,7 limit order protection,8 and offers at stated prices.9 In addition, NASD proposes two technical changes that are necessary given the commencement of Nasdaq as a national securities exchange. III. Summary of Comments bajohnson on PROD1PC69 with NOTICES 6 NASD proposes to define ‘‘OTC equity security’’ as any equity security that: (1) Is not listed on a national securities exchange; or (2) is listed on one or more regional stock exchanges and does not qualify for dissemination of transaction reports via the facilities of the Consolidated Tape. 7 NASD Rule 2320. 8 NASD Rule 6541. 9 NASD Rule 3320. 10 See supra, note 4. 04:06 Oct 18, 2006 One of the commenters requested clarification of the definition and scope of ‘‘OTC equity security’’ and suggested that the appropriate scope of OATS reporting should include only those securities currently subject to Automated Confirmation Transaction (‘‘ACT’’) Service reporting requirements.11 NASD responded that it does not believe that the scope of the proposed definition of ‘‘OTC equity security’’ should be limited as suggested by this commenter and stated that, as originally proposed, members should be required to record and report OATS information for all OTC equity securities. However, to address the situation where an OTC equity security does not have a symbol assigned to it at the time an OATS order event occurs, NASD proposed a clarifying change in Amendment No. 1 whereby, pursuant to NASD Rule 6955(b)(2), members would not be required to comply with their OATS reporting obligations with respect to an OTC equity security until a symbol has been assigned to that security.12 NASD explained that members would still have an obligation to immediately record all other applicable OATS information in accordance with the provisions of NASD Rule 6954, irrespective of whether the security has a symbol assigned to it at the time the order is originated or received.13 NASD represented to the Commission that it would detail these obligations under NASD Rules 6954 and 6955 in a Notice to Members and the revised OATS Technical Specifications,14 both of 11 See SIA Letter, supra note 4, at 4. proposing this exception from the reporting obligations, NASD emphasized that members should be diligent in their efforts to obtain a symbol, as necessary, for securities they wish to trade so that they can comply with their trade reporting obligations under NASD Rule 6620. NASD Rule 6620(c)(1) requires that each trade report include the symbol of the OTC equity security; trade reports that do not contain this information are rejected by the system. In addition, NASD noted that members have an obligation to report trades within ninety seconds of execution or on a next-day basis, as applicable under Rule 6620(a). 13 NASD stated that it does not believe that members should face any technological difficulties in recording OATS information for an OTC equity security that does not have a symbol assigned to it, but the extended implementation period should allow sufficient time to address any such problems. 14 NASD states that since OATS Phase III has been implemented, it does not expect any significant changes to the OATS Technical Specifications as a result of this proposed rule change. NASD anticipates that the only such change 12 In The Commission received comment letters in response to the publication of the notice in the Federal Register.10 The primary issues two of the commenters raised concern the scope of a member’s obligations to record and report OATS information relating to OTC equity securities and the timing of the proposed rule change. VerDate Aug<31>2005 1. Comments Relating to the Issuance of a Security Symbol Jkt 211001 PO 00000 Frm 00100 Fmt 4703 Sfmt 4703 61113 which NASD will publish following this approval of the proposed rule change. 2. Comments Relating to DPPs One commenter stated that DPPs should not be OATS reportable because they are ‘‘effectively subscriptions, not trades’’ and sold through a process that is not captured in automated systems within the firm.15 Additionally, this commenter stated that the volume for these securities is low, and OATS reporting may discourage the sale of such products.16 In response to the concerns raised by this commenter, NASD proposed in Amendment No. 1 to exclude DPPs from the definition of ‘‘OTC equity security.’’ NASD stated, however, that it would continue to monitor member activities relating to DPPs and may determine, at a later date, that applying OATS requirements to DPPs is appropriate. If that situation arises, NASD represented that it would submit a proposed rule change. 3. Additional Comments One commenter stated that members should not be required to identify the type of security (e.g., Nasdaq, OTCBB, Pink Sheets) in OATS reports and suggested that NASD provide a list of all OATS reportable securities, so that members do not have to rely on third party vendors for this information.17 NASD responded that it will not require at this time that members identify the type of security as part of their OATS obligations. In addition, NASD stated it would provide a list of OTC equity securities that are subject to the OATS requirements on the OATS Web site.18 This same commenter also suggested that OATS should be capable of recognizing stocks that have had symbol changes and suggested that using the CUSIP number instead of the security symbol may be appropriate.19 NASD responded by stating that a change to CUSIP number rather than security symbol would be costly and burdensome and is unnecessary because NASD’s OATS system is able to track symbol changes (e.g., where an ‘‘E’’ is appended to the symbol of an OTCBB issuer that is delinquent in its SEC filings). One commenter stated that it understands OATS reporting is not required for OTC options, derivatives or would be expansion of the list of securities that are OATS reportable. 15 See SIA Letter, supra note 4, at 4–5. 16 Id. 17 See Ameritrade Letter, supra note 4, at 2. 18 This list can currently be found under the Symbol Directory at https://www.nasdaqtrader.com/ trader/symboldirectory/symbol.stm. 19 See Ameritrade Letter, supra note 4, at 2. E:\FR\FM\17OCN1.SGM 17OCN1 61114 Federal Register / Vol. 71, No. 200 / Tuesday, October 17, 2006 / Notices bajohnson on PROD1PC69 with NOTICES swaps, and with respect to foreign securities, trades effected by NASD members in the U.S. would be reportable, while trades effected by a foreign affiliate of a member would not be reportable.20 NASD confirmed that the commenter’s understanding relating to the proposed OATS reporting requirements on this point is correct. NASD stated that, in addition, with respect to non-member foreign affiliates of members, OATS obligations do not apply, provided that the order is never received or held by the member, for example, where the order originates with a foreign affiliate and is not routed to the member. NASD clarified that, with respect to orders received by members for foreign securities that otherwise meet the definition of an OTC equity security, members would have an OATS obligation, irrespective of whether the order is ultimately effected inside or outside the United States. If, for example, a member receives an order in a foreign security and routes that order to a foreign exchange for handling and execution, the member would need to record and report to OATS the receipt of that order and the route to the foreign exchange. Finally, this commenter also stated that an audit trail is not necessary for all markets and that NASD should be required to make the case that the accretive value of an order audit trail to the surveillance of the OTC market outweighs the imposition of additional costs and burdens on member firms.21 NASD responded that it does not agree that it has to meet that standard and, rather, that the standards it must satisfy in any proposed rule change are set forth in Sections 15A 22 and 19(b) of the Act.23 NASD believes it has made the requisite showing. NASD also responded that while it recognizes that the proposed rule change may impose additional costs and burdens on member firms, OATS reporting of OTC equity securities is important to NASD’s surveillance systems and regulatory program. In recognition of the potential additional burden on members, however, as discussed in greater detail below, NASD proposed to extend the implementation period of the proposed rule change. 20 See SIA Letter, supra note 4, at 4. This commenter also suggested that NASD exclude from the requirements of Rule 6620 transactions executed on a foreign exchange that is an ‘‘affiliate member’’ of the Intermarket Surveillance Group. Id. NASD has stated that Rule 6620 is not at issue in this rule filing. 21 See SIA Letter, supra note 4, at 4. 22 15 U.S.C. 78o–3. 23 15 U.S.C. 78s(b). VerDate Aug<31>2005 04:06 Oct 18, 2006 Jkt 211001 B. Timing of Proposed Rule Change One commenter stated that NASD should allow a minimum of six months for implementation of the changes necessary for OATS reporting of OTC equity securities.24 Another commenter stated that OATS for OTC equity securities should not be implemented until the industry can properly devote the personnel and technical resources necessary to achieve compliance.25 This commenter also stated that OTC markets are manual by nature, and expanding OATS reporting to OTC equity securities at this time could render obsolete all of the work that has been put into production for OATS Phase III compliance.26 NASD responded that while it does not agree that the proposed expansion of OATS reporting to OTC equity securities would have a negative impact on the work done relating to OATS Phase III, it does acknowledge the technological burdens that may be imposed on members as a result of this proposal, as well as the fact that members have a number of regulatory initiatives requiring technological and system changes. Accordingly, in Amendment No. 1, NASD proposed an implementation date of six months following publication of revised OATS Technical Specifications incorporating the proposed rule change, which will be published no later than sixty days following Commission approval of the proposed rule change.27 NASD believes that the extended implementation period will provide members sufficient time to make any adjustments necessary to implement OATS reporting for OTC equity securities, especially since, according to NASD, the technical specifications for OATS reporting of OTC equity securities would be substantially similar to the technical specifications that have been in place since July of 2006 for OATS Phase III. In addition, one commenter suggested that NASD implement certain operational and/or procedural regulations relating to the OTC marketplace, such as expansion of the trade-through protections and limit order display requirements, prior to implementation of OATS reporting requirements and that until such time, best execution standards for NMS stocks and OTC stocks will remain unequal.28 Ameritrade Letter, supra note 4, at 2. SIA Letter, supra note 4, at 2. 26 See SIA Letter, supra note 4, at 3. 27 The initial rule text as published in the notice proposed an implementation date of 120 days from publication of the OATS Reporting Technical Specifications. 28 See Ameritrade Letter, supra note 4, at 3. In response to this comment, NASD noted that it already has order handling and trading rules in effect that apply to the OTC marketplace, including, but not limited to, Rule 2320 (Best Execution and Interpositioning) and Rule 6541 (Limit Order Protection). NASD further stated that OATS reporting is necessary to enhance NASD’s ability to review and examine for member compliance with these and other rules. Finally, NASD responded to a commenter that expressed general opposition to OATS and asserted that OATS is a mechanism for NASD to generate income through fines.29 The commenter further claimed that there has been no evidence that OATS has helped the investing public or assisted in any way in improving the capital markets.30 In addition, the commenter noted the burdens that OATS imposes on members, and in particular, small firms.31 NASD responded that it is aware of the costs and technological burdens associated with the proposed rule change, and in recognition proposed an extended implementation period in Amendment No. 1. IV. Discussion and Commission Findings The Commission has reviewed carefully the proposed rule change, the comment letters, and NASD’s response to the comments. The Commission finds that the proposed rule change, as amended, is consistent with the requirements of the Act and the rules and regulations thereunder applicable to a national securities association,32 particularly Section 15A(b)(6) of the Act,33 which, among other things, requires 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, to foster cooperation and coordination with persons engaged in regulating transactions in securities, 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. As discussed above, NASD currently requires member firms to record and report order information for transactions in Nasdaq Stock Market equity securities. NASD’s OATS uses this 24 See 29 See 25 See 30 Id. PO 00000 Frm 00101 Fmt 4703 Sfmt 4703 Bertematti Letter, supra note 4, at 1. 31 Id. 32 In approving this proposed rule change, the Commission has considered the proposed rule’s impact on efficiency, competition, and capital formation. See 15 U.S.C. 78c(f). 33 15 U.S.C. 78o–3(b)(6). E:\FR\FM\17OCN1.SGM 17OCN1 Federal Register / Vol. 71, No. 200 / Tuesday, October 17, 2006 / Notices bajohnson on PROD1PC69 with NOTICES information for integration with trade and quotation information to provide NASD with an accurate time-sequenced record of orders and transactions to detect for possible violations of NASD rules and other securities laws and regulations. NASD recognizes that the trading in OTC equity securities is often more manual than Nasdaq Stock Market equity securities, and while this may result in additional burdens on member firms to capture this data electronically, NASD believes that reporting information related to OTC equity securities is critical to its surveillance program. The Commission believes that it is consistent with the Act for NASD to expand the OATS reporting requirements to include OTC equity securities to assist it in detecting possible fraud or manipulation in the trading of such securities in order to help protect investors. In addition, the Commission believes that the technical changes proposed by NASD, which NASD has noted are needed in light of Nasdaq’s operation as a national securities exchange, are not only consistent with the Act, but also necessary to clarify NASD’s rules. 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 NASD. All comments received will be posted without change; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR–NASD–2005–101 and should be submitted on or before November 7, 2006. VI. Accelerated Approval of Amendment No. 1 The Commission finds good cause for approving Amendment No. 1 to the V. Solicitation of Comments Concerning proposed rule change prior to the thirtieth day after publication for Amendment No. 1 comment in the Federal Register Interested persons are invited to pursuant to Section 19(b)(2) of the submit written data, views, and Act.34 As discussed in greater detail arguments concerning Amendment No. 1, including whether Amendment No. 1 above, in Amendment No. 1, NASD proposed revisions to clarify that to the proposed rule change is consistent with the Act. Comments may member firms do not need to comply with the OATS reporting obligations be submitted by any of the following with respect to an OTC equity security methods: until a symbol has been assigned to that Electronic Comments security. In addition, in response to a comment letter, it proposed to exclude • Use the Commission’s Internet comment form (https://www.sec.gov/ DPPs from the definition of OTC equity rules/sro.shtml); or security. Because two commenters • Send an e-mail to ruleraised issues specific to the timing of comments@sec.gov. Please include File the proposed rule change, NASD also Number SR–NASD–2005–101 on the proposed an extended implementation subject line. period in Amendment No. 1. Finally, NASD proposed two technical changes Paper Comments in Amendment No. 1 that are necessary • Send paper comments in triplicate to reflect the commencement of Nasdaq to Nancy M. Morris, Secretary, as a national securities exchange. Securities and Exchange Commission, Since the changes proposed in 100 F Street, NE., Washington, DC Amendment No. 1 address commenter 20549–1090. concerns and make changes that the All submissions should refer to File Commission believes will help clarify Number SR–NASD–2005–101. This file the proposed rule change and should number should be included on the subject line if e-mail is used. To help the assist firms by providing greater guidance, as well as time for testing Commission process and review your systems to help ensure compliance with comments more efficiently, please use only one method. The Commission will the rule, and it does not raise any new post all comments on the Commission’s issues of regulatory concern, the Commission finds good cause to Internet Web site (https://www.sec.gov/ accelerate approval of Amendment No. rules/sro.shtml). Copies of the submission, all subsequent 34 15 U.S.C. 78s(b)(2). amendments, all written statements VerDate Aug<31>2005 04:06 Oct 18, 2006 Jkt 211001 PO 00000 Frm 00102 Fmt 4703 Sfmt 4703 61115 1, consistent with Section 15A(b)(6) of the Act 35 and Section 19(b) of the Act.36 VII. Conclusion It is Therefore Ordered, pursuant to Section 19(b)(2) of the Act,37 that the proposed rule change (File No. SR– NASD–2005–101), as amended, be and hereby is, approved, and that Amendment No. 1 is approved on an accelerated basis. For the Commission, by the Division of Market Regulation, pursuant to delegated authority.38 Jill M. Peterson, Assistant Secretary. [FR Doc. E6–17167 Filed 10–16–06; 8:45 am] BILLING CODE 8011–01–P SECURITIES AND EXCHANGE COMMISSION [Release No. 34–54411A; File No. SR– NASD–2004–171] Self-Regulatory Organizations; National Association of Securities Dealers, Inc.; Order Approving Proposed Rule Change Relating to Rule 2340 Concerning Customer Account Statements October 6, 2006. Correction FR Doc. E6–15186, beginning on page 54105 in the issue of September 13, 2006,1 contained an incorrect footnote. On page 54107, in the 1st column, footnote 24 provided an incomplete description of an explanation of an interpretive position in Securities Exchange Act Release No. 31511. The corrected citation to Release No. 31511 in footnote 24 reads as follows: ‘‘See Securities Exchange Act Release No. 31511 (Nov. 24, 1992), 57 FR 56973 (Dec. 2, 1992) (amending the SEC’s net capital rule and explaining the staff’s interpretation that to avoid more stringent capital requirements under the rule, an introducing firm must ‘‘have in place a clearing agreement with a registered broker-dealer that states, for the purposes of SIPA and the Commission’s financial responsibility rules, customers are customers of the clearing, and not the introducing, firm. Furthermore, the clearing firm must issue account statements directly to customers. Each statement must contain the name and telephone number of a 35 15 U.S.C. 78o–3(b)(6). U.S.C. 78s(b). 37 15 U.S.C. 78s(b)(2). 38 17 CFR 200.30–3(a)(12). 1 See Securities Exchange Act Release No. 54411 (Sept. 7, 2006), 71 FR 54105 (Sept. 13, 2006). 36 15 E:\FR\FM\17OCN1.SGM 17OCN1

Agencies

[Federal Register Volume 71, Number 200 (Tuesday, October 17, 2006)]
[Notices]
[Pages 61112-61115]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E6-17167]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-54585; File No. SR-NASD-2005-101]


Self-Regulatory Organizations; National Association of Securities 
Dealers, Inc.; Order Approving Proposed Rule Change and Notice of 
Filing and Order Granting Accelerated Approval to Amendment No. 1 
Thereto Relating to Expansion of OATS Reporting Requirements to OTC 
Equity Securities

October 10, 2006.

I. Introduction

    On August 25, 2005, 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\ the 
proposed rule change relating to expansion of the Order Audit Trail 
System (``OATS'') reporting requirements to OTC equity securities. The 
proposed rule change was published for comment in the Federal Register 
on October 18, 2005.\3\ The Commission received three comment letters 
on the proposal.\4\ NASD filed Partial Amendment No. 1 to the proposed 
rule change on September 21, 2006 (``Amendment No. 1'').\5\ This order 
approves the proposed rule change, grants accelerated approval to 
Amendment No. 1, and solicits

[[Page 61113]]

comments from interested persons on Amendment No. 1.
---------------------------------------------------------------------------

    \1\ 15 U.S.C. 78s(b)(l).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 52581 (October 11, 
2006), 70 FR 60592 (the ``Notice'').
    \4\ Two comment letters were specific to this proposal. See 
letters to Jonathan G. Katz, Secretary, Commission, from John 
Polanin Jr., Chair, SIA Self-Regulation and Supervisory Practices 
Committee, dated December 2, 2005 (``SIA Letter'') and from Phylis 
M. Esposito, Executive Vice President, Chief Strategy Officer, 
Ameritrade, Inc., dated November 8, 2005 (``Ameritrade Letter''). 
One comment letter expressed general opposition to OATS. See letter 
filed via the Commission's Web Comment Form, from Rich Bertematti, 
dated September 7, 2006 (``Bertematti Letter''). In addition, NASD 
received comment letters about the proposed rule change following 
publication in NASD's Notice to Members 04-80 (November 2004). NASD 
addressed those comment letters in the Notice.
    \5\ In Amendment No. 1, NASD proposes to (1) amend NASD Rule 
6955(b)(2) to clarify that members will not be required to comply 
with OATS reporting obligations with respect to an OTC equity 
security until a symbol has been assigned to the security; (2) 
exclude direct participation programs (``DPPs'') from the proposed 
definition of ``OTC equity security;'' (3) extend the implementation 
period; and (4) make technical changes necessary in light of the 
commencement of The NASDAQ Stock Market LLC (``Nasdaq'') as a 
national securities exchange. NASD also responded to comment letters 
received.
---------------------------------------------------------------------------

II. Description of the Proposed Rule Change

    NASD Rules 6950 through 6957 impose obligations on member firms to 
record in electronic form and report to NASD on a daily basis certain 
information with respect to orders originated, received, transmitted, 
modified, canceled or executed by NASD members relating to equity 
securities listed and traded on Nasdaq. OATS captures this order 
information and integrates it with quote and transaction information to 
create a time-sequenced record of orders, quotes and transactions. NASD 
believes this information is critical to its conducting surveillance 
and investigations of member firms for violations of NASD rules and 
Federal securities laws.
    To enhance the effectiveness of OATS as a regulatory tool, NASD 
proposes to amend NASD Rules 6951, 6952, and 6955 to require members to 
record and report to OATS order information relating to OTC equity 
securities.\6\ Currently, the OATS requirements do not apply to OTC 
equity securities and as a result, NASD is unable to recreate, on an 
automated basis, an order and transaction audit trail for these 
securities. NASD believes that expanding OATS requirements to these 
securities would enhance its ability to review and examine for member 
compliance with certain trading rules, including, but not limited to, 
NASD's rules governing best execution and interpositioning,\7\ limit 
order protection,\8\ and offers at stated prices.\9\
---------------------------------------------------------------------------

    \6\ NASD proposes to define ``OTC equity security'' as any 
equity security that: (1) Is not listed on a national securities 
exchange; or (2) is listed on one or more regional stock exchanges 
and does not qualify for dissemination of transaction reports via 
the facilities of the Consolidated Tape.
    \7\ NASD Rule 2320.
    \8\ NASD Rule 6541.
    \9\ NASD Rule 3320.
---------------------------------------------------------------------------

    In addition, NASD proposes two technical changes that are necessary 
given the commencement of Nasdaq as a national securities exchange.

III. Summary of Comments

    The Commission received comment letters in response to the 
publication of the notice in the Federal Register.\10\ The primary 
issues two of the commenters raised concern the scope of a member's 
obligations to record and report OATS information relating to OTC 
equity securities and the timing of the proposed rule change.
---------------------------------------------------------------------------

    \10\ See supra, note 4.
---------------------------------------------------------------------------

A. Scope of a Member's OATS Obligations Relating to OTC Equity 
Securities

1. Comments Relating to the Issuance of a Security Symbol
    One of the commenters requested clarification of the definition and 
scope of ``OTC equity security'' and suggested that the appropriate 
scope of OATS reporting should include only those securities currently 
subject to Automated Confirmation Transaction (``ACT'') Service 
reporting requirements.\11\ NASD responded that it does not believe 
that the scope of the proposed definition of ``OTC equity security'' 
should be limited as suggested by this commenter and stated that, as 
originally proposed, members should be required to record and report 
OATS information for all OTC equity securities. However, to address the 
situation where an OTC equity security does not have a symbol assigned 
to it at the time an OATS order event occurs, NASD proposed a 
clarifying change in Amendment No. 1 whereby, pursuant to NASD Rule 
6955(b)(2), members would not be required to comply with their OATS 
reporting obligations with respect to an OTC equity security until a 
symbol has been assigned to that security.\12\ NASD explained that 
members would still have an obligation to immediately record all other 
applicable OATS information in accordance with the provisions of NASD 
Rule 6954, irrespective of whether the security has a symbol assigned 
to it at the time the order is originated or received.\13\ NASD 
represented to the Commission that it would detail these obligations 
under NASD Rules 6954 and 6955 in a Notice to Members and the revised 
OATS Technical Specifications,\14\ both of which NASD will publish 
following this approval of the proposed rule change.
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    \11\ See SIA Letter, supra note 4, at 4.
    \12\ In proposing this exception from the reporting obligations, 
NASD emphasized that members should be diligent in their efforts to 
obtain a symbol, as necessary, for securities they wish to trade so 
that they can comply with their trade reporting obligations under 
NASD Rule 6620. NASD Rule 6620(c)(1) requires that each trade report 
include the symbol of the OTC equity security; trade reports that do 
not contain this information are rejected by the system. In 
addition, NASD noted that members have an obligation to report 
trades within ninety seconds of execution or on a next-day basis, as 
applicable under Rule 6620(a).
    \13\ NASD stated that it does not believe that members should 
face any technological difficulties in recording OATS information 
for an OTC equity security that does not have a symbol assigned to 
it, but the extended implementation period should allow sufficient 
time to address any such problems.
    \14\ NASD states that since OATS Phase III has been implemented, 
it does not expect any significant changes to the OATS Technical 
Specifications as a result of this proposed rule change. NASD 
anticipates that the only such change would be expansion of the list 
of securities that are OATS reportable.
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2. Comments Relating to DPPs
    One commenter stated that DPPs should not be OATS reportable 
because they are ``effectively subscriptions, not trades'' and sold 
through a process that is not captured in automated systems within the 
firm.\15\ Additionally, this commenter stated that the volume for these 
securities is low, and OATS reporting may discourage the sale of such 
products.\16\ In response to the concerns raised by this commenter, 
NASD proposed in Amendment No. 1 to exclude DPPs from the definition of 
``OTC equity security.'' NASD stated, however, that it would continue 
to monitor member activities relating to DPPs and may determine, at a 
later date, that applying OATS requirements to DPPs is appropriate. If 
that situation arises, NASD represented that it would submit a proposed 
rule change.
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    \15\ See SIA Letter, supra note 4, at 4-5.
    \16\ Id.
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3. Additional Comments
    One commenter stated that members should not be required to 
identify the type of security (e.g., Nasdaq, OTCBB, Pink Sheets) in 
OATS reports and suggested that NASD provide a list of all OATS 
reportable securities, so that members do not have to rely on third 
party vendors for this information.\17\ NASD responded that it will not 
require at this time that members identify the type of security as part 
of their OATS obligations. In addition, NASD stated it would provide a 
list of OTC equity securities that are subject to the OATS requirements 
on the OATS Web site.\18\
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    \17\ See Ameritrade Letter, supra note 4, at 2.
    \18\ This list can currently be found under the Symbol Directory 
at https://www.nasdaqtrader.com/trader/symboldirectory/symbol.stm.
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    This same commenter also suggested that OATS should be capable of 
recognizing stocks that have had symbol changes and suggested that 
using the CUSIP number instead of the security symbol may be 
appropriate.\19\ NASD responded by stating that a change to CUSIP 
number rather than security symbol would be costly and burdensome and 
is unnecessary because NASD's OATS system is able to track symbol 
changes (e.g., where an ``E'' is appended to the symbol of an OTCBB 
issuer that is delinquent in its SEC filings).
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    \19\ See Ameritrade Letter, supra note 4, at 2.
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    One commenter stated that it understands OATS reporting is not 
required for OTC options, derivatives or

[[Page 61114]]

swaps, and with respect to foreign securities, trades effected by NASD 
members in the U.S. would be reportable, while trades effected by a 
foreign affiliate of a member would not be reportable.\20\ NASD 
confirmed that the commenter's understanding relating to the proposed 
OATS reporting requirements on this point is correct. NASD stated that, 
in addition, with respect to non-member foreign affiliates of members, 
OATS obligations do not apply, provided that the order is never 
received or held by the member, for example, where the order originates 
with a foreign affiliate and is not routed to the member. NASD 
clarified that, with respect to orders received by members for foreign 
securities that otherwise meet the definition of an OTC equity 
security, members would have an OATS obligation, irrespective of 
whether the order is ultimately effected inside or outside the United 
States. If, for example, a member receives an order in a foreign 
security and routes that order to a foreign exchange for handling and 
execution, the member would need to record and report to OATS the 
receipt of that order and the route to the foreign exchange.
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    \20\ See SIA Letter, supra note 4, at 4. This commenter also 
suggested that NASD exclude from the requirements of Rule 6620 
transactions executed on a foreign exchange that is an ``affiliate 
member'' of the Intermarket Surveillance Group. Id. NASD has stated 
that Rule 6620 is not at issue in this rule filing.
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    Finally, this commenter also stated that an audit trail is not 
necessary for all markets and that NASD should be required to make the 
case that the accretive value of an order audit trail to the 
surveillance of the OTC market outweighs the imposition of additional 
costs and burdens on member firms.\21\ NASD responded that it does not 
agree that it has to meet that standard and, rather, that the standards 
it must satisfy in any proposed rule change are set forth in Sections 
15A \22\ and 19(b) of the Act.\23\ NASD believes it has made the 
requisite showing. NASD also responded that while it recognizes that 
the proposed rule change may impose additional costs and burdens on 
member firms, OATS reporting of OTC equity securities is important to 
NASD's surveillance systems and regulatory program. In recognition of 
the potential additional burden on members, however, as discussed in 
greater detail below, NASD proposed to extend the implementation period 
of the proposed rule change.
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    \21\ See SIA Letter, supra note 4, at 4.
    \22\ 15 U.S.C. 78o-3.
    \23\ 15 U.S.C. 78s(b).
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B. Timing of Proposed Rule Change

    One commenter stated that NASD should allow a minimum of six months 
for implementation of the changes necessary for OATS reporting of OTC 
equity securities.\24\ Another commenter stated that OATS for OTC 
equity securities should not be implemented until the industry can 
properly devote the personnel and technical resources necessary to 
achieve compliance.\25\ This commenter also stated that OTC markets are 
manual by nature, and expanding OATS reporting to OTC equity securities 
at this time could render obsolete all of the work that has been put 
into production for OATS Phase III compliance.\26\
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    \24\ See Ameritrade Letter, supra note 4, at 2.
    \25\ See SIA Letter, supra note 4, at 2.
    \26\ See SIA Letter, supra note 4, at 3.
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    NASD responded that while it does not agree that the proposed 
expansion of OATS reporting to OTC equity securities would have a 
negative impact on the work done relating to OATS Phase III, it does 
acknowledge the technological burdens that may be imposed on members as 
a result of this proposal, as well as the fact that members have a 
number of regulatory initiatives requiring technological and system 
changes. Accordingly, in Amendment No. 1, NASD proposed an 
implementation date of six months following publication of revised OATS 
Technical Specifications incorporating the proposed rule change, which 
will be published no later than sixty days following Commission 
approval of the proposed rule change.\27\ NASD believes that the 
extended implementation period will provide members sufficient time to 
make any adjustments necessary to implement OATS reporting for OTC 
equity securities, especially since, according to NASD, the technical 
specifications for OATS reporting of OTC equity securities would be 
substantially similar to the technical specifications that have been in 
place since July of 2006 for OATS Phase III.
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    \27\ The initial rule text as published in the notice proposed 
an implementation date of 120 days from publication of the OATS 
Reporting Technical Specifications.
---------------------------------------------------------------------------

    In addition, one commenter suggested that NASD implement certain 
operational and/or procedural regulations relating to the OTC 
marketplace, such as expansion of the trade-through protections and 
limit order display requirements, prior to implementation of OATS 
reporting requirements and that until such time, best execution 
standards for NMS stocks and OTC stocks will remain unequal.\28\ In 
response to this comment, NASD noted that it already has order handling 
and trading rules in effect that apply to the OTC marketplace, 
including, but not limited to, Rule 2320 (Best Execution and 
Interpositioning) and Rule 6541 (Limit Order Protection). NASD further 
stated that OATS reporting is necessary to enhance NASD's ability to 
review and examine for member compliance with these and other rules.
---------------------------------------------------------------------------

    \28\ See Ameritrade Letter, supra note 4, at 3.
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    Finally, NASD responded to a commenter that expressed general 
opposition to OATS and asserted that OATS is a mechanism for NASD to 
generate income through fines.\29\ The commenter further claimed that 
there has been no evidence that OATS has helped the investing public or 
assisted in any way in improving the capital markets.\30\ In addition, 
the commenter noted the burdens that OATS imposes on members, and in 
particular, small firms.\31\ NASD responded that it is aware of the 
costs and technological burdens associated with the proposed rule 
change, and in recognition proposed an extended implementation period 
in Amendment No. 1.
---------------------------------------------------------------------------

    \29\ See Bertematti Letter, supra note 4, at 1.
    \30\ Id.
    \31\ Id.
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IV. Discussion and Commission Findings

    The Commission has reviewed carefully the proposed rule change, the 
comment letters, and NASD's response to the comments. The Commission 
finds that the proposed rule change, as amended, is consistent with the 
requirements of the Act and the rules and regulations thereunder 
applicable to a national securities association,\32\ particularly 
Section 15A(b)(6) of the Act,\33\ which, among other things, requires 
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, to foster cooperation and 
coordination with persons engaged in regulating transactions in 
securities, 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.
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    \32\ In approving this proposed rule change, the Commission has 
considered the proposed rule's impact on efficiency, competition, 
and capital formation. See 15 U.S.C. 78c(f).
    \33\ 15 U.S.C. 78o-3(b)(6).
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    As discussed above, NASD currently requires member firms to record 
and report order information for transactions in Nasdaq Stock Market 
equity securities. NASD's OATS uses this

[[Page 61115]]

information for integration with trade and quotation information to 
provide NASD with an accurate time-sequenced record of orders and 
transactions to detect for possible violations of NASD rules and other 
securities laws and regulations. NASD recognizes that the trading in 
OTC equity securities is often more manual than Nasdaq Stock Market 
equity securities, and while this may result in additional burdens on 
member firms to capture this data electronically, NASD believes that 
reporting information related to OTC equity securities is critical to 
its surveillance program. The Commission believes that it is consistent 
with the Act for NASD to expand the OATS reporting requirements to 
include OTC equity securities to assist it in detecting possible fraud 
or manipulation in the trading of such securities in order to help 
protect investors.
    In addition, the Commission believes that the technical changes 
proposed by NASD, which NASD has noted are needed in light of Nasdaq's 
operation as a national securities exchange, are not only consistent 
with the Act, but also necessary to clarify NASD's rules.

V. Solicitation of Comments Concerning Amendment No. 1

    Interested persons are invited to submit written data, views, and 
arguments concerning Amendment No. 1, including whether Amendment No. 1 
to 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 rule-comments@sec.gov. Please include 
File Number SR-NASD-2005-101 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number SR-NASD-2005-101. 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 NASD. All comments received will be posted without change; 
the Commission does not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly. All submissions should refer to File Number SR-
NASD-2005-101 and should be submitted on or before November 7, 2006.

VI. Accelerated Approval of Amendment No. 1

    The Commission finds good cause for approving Amendment No. 1 to 
the proposed rule change prior to the thirtieth day after publication 
for comment in the Federal Register pursuant to Section 19(b)(2) of the 
Act.\34\ As discussed in greater detail above, in Amendment No. 1, NASD 
proposed revisions to clarify that member firms do not need to comply 
with the OATS reporting obligations with respect to an OTC equity 
security until a symbol has been assigned to that security. In 
addition, in response to a comment letter, it proposed to exclude DPPs 
from the definition of OTC equity security. Because two commenters 
raised issues specific to the timing of the proposed rule change, NASD 
also proposed an extended implementation period in Amendment No. 1. 
Finally, NASD proposed two technical changes in Amendment No. 1 that 
are necessary to reflect the commencement of Nasdaq as a national 
securities exchange.
    Since the changes proposed in Amendment No. 1 address commenter 
concerns and make changes that the Commission believes will help 
clarify the proposed rule change and should assist firms by providing 
greater guidance, as well as time for testing systems to help ensure 
compliance with the rule, and it does not raise any new issues of 
regulatory concern, the Commission finds good cause to accelerate 
approval of Amendment No. 1, consistent with Section 15A(b)(6) of the 
Act \35\ and Section 19(b) of the Act.\36\
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    \34\ 15 U.S.C. 78s(b)(2).
    \35\ 15 U.S.C. 78o-3(b)(6).
    \36\ 15 U.S.C. 78s(b).
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VII. Conclusion

    It is Therefore Ordered, pursuant to Section 19(b)(2) of the 
Act,\37\ that the proposed rule change (File No. SR-NASD-2005-101), as 
amended, be and hereby is, approved, and that Amendment No. 1 is 
approved on an accelerated basis.
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    \37\ 15 U.S.C. 78s(b)(2).
    \38\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\38\
Jill M. Peterson,
Assistant Secretary.
[FR Doc. E6-17167 Filed 10-16-06; 8:45 am]
BILLING CODE 8011-01-P